Distributed Ledger Technology (DLT) is taking the world by storm. Especially within the financial industry, it raises the question: is it a hype or a haven? In collaboration with Vlerick, we have put together a report, giving an overview of the technology, the platforms, some existing use cases and the challenges and opportunities this technology faces. An ideal read to get started with the biggest trend in fintech!
By Robin Bracke & Lei Zhou
Since the success of Bitcoin, researchers from a variety of areas have been wondering whether the technology behind the platform, the distributed ledger technology (DLT), may benefit their daily lives. This report aims to offer the reader a comprehensive overview of the DLT environment and comprises a discussion of technical building blocks, platforms, use cases, collaborations, industry incumbent involvement, challenges, and several opportunities. It is based on extensive desk research, including the study of white papers, company websites and news articles, as well as interviews with technical experts.
The technology employed in DLT platforms can be broken down into five parts: transactions, chains of blocks, public and private keys, consensus mechanisms, and smart contracts. The basic element of a DLT system is a transaction which represents a transfer of value from one address to another and which can include additional transaction information as well as contract code. These transactions are organized in blocks that are chained together by linking subsequent blocks to their preceding block thus providing a history of transactions in the form of a ledger. While all the information stored on a distributed ledger is transparent to the whole network, only the true owner is able to access the value belonging to his addresses through the use of private keys, public keys, and signatures. Moreover, consensus mechanisms introduce different algorithms, such as Proof of Work and Proof of Stake, that allow the network participants to synchronize with one another so as to come to an overall consensus about the state of the distributed ledger. Smart contracts, on the other hand, are a more recent evolution in the DLT environment and enable functionalities beyond the mere transacting of value such as automatic transaction generation and multi-signature transactions. In addition to the technological elements, twelve popular platforms, which have been created using the technical building blocks mentioned above, are discussed in more detail. These platforms help developers in their development of DLT applications. Moreover, an overview of about 120 use cases that are already in existence is given grouped into five main categories and further subcategories based on the purpose for which they have been created. The main categories consider general purposes, business purposes, social purposes and financial purposes, besides a miscellaneous category.
Some industry-wide or even cross-industry collaborations have been set up so as to foster developments within the DLT environment. Two promising collaborations comprise the Hyperledger Project and R3. Besides these collaborations, individual companies have also looked into the technology by themselves. Therefore, a brief outline of industry incumbent and government involvement is considered as well and contains organizations in the financial industry (e.g., BNP Paribas, ABN AMRO, and institutions in the Wall Street), the technology industry (e.g., Microsoft and IBM), and the public industry (e.g., Republic of Georgia and the UK Treasury).
Unfortunately, as is always the case with new technologies, DLT too is dealing with several challenges. These challenges have been separated into five categories and can be summarized as follows. Reliability constitutes one of the main limitations and concerns the availability of a DLT system (e.g., emergence of soft forks, double-spending attacks and validator incentivization), issues related to mining power (e.g., 51% attack and limited miner availability in private networks), and security issues (e.g., recovering from security breaches, wallet hacking and private key loss). Another important limitation is posed by scalability even though this is less of an issue for private networks. However, public networks depend on the infrastructure of individuals which may at times be a restricting factor concerning scalability. Challenges can furthermore be identified within the area of anonymity and identification as distributed networks operate in a transparent fashion among the participants while confidentiality of transacted information is often a prerequisite. Such networks may moreover pose issues because of their pseudo-anonymous character while many parties, such as regulators often require full identity transparency. From the perspective of regulation and supervision can be observed that the immutability, which is often perceived as an advantage, and the anonymity of the technology make it difficult to take action to prevent or recover from malicious activities such as fraud and the sharing of illegal information. A proper regulatory framework supporting the DLT environment has unfortunately not been established yet, but is desirable for especially business applications. Standardization is a fourth type of limitation that can be identified and that concerns the standardization of transaction messages and the interoperability with legacy infrastructures and between DLT platforms which would form a hurdle to adoption if absent. A last category of challenges can be termed ‘people, planet, and profit’ as it considers the energy wasted in the often disputed computation-intensive consensus mechanisms (e.g., Proof of Work), the abundance of data duplication, and the need to educate the public for which it is hard to comprehend the technology.
A last section within this report discusses several opportunities including the potential of the technology for ownership tracking, record keeping, and smart contracts applications. Nevertheless, the main focus has been devoted to a deep-dive into a DLT system that may support Know Your Customer (KYC) processes which is an interesting opportunity that may provide significant benefits for financial institutions, telecom operators, their customers, as well as other parties. The three central activities of these processes, namely information collection, information verification and behavior monitoring, are highly resource-intensive for the organizations subject to KYC regulations while non- compliance comes at a high cost as well. This report considers the technical elements that could be employed in a KYC system supported by DLT and makes a recommendation that includes encrypted documents and encrypted document keys, off-chain selective storage, and on-chain verification communication. How such a system could be implemented using these building blocks is illustrated by means of a structured example. The proposal nevertheless merely serves as a starting point for the potential design of a KYC system and requires further investigation.
This report concludes that while the technology is currently still dealing with its limitations, it does show a promising future. Further improvements related to its performance and functionalities are required and it is therefore unlikely that, in the short term, it will replace existing systems and become a central part of the business and private world. Nevertheless, in the longer term, it may become well- established as more and more parties are looking into it and as developments are quickly succeeding one another.