This article forms part of Blockport’s article series on cryptocurrencies and Blockchain technology. It sets out to explore the foundational technology and frameworks that make up Blockchain and that underlie cryptocurrencies, with a specific emphasis on what constitutes a ‘distributed ledger’.
Table of contents
- A Distributed Ledger
- Looking ahead
1. Introduction: why care about distributed ledgers?
The term ‘distributed ledger’ is one that is widely used within contemporary conversations around cryptocurrency and Blockchain. When you dive into a discussion with someone about Blockchain, people often talk about it as “simply a distributed ledger”, or as a “slow distributed database”.
When going into these conversations, wouldn’t it be better to truly understand what is meant by the term ‘distributed ledger’?
1.1 A glimpse into the past: ledgers and history
A good starting place for making sense of distributed ledgers is with history.
Following the Agricultural Revolution, thousands of years ago, societies began to form in entirely new ways. Populations grew, and people tended less toward small-scale, agrarian communities. Rather, they opted to congregate in larger villages, amongst more and more people.
With increased scale comes increased complexity.
As larger, more complex societies began to emerge following the agricultural revolution, it became necessary to utilise a different system for managing information: numbers.
In ancient times a forager, let’s call him Jack, was responsible for collecting fruits, berries and nuts for his family. By nature, this work did not require him to memorise the number of fruit on every tree within the forest. As a result, the human brain did not adapt to storing and processing numbers, at least not in an efficient or scalable way.
As societies grew, however, it became crucial for community leaders, village chiefs and kings to collect taxes from their citizens. In order to do this at scale, it was vital that authoritative bodies were able to adequately store and process numerical information.
1.2 The role of data
This led to the requirement of different forms of data: information about people's incomes, about debts between people, and about payments and barters made between citizens or villages.
For example, if a community of herders (Community A) had an excess of water following a harvest season, and a neighboring community (Community B) had a shortage of fresh water due to their poorly-positioned dam and a lack of rain, the two community chiefs could engage in a form of trade. In exchange for 5000 liters of fresh water from Community A, Community B would be in debt to community A, owing them 2000 liters the following year, as well as three tons of wheat, of which they have plenty.
At a large scale, debts such as this one made up thousands of data bits, all of which had to be stored and processed in an efficient way. Unfortunately, when required to memorise and calculate such mathematical data, the human brain generally falls short. Due to the brain’s inability to handle complexity at scale, human networks and civilisations remained simple and small, until a system came along that enabled the processing of numerical data at scale.
1.3 What mechanism was used to overcome the limitations of human brain power?
The short answer: Language.
Specifically, symbols and figures representing certain numbers, figures, products, and causal relationships. Effectively, this can be understood as the original ledger system: not lines and stick-figure drawings inside caves, but simple bookkeeping systems to mediate the numerical relationships between people, families, and communities.
Therefore, if grain was traded between Jack’s family and their neighbours in exchange for berries and nuts, this was recorded in the community’s ledger system: a pen-and-papyrus mechanism entrusted to the community leaders (the state), who maintained the records in order to maintain order and enforce debts.
Years later, this system led to the formation of ‘Guilds’ in Western Europe, which can be understood as the earliest versions of banks. Guilds were granted with the authority (and capital) to offer loans to farmers and builders, and therefore used basic accounting practices to manage various transactions from one ‘centralised’ point (the guild).
1.4 In light of all of this, what exactly is a (centralised) ledger then?
Simply put, a centralised or general ledger is a record-keeping mechanism for financial transactions within a particular organization, community, or ecosystem.
In other words, wherever financial values come into play, and transactions or value-exchanges occur, a ledger is required.
Fast forward a few hundred years, and in modern accounting terms, a general ledger is what contains all the transactions relating to a company’s assets, liabilities, equity, costs, and overall revenue. Traditionally, this was a large book, in which each account in the general ledger consists of one or more pages.
In even more recent , and more technologically advanced times, ledgers (not to be confused with ledger hardware wallets) are accounting systems managed by computer programmes. Today, the process of maintaining a ledger and keeping record of financial processes is made significantly faster and more convenient through Excel spreadsheets and algorithms that have proven to be far more reliable than the human brain when it comes to processing large amounts of complex financial data.
This seems simple enough, but why is everyone now talking about ‘distributed’ ledgers, and what is the difference?
2. A Distributed Ledger
2.1 Understanding a distributed ledger
For the sake of simplicity, a ‘distributed ledger’ can be understood as nothing more than a ledger that is shared.
In other words, it is still a system for managing transactions within a particular system. The difference, however, lies in the nature of how the ledger is maintained and managed.
Every node and many wallet applications too have their own copy of the ledger, and their own view of 'the truth'.
In the case of a distributed ledger, facilitated by computers and the internet, a database of transactions is shared across a large network of nodes (computers running the distributed ledger software) . This means that those with access to the asset database are all able to see a copy of a ledger, from their respective computer screens, in real time. Therefore, if a change is suggested by one party to the ledger, it is reflected amongst all parties within seconds or minutes.
For a suggested change to go through, different nodes (participants) will need to validate such a change, and it will only be certain after a certain number of “blocks” have been processed in the mining process, at least within the context of Bitcoin.
2.2 Who gets access to the distributed ledger?
That depends. Generally in the case of distributed ledgers, the people who have access to it are those who are supposed to have access to it.
In other words, anyone who forms part of the network of transactions and that therefore should be able to see the ledger, is able to see it, by for example logging into the ledger with an encrypted password.
In the case of cryptocurrencies and Blockchain (don’t worry about understanding these just yet), it is normal for a distributed ledger to exist publically, meaning anybody can find and see every transaction within a ledger database.
Remember: just because members of the public can see all transactions within a public ledger, this doesn’t mean that they can change these transactions or tamper with them in any way.
