What is a Distributed Ledger in a Nutshell?
Distributed ledger technology, also known as DLT, represents a system that records digital asset transactions. Its main feature is that transaction details are recorded on multiple databases, rather than a single one.
DLT is also decentralized, meaning that it does not employ a central data storage unit, and individual administrative functionalities do not exist. As part of the distributed ledger definition, the tech is often confused to blockchain technology, so it’s important to keep in mind that blockchain is an implementation of DLT, but not all distributed ledgers are blockchains.
People have been recording transactions and various types of data for thousands of years in physical ledgers. At the end of the 20th century, the first digital ledgers appeared. They were similar to paper-based ledgers in terms of functionality, but allowed access from anywhere as long as an internet connection was present.
Ledgers became centralised and more functional a couple of years later, when banks began using them to validate and verify recorded transactions. These ledgers were centralised, which means that banks were able to modify the ledger however they wished, and control wasn’t divided between more entities.
So, what is a blockchain ledger?
Around a decade ago, distributed ledgers sprung to existence. Bitcoin, which was created in 2009, represents the world’s first popular implementation of the technology. Today’s DLT employs cryptography, computes power provided by nodes, and uses numerous algorithms, making transaction data storing easier, faster and more efficient. The most common distributed ledger implementation today is found in digital currency blockchains. These distributed ledgers verify and record transactions on blocks, thus keeping the blockchain and financial system online and safe 24/7.
So, what is a Bitcoin ledger? As a P2P payment system, people can easily, securely, cheaply, and quickly send funds to one another, in what many describe as a powerful alternative to the world’s financial system. For those who do not know, the bitcoin blockchain can be compared to a crypto ledger, since it employs cryptography to handle, and verify transactions.
How DLT Works
Our ‘distributed ledger technology for dummies’ guide wouldn’t be complete without explaining how it works. A distributed ledger employs network nodes, which are internet-connected devices that are linked with one another. They are individual parts of larger data and network structures, such as shared online databases. Nodes offer the distributed or decentralized status associated with distributed ledgers, which means that databases no longer have to rely on third parties to carry out transactions.
When a transaction is made, a node will pick it up and verify whether it follows all network rules. If it does, many of the other nodes on the network will perform the same check, and then create an identical copy of the data, which is then stored on all nodes. This means that if one computer shuts down, the database remains online. Blockchain nodes use a consensus mechanism to determine the authenticity of the information transferred.
Once the data is accepted and stored on the distributed ledger’s network nodes, several things happen. With this in mind, data transactions cannot be deleted or altered unless all participants on the network agree to the change. This increases trust in data storage, as all users can rest assured that the data they’re accessing is authentic.
DLTs can be modified to meet whatever needs their creator has, which makes them highly flexible and helps grant them a large number of potential use cases.
Distributed Ledgers vs. Blockchain Technology
Earlier, we mentioned that blockchains and distributed ledgers are similar in terms of their functionalities, but there are differences that you should note.
Distributed ledgers are databases that are stored on several computers, or network nodes. Each node is responsible for replicating and saving a copy of the ledger, so it doesn’t require a central administration unit. Distributed ledgers can store any type of data in a decentralized manner, while offering insurance that all stored data is identical and authentic.
This sounds similar to blockchain, right? Well, the main difference is that all blockchains record and organize transactions in blocks, which are then linked to previous blocks, secured via cryptography, and stored on the chain. This also helps the network attain valid, distributed consensus on all transaction data. A DLT system can also use blocks, but this often isn’t the case. Additionally, when depicting decentralized vs. distributed, you should note that all decentralized systems are also distributed.
Distributed ledgers wouldn’t be relevant without a consensus protocol. This mechanism sets the rules that nodes follow when validating transactions. Without a verifiable consensus system, a rogue node could choose to reject valid transactions, or approve transactions that do not respect the general system rules. So, consensus can be described as the judiciary system of distributed ledgers.
At this moment in time, there are numerous consensus mechanisms available on the market. For instance, the Bitcoin blockchain employs proof-of-work, which is highly functional but unable to scale to fit the demands of a bigger network. It’s important to point out that the main purpose of all consensus mechanisms is the same, but the differences lay in the methodology used. So, in most cases, consensus needs to follow four rules:
- Once a transaction is made, each node replicates the transactions it needs to record;
- The transaction data is shared between the network nodes, since all nodes need to store the entire database of transactions;
- Consensus kicks in, and follows certain protocols and algorithms to determine whether the transactions are valid;
- If the result is positive, all nodes update the transaction data to reflect the result of the consensus mechanism, and the transaction can be considered complete.
This is how consensus works in broad terms. However, consensus can only be achieved via the different protocols and algorithms used by the system. Based on this, consensus protocols can be described as a set of rules, responsible for governing how a system functions.
