Part 1: Blockchain Fundamentals

This is 4 part series covering about the basics of Blockchain:

Part 1: Blockchain Fundamentals

Part 2: How Blockchain Works?

Part 3: Propelling Business with Blockchains

Part 4: Blockchain in Action

In this Part 1, we will cover about the basics of block chain.

What is Blockchain?

Blockchain is a shared, distributed ledger that facilitates the process of recording transactions and tracking assets in a business network. An asset can be tangible — a house, a car, cash, land — or intangible like intellectual property, such as patents, copyrights, or branding. Virtually anything of value can be tracked and traded on a blockchain network, reducing risk and cutting costs for all involved.

Shortcomings of current transaction systems:

Many business transactions remain inefficient, expensive, and vulnerable, suffering from the following limitation:

• Cash is useful only in local transactions and in relatively small amounts.

• The time between transaction and settlement can be long.

• Duplication of effort and the need for third-party validation and/or the presence of intermediaries add to the inefficiencies.

• Fraud, cyberattacks, and even simple mistakes add to the cost and complexity of doing business, and they expose all participants in the network to risk if a central system, such as a bank, is compromised.

• Credit card organizations have essentially created walled gardens with a high price of entry. Merchants must pay the high costs of onboarding, which often involves considerable paperwork and a time-consuming vetting process.

• Half of the people in the world don’t have access to a bank account and have had to develop parallel payment systems to conduct transactions.

Emergence of Bitcoin:

One solution that has been developed to address the complexities, vulnerabilities, inefficiencies, and costs of current transaction systems is bitcoin  — a digital currency that was launched in 2009 by a mysterious person (or persons) known only by the pseudonym Satoshi Nakamoto. 

Unlike traditional currencies, which are issued by central banks, bitcoin has no central monetary authority. No one controls it. Bitcoins aren’t printed like dollars or euros; they’re “mined” by people and increasingly by businesses, running computers all around the world, using software that solves mathematical puzzles.

Rather than rely on a central monetary authority to monitor, verify, and approve transactions and manage the money supply, bitcoin is enabled by a peer-to-peer computer network made up of its users’ machines, akin to the networks that underpin BitTorrent and Skype.

Advantages of Bitcoin:

• Cost-effective: Bitcoin eliminates the need for intermediaries.
• Efficient: Transaction information is recorded once and is available to all parties through the distributed network.
• Safe and secure: The underlying ledger is tamper-evident. A transaction can’t be changed; it can only be reversed with another transaction, in which case both transactions are visible.

The birth of blockchain:

Bitcoin is actually built on the foundation of blockchain, which serves as bitcoin’s shared ledger. Think of blockchain as an operating system, such as Microsoft Windows or MacOS, and bitcoin as only one of the many applications that can be run on that operating system. Blockchain provides the means for recording bitcoin transactions — the shared ledger — but this shared ledger can be used to record any transaction and track the movement of any asset whether tangible, intangible, or digital. For example, blockchain enables securities to be settled in minutes instead of days. It can also be used to help companies manage the flow of goods and related payments, or enable manufacturers to share production logs with original equipment manufacturers (OEMs) and regulators to reduce product recalls.

The takeaway lesson: Bitcoin and blockchain are not the same. Blockchain provides the means to record and store bitcoin transactions, but blockchain has many uses beyond bitcoin. Bitcoin is only the first use case for blockchain.

Key characteristics of Blockchain:

• Consensus: For a transaction to be valid, all participants must agree on its validity. 
• Provenance: Participants know where the asset came from and how its ownership has changed over time.
• Immutability: No participant can tamper with a transaction after it’s been recorded to the ledger. If a transaction is in error, a new transaction must be used to reverse the error, and both transactions are then visible.
• Finality: A single, shared ledger provides one place to go to determine the ownership of an asset or the completion of a transaction.

Exploring a blockchain application:

Car companies make leasing a vehicle look easy, but in reality, it can be quite complicated. A significant challenge faced by today’s car leasing networks is that even though the physical supply chain is usually integrated, the supporting systems are often fragmented. Each party within the network maintains its own ledger, which can take days or weeks to synchronize (see Figure below).

 Tracking the vehicle ownership without blockchain

By using a shared ledger on a blockchain network, every participant can access, monitor, and analyze the state of the vehicle irrespective of where it is within its life cycle (see Figure below).

