What is blockchain technology?

Blockchain technology has become something of a buzz phrase. But what exactly is it and what can it be used for? Emily Spaven takes a look.

The smell of burning rubber sears through your nose and hits the back of your throat. The sound of screeching tires and revving engines reverberates in your ears – you’re watching, smelling and hearing a bank robbery getaway unfold. Along with 200 other people on the high street – people you don’t know – you see the vehicles turn left at the end of the road. Imagine you then all had to instantly, without discussion, write down what happened.

That’s a very simplistic interpretation of how a blockchain works – multiple, independent parties prove something happened by recording the exact same result. In reality, it’s not people writing results on paper, it’s geographically isolated computing nodes making notes on a distributed ledger, which can’t be tampered with.

This method of recording events is revolutionary in comparison to how operations currently occur across all industries and sectors in the modern world. It removes the need to trust any one person or institution and there is no central point of failure.

Currency

The existing application of blockchain technology that people are most aware of is digital currency and the transfer of funds. More specifically, bitcoin. Bitcoin’s blockchain is a cryptographically secure public register of transactions, which is operated by a decentralised peer-to-peer network.

The open source code for bitcoin was released in January 2009 and its popularity as a method of currency transfer and store of value has increased steadily since then. Around 170,000 transactions occur on the network each day and, at the time of writing, the price of bitcoin is hovering around $417, bringing the currency’s market cap to $6.4bn.

Part of the reason bitcoin has gained the degree of popularity it has to date is down to the fact people are so dissatisfied with the world’s existing financial structure. The crash of 2008 and many scandals since have left the public’s faith in banks in tatters. Droves of people sought an alternative – a system that gave them control of their own finances and didn’t require them to put their faith in one particular institution.

One of bitcoin’s key features is the (semi) anonymity of transactions. Depending on who you speak to, this is either a good or a bad thing. Die hard crypto-anarchists and libertarians view the ability to buy and sell what you want with who you want almost as a human right. The FBI and GCHQ, however, likely just view it as a facilitator of crime.

The cryptocurrency has certainly had a rough ride and is frequently making the headlines for all the wrong reasons. The degree of anonymity provided by the payment network means the cryptocurrency is frequently used on online dark marketplaces in the purchase of illegal items such as drugs and firearms. Bitcoin has also received flack for reportedly being used in the funding of terrorist groups and in money laundering.

Aside for its use in illegal circles, bitcoin and its blockchain prove useful tools in a number of circumstances, such as remittance and merchant payment acceptance. Foreign workers sending money home can use bitcoin to circumvent the expensive traditional remittance platforms such as Western Union, and merchants can avoid the fees charged by card payment processors by accepting funds in bitcoin.

The way bitcoin transactions work has also highlighted a greater efficiency that could be adopted by the financial services industry.

Financial sector

When bitcoin is sent from one bitcoin wallet to another, the transaction reaches finality within 10 minutes (when it is confirmed in a block on the blockchain) – there is no separate clearing and settlement process. In comparison, typical value transfers in the financial sector today, be it an interbank transfer, a sale/purchase of shares, a bond issuance, a derivative or a commodities trade; the clearing and settlement process is separate from the trade itself.

“Much of this is due to historical reasons: think about the transfer of paper share certificates, which needed to be physically moved – while the buyer and seller could agree on the price for the shares, the process to physically exchange the shares and the monies would take time,” explained Jeremy Millar, founder and partner at Ledger Partners, which works with tech companies, investors and financial institutions to drive progress in blockchain technology.

Other technologies exist that would enable ‘real-time’ settlement, but the properties of the blockchain, such as its cryptographic integrity and secure distributed ledger, make it ideally suited to develop next generation infrastructure for capital markets.

“Of course, for the next few years, there will be issues of maturity and supporting capabilities. Blockchain today lacks the overall set of supporting infrastructure available for cloud or traditional database systems – there are no systems management tools, reporting tools or legacy system integration in place,” added Millar.

In terms of adoption by financial institutions, blockchain is currently at a proof of concept phase, with only a few firms pushing ahead with anything that is close to being production-ready.

“But with around $1bn of total equity investment in bitcoin and blockchain companies and projects and the huge level of talent in the space, I think we are seeing the development of the next multi-billion dollar enterprise software market,” Millar claimed.

