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Bitcoin and Blockchain The distributed ledger technology utilised by blockchain can be employed for many different uses. We look at how it works and at several examples.

Bitcoin and Blockchain

 Bitcoin and Blockchain

by Sven Korschinowski, Partner, and Johannes Nöbel CFA, Financial Services Consultant, KPMG Germany

In 2009 the first bitcoins went into circulation around the world. Bitcoins were a revolutionary breakthrough because they allowed the transfer of a digital currency from one person to another in a safe way without using an intermediary such as a bank. Today bitcoins are transferred in large amounts and are the well-known example of a digital cryptocurrency [1]. But bitcoin was only one example and just the start for the underlying evolving technology of distributed ledgers. Distributed ledger technology based on blockchain is a very hot topic and it is getting very much attention lately as it will be used in many scenarios throughout the whole financial services sector and will certainly change the way business is done in many areas.

Blockchain – a distributed ledger technology 

What is a blockchain? For transferring money through the internet the bitcoin network uses a distributed ledger technology – a blockchain. The blockchain stores information about all past transactions and gets distributed and replicated across many computers. In the case of bitcoin everyone can join and participate in the blockchain network with a computer and a special software. 

The transfer of payments from one person to another requires a transaction between the participants of the blockchain network. These transactions need to be validated and they also need to be stored so that it is clear whom the transferred amount currently belongs to. For amounts to be transferred the respective transaction is validated by the network and then stored in a so-called ‘block’. All of these blocks are stored with a timestamp and connected in a cryptographic way to each other so that the transaction can’t be altered (called immutability). Together all these single blocks form a chain that represents the current state of the whole ledger – the blockchain. 

All the computers on the network have exactly the same information about transactions stored in a chain of blocks. The information about transactions in a blockchain basically resembles a ledger, hence the blockchain is a type of a distributed ledger technology. 

The creation of single blocks for a blockchain is mathematically complex and time consuming for computers to calculate. The process of building these blocks is called ‘mining’. Since the mining process is crucial to the network each successful miner and his provided computing power is rewarded by the network.

In short the blockchain is a distributed ledger technology that enables a network of computers to do transactions that are validated and stored with a cryptographic audit trail.

 

Technology and features of blockchains

During the last years many different kinds of blockchains were created. They hold different features and can be used for various scenarios. Bitcoin, the classic example of the blockchain network, is a permissionless public peer to peer network that everyone can join anonymously. It is called permissionless because everyone has the right to join the network, commit transactions, verify transactions and create new blocks. For financial institutions in most cases a different variant of blockchain is preferred. For example, private blockchains are preferred to public blockchains since the network can be restricted to certain partners of trust and the counterparty of the transactions in most cases must be known. 

Blockchain technology is based on various pillars that evolved over the last decades and blending these pillars has enabled the creation of the blockchain. One important pillar is the public-private key cryptography – well known for the encrypted transfer of emails. Another important pillar lies in the method of consensus for transactions. 

Consensus describes the trust mechanism and the prerequisites for validation and storage of transactions in a distributed network. Especially the methods of consensus have experienced rapid development and determine to a large degree the features and performance of a blockchain [2]. The consensus mechanism defines amongst others the means of authentication, integrity, privacy, security, scalability and fault tolerance. 

 

Notes

  1. By using cryptographic mechanisms it can be ensured that transactions with bitcoin can only be done by their respective owners and that there are never multiple units of the same bitcoin. It is therefore a cryptocurrency.
  2. Examples of consensus methods are ‘Proof-of-Work’ which is used by bitcoin, federated consensus – ‘ripple consensus ledger’ used by Ripple and ‘N2N’ used by R3CEV Corda.

 

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