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The Blockchain Ecosystem – Short FAQ

In last few days, I was reading many news articles about banks & financial companies joining hands for digitising of processes in different areas like vendor financing, International payments etc. using “blockchain technology” (underlying technology to Bitcoin) & its potential to disrupt traditional processes particularly in financial service industry. I decided to delve deeper into it particularly after reading news that Goldman SachsJP Morgan & few other leading financial institutions filing patents for different solutions with underlying Blockchain technology.

Post my study on this topic, I found that it’s very important to understand “Blockchain & its Ecosystem” rather than focusing on its technical working or Industry specific use cases. Once Ecosystem is understood it’s very easy to correlate the developments in this area. For initial understanding, we can consider technical details, like which Algorithms are used, execution of blockchain transaction, how they solve typical ‘double spending problem’ as “BlackBox” & try to understand the basics of ecosystem. As a business consultant, taking pride in simplifying the complex concept and presenting it to business stakeholders, I decided to connect all these dots & present it in frequently asked question format (FAQ) with my own explanation. It would take 7-9 minute of your reading time, I tried to keep it for 5 minute reading, but looking at topic, I hope additional few minutes would be worth spending.

Q1. What is Blockchain Technology?

A Blockchain—the technology underlying bitcoin and other crypto currencies—is a shared digital ledger, or a continually updated list of all transactions. This decentralised ledger keeps a record of each transaction that occurs across a fully distributed or peer-to-peer network, either public or private.

  • Using Blockchain technology, any party in the network can initiate a transaction (e.g. fund transfer, or any other digitised asset) and updates the copy of “distributed ledger” maintained by all stakeholders in this transaction.
  • Once updated, this transaction is verified by other nodes (called Miners in Bitcoin context) on the network & based on different “consensus mechanism” (running sophisticated algorithms) these nodes confirms only genuine update.
  • Post verification by all required nodes, it’s stored as block. Each time a block gets completed, new block is generated and these blocks are linked to each other (like a chain) in proper linear, chronological order and it’s available for all nodes to check and validate for next processing, providing total transparency.

Note: People who don’t understand ledger can consider it as a “File” where different entries are made regarding transactions.

Q2. Who are these “Parties” in the above transaction?

  • Transacting “party” is nothing but one of the different stakeholder representing nodes of the blockchain network e.g. Bank initiating fund transfer or person initiating any asset transfer request.
  • If we consider “Bitcoin” as reference then any person with computer or mobile can buy and exchange bitcoins or pay for the goods and services.

In terms of two financial entities, it’s like two banks in different countries doing fund transfer transaction. But so far it’s only on “Private Blockchain Network” (please check explanation of it in due course).

Currently, most of the large financial institutions are working on different applications in their labs or technology centre. Few have started on experimental basis. E.g. Goldman Sachs wants to put foreign exchange trade on block chain, New York stock exchange (NYSE) & few other exchanges wants to explore block chain technology etc.

Q3. Can any Party or Entity take part in the transaction?

Again in “Bitcoin” context yes, and technically based on a blockchain technology also it’s possible. But to answer in detail, it’s also important to understand the concept of

  • “Public Blockchain Network”
  • “Private Blockchain Network”

Public Blockchain Network:

  • No one owns the technology in public Blockchain network, like technology behind Internet or email. E.g. Bitcoin is an example of “Public Blockchain Network” It’s controlled by Bitcoin users and developers around the world on consensus.
  • Once any transaction is verified and updated, it’s almost not possible to revert it in Public Blockchain Network, any changes in it can create security risk.
  • It also offers potential to reduce transaction fee.

Private Blockchain Network:

  • This blockchain network is set up & maintained by private entity. Security protocol control & limit access to authorised parties only. E.g. one of the large private bank in India ICICI Bank executed money remittance from Dubai with their Private Blockchain Network.
  • Nodes in this network are part of one organisation or consortium which decides their participants & aim of using this technology in advance. E.g. R3 which is distributed database technology company and it leads a consortium of more than 50 of world’s biggest financial institutions.
  • Private blockchains can authenticate transactions more quickly and there is possibility to revert any transactions as all nodes are of pre-selected parties or of one organisation as compare to public network.

Q4. Who is doing verification of this transaction on “Distributed Ledger” by running sophisticated algorithms & What are their incentive?

  • Processing & validating these transactions needs computer power and in turn investment in specialised hardware and software. In “Bitcoin” context many Fintec companies or startups are investing in it and they are rewarded for this mining work with “Bitcoin”.
  • These companies are “nodes” in this Public Blockchain Network. These participants are very important, because in distributed ledger” system we need more number of nodes to reduce cost, increase speed and possibility of frauds.
  • In “Private Blockchain Network” these nodes could be simply computing terminals maintained by owner of that network or consortium members with technical capabilities to perform validation of transaction.

Q5. Is Blockchain technology really going to remove the third party intermediaries?

  • In “Public Blockchain Network” yes, we can see it from the “Bitcoin Network” but bitcoin is not any sovereign backed currency. When we talk about large scale authorised financial transactions of sovereign currency, we have yet to see any commercial use of “Public Blockchain Network”.
  • In case of “Private Blockchain Network”, Private entities or Consortium’s have own protocols & authorisation rules etc. then that particular entity itself is equivalent of third party intermediary e.g. if R3 consortium today comes up with “Private Blockchain Network” for “International Payment” then indirectly it becomes intermediary (trusted entity), even though technically this transaction is with “distributed ledger” technology.

Q6. Any company, who wants to take benefits of “Blockchain Technology”; do they have to invest in technical infrastructure (hardware, computing machines executing smart contracts, consensus algorithms etc.)?

  • Not necessarily, It’s normal strategic decision making for any organisation to go for cloud solutions (pay-as-you-use models) or invest in own infrastructure. In my view, big multinationals or financial institution may set up own private block chain network depending on applicable regulations & cost benefit analysis.
  • Consortium’s can also set up their own Private Blockchain Network or may use “Blockchain-as-Service” model offered by many leading technology companies.
  • Blockchain service suits and platform providersThese are also very important stakeholder in this ecosystem; these companies are offering Blockchain Technology as service. Hence many corporations who don’t want to develop their own network or invest in technology can use these solutions. Few leading providers are,
    • Hyperledger Project: IBM leading role in the Linux-led Hyperledger Project.
    • Ethereum: It is an open source, public blockchain-based distributed computing platform, featuring smart contract.
    • Microsoft Azure: Block chain as service (BaaS) from Azure.

There is no doubt that blockchain will usher huge benefits to banks and financial institution, but below two points are important and needs to be considered about this technology.

  • It’s not “one-size-fits-all” solution. Based on requirements, appropriate solution should be designed.
  • Apart from technological requirements, certain legal points are still not clear for commercially role out of financial use cases. E.g. Lack of Legal framework for the insolvency of the block chain participants, liability for enforcing anti-money laundering (AML) standards & managing overlapping jurisdictions. I hope benefits of this technology will force governments and legal bodies to work on it or priority.

I believe this technology is going to be disruptive & in today’s challenging business scenario Corporations need to come up with strategy to implement it sooner than expected.

Acknowledgement & Note: I have tried to use links in the post, but this analysis is outcome of secondary research on Internet. Views shared are my own and I welcome your views, suggestions through comments!!

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