By: Rajashekara V. Maiya, Associate Vice President & Head – Finacle Product Strategy, EdgeVerve
The General Ledger (GL), which is at the heart of financial accounting, survived five and a half centuries without significant alteration. All that changed in 2008 with the arrival of blockchain, the first – and possibly best-known – distributed ledger technology, which is the foundational layer underpinning a cryptocurrency called bitcoin.
Where the GL is primarily concerned with just the two (or more) parties to a transaction, the distributed ledger is shared by a vast network of participants, often numbering millions, who must validate each transaction through consensus in real-time before it can be recorded.
A set of verified transactions is written into a block that is uniquely identified by a hash number and linked with other blocks to form a chain. An identical copy of the blockchain ledger (or any other distributed ledger, such as Ripple, Ethereum, Hypelredger or Corda) is available to every member of the network.
Because every transaction on blockchain has the approval of a massive network, it is inherently trustworthy and secure, which means there is no longer any need for a central supervisory authority, or for an elaborate chain of intermediaries to ensure things are as they should be. Any changes to a transaction must also go through a similar approval process, making it impossible for a lone actor to tamper with the entries.
This, in short, describes the working of blockchain and other public (or “permissionless”) ledgers, where anyone can join the network to receive identical privileges to view, modify and affix their assent to a transaction. But while the ledger itself is public, and visible to all network participants, the identity of the transacting parties is never revealed. For financial institutions and other highly regulated industries, which must comply with stringent Know Your Customer (KYC) norms, such anonymity is clearly not acceptable. What’s more, the openness of the public distributed ledger, which exposes all transaction data to an enormous network, also conflicts with their data privacy and confidentiality obligations, not to mention their business interests.
Given these constraints, a variant, namely the permissioned or private ledger, seems better suited to the needs of such organizations. The private ledger is like its public counterpart in most respects – it is decentralized, distributed, highly secure, immutable, and transparent. But where every member on the public ledger network shares the same privileges to view, modify and authorize transactions, these are restricted to a select circle on the private one. Basically, if a network member does not want its transactions and other information to be visible without restriction, it can allocate specific rights to view, modify or participate in the consensus to different members. Such rights may also be qualified by the type of transaction – for instance, allow A to view payment transactions, B to edit trade finance transactions and so on. Beyond that, a member – and a bank is a good example here – may also choose to build or participate in a private blockchain where the trading parties are identified and known.
Between the two extremes of public and private, lies the hybrid distributed ledger. As the name implies, the hybrid ledger possesses a combination of public and private ledger characteristics. Its network members or governing body can determine which transactions can remain public, and which must be restricted to a smaller group of members.
The public ledger entails the most economical cost of ownership; the private ledger is the most expensive, and the hybrid costs something in between. The three also differ in their consumption of computational power. The public blockchain, being vast, needs a humungous amount of computing and other resources. It is believed the bitcoin network consumes more energy than all of Ireland. But it is a necessary evil, because only a massive network, numbering millions, can create the required level of security and trust between participants who know absolutely nothing about each other.
On the other hand, if a private or permissioned blockchain is formed between members who also have offline relationships, it need not conduct the elaborate cryptographic verification and synchronization of each and every node, which would save considerable computing and energy resources.
When it comes to use cases, the lines are not as distinct and in theory, most transactions can be conducted on public, private and hybrid blockchains. That being said, one of these three options is likely to make more sense. Bitcoin trades, are of course, conducted only on a public blockchain. Other transactions involving virtual commodities, or even the purchase and sale of a commodity, such as art where creating trust and confidence is key, are best done on a public ledger. On the other hand, transactions involving financial institutions – trade finance, remittances, syndicated lending, treasury operations etc. – need certain controls that are only possible in a permissioned ledger.
A good example of private blockchain implementation is the pilot network that Emirates NBD and ICICI Bank launched last October to carry international remittances on the UAE-India corridor.
A hybrid ledger could be the choice of a goods retailer, who also has bitcoin dealings. While all the monetary exchanges through bitcoin may proceed on the public part of the hybrid ledger, the physical operations – goods movement, vendor network, pricing, warehouse locations etc. – can all be recorded on the permissioned part to protect the retailer’s business interests.
In the final analysis, each variant of the distributed ledger has its advantages and limitations, and users should make a careful comparison before throwing in their lot with any one.