In order for a change to occur within the decentralised ledger, all parties within the network (all the people connected to each other via their computers) need to share a moment of mutual agreement known as consensus.
Quite simply, this means that they all need to agree on a change being made to the records in order for such a change to become finalised. Read more about the principle of consensus here.
2.3 What kind of assets are transacted within a distributed ledger?
With a decentralised ledger system, the type of managed asset transactions are less important than how the asset transactions occur (for example via Blockchain technology), and how the record-keeping is managed (in an open, transparent, and collective way).
This means that the type of asset within a decentralised ledger system can vary from financial (money), to legal, electronic, or even physical.
For example, a distributed ledger could be used to oversee a herd of cattle between a group of farm owners: Pete, John, and Dave. All three farmers live miles away from their farm, but they employ a farm manager, Steve, to oversee the buying and selling of cows. Each morning, Steve updates the decentralised ledger system that Pete, John, and Dave have access to, and all three are able to immediately see whether or not a cow was bought or sold, and for what price the transaction took place.
2.4 How do distributed ledgers work?
Without getting overly technical, it suffices to say that distributed ledgers function through nodes. Nodes are simply connection points within a network that are able to receive, store, send, or create data via distributed networks.
Simply put, a node is a computer that runs the software of the distributed ledger system.
Within the example of Pete, John, and Dave’s ledger for managing their cattle, each of their PCs would quite simply be a node, in that they have been programmed to recognize, process, and forward transmissions to each other.
Therefore, nodes are simply points within a network or system.
Another example is that of a conference call: Each party in the call is a node and the network connections between them ensures that they can talk to each other.
To understand how decentralised ledgers operate, it is therefore key to understand the concept of nodes. Nodes are the communication points that enable devices and users within a network to be connected to one another, and that facilitate peer-to-peer engagement between different parties within a network.
Within the context of Blockchain and cryptocurrencies, distributed ledgers also operate based on the principle of consensus, which you can read about here.
2.5 Where does Blockchain come into the picture?
Let’s clarify something important here first: every blockchain is a distributed ledger, but not every distributed ledger is a blockchain.
At its core, a blockchain is therefore a distributed ledger or database, used to maintain a growing list of records, called ‘blocks’.
Through the principle of cryptography, users are assigned unique private keys, which are used to “sign” a transaction. Thus, a private key is used as proof that you are an owner within the ledger system, and that you approve of a proposed change or transaction.
For the purpose of understanding a blockchain (distributed) ledger, this definition should suffice. Read more about how blockchain technology works in detail here.
3. Looking ahead
3.1 In summary: the characteristics of a distributed ledger
Let’s recap, shall we?
A decentralised ledger is quite simply a shared administration book, and it is not necessarily tied to ‘Blockchain’ technology or ‘cryptocurrencies’ (As mentioned, a blockchain is just one type of distributed ledger). Anything that could benefit from a validated history that requires consensus could use this technology. For example, car manufacturers are using it to track their cars through the automobile supply chain.
Furthermore, a distributed ledger is not managed by a central administrator or via a central point of data storage. Rather, it is overseen by various parties within a network who are granted access to the network through encryption mechanisms.
3.2 What are the advantages of a distributed ledger?
If traditional ledger systems have been around for thousands of years, what are the benefits of using distributed ledgers instead?
In exploring these advantages, let us stick to the example of a Blockchain as a form of distributed ledger (because this is probably what you are most interested in).
For starters, decentralisation
As you may have guessed by now, the first benefit of distributed ledgers related to how they allow for an exchange to occur between parties without there needing to be oversight or intervention from a third party. Based on a network protocol (the rules of the network), it’s transparency, and its resistance to being tampered with, users can be sure that transactions will be executed as they were programmed to be, without needing assistance or input from an external party along the way.
Whether this is a bank, broker, or other form of intermediary (middleman), this means that the factor of ‘counterparty risk’ is strongly reduced.
Furthermore, without needing to pay for third parties to mediate transactions or oversee asset exchanges, users are able to save money.
What are some other advantages?
A second advantage is that all users and network participants are entirely in control of all of their information and transactions. They are able to see all of the relevant data within the the network, whilst the data itself is consistent, complete and timely.
Thirdly, because the network is spread between nodes across different places and devices, a blockchain-based distributed ledger has no central point of failure. Not only does this reduce the risk of system crashes and malfunctions, but it also means that the network is better able to withstand malicious attacks or attempted hacks. This is because you would need to have control over at least 51% of the entire network to singularly change the consensus of the entire network.
Fourth, because distributed ledgers are able to manage live data between different places and contexts, they reduce the complications and various forms of clutter that come with managing multiple (centralised) ledgers.
3.3 In conclusion: what does this mean for the future of finance?
At Blockport, this is a question that we ask ourselves on an almost daily basis.
Although no one can say for certain what the role of distributed ledgers will be in defining the future of finance, it is certain that the potential of this technology is vast.
Not only are blockchain ledgers a giant leap forward in the direction of transparency, they are also pivotal in improving overall efficiency. In the banking sector, for example, interbank transactions can take days due to the slow processes of ‘clearing’ and ‘final settlement’.
With Blockchain technology which processes transactions regardless of whether it is 11 PM on a Friday evening or 8 AM on a sunday morning, transaction times can be reduced to seconds and minutes.
We are on a mission to bridge the gap that still exists between this technology and the traditional financial sector. With an emphasis on (digital) cryptocurrencies, we provide a platform for anybody to engage with and partake in the new, digital crypto-economy, which we believe is still in its infancy.
If you’re interested to learn more about cryptocurrencies: how they originated, the way they work, and their future potential, read our extended blog post about cryptocurrencies.
Thanks for reading!