Simon Taylor, VP of entrepreneurial partnerships at Barclays, is the bank’s primary expert on blockchain and distributed ledger technology. Its accelerator programme has welcomed a number of blockchain companies, such as Atlas, Chainalysis, Everledger, Safello and Wave. It has also run over 40 experiments internally, and signed contracts with both Chainalysis and Wave to pilot their technology.

“We’ve also been highly active participants externally, meeting with over 200 startups and as a founding member of R3CEV – the consortium of 42 banks experimenting with blockchain,” he added.

It feels a little like we are in the midst of something of an arms race, with the world’s major banks all eagerly exploring blockchain technology and working on potential applications. But who will be first to deliver? Taylor said Barclays is in no panic.

“The rush to exploit blockchain for payments may lead some to assume blockchain is complete and could lead people into using unsecure, un-tested solutions. Whilst the promise of this technology is significant, it’s important to thoroughly test something first,” he explained.

Trade finance and identity

Going back to Millar, he sees two other areas where blockchain technology could be truly disruptive: trade finance and identity.

“Trade finance is a very interesting use case, as it represents a complex multi-party value transfer. A purchaser places an order to a producer, and the order is financed by a series of banks. But only a portion of the value of the order actually goes to the producer; the rest goes to shipping, customs handling, insurance, etc, and probably multiple parties in each case,” he explained.

This is an example of a distributed application – multiple parties collaborating without necessarily knowing each other beforehand. It features multi-step value transfer, so would fit perfectly on a blockchain. A number of startups recognise the opportunities in this space, with firms such as SKUChain, Wave.bl and TallySticks leveraging the blockchain to address issues around trade credit and invoice financing.

The use of blockchain in identity verification is another interesting one. Just think about the number of times you’ve had to produce your passport, driving license, proof of address, etc, for personal transactions.

“With the cryptographic assurity of the blockchain, it is possible to share verification of identity, without the need to continually produce the underlying original documents. Not only is this more efficient, but also can provide additional security, for example double checking across institutions,” Millar explained.

Blockchain tech, therefore, could become a useful tool in the know-your-customer and anti-money laundering processes financial institutions are legally bound to adhere to.

But it’s not just banking corporations that can profit from this – individuals could also benefit from identity being stored on a blockchain. Millions of people across the globe do not have government-issued identity cards, which prevents them from doing everything from opening a bank account and voting in an election to boarding a flight or enrolling for university. Millions more are the targets of identity theft. Blockchain technology could potentially solve both of these problems.

There are a few projects currently looking into the creation of a global, blockchain-based record of digitized birth certificates. Entrepreneur John Edge is doing just this through his ID 2020 project in conjunction with international child welfare agencies, with the aim of helping protect children from human-traffickers.

Once such a database is created, data could be added, ranging from information on bank accounts opened and credit borrowed to vaccinations received and other medical records. All this information could be tied to a person’s identity, which could prove useful, but could also tip over into Orwellian territory. With this in mind, companies have been exploring the creation of blockchain platforms that enable the parties involved to learn certain types of information about one another without compromising their full privacy.

In an election scenario, for example, your vote would be tied to your identity so the government would know your vote is legitimate, but wouldn’t know whose box you ticked on a digital ballot paper.

Provenance

While certain sectors of society are increasingly keen to have more control over their identity and how their personal data is shared, others are concerned with where the items they use and consume on a daily basis have originated. We’re seeing the rise of the conscious consumer and blockchain technology is the perfect tool to track the origin and journey of items such as clothing or food.

Projects such as Provenance are enabling a physical product to come with a digital ‘passport’, which proves it is the product it claims to be, plus shows where is has come from. This prevents the sale of fake goods. Think back to some of the headlines of the past few years – remember the horse meat scandal, where 50,000 tonnes of meat sold as beef was found to contain horse DNA? A blockchain mapping the origins of meat could prevent such an issue occurring again.

Solutions that detail product backgrounds already exist, but they are difficult to verify and the fragmentation of these efforts make them susceptible to fraud.

Fair trade information could also be recorded on such a blockchain, so a consumer could see exactly how much of the money they pay for their box of eggs, for example, actually goes to the farmer.

Low-value and everyday goods aside, blockchain tech could also be used for the tracking and verification of high-value goods, such as precious stones or antiques.

“A blockchain is a fantastic auditor,” said Barclay’s Taylor. “Whenever someone buying art or a diamond needs to be sure it’s legitimate, a blockchain is a fantastic way to prove that, because it contains a ‘chain’ of proof, over who owned the item throughout its history,” he explained.

