ovum blockchain for beginners

Blockchain for BeginnersDistributed ledger technology for the non-expert

Gilles Ubaghs, Senior Analyst, Financial Services [email protected] 2016

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Ovum | TMT intelligence | informa2 Copyright © Informa PLC

Catalyst Ovum view Cheat sheet Bitcoin helped ignite the distributed ledger market Blockchain technology is more important than Bitcoin Major blockchain players are now emerging

Contents


Blockchain-related technologies are growing at a rapid pace with new developments, announcements, and investments occurring on a near-daily basis. This activity is not restricted to financial services and is now occurring across all industries.

Despite the hype, many remain unsure of what blockchain, or distributed ledger technologies, are and what they mean for their business.

This slide deck aims to provide a broad overview of how this technology works, its implications, and potential use cases in non-financial services businesses. It is aimed at non-experts in blockchain technology.

Catalyst: Despite the hype, blockchain tech remains misunderstood


Bitcoin and blockchain are not a consumer proposition and will not be anytime soon. Bitcoin is more than a currency – exchange rates are volatile, but it will not die easily. Blockchain is at an early stage of development. There are many parallels to the early-stage

Internet, such as its huge development potential and the huge hype surrounding it. The bubble will likely burst at some point soon, if it has not already, but the technology will survive and evolve.

Not everyone needs a blockchain yet and many never will. Many poor use cases are now being developed where a standard database may prove to be more effective.

Blockchain technology has implications for all types of transaction networks, particularly for payments and any other secure transaction. Expect financial markets to lead on deployments.

The huge rush in blockchain service launches is likely to lead to a lack of industry talent in the near term and enterprises should focus on building up knowledge internally.

Enterprises and vendors alike should now be investigating blockchain and distributed ledger technology as it will likely play a major role in some form in the future. True disruption from blockchain is still some way off, but disruption of some sort is likely in the medium term.

Ovum view: Now is the time to experiment with blockchain


Cheat sheet

Distributed ledger A broad term that encompasses blockchain technology, but may use alternative consensus mechanisms than those found in the most popular blockchains. The term is often used interchangeably.

Blockchain Blockchain technology is, in essence, a database technology that allows data to be shared among users without the need for a centralized authority through the use of a consensus mechanism.

Permissioned / permissionless networks

Permissioned blockchain networks are open to users who abide by the protocols and guidelines. In permissionless networks, only invited participants are able to take part.

Bitcoin A virtual or crypto currency using its own blockchain to enable the exchange of Bitcoins. Intended to serve as a digital version of cash, but Bitcoins can be used as markers for other forms of data.

Consensus mechanism The means by which an agreement is achieved across a distributed ledger. Bitcoin uses a proof-of-work mechanism, but other mechanisms exist, such as proof of stake and Byzantine fault tolerance.


Bitcoin led to the boom in distributed ledger technology


"Bitcoin is a remarkable cryptographic achievement and the ability to create something that is not duplicable in the digital world has enormous value.“ – March 2014Eric Schmidt, CEO of Google

"[Virtual currencies] may hold long-term promise, particularly if the innovations promote a faster, more secure, and more efficient payment system.“ – November 2013Ben Bernanke, former chairman of the US Federal Reserve

"Bitcoin is evil.“ – December 2013Paul Krugman, economist, Nobel Prize winner and New York Times columnist

"Greece, Portugal, Spain, Italy. EU countries that won't pay debts. Citizens had enough. Watch the banking system go down in flames. #Bitcoin“ – February 2015Kim Dotcom, hacker and founder of Megaupload

Understanding Bitcoin is a useful starting point for understanding blockchain technology

Bitcoin is among the most hyped and least understood technologies to emerge this century:


Bitcoin's value is volatile and this has clouded understanding of the technology

Source: www.coindesk.com

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Bitcoin is more than an asset or a currency – it is a technology at an early stage of development

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In a brief and elegant nine-page document, the author(s) suggested the means to enable a peer-to-peer electronic cash system using a cryptographic distributed network.

The key goal was to enable an electronic transaction over a communications channel without the need to go through a financial institution.

Rather than a trust-based model, Nakamoto proposed a cryptographic math-based model.

The Bitcoin Protocol model remains open source and is not controlled by any single agent or agency.

