Distributed ledgers: The key concept behind Bitcoin and the cryptocurrency hype

Bitcoin is the world’s first decentralised digital payments system. In the beginning of this decade, very few people knew about it and they were mostly hobbyists on Internet fora. Just before the end of 2017, the value of a bitcoin (BTC) exceeded $20,000. The sudden growth of Bitcoin drew everyone’s attention. Yet, the recent precipitous drop of BTC has rekindled doubts as to the true value of Bitcoin and had famous economists, such as Nouriel Roubini, calling it a “gigantic speculative bubble.”

The tremendous publicity that was given to anything related to Bitcoin led to numerous discussions, articles, conferences, and so on, about the underlying infrastructure and protocols that make its existence possible. The protocol that was novel in Bitcoin and deserves special attention is blockchain.

Blockchain is a protocol that creates a distributed ledger of transactions – by “distributed ledger” we mean a sequence of data organised in blocks, where everyone can read a transaction, everyone can write a transaction, and no one can tamper with any transaction. It is important to note that there is not a single blockchain protocol. There is a whole family of protocols. Nevertheless, all known protocols use two of the most mature cryptographic technologies, namely, digital signatures and random hashing.

Most of the protocols fall into a category that we can call “descendants of Bitcoin”. These protocols rely on eventual consensus via “proof-of-work” related to solving a riddle that the system generates. Interestingly, the main assumption that these types of protocols make is that the majority of participants are honest.

There are certain fundamental limitations with the descendants of Bitcoin, such as a high computational cost to operate, concentration of power that defeats the original intent of “democratising” the creation (and control) of currency, and ambiguity in the generation of new bitcoins. The high computational cost is related to the proof-of-work approach and the fact that the block generation requires an enormous amount of computation. With just a few hundred thousand public keys in the Bitcoin platform, the top 500 most powerful supercomputers can only muster a mere 12.8 per cent of the total computational power required from the Bitcoin participants. This amount of computation will only increase as new users join the system.

Promise and Potential

The high computational cost that is required for the generation of new blocks leads to another adverse effect: the concentration of power. Exogenous concentration of power, aside from defeating the original intent of democratising the control and flow of money, it also introduces vulnerability in the system since known locations and low margins for mining make their owners an easier target for corruption. Lastly, the relatively long time to reach consensus across the network means that the blockchain that you have is not necessarily unique, when we consider the newest blocks in the chain. The existence of “forks” in the chain imply that it is prudent not to rely right away on the payments contained in the last block of the chain. Instead, one should wait and see whether the block succeeds to propagate deep in the chain and become sufficiently reliable.

The above shortcomings of the Bitcoin-like implementations should not discourage us from the main premise and potential of the key concept of distributed ledgers. In fact, a new family of blockchain algorithms appeared recently and holds the promise of materialising an efficient and effective distributed ledger. This category of blockchain protocols goes by the name of Algorand. These protocols rely on a message-passing version of the Byzantine Agreement and cryptographic sortition.

Like the Bitcoin category, they assume that the majority of participants are honest. Unlike Bitcoin, there are no forks and no proof-of-work stages. These differences provide guarantees of agreement and consistency amongst participants and substantially reduce the amount of work and time required to add a new block on the chain. Algorand protocols also offer true decentralisation, finality of transactions, and scalability.

In theory, a distributed ledger of transactions can enable the implementation of an indisputable global registry of ownership. Here is an analogy that I find quite interesting: The Internet can be viewed as the infrastructure for the exchange of information. A distributed ledger platform can be viewed as the infrastructure for the exchange of assets. Of course, there is a fundamental difference between the exchange of information and the exchange of assets. When you download a document from my website, you effectively obtain a copy of the document that is stored on my server. If I wanted to pay you $10, at the end of our exchange, there should be ten dollars less in my “pocket” and ten dollars more in yours.

Myriad of Potential Applications

The ability to generate a decentralised network of trust where assets can be exchanged is a key concept behind cryptocurrencies and the true value behind the hype. The current implementations of blockchain have several drawbacks, which several researchers (e.g. Silvio Micali and his collaborators) have described quite clearly, as noted above. Nevertheless, everyone agrees that a properly implemented distributed ledger can be an enormously valuable infrastructure.

Payments and cryptocurrencies are the obvious and archetypal use of distributed ledgers, however, there are myriad of potential applications. Exchanging stocks, bonds, frequent flyer points, stuff you buy on Amazon (or anywhere else for that matter), intellectual property rights, work contracts, deeds, coupons, music songs, other digital art, carbon credits, personal data, and so on, all that can be achieved on a platform that provides a distributed ledger. From a social and political perspective, the most interesting application is the support that it can provide for the modernisation of our democracies.

Innovators are exploring ways to use blockchain to disrupt and transform traditional business models across global supply chains, financial services, healthcare, government and many other industries. Many industry leaders have already achieved significant business benefits, including greater transparency, enhanced security, improved traceability, increased efficiency and speed of transactions, and reduced costs. We are witnessing just the beginning of the era of distributed ledger infrastructures so watch this one carefully and look behind the hype. There is tremendous value for those who will succeed in delivering a robust, cost-efficient, infrastructure for building distributed ledgers.


A version of this post originally appeared on IT Portal.


Author: Babis Marmanis

Babis Marmanis, Ph.D., is responsible for defining the technology vision of all software systems at CCC. He leads a global team of professionals with a passion for continuous technological innovation and the delivery of high-quality software systems. Babis has written the books Spend Analysis and Algorithms of the Intelligent Web, and contributes to journals, conferences and technical magazines.
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