tracts can be set up just as effectively on a centralized system.

Other significant cost savings may come from improved encryption, which results in increased security of the system. Currently, encryption is underutilized in business practice. Bitcoin’s blockchain itself uses standard, well-established cryptography tools. But excitement about blockchain’s safety turned more attention to the new developments in cryptography.

What Are the Benefits
of Blockchain?

What about the benefits of a distributed ledger—the blockchain itself? A distributed ledger allows multiple parties in the system to add transactions to a shared ledger in a way that the changes are reflected consistently across all copies.b It brings benefits in places where reconciliation of contradictory ledgers is costly. At the same time, recording transactions on a shared ledger takes more time than on a centralized ledger, because of the reconciliation mechanisms (consensus mechanisms) that must be employed. Moreover, the need to store the ledger in multiple locations may significantly add to storage and computational costs. So far it has not been clearly demonstrated in which circumstances the benefits of employing a distributed ledger outweighs the cost of delays and duplicated storage.

Distributed ledgers are a special case of distributed databases. They have been known, and used, for three decades. But proponents of blockchain technologies expect more from the new technology than just distributed ledger. They expect that adopting blockchain could result in further cost savings due to disin-termediation, as it does not require a trusted third party to be virtually immutable. Indeed, the core of Bitcoin’s computer-scientific innovation was the security of a permissionless distributed ledger, so that there is no need for a trusted third party anywhere in the system.

 

b Technically, distributed databases also have other desirable properties, but this one seems to be the focus in the context of blockchain technologies and fintech.

and commonly used is “distributed ledger of transactions.”a This is why the term “blockchain technologies” is often used interchangeably with the phrase “distributed ledger technologies.”

Where Is the Confusion
Coming From?

The source of confusion around blockchain can be traced to the origin of the term. “Blockchain” was introduced as a shorthand term for “chain of blocks of transactions,” which was part of the Bitcoin system. 4 Later, “blockchain” became an independent term in media discussions of whether there are other uses for distributed ledgers of transactions beyond Bitcoin.

Bitcoin’s system—a system operating without a trusted third party—has been quite successful since it started in 2009, in the sense there has been no fraud on its blockchain. For this reason, it is often said to be secure. Bitcoin’s blockchain is also public (all transactions are visible), and permissionless (any computer may participate in validating transactions and adding them to the ledger).

Some pundits erroneously extrap-
olate that any blockchain will have
these properties: distributed, secure,
public, permissionless, and will op-
erate without the need for a trusted
third party. This extrapolation may
come from a misconception that the
Bitcoin’s blockchain properties come
solely from technology, while in real-
ity they come from a combination of
technology and an incentive system
that accounts for the behavior of hu-
man participants. Yes, the Bitcoin
system uses cryptographic tools. But
the reason why the system is virtually
immutable is because it is too costly to
“rewrite the history.”
Note that smart contracts are not
a core property of the Bitcoin block-
chain. The Bitcoin system has a ru-
dimentary capability to create code
that would allow for some transac-
tions to be automatically executed.
Ethereum expanded on this feature,
introducing a blockchain with a main
a Note that “ledger of transactions” is different
from “ledger of balances.” The former keeps
the history of transactions, as in the “chain of
blocks of transactions.” Using this definition,
“Ledger of balances” would not be a blockchain.

purpose to facilitate smart contracts (see http://www.ethereum.org.) Since the term “smart contracts” entered the mainstream media in the context of blockchain, this may have created a perception that smart contracts are native to blockchains. However, a code automatically executing a transaction can be implemented by a wide range of entities. 5

Therefore, smart contracts, encryption, and distributed ledger are separate concepts. They may be implemented together, but do not need to be. The term “blockchain” should not be used as a catch-all aggregation of these different terms.

 

Why Is It Important to Consider Smart Contracts, Encryption, and Distributed Ledger Separately? The distinction matters for estimating costs and benefits, or even predicting the best uses of blockchain technologies. For example, smart contracts are computer programs that automatically implement the terms of an agreement between parties. One typically given example is that of a car lease: upon a missed payment, the car automatically locks and returns the control to the lender. Since execution of a smart contract does not involve a decision or an action of a human, it may increase speed as well as minimize the number of mistakes. Both would result in cost savings.

Some media outlets state that “through blockchain technology,

smart contracts are now a reality.” 3 However, smart contracts were a reality long before: an automated recurring payment that someone sets up with his or her bank or a limit order with a stock exchange are examples of smart contracts. Blockchain is not needed to gain the benefits from smart contracts, because smart con- Current applications of blockchain have gathered only limited appeal.