An introduction to Blockchain

Blockchain technology is typically associated with cryptocurrencies but it has far more to offer. This article explores what a blockchain is and looks at potential uses.

16 November 2017

Blockchain can be dated back to 1991. However, it was not until 2008 that “Satoshi Nakamoto” used distributed blockchain in its modern incarnation. Distributed blockchain was used as a key part of the bitcoin to act as the public ledger for all transactions using Bitcoin. It is this ability to act as a ledger that makes a blockchain so versatile.

What is a blockchain?

A blockchain facilitates secure online transactions by acting as a digitised, decentralised public ledger.

The block is the 'current' part of the chain. Once the block is completed, it goes into the chain, which acts as a permanent database of all of the previous blocks. A new block is then generated for new information to be stored on.

The blocks are all connected chronologically – by containing a 'hash' of the previous block – meaning that every transaction or piece of information on the chain can be traced back to the original block.

The blockchain is stored across many computers  and each computer (or node) on the network has a copy of the blockchain.

The decentralised nature of the blockchain means that there is no centralised point for hackers or similar nefarious figures to concentrate on. If one node is compromised then the other nodes will still hold the original version of the chain.

Similarly, there is no one point of failure. Each node is trusted equally and there isn't one official copy. The record cannot be changed retroactively or deleted without all of the nodes agreeing to the changes and without changing later blocks in the chain. This provides certainty to those who use the chain and means that it can be audited and verified inexpensively.

It is also a secure technology as data stored on a block can be read back, if desired. Each block contains the fact that the transaction happened and the 'hash' of the transaction.

What is a ‘hash’?

The 'hash' is an encryption of the details of the transaction. The process is carried out by different nodes on the network and is called 'hashing'. If all of the nodes agree on the hash then the block's digital signature is set and cannot be converted back to its previous data or read by anyone. The hash also prevents changes to the data. If the original data is later altered then a new hash is created, which will alert the network to the alteration.

Why is blockchain often associated with bitcoin?

Blockchain is a key part of Bitcoin. The two are often confused as Bitcoin is what brought blockchain technology to the forefront of people's minds. Bitcoin is a type of blockchain technology, but not the only one.

Users of Bitcoin, as well as most other cryptocurrencies like Ether, use a blockchain to record that a transaction has happened. The new block is then added onto the chain creating a chronological ledger of all of the transactions for that coin without needing a centralised book-keeper like a central bank.

New coins are mined by computers solving mathematical puzzles, which results in the hash. Cryptocurrencies are generally not related to any centralised bank (though this is changing) meaning that there are no government controls over them. This means that international payments can be made quickly and without fees, which helps businesses and consumers alike.

How is it different to distributed ledger technology or ‘DLT'?

You may have heard people referring to distributed ledger technology (DLT) in the context of blockchain technology or seen them used interchangeably. In fact, a blockchain is a type of DLT.

DLTs are databases where control over the data’s evolution is shared between entities. The data is shared across multiple computers and there is a consensus about what the data looks like across each point of access. Changes are then replicated as each node is synchronised with each other. Blockchain technology does this by using a chain of blocks linked together which need to be validated by all of the nodes. This is only one way, however.

For example, the Tangle Network uses a directed acyclic graph based network instead of a blockchain structure. Created by IOTA, the Tangle Network is an open-source distributed ledger/cryptocurrency focused on providing secure communication and payments between machines on the internet of things.

The Tangle Network does not have miners and allows for a fee-free network and infinite scalability. A directed acyclic graph based network is one where there are many vertices and edges with each edge directed from one vertex to another so that no consistently-directed sequence of edges will lead back to the starting vertex.

Therefore, blockchain technology is just one way of sharing data across a ledger with many points of control.

What are the potential uses of blockchain technology?

The blockchain's distributed database system can simplify operations for all parties and has implications for outside of the financial sphere.

Data stored on a blockchain is more transparent and can be easily authenticated and authorised. This lowers the cost of trust and authenticating transactions in the digital sphere. 

Blockchain technology has clear benefits when complying with 'know your client' and anti-money laundering regulations. A business can be assured that data it receives has not been tampered with and can trace transactions with money back to ensure that it has not been laundered. The transparency of blockchain technology is also welcomed by regulators and could help to tackle tax fraud.

Blockchain also means that there is no need to use a trusted third party (such as a bank) when checking the authenticity of a previous transaction. This could mean that simple and complex exchanges could be managed without a third party being involved.

For example, Everledger is a company using blockchain technology to develop warranties to ensure that their rough-cut diamonds are not being used to fund conflicts between militias as the previous ownership of any diamond is available and cannot be tampered with.

Similarly, Guardtime, an Estonian firm, is helping its government to manage and protect data on its citizens using blockchain. The benefits of this to an organisation such as the NHS or the Land Registry are clear.

Blockchain technology can work with other technologies to change the business landscape. For example, a blockchain can be used with smart contracts, so that partial payments are made when certain conditions are met without the involvement of a human or only requiring partial human involvement.

For banks, blockchain technology is a challenge and an opportunity. Although blockchain removes a banks position as a middle-man brokering transactions and remove its control over data, using a blockchain will allow banks to remove their own layers of bureaucracy, reduce errors, speed up transactions and streamline accounting practices which will reduce costs. Cross-border trades will be easier to manage as the involvement of people can be minimised.

What are the hurdles and downsides?

Although revolutionary and exciting, blockchain technology will not be adopted tomorrow. Like all new technology, it has teething problems.

There are implementation challenges. For example, each block on the chain needs to be stored somewhere and there is risk that the technology will become unwieldy and difficult to store as it takes ever increasing amounts of memory. The interface between blockchain and other platforms will also need to be seamless in order to take full advantage of efficiency gains.

Despite its secure nature, there are some security concerns from governments and central banks. The Bank of England, the Federal Reserve and the Bank of Canada are conducting investigations. They are concerned with systematic attacks and making sure that there is some control over their currencies. If the creation tools of a blockchain are compromised then the attackers effectively control 100% of the network and can alter transactions. Risks will need to be weighed against the advantages of blockchain technology.

Institutions and other regulatory bodies are concerned with the regulation of a blockchain. Who is responsible for it? Who maintains it? Who allows new users in? This will have to be carefully thought through to ensure that everybody is allowed to take advantage of the technology and that it follows the same rules as everything else without losing its advantages.

Perhaps the biggest hurdle is the huge amount of computing energy that is used to process the transactions, which  makes some blockchains like the Bitcoin blockchain environmentally unsustainable.

However, there are plenty of people working on making blockchain technology commercially viable for a range of uses.

How can Burges Salmon help?

We have an established fintech practice. Our team offers legal and commercial advice, drawing on our knowledge of the fintech sector to help you. If you have any questions on Bitcoin, please contact our fintech team or your usual Burges Salmon lawyer.

This article was written by Guinevere Wentworth.

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