Understanding DLT

Common Terms
• Distributed
– Records are maintained on multiple nodes as opposed