A distributed ledger is a database designed to record various transactions. Just as electronic transactions and digital banking applications have changed how consumers spend money, distributed ledgers can simplify transactions in a way that improves convenience and reduces costs. Although blockchain is currently the most common form of distributed ledger, the technology can be used in many industries. By learning more about distributed ledgers, you can better understand how the technology is being used now and likely to be used in the future.
What is a distributed ledger?
A distributed ledger is a database that is updated individually by each member of a large network through an automatic voting and updating process called consensus. Computing devices controlled by individuals (called nodes) create a network at different locations. Instead of depending on a trusted third party authority (such as a bank) to oversee transactions, a distributed ledger allows transactions to have public witnesses who confirm and record the transaction. By eliminating the third party, the process eliminates errors or intentional changes to the transaction. It also increases the speed at which transactions occur, removing banking hours and cumbersome manual processes from the equation.
Ledgers have always been used to record financial transactions. However, the registries we are used to are centralized registries controlled by a trusted third party, such as a bank. This traditional accounting model is based on accounts. The most common form of financial ledger used by individuals is the current account book. When deposits are added or purchases are completed, the bank records the transactions. Centralized registers are controlled by a single authority and can be modified or changed from a single destination. Conversely, the distributed ledger is written by each node, and once a transaction is completed, it cannot be changed, it can only be deleted with another approved transaction. Although distributed ledger technology is promising for use in various industries, including supply chains and real estate, it is still in its early stages of development. The most recognizable use of distributed ledgers currently involves cryptocurrency exchanges and online NFT exchanges.
How does a distributed ledger work?
A distributed registry is created by individual participants with complex computing devices (nodes) that form a network. Each member of the database independently builds a network. When a transaction occurs, it is processed by each node and then voted on. If 51% of participants agree, the new transaction is accepted into the database. All nodes then update the database so the registry shows the same version on all devices. These transactions and any changes to the registry are reflected in seconds.
Since a distributed ledger depends on a peer-to-peer process, it makes sense to ask who are the participants who make up the database and vote when approving a transaction. Participants in a distributed ledger are sometimes called miners because the race to compute the equation and enter a new transaction first is called digital mining. Anyone can be a miner, from individuals using their own hardware to pools of miners that join together to cut costs. The first miner to solve the equation is rewarded with digital currency. Because the system provides compensation and the correct answer is required, the system maintains a balance.
How is a distributed registry different from a centralized digital registry?
In order for any business or individual to keep track of income and expenses, they must record economic data in a ledger. Until recently, the most common form of individual accounting was a paper form. Bank transactions were completed with a paper check, and the account holder recorded the transaction in a notebook called a checkbook register. Each month, a bank statement can be used to compare the account holder’s record with the bank’s official transaction record. The digital age has seen the emergence of applications that share transaction information with account holders in real time. Virtual transactions have become commonplace and people can now track transaction data on their devices. Even though the information about these transactions is available in different places, the ledger (and activity associated with the transaction) comes from a centralized entity. Traditional electronic payments are processed through accounts opened in centralized locations.
The distributed ledger processes and records transactions in a completely different format. The simplest explanation for a distributed ledger transaction is the I/O system. When a transaction occurs, the relevant data is fed into the system as input. Withdrawal occurs when a transaction has been voted on and approved, completing a “block” that represents an entry in the ledger. The distributed ledger does not require an account, but still records the cost of the transaction.
Benefits of Using Distributed Ledgers
Distributed ledger technology addresses certain problems of economic transactions being dependent on a central authority. It can also reduce the costs and tasks associated with the exchange of certain goods and supply chain requirements. The use of distributed ledgers can eliminate the cost of a third-party trust across a variety of exchanges, including those that require notaries, contract witnesses, and complex transactions. Although decentralized registries have not yet been adopted in most formal environments, they can offer the following benefits:
- Difficult to counterfeit: Both paper and digital ledgers are easy to counterfeit with today’s technology. Distributed ledgers are written by each node and therefore exist in multiple locations. The complex nature of the technology also makes them difficult to counterfeit. This is also true of NFTs, which make counterfeiting art nearly impossible.
- High Transparency: Because all stored information is freely and easily viewable, there is complete transparency.
- More secure: The decentralized nature of the distributed ledger makes it more secure from potential attacks. Since the database is distributed all over the world and updated individually, it is difficult to attack it.
- Faster Processes and Lower Costs: Without the need for a third party and manual tasks performed in third-party transactions, distributed ledgers can eliminate delays and reduce costs.
At first glance, distributed ledgers seem like a complex process that will not change financial transactions in the near future. However, once you have a clear understanding of the process, it is easy to see that distributed ledgers can drive significant change in many industries.