 Tracking the vehicle ownership with blockchain

With blockchain, network participants can interact as follows:

1. The government regulator creates and populates the registration for the new vehicle on the blockchain and transfers the ownership of the vehicle to the manufacturer.

2. The manufacturer adds the make, model, and vehicle identification number to the vehicle template within the parameters allowed by the smart contract (a digital agreement or set of rules that govern a transaction).

3. The dealer can see the new stock availability, and ownership of the vehicle can be transferred from the manufacturer to the dealership after a smart contract is executed to validate the sale.

4. The leasing company can see the dealer’s inventory. 

Ownership of the vehicle can be transferred from the dealer to the leasing company after a smart contract is executed to validate the transfer.

5. The lessee can see the cars available for lease and complete any form required to execute the lease agreement.

6. The leasing process continues between various lessees and the leasing company until the leasing company is ready to retire the vehicle.

At this point, ownership of the asset is transferred to the scrap merchant, who, according to another smart contract, has permission to dispose of the vehicle.

Recognizing the key business benefits:

For business, blockchain has the following specific benefits:

Time savings: Transaction times for complex, multi-party interactions are slashed from days to minutes. Transaction settlement is faster, because it doesn’t require verification by a central authority.

Cost savings: A blockchain network reduces expenses in several ways:

• Less oversight is needed because the network is selfpoliced by network participants, all of whom are known on the network.
• Intermediaries are reduced because participants can exchange items of value directly.
• Duplication of effort is eliminated because all participants have access to the shared ledger.

Tighter security: Blockchain’s security features protect against tampering, fraud, and cybercrime. If a network is permissioned, it enables the creation of a members-only network with proof that members are who they say they are and that goods or assets traded are exactly as represented.

Not all blockchains are built for business. Some are permissioned while others aren’t. A permissioned network is critical for a blockchain for business, especially within a regulated industry. It offers

• Enhanced privacy: Through the use of IDs and permissions, users can specify which transaction details they want other participants to be permitted to view. Permissions can be expanded for special users, such as auditors, who may need access to more transaction detail.
• Improved auditability: Having a shared ledger that serves as a single source of truth improves the ability to monitor and audit transactions.
• Increased operational efficiency: Pure digitization of assets streamlines transfer of ownership, so transactions can be conducted at a speed more in line with the pace of doing business.

Building trust with blockchain:

Blockchain enhances trust across a business network. It’s not that you can’t trust those who you conduct business with; it’s that you don’t need to when operating on a blockchain network.

Blockchain is particularly valuable at increasing the level of trust among network participants. Because every transaction builds on every other transaction, any corruption is readily apparent, and everyone is made aware of it. This self-policing can mitigate the need to depend on the current level of legal or government safeguards and sanctions to monitor and control the flow of business transactions. The community of participants does that. 

Where third-party oversight is required, blockchain reduces the burden on the regulatory system by making it easier for auditors and regulators to review relevant transaction details and verify compliance.

Blockchain builds trust through the following five attributes:

• Distributed and sustainable: The ledger is shared, updated with every transaction, and selectively replicated among participants in near real time. Because it’s not owned or controlled by any single organization, the blockchain platform’s continued existence isn’t dependent on any individual entity.
• Secure, private, and indelible: Permissions and cryptography prevent unauthorized access to the network and ensure that participants are who they claim to be. Privacy is maintained through cryptographic techniques and/or data partitioning techniques to give participants selective visibility into the ledger; both transactions and the identity of transacting parties can be masked. After conditions are agreed to, participants can’t tamper with a record of the transaction; errors can be reversed only with new transactions.
• Transparent and auditable: Because participants in a transaction have access to the same records, they can validate transactions and verify identities or ownership without the need for third-party intermediaries. Transactions are time-stamped and can be verified in near real time.
• Consensus-based and transactional: All relevant network participants must agree that a transaction is valid. This is achieved through the use of consensus algorithms. Each blockchain network can establish the conditions under which a transaction or asset exchange can occur.
• Orchestrated and flexible: Because business rules and smart contracts (that execute based on one or more conditions) can be built into the platform, blockchain business networks can evolve as they mature to support end-to-end business processes and a wide range of activities.

What Next?
Part 2: How Blockchain Works?