Distributed ledger technology (DLT) provides a new way of storing data and processing transactions, keeping a record of transactions across multiple computers.
DLT and blockchain are the building block of what’s become known as the “internet of value.” These technologies allow people to transfer value between themselves in a peer-to-peer fashion without needing a centralized third-party intermediary. This is a new digital frontier that has only become widespread since the invention of Bitcoin in 2009.
In this article, we’ll answer questions like what is a distributed ledger, how does distributed ledger technology work, and what are the pros and cons of DLT.
What is Distributed Ledger Technology?
A distributed ledger, sometimes referred to as a shared ledger, is a type of digital record that uses independent computers to record, share, and synchronize transactions.
Whereas a traditional ledger would be contained on a centralized server, distributed ledgers have many different servers in different geographical areas. These servers are referred to as “nodes.” In a blockchain, data gets organized into blocks, which are chained together in a way that makes them immutable, meaning the record can’t be tampered with.
All the computers work in concert to agree that transactions are valid in a process called “achieving consensus.” The entire record of transactions is then kept on file with each computer in the network forever.
DLT is instrumental in Bitcoin transactions, which allow for the peer-to-peer transfer of monetary value over a blockchain. But there are also other potential use cases for DLT and blockchain. Decentralized finance (DeFi), which can bring financial services to those without access to the traditional financial system, is one sector that could be transformative for the world economy.
The Difference Between DLT and Blockchain
While all blockchains are distributed ledgers, not all distributed ledgers are blockchains.
Blockchain technology involve the creation of a specific type of distributed ledger that often establishes an immutable database within a decentralized network that uses cryptography to record and validate all transactions through the use of a specific consensus mechanism. Transactions are processed in groups known as “blocks,” with each block being cryptographically linked to the one that came before it, giving rise to the term “blockchain.”
One fundamental way that blockchains differ from distributed ledgers is consensus. A blockchain has to get all of its nodes to agree that transactions are valid, which is referred to as achieving consensus. Distributed ledgers can be designed in such a way as to achieve this goal without validation from the network as a whole.
Pros and Cons of Distributed Ledger Technology
There are pros and cons of using distributed ledgers. Here are the highlights.
Pros of DLT
The upside of distributed ledger technology includes increased security and transparency, and the lack of need for third-party intermediaries. Let’s do a deeper dive.
Security
A distributed ledger removes the possibility of a single attack vector. From a cybersecurity standpoint, this is an outstanding benefit. With a centralized database, attackers only need to compromise one computer or system. With a distributed ledger, attackers would have to compromise the majority of nodes in the network. This can be difficult if not impossible to accomplish.
Transparency
Most distributed ledgers, including blockchains, are fully public, meaning anyone can see their activity. The records kept by a distributed ledger can only be altered by a party in control of at least 51% of the network’s computing power.
Recommended: What Is a 51% Attack?
No Need for Intermediaries
Using a distributed ledger tends to reduce operational inefficiency. Cutting out third parties can save time and money. These ledgers are beneficial for financial transactions, which currently come with high costs and long wait times.
DLT also has the potential to contribute to positive change in industries like clean energy, manufacturing, and government financial management systems.
Cons of DLT
There are some downsides of distributed ledger technology.
Lack of Agility
Because they are decentralized, making changes to blockchains can be a slow and cumbersome process. A majority of nodes on the network have to agree to any proposed changes.
The Bitcoin Cash (BCH) hard fork of the Bitcoin network in 2017 exemplifies this kind of conflict. Some people wanted to increase the block size for Bitcoin’s blockchain, leading to greater transaction throughput, while others wanted to implement different software changes to achieve similar ends. The result was a hard fork, where some of the computers in the network adopt a slightly different protocol and go on to create their own blockchain.
Potential for Centralization
Distributed ledgers can also take a centralized, permissioned form, and this can create problems. When under the control of a single entity, a distributed ledger could empower a person or organization to do just about anything with the data at their disposal. They would be able to decide who gets access to the system and who doesn’t, while possibly presenting the system as democratic. Permissioned ledgers also require participants to be approved before they can participate in the network.
Recommended: What Happens When Bitcoin Forks?
DLT in Blockchain
A blockchain is a specific type of decentralized, permissionless distributed ledger that groups transactions into blocks. Each block gets attached or “chained” to the previous block, creating a chain of blocks, i.e., a blockchain.
Blockchains are decentralized because their distributed ledgers must achieve consensus across its nodes, meaning no single entity can control the network on its own. Blockchains are permissionless because anyone can use them without needing to obtain permission from a third-party intermediary.
DLT in Finance
DLT has the potential to bring fundamental change to the financial sector, increasing efficiency, reliability, and resiliency in many areas.
The use of DLT could lead to solutions for problems that have plagued financial institutions for many years. Central banks are exploring the possibility of their own central bank digital currencies (CBDCs) using DLT or blockchain. This would, in theory, give central banks direct control over monetary policy and money creation, possibly bypassing national treasuries.
In early 2021, China became the first country to run a real trial of its CBDC, the digital yuan. The digital currency was distributed to a number of digital wallets held on the smartphones of Chinese citizens.
A central bank digital currency would presumably be issued on a permissioned distributed ledger or blockchain, making it subject to the cons of the tech detailed in the section on pros and cons of DLT.
The Takeaway
A distributed ledger is a type of database that gets duplicated, synchronized, and shared across multiple regions, users, and servers without needing centralized confirmation or a specific data structure. Blockchains, for example, are distributed ledgers. But distributed ledger technology could have broader applications, within finance and beyond.
Photo credit: iStock/andresr
SoFi Invest®
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below:
Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.
Crypto: Bitcoin and other cryptocurrencies aren’t endorsed or guaranteed by any government, are volatile, and involve a high degree of risk. Consumer protection and securities laws don’t regulate cryptocurrencies to the same degree as traditional brokerage and investment products. Research and knowledge are essential prerequisites before engaging with any cryptocurrency. US regulators, including FINRA , the SEC , and the CFPB , have issued public advisories concerning digital asset risk. Cryptocurrency purchases should not be made with funds drawn from financial products including student loans, personal loans, mortgage refinancing, savings, retirement funds or traditional investments. Limitations apply to trading certain crypto assets and may not be available to residents of all states.
Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
SOIN0421178