Bitcoin was first described in a 2009 white paper by an anonymous writer(s) known as Satoshi Nakamoto

Source: www.newsweek.com


A Bitcoin is a code comprised of dynamic signature data that is secured through cryptography Each Bitcoin contains the electronic signature of its previous owner, and a cryptographically

secure record or "hash" of its previous transactions. On any subsequent transaction the current owner will then electronically sign the Bitcoin and

the hash changes as it passes to its next owner. Bitcoins are not purely fungible and hold a record of their ownership history. Each Bitcoin is digital and can be copied, but also remains unique and can only be spent once.

However, they can also be stolen, destroyed, or lost.

Owner 0 Signature + Hash

Owner 1 Signature +

Hash

Owner 2 Signature +

Hash

Owner 1 Owner 2 Owner 3


The challenge, however, is how to ensure the same coin is not double spent

BitcoinA

BitcoinA

Kanye

Kim

BitcoinA

Taylor

Transaction

Transaction

Which transaction is legitimate?


Nakamoto's solution was a time stamped cryptographic ledger of all transactions, later called the blockchain

Block one

Transaction log

Hash

Block two

Transaction log

Hash

Block three

Transaction log

Hash


But how does the blockchain network reach consensus? This is sometimes known as the Two Generals' Dilemma

Secure message?

Message

MessageSecure

message?

Attack Attack

Without a centralized authority, how can two agents know the validity of a message they have received, or whether their sent message has been received?

This is an established thought experiment in computing theory that ties in with broader networking concepts.


The blockchain's breakthrough is in the use of proof of work cryptography, rather than trust

Nodes within the Bitcoin network, known as miners, compete to reach a mathematical solution, which enables them to organize transactions and time stamp a blockchain block as complete.

This mathematical solution is relatively simple, but requires brute computing power to achieve and is the equivalent of trying every combination on a lock (to an exponential power).

Once a solution is found, it is broadcast to the network and verified, and the miner receives a reward of 12.5 Bitcoin. The network then moves to solving the next block.

Proof-of-work solution: The finish line


The linked nature of the blockchain ensures security through the use of the network's consensus

Time

Less secureMore secure

An attacker's attempt to change an existing block would be rejected as it would change the hash of all following blocks.

An attack at the newest end of the blockchain means an attacker would subsequently require any attacker to outpace the rest of the blockchain network.


As the blockchain grows in scale, the possibilities of attack become diminished A successful attacker would need to control at least 51% of the network. As of July 2016, the entire blockchain's processing power stood at more than 1.4 million

terahashes per second, which is equivalent to 18.4 million petaflops. In comparison, the world's fastest super computer, the Sunway TaihuLight, has a theoretical

maximum processing speed of 93 petaflops.


Bitcoin, however, faces severe challenges in scalability

Bitcoin averages a processing capability of fewer than 10 transactions per second (tps), compared to Visa and MasterCard, which typically handle between 2,000–4,000tps (Visa's capacity is approximately 56,000tps), while PayPal averages 115tps.

Low-level tps capacity is leading to an internal war in the Bitcoin community over whether the size of a block in the blockchain should be scaled up above 1MB, which is likely to lead to a "forking" across Bitcoin.


Bitcoin also faces severe challenges in sustainability Bitcoin mining has lead to the emergence of Bitcoin

pools where miners aggregate computing power, alongside the rise of Bitcoin farms, which mine coins using specialized ASIC hardware.

The resource-intensive nature of Bitcoin – in terms of electricity, heating, and cooling – means much of the mining market is now concentrated in select regions, such as western China, where electricity costs are low due to cheap hydroelectric energy.

As mining becomes more difficult, the economics of Bitcoin become more challenging and will be strongly influenced by the value of Bitcoin, along with external factors such as the cost of electricity.

Low oil prices globally leads to lower energy costs and helps support mining. However, any increase in electricity costs could have a profound effect on the sustainability of mining.

A typical Bitcoin farm (Source: Coindesk)


Blockchain technology is more important than Bitcoin


Blockchain is a nascent technology, but it has created a paradigm shift that others are building on

Bitcoin is not the first distributed ledger, but it is arguably the most successful and has helped to ignite the development of a broader distributed ledger market.