To put things into perspective, protocols decide how parts interact with each other, what conditions need to be respected by valid transactions, and the basic functioning of network participants. Protocols do not provide the rules that the system follows to achieve a set result, as they lack objectives, and aren’t responsible for creating an output.
This part is handled by consensus algorithms, which establish and directly relate to the mathematical rules that all nodes must follow for network-wide consensus to be achieved. Algorithms are therefore instructions for producing a result. The result depends directly on the use case of the distributed ledger system.
Benefits of the Technology
Distributed ledger technology has a lot of benefits, and is certainly a system that be used often in the future. We won’t dwell on the benefits provided by digital ledgers alone, but only on those offered by distributed ledgers.
- Creating a trustless system
With DLT systems, nobody needs to trust anyone. All parties can rest assured that the transaction will go through, and that all received data will be authentic. As the system takes care of this by itself, those involved will no longer have to spend time and money verifying transactions, or looking for what went wrong.
- Lack of individual control
With DLT systems, groups hold the ultimate power. Because of this, an ill-intended party cannot compromise a transaction by itself. It would need the support of the majority of network nodes, in what is often referred to as a 51% attack – when a party takes control of the majority of the nodes and takes control of the network. So far, this hasn’t happened, as controlling all nodes is bound to be expensive and difficult for an attacker.
- Online 24/7
DLT systems are comprised of numerous nodes that are responsible for keeping the network online. Going offline would require all nodes to crash or shut down, but due to their large number, this is highly improbable.
- Cheaper and faster
Transactions processed via distributed ledgers are considerably cheaper and faster. This is because a node doesn’t do all the work alone; the workload is divided among the free nodes. This provides the network with increased speeds, and helps it run cheaper.
Use Case Scenarios and the Future
In their book, Dan and Alex Tapscott stated: “Blockchain could be the great economic leveller – a tool to strip out the middlemen from our economy and reward the makers and doers who truly create value.” This statement is fully valid. Distributed ledgers can disrupt numerous industries by creating transparent systems that are cheaper, faster, and also more secure and capable. Here are a couple of use cases, showing DLT’s true potential:
- Supply chain management
The supply chain industry is responsible for tracking the movement of goods, including their origin, quantity, and in some cases, freshness. With a DLT system, stakeholders can create a new level of transparency that allows them to easily access all data on shipments. It also simplifies a variety of processes, including production assurance, ownership transfer, and payments.
DLT is especially relevant in the food supply chain. When an irregularity is found, the DLT system can easily point to its origin, leading to a quicker detection of the issue, what causes it, and all affected products.
- Smart contracts
DLT supports smart contracts, which are program transactions that self-execute when a set of conditions is met. Enterprises can save time and money, as a multitude of processes and agreements can be automated.
- Energy supply
Distributed ledger technology can help energy trading markets, which allow energy consumers to purchase energy from their favourite providers for a good price, without needing to change contracts. Blockchain implementation on the energy market will also encourage the use of renewable energy sources, and allow businesses to achieve a higher level of eco-friendly regulatory compliance.
- A worldwide P2P financial system
Digital currencies represent the best and most popular implementation of DLT so far. With blockchain-based currencies, funds can be sent anywhere in the world securely, in only a few seconds, for a minimal fee.
The potential of DLT is virtually unlimited. Some other use cases include tax collection, property transfer, online signatures, reduced bureaucracy, smarter voting procedures, social benefits distribution, intellectual property protection, control of personal information, access of medical records, and ownership records for art pieces, and any other objects.
The difference between distributed ledger vs blockchain is that DLT still in its nascent stage, which is why we don’t yet deal with it on a daily basis. However, research on potential uses, testing and innovation will continue. So we can be sure that DLTs will be mass-adopted in the future.
One challenge worth pointing out is compliance with government regulations. As DLTs become mainstream, governments throughout the world will need to pass new laws to regulate the industry. This is especially relevant for smart contracts, as several use case scenarios require legal backing to be possible. Just remember Bitcoin – what started out as a cryptocurrency shared among few amateur cryptographers now grew up to be a real industry. Today, governments are pressed to put it in legal frames as there are growing(and taxable) Bitcoing gambling and Bitcoin financial exchange markets.
Additionally, replacing the traditional systems won’t be easy, as DLT needs to be customised for each implementation. It will likely take several years before standardised and customisable blockchains which ensure interoperability will be released to the market. However, are getting pretty close. Projects such as the Lightning Network or the Hyperledger project, created by distributed ledger technology companies, are already revolutionising the current blockchain systems, but there’s a lot more left to discover.
Based on everything that has been outlined so far, distributed ledgers are bound to be around for many years to come. As the technology continues to grow, it will disrupt numerous aspects of our daily lives. As such, in the future, digitised processes will become cheaper, faster, more secure and streamlined for a rapidly-changing world.