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Distributed ledgers: How they work

Tanja Nechet

News editor

Sep 21, 2022 at 01:24

What are distributed ledgers?

Distributed ledger (also referred to as distributed ledger technology, general ledger, and DLT)  uses independent and geographically dispersed computers (nodes) to record, exchange, and synchronize transactions in e-books. Distributed ledger has no central administrator, so it does not have a single point of failure. Each node member can obtain access to the records shared on that net and own an exact copy. Any modifications to such a ledger are reflected and copied for all participants.

This distinguishes it from a centralized ledger, which is more susceptible to cyberattacks and fraud because of the single point of failure.

Blockchain represents the most common form of DLT. It can be on a public or private network. And in blockchain, data is recorded in blocks, which are combined into chains. Data can only be added, but cannot be changed or moved.

DLTs allow interactions to be recorded and any record of ownership of various kinds of assets to be transferred from one person to another without centralized coordination.

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Distributed ledgers can improve efficiency, reduce the cost of remittances, and potentially provide better financial access for unbanked groups that do not have access to traditional financial services.

How distributed ledgers work

Distributed ledgers are stored, reorganized, and controlled by nodes. The database does not depend on an individual node. Each transaction on the network is processed, and each node creates a report on the development of the database.

All nodes vote on the transaction to make changes to the database. At least 51% of them must agree. Only then will the transaction be accepted by the database. The nodes then update the database versions to be the same. The new transaction is then written to a block on the blockchain.

In a blockchain that runs on the Proof-of-Work consensus mechanism, nodes are called miners. A miner is rewarded for successfully placing each new transaction into the block. Miners are involved in calculating the cryptographic hash for new blocks. The first one to successfully find the hash also receives a bounty.

The more computational power a miner spends searching for a hash, the more chances he has of doing it the fastest. But the more blocks are generated, the harder it becomes to find hashes. The objective is to remain at a constant block generation rate.

Understanding distributed ledgers

Ledgers have always been the basis of economic transactions to record everything, payments, transactions, and assets or property movement. At first, they were simple clay tablets or notes on papyrus, and then paper came along.

During the last decades, their enormous step in development was due to the advent of computers. This made it possible to keep hundreds and thousands of ledgers simultaneously much faster and more conveniently. Now, thanks to cryptographically secured, fast, and decentralized inventions, distributed ledgers have emerged.

In simple words, DLT is a ledger of any transactions or contracts stored in a decentralized form in different places and by others, so there is no need for a central authority to control possible fraud and cheating schemes. There is also no need for authorization or confirmation of transactions by a central authority.

All information in the distributed ledger is stored safely and protected by cryptography and can be accessed using keys and cryptographic signing. While the data is stored, it becomes a database governed by network rules and cannot be changed.

How is blockchain and distributed ledger different?

Blockchain is a type of distributed ledger, a specific order of blocks. And distributed ledgers do not need such a chain (a sequence of data in blocks) or a proof of work. A distributed ledger is a database distributed among multiple sites, regions, or participants. And unlike blockchain, it does not have to have a data structure in blocks.

Essentially, all blockchains are distributed ledgers, but not all distributed ledgers are blockchains. Blockchain is just one type of distributed ledger and a subset of it.

Advantages of distributed ledgers

Transparency, security, tamper-proof, and impossible to change. Entries are entered into the database without the involvement of a third party. Once entered, records cannot be altered and thus – falsified.

No need for a third party. This saves money and time. For example, if a business uses supply chains, sensors can record the results in a blockchain.

The decentralized nature of distributed ledgers gives a security bonus. They are distributed worldwide, so they are difficult to attack.

High level of transparency. All stored information can be easily viewed but cannot be changed.

Problems with current business ledgers

Ledgers are inefficient, expensive to maintain, and can be falsified. Lack of transparency leads to corruption and fraud. Disputes also arise, creating the risk of transaction cancellation and their insurance. And this increases costs.

When copies of the ledgers are stored in different proprietary systems of each network member, it leads to decisions being made based on incorrect data. Or it is delayed by the time further copies of the ledgers are reconciled.

Use of distributed ledgers

Distributed ledger technology could revolutionize how governments, institutions, and corporations operate. Simplify and make tax collection, document issuance, registration, licensing, benefits, and voting more reliable.

This technology is already increasingly used in diamond and valuable asset mining, art, music, finance, entertainment, and supply chain. 

However, DLT is still in its infancy. But it is already clear that it could become the future progressive, reliable and decentralized format of centuries-old ledgers.

Types of distributed ledgers

  • Disseminated ledgers can be categorized based on their data structures, consensus algorithms, permissions, and mining capabilities. 
  • DLTs can be linear (blockchain), directed acyclic graphs (DAGs), and hybrid data structures. 
  • By type of consensus algorithms, DLTs are Proof-of-Work (PoW), Proof-of-Stake (PoS), DAG consensus and voting algorithms.
  • DLTs are usually either public or private.
  • Blockchain is the most common type of DLT, with a 256-bit secure hashing algorithm.
  • DLTs with a DAG or hybrid blockchain-DAG data structure reduce transaction data size and cost while increasing speed.

Examples of distributed ledger technology

The best and clearest example of how distributed ledger technology works are the Bitcoin blockchain. This first fully decentralized cryptocurrency requires no centralized authority (usually a bank) to operate. Every Bitcoin transaction is processed and recorded in a blockchain and can be traced back to accounts.

Also, in 2016, some banks tested DLTs for payments to see how useful they could be.

In 2020, Axoni launched Veris, a distributed ledger platform that manages stock swap transactions (A swap is an agreement between two counterparties to exchange financial instruments, cash flows, or payments over time.)

The platform consolidates and reconciles post-trade data on stock swaps. It is used by well-known investment companies such as Citigroup Inc., Goldman Sachs Group Inc., and BlackRock Inc.

The future of distributed ledger technology

Everyone follows Bitcoin closely, but not everyone realizes that this cryptocurrency is just the tip of the iceberg. One of the technologies on which it operates is much more important, the distributed ledger or blockchain. And it is the one that is capable of having a far greater impact on the world than Bitcoin itself.

In the Bitcoin system, a distributed ledger logs the story of all transactions, duplicated on all the computers (nodes) in the protocol. A consensus algorithm keeps all individual records consistent, and cryptographic protection ensures that past transaction data remains unchanged without a centralized trusted authority.

This is what makes DLTs a very interesting technology for use by financial institutions and investors.

Distributed ledgers are still in development, but already or in the future can improve payments and the international correspondent banking system (sometimes several banks can participate in the exchange of payments, which harms cybersecurity).

Several blockchain-based money transfer services are already under development.

Also, a distributed ledger can be used to maintain a virtual digital identity record, eliminating the need for paper records.

Distributed ledgers can already facilitate the transfer of any assets: real estate, cars, securities, and so on.

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