Bitcoin is only one application to use blockchains, and there are many other use cases and blockchains out there. Any form of data could be exchanged and maintained via a blockchain.

Central to this is a blockchain's ability to remove the need for a centralized authority.

Centralized network Distributed network


New services and use cases are now being developed using existing or new blockchains

Altcoins are alternative currencies using their own blockchain, which hold different design features and characteristics to Bitcoin. More than 450 altcoins exist, including the Dogecoin, which is based on a popular online meme (see image at right).

Colored coins are specific Bitcoins that have been marked with data to act as a token for another object of value. Specifically, they are used as an asset management tool using Bitcoin for shares, bonds, and so on.

Sidechains are offshoots of the Bitcoin blockchain in which Bitcoins can be frozen and pegged to alternative currencies. Bitcoin would, therefore, become the dollar base of the virtual currency world.

Potential uses for the blockchain are constantly expanding into other areas. These areas include remittances, micropayments, domain name registration, legal documents, smart contracts, voting, record keeping, gambling, asset trading, identity management, smart devices, and corporate governance.


Alternative consensus mechanisms and distributed ledger technology (DLT) designs are now taking hold Not all DLT applications need a full blockchain – particularly where complete autonomy from

intermediaries is not at issue – thereby giving rise to new kinds of DLTs: Permissionless: like Bitcoin, anyone can take part, with no need for trust Permissioned: preferred by banks and regulators, as only invited members can take part

Permissioned networks are seeing by far the most development by established enterprises and major IT vendors. This is largely being driven by the need for greater security and regulatory compliance. Being censor proof, however, holds no benefit to most businesses.

Other consensus mechanisms are gaining in popularity and do not face the challenges in sustainability or scalability that Bitcoin faces.

This includes proof of stake, whereby mining is only carried out by stakeholders in the network. The bigger their stake, the bigger their role.

A Byzantine fault tolerance-based consensus is based on the use of known and trusted nodes within a network. This mandates some form of central authority to mandate a node, but can be beneficial due to the equal distribution between nodes, meaning small players are equally as important.


Blockchain technology has applications beyond financial services

At its most basic, blockchain-enabled identity can store unfalsifiable and accessible proof of identity, which remains secure through cryptographic hashing, and cannot be lost or destroyed.

This removes the need for storing secure information with third parties and, in theory, reduces the risk of identity theft. Cryptographic keys are harder to hack than guessing user passwords.

Issues remain, however, in terms of initial registration of identity and verification.

Potential applications range from online sign-ins and e-commerce, through to government identification and passports.

Several starts-ups have emerged for blockchain identity registration, such as ShoCard and Onename. There is interest among non-profits and government organizations in developing the technology for use with refugee identification. This includes the ID2020 project and the Bitnation Refugee Emergency Response initiative.


Blockchain tech can help in authenticating the provenance of goods Maintaining a shareable source database of the provenance of an item and its history

throughout its supply cycle can be made more scalable using blockchains. This has potential applications in various industries, including FMCG (fast-moving

consumer goods), food, pharmaceuticals, copyrighted goods and services, and diamonds (as currently being undertaken by Everledger).

Source: www.provenance.org


The blockchain is impacting thinking across technology development and design

In 2015, IBM and Samsung issued a white paper detailing a proof-of-concept of a blockchain-enabled Autonomous Decentralized Peer-to-Peer Telemetry (ADEPT) network. This combines the blockchain with the IoT.

This would enable smart objects such as dishwashers, cars, and televisions to interact autonomously without the need to refer to a central authority server, ensuring scalability.

For instance, a smart washing machine could automatically negotiate in real time with other devices in the house and local power companies, in order to form a temporary contract to purchase electricity at an ideal price, and set itself to wash at an appropriate time.


However, despite the hype, most sectors remain in a proof-of-concept phase

Financial markets remain by far the most advanced in their development of blockchain technology, in most instances using permissioned networks designed for very specific functions, such as Nasdaq's development of private share trading driven by the blockchain.

The broader financial services space is also seeing rapid development through the growth of major distributed ledger technology consortiums and key enterprises such as Ripple, Data Asset Holdings, and the R3 consortium.

