Distributed Ledger Technologies (part I)
Distributed Ledger Technologies
The Blockchain and the Bitcoin have already been live for a decade.
We will review in this set of articles the caracteristics of the Blockchain, the changes made to the Blockchain, the alternative distributed ledgers to the Blockchain, the difficulties to run financial services on a distributed ledger without a legal tender. This first part explains the main caracteristics of the Blockchain.
Part I: Caracteristics of the Blockchain
The rise of the Bitcoin is associated to the Blockchain technology that allows to create trust between untrusted parties.
The initial Blockchain is organized with anonymity of the holders of Bitcoins who are represented in the registry by a public reference number, with transparence and traceability on all transactions that are freely accessible and finally with quasi-immutability of the registry of transactions.
These characteristics can almost be taken for granted, even if there are limitations.
Anonymity has been broken in cases where the Police has seized access keys to the Blockchain allowing them to trace flows and identify key accounts involved in criminal activities. The terminology has now shifted to pseudonymity, as the Bitcoin account holder is represented by his public key which is only the equivalent of a pseudonym.
Traceability is a given as all transactions from accounts to accounts are publicly available, even though some research is needed to precisely follow the flows. There is no hurdle too create a new account and some players have clearly demonstrated the capability to break down large amounts across a multitude of accounts to only move small amounts about.
Immutability could a real game changer, as no book would not be cooked anymore. On the Blockchain, the immutability is guaranteed by the mechanism called Proof of Work (PoW). Oversimplifying the mechanism, the amount of computing power required to book a transaction is increasing transaction after transaction. To rewrite the ledger of transactions, a hacker would need to be able to control more than half of the computing power that is required at a given time. Therefore, such an attack is called a majority attack.
Such majority attacks have already happened in 2014 on the Bitcoin, and more recently on 18 May 2018 where the Bitcoin Cash, a cryptocurrency derived from Bitcoin, a fork in technical jargon, suffered a transaction roll back authorizing a double spend. A cryptocurrency amount is used to purchase a good and, with sufficient computing power, the transaction, and many others, is erased so the cryptocurrency amount is made available for a second purchase.
Eric Buddish1 explains that the transaction cost of Blockchain must be high to prevent a majority attack. And he demonstrates that high means above 2% or even much more for small value transactions. Today the cost is hidden in the incentive fees distributed by the Blockchain itself that still mints new Bitcoins.
Buddish concludes that Bitcoin cannot be an asset, that is a mean to store value, because of this “high” cost. This assumption can be challenged, as most assets, if not all, require safekeeping or maintenance. As illustrations, storing gold requires a physical safe and security arrangement, and periodical upgrades on the safe and on the security organization; real estate requires maintenance and possibly improvement to keep its value.
Immutability of the Blockchain would generate a sequential order that is needed in many types of applications linked to precedence or traceability.
Just like the Internet, the Blockchain is a system with a distributed architecture. On the Internet, it is only the transport which is distributed over the network. On the Internet, a provider offers its services through a server at an Internet address that can be identified through the ICANN registry2 or through local registries.
By contrast, a changing set of servers that are called nodes are running the Blockchain. It is inspired from the Peer-to-Peer decentralised organisation that Napster and then Gnutella or BitTorrent popularized around 2000 to share files. Anyone anywhere at any time can become a node, part of this organization provided he has some storage capacity and processing capability. No one is directly responsible or accountable. This makes it difficult to comprehend, to govern or to rule.
Responsibility over the Blockchain cannot be attributed to a single person or an organisation. Since the Blockchain was launched, it is a loose set of unrelated entities that keeps it running.
In distributed system, governance is a challenge. To modify the Blockchain, a majority of nodes must be persuaded to shift to the new version. It is possible to gauge their appetence in advance by making a poll. In the early days, when the Bitcoin was very confidential, some amendments have been made with the blessing of the people running nodes, the miners, who all switched to the new versions. And the Blockchain parameters have evolved. Today, modifying the Blockchain proves more difficult.
If a set of people or organizations is capable to set up a governance between themselves, a Blockchain is not be needed. Any proven database with appropriate transaction processing is sufficient. The Blockchain may be a solution when the set is changing or when the governance between the parties cannot established durably.
The persistence of the governance is transfered to a system, the Blockhain which is difficult to make evolve.
Since no one is clearly responsible of the Blockchain which spreads across borders, laws and regulations whichare made by States to establish standards, maintain order, resolve disputes or protect liberties and rights3, are difficult to apply. Regulators might be tempted to regulate either the user who makes transactions on the Blockchain, the issuer which is the Blockchain itself in the context of Bitcoin, or possibly the miner, who provides support to the Blockchain system, or finally the changer who convert a legal tender against Bitcoin.
Some States, typically Islamic countries, have just forbidden the use of the Bitcoin for users. Some State, like China, have chased miners. Most are just ignoring it as it is not a legal tender, and finally most are trying to regulate the Bitcoin or its changers, and even taxed them.
1. The Economic Limits of Bitcoin and the Blockchain by Eric Buddish from University of Chicago Booth
3. Business Law Basicsby Berger Harris, LLP and Samuel D. Brickley 2nd