Everledger, a London-based startup, uses a private blockchain combined with the public bitcoin blockchain to track diamond ownership with the aim of reducing fraud in the industry.

“Fraud is such a big problem in the diamond industry,” said Leanne Kemp, founder and CEO of Everledger.

High-quality synthetic diamonds have entered the market, so there is a desperate need for a digital, decentralised certification platform. The Gemological Institute of America, one of the world’s largest diamond certification houses, was hacked last year, with the color or clarity reports for over 1,000 stones being altered. Kemp claims this is a prime example of the incompetence of the industry’s legacy systems.

Blockchain tech could also help combat the proliferation of blood diamonds in the market, allowing sellers and buyers to check the stone’s provenance against the ledger’s records. Additionally, it could prove useful to the police and other law enforcement agencies – if investigators uncovered a haul of stolen jewellery, they would be able to consult the blockchain and return the gems to their rightful owners.

Legal

While law enforcement could benefit from the use of blockchain in various industries, the legal system in general could also be shaken up by the technology.

Records on bitcoin’s ledger represent a currency, but in other use cases, they could represent another carrier of value. Other blockchains, for example, could be used as a ledger of shares in companies. The trade of shares on a blockchain could occur entirely without the intermediation of a lawyer or stock exchange, with little cost and practically in real-time. In fact, NASDAQ is already exploring this.

A key aspect of blockchain tech that could be utilised in the legal space is the programmable smart contract: code stored on a blockchain that automatically executes when certain conditions have been met.

Using a will writing as an example, a person could create multiple versions of their will throughout their lifetime and each would be time stamped and sit on the same blockchain, so there would be no doubt over which was the most recent version. When the will’s creator dies, a hospital doctor could certify the person’s death by adding a new hash to a blockchain. When this is added, it could automatically execute the will, perhaps even automatically reassigning property, such as real estate, to new owners.

“As with any emerging technology, the thought process is ongoing as to how useful the blockchain could be to either a consumer – to bypass lawyers – or to lawyers in order to simplify a transaction and indeed record that transaction,” said Richard Howlett, commercial litigation solicitor at Selachii LLP.

The concept of smart contracts comes with its own set of challenges. In particular, how they fit within existing legislation. Sticking with the will writing example, for a will to be properly executed in England and Wales, it must be signed by the maker and witnessed by two individuals. This means a will recorded on the blockchain would not be considered legally binding under existing laws.

“The legislation is some 179 years old and could certainly do with updating,” said Howlett. “As the blockchain evolves and becomes an integral part of our everyday lives, it is inevitable that legislation will have to be amended to keep pace and to allow the full potential of the blockchain to flourish.”

It’s worth bearing in mind, however, that smart contracts function in a decentralised network – one that can’t be assigned to a specific jurisdiction and so can’t really be governed by one nation’s legal system.

This leads to a point that has been discussed before in relation to the internet: there is a necessity for global/centralised legislation when it comes to the application of certain technologies. Governments around the world agreeing on unified legislation sounds great, but will it ever happen?

“I doubt it,” concluded Howlett.

Another issue, relevant to all the many use cases of blockchain tech discussed in this article and beyond, is that of responsibility. What happens if something goes wrong? Where does the blame lie? If a smart contract fails to execute, for some reason, whose fault is it? The decentralisation inherent in blockchain technology makes it difficult to confirm which of the participants in a given transaction is responsible for any failure or error.

While we’re on the topic of blockchain tech criticisms, some believe it is over-hyped and won’t actually end up being the cross-industry game-changer many are claiming it to be. Constellation Research VP and principal analyst Steve Wilson, for example, believes its utility is actually very limited.

“My research shows that blockchain is not necessary nor sufficient for any mainstream business application,” he said recently. “All it does is stop fraud in electronic cash without needing a central umpire. That’s a very special, special case.”

Outsider interest

Whatever the thoughts of the few, the thoughts of the many seem to be that blockchain is hot property, and it’s on-trend for investors, too. There has been some $1bn of VC investment in blockchain companies to date and specialist investment bank Magister Advisors predicts an additional $1bn will be spent on blockchain by large financial institutions across 2016 and 2017. The firm expects to see multiple $100m+ funding rounds in blockchain companies this year.

Work on blockchain projects has picked up considerable pace over the past few years and the potential application of the technology seems endless. Now the question isn’t whether blockchain tech will make an impact, but when.

This article first appeared in Issue 10 of our print magazine – The Blockchain Issue.