Numerous government agencies have also expressed interest in the blockchain as a means of enabling a range of functions, including smarter benefits and aid distribution, and legal document repositories.

However, most sectors, including telecoms and the broader enterprise IT space, remain in a proof-of-concept phase of development.

Many, but not all, of the highly publicized activity from major enterprises revolve around investing in start-ups, investment, and incubation activity.


Major players are now emerging in the blockchain space


Ripple is emerging as among the biggest players to bring the blockchain to financial services The Ripple Protocol from Ripple Labs is a universal

payments system enabling users to transfer funds in any currency, including fiat, digital, or other assets, electronically and internationally, with near-real-time clearing and settlement.

This includes real-time offers on buying or selling currencies and assets, making Ripple the world's first distributed exchange.

Ripple is aimed at financial institutions to enable them to offer these cross-border payment services, by integrating into banks' existing payment stack. It is a financial services back-office function and not a consumer-facing technology.

In May 2014, Germany's Fidor Bank became the first to integrate the Ripple Protocol into its payments infrastructure.

In 2016, Ripple announced a partnership with SAP to develop a cross-border payment proof-of-concept between Canada and Germany using SAP's HANA cloud platform.

Source: Ripple Labs


The distributed ledger market is now seeing the rise of consortiums and pan-blockchain services

R3: A London-based start-up operated by well-connected bankers aiming to create a benchmark blockchain standard across a growing number of participating banks. Focused on the financial services space, the R3 consortium now has major momentum with more than 40 major banks internationally.

Digital Asset Holdings: Run by high-profile former Goldman Sachs bankers, Digital Asset Holdings has been acquiring major blockchain platform start-ups with a focus on delivering distributed ledger technology to major institutions, which includes the Australian Securities Exchange (ASX).

Interledger: A cross-ledger protocol developed by Ripple that enables automated distributed escrow services between distributed ledger networks and interoperability between any blockchain network.


Ethereum aims to add functions to the blockchain to enable any type of contract

Start-up Ethereum is building a blockchain-based network that would enable the inclusion of more complex contractual obligations and functions into its blockchain protocol.

This would allow for complex items to be exchanged and maintained beyond currency, including voting systems, domain name registries, financial exchanges, self-enforcing contracts and agreements, and smart property.

Theoretically, it would enable distributed autonomous corporations that could perform and decide business activity automatically using a set of predefined business rules.

Ethereum is gaining major momentum among developers, including for distributed apps.

In 2016, Ethereum suffered a major crisis due to theft of its underlying currency, which in turn led to a "rewinding fork" to undo the damage.

This was a major blow to Ethereum and it is unclear whether the protocol will survive.


Major IT and consulting companies are now ramping up their blockchain capabilities

Many of the big IT and consulting service providers are now launching blockchain practices, including Ernst & Young, Capgemini, Accenture, Deloitte, ConsenSys, and PwC.

Microsoft has added blockchain-as-a-service capabilities to its Azure platform. This is intended to aid organizations in developing their own industry consortia, along the lines of the R3 consortium.

IBM has been highly proactive in developing its blockchain capabilities, including involvement in major initiatives and consortiums, such as Hyperledger. It is active in numerous proof-of-concept trials with other organizations, including for blockchain security and identity services. IBM operates numerous development labs and industry conferences, and in 2016, announced it was working to develop the merging of blockchain with AI via its Watson platform.

IT services company Cognizant offers blockchain services. In 2016, it announced it was developing a blockchain-based solution for sharing and storing enterprise documents with Mizuho Financial Group.


Appendix

Further readingBlockchain in Financial Services, IT0059-000069 (July 2016)"PSD2, instant payments, and Blockchain: Three problems or one opportunity?," IT0059-000065 (June 2016)"The hype around blockchain is only adding to the confusion," IT0001-000013 (February 2016)"Musical artists and firms look to the blockchain to reform a 'broken' system," ME0002-000621 (October 2015)

AuthorGilles Ubaghs, Senior Analyst, Financial Services [email protected]

Ovum ConsultingWe hope that this analysis will help you make informed and imaginative business decisions. If you have further requirements, Ovum’s consulting team may be able to help you. For more information about Ovum’s consulting capabilities, please contact us directly at [email protected].


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