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
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
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-
only limited appeal.