Residing at the intersection of database technology, distributed networks and cryptography, distributed ledger technology is the technical foundation behind bitcoin.
From venture capital-fueled startups to established tech giants, companies are pursuing practical ways to apply this emerging technology to their everyday business practices. This may not be feasible for several years, but as with any new technology, it’s capable of being thoroughly disruptive.
Many leading financial institutions are exploring distributed ledger.
For example, at U.S. Bank we’re exploring distributed ledger technology as we seek ways to provide more efficient and economical solutions to our corporate and institutional clients. We find treasury managers throughout all industries are learning about distributed ledger advancement to prepare for the possibility of using it in the future.
Traditionally, the one definitive record of a financial transaction lives at a clearinghouse, such as a bank, trust company or the Federal Reserve. This entity is in the middle of the transaction and provides a golden record of truth. That is, the clearinghouse determines the single version of truth for all parties of a transaction.
An established protocol, spread by peer-to-peer file sharing, requires each party, electronically, to arrive at a consensus on the validity — on the truth — of a pending transaction before a new set of information is accepted. This eliminates the role of the clearinghouse. The parties to the transaction have sufficient information — secured using advanced cryptographic measures — to determine the transactions that can go through, and those that cannot.
Anybody can conduct transactions using bitcoin because it’s a “permissionless blockchain.” This means there’s no central authority — no bank, corporation or government — that dictates who can or can’t use the network. Organizations, as an alternative, may choose to establish a closed network, composed only of accepted players.
Here’s a step-by-step example of goods sold from one business to another:
1. Company A agrees to purchase 100 widgets from Company B.
2. Company A and B agree to contract terms that set the purchase price and determine the payment timing as 24 hours after delivery.
3. The agreement is entered into a distributed ledger system, which creates a future state.
4. Time passes and then B ships the 100 widgets to A. The shipment is tracked electronically with, for example, an embedded radio-frequency identification (RFID) chip.
5. When the widgets arrive at the loading dock of Company A, the fact and place of their arrival automatically transmits to the ledger system and is reconciled with the original terms of the contract.
6. The ledger system, recognizing that the contract requirements have been satisfied, starts the 24-hour countdown to payment.
7. After 24 hours, an automatic payment from Company A to Company B completes the purchase.
Humans aren’t very involved. They only complete the original agreement and input it into the ledger. Also, the payment can take any form the parties agree to; it could be bitcoins, it could be digital representations of dollars or it could be anything.
It’s very different to send a transaction up into the ether where code and math are the intermediary that determine whether the transaction will be allowed. People need to be comfortable with an intangible system.
High-dollar transactions are a prime proving ground for distributed ledger, because increased efficiency in such transactions can have a larger bottom-line benefit. Initial testing of distributed ledger-based transactions have included securities, such as bank-to-bank trades involving interest rate and credit default swaps — deals that don’t always include a clearing agent. If a clearing agent or custodian does participate, their involvement can be minimal, so it doesn’t slow the process.
Distributed ledger for business transactions might be many years away. Implementation standards aren’t established yet, cybersecurity systems need to be adapted, and the legitimate legal and regulatory concerns (particularly those involving banks) need to be considered.
Ready to learn more? Swanson participated in a panel discussion on the practical applications of distributed ledger technology that you may find interesting.
Chris Swanson is a senior vice president at U.S. Bank who focuses on the research and development of blockchain and distributed ledger technology. He has more than four years of experience in distributed ledger strategy.