‘Blockchain’ has become one of the most hyped technologies since the Internet. It is also one of the most poorly understood. A recent HSBC global survey found that 80% of those who have heard of ‘blockchain’ said they don’t understand it.3 This state of affairs exists despite the fact that significant effort has been made to explain blockchain technology to non-technical audiences through the mainstream media, industry reports, academic and online courses, and other channels. This section of the report provides an introduction to blockchain and distributed ledger technology (DLT), addressing questions such as: Why use a blockchain?, What are the technology’s core components?, and What are its limitations? We also cover the reasoning behind the preference for ‘permissioned’ blockchains, which are favoured by more established institutions such as banks over ‘open, permissionless’ blockchains used by cryptocurrencies such as bitcoin. We also clarify blockchain jargon and debunk some popular blockchain myths.
In simple terms, a blockchain is a type of database that is replicated over a peer-topeer (P2P) network. However, this definition could also apply to other types of distributed databases that have no central database manager, such as ones sold by software vendors like Oracle. So, what makes a blockchain special?
The principal way in which a blockchain is different from other distributed databases is that a blockchain is designed to achieve consistent and reliable agreement over a record of events (e.g., “who owns what”) between independent participants who may have different motivations and objectives.4 Put in a slightly different way, participants in a blockchain network reach consensus about changes to the state of the shared database (i.e., transactions amongst participants5 ) without needing to trust the integrity of any of the network participants or administrators. The agreement between blockchain network participants over the state of the database is achieved through a consensus mechanism, which ensures that each participant’s view of the shared database matches the view of all other participants. The combination of the consensus mechanism with a specific data structure allows blockchains to solve the so-called ‘double spending’ problem – the same digital file being ‘copy-and-pasted’ and transferred multiple times – without requiring a centralised ledger or party that prevents users from duplicating/spending the same digital file twice. Blockchains can thus facilitate the transfer of assets and other data without needing a trusted central authority.
have different motivations and objectives.4 Put in a slightly different way, participants in a blockchain network reach consensus about changes to the state of the shared database (i.e., transactions amongst participants5 ) without needing to trust the integrity of any of the network participants or administrators. The agreement between blockchain network participants over the state of the database is achieved through a consensus mechanism, which ensures that each participant’s view of the shared database matches the view of all other participants. The combination of the consensus mechanism with a specific data structure allows blockchains to solve the so-called ‘double spending’ problem – the same digital file being ‘copy-and-pasted’ and transferred multiple times – without requiring a centralised ledger or party that prevents users from duplicating/spending the same digital file twice. Blockchains can thus facilitate the transfer of assets and other data without needing a trusted central authority.
A few years after Bitcoin was launched, attempts were made to go beyond simple P2P value transfers and offer functionality not available in Bitcoin. For example, in 2012, the concept of ‘coloured coins’ emerged, which enabled the Bitcoin blockchain to be used to record and transfer ‘non-native’ assets and data. In 2013, public awareness of cryptocurrencies dramatically increased, and a number of more established organisations began to inspect Bitcoin and related technologies to see how they could be exploited. The breadth of potential use cases facilitated by the technology was noted, but many concluded that using a public blockchain such as Bitcoin was ill-suited for regulated corporations for a variety of reasons (see ‘Enterprise requirements’ side box to get an overview). For instance, financial institutions seemed uncomfortable using a public infrastructure run by anonymous miners and powered by an unregulated, volatile currency. Legal and reputational issues also gave many organisations pause. However, many organisations recognised that the blockchain - the particular data structure underlying Bitcoin and other cryptocurrencies forming an auditable log of transaction records - was a key innovation.
Work began on how best to adapt blockchain technology for the needs of large and regulated organisations. For example, it was determined that substituting Bitcoin’s anonymous miners with known participants would allow institutions to remove the native currency and replace the energy-intensive, computationally difficult proof-of-work (PoW) puzzle needed for reaching consensus in Bitcoin with a less resource-intensive and more efficient consensus algorithm.
In order to distinguish these new permissioned blockchains from the open, public blockchains that power cryptocurrency systems, the industry started using terms like ‘private’, ‘permissioned’ or ‘closed’ to refer to blockchains where access is restricted to a specific set of vetted participants. In practice, these terms are often used interchangeably. However, blockchains can be further segmented by distinguishing between different types of permission models. The permission model refers to the different types of permissions that are granted to participants of a blockchain network. There are three major types of permission that can be set when configuring a blockchain network: Read (who can access the ledger and see transactions), Write (who can generate transactions and send them to the network), and ‘Commit’ (who can update the state of the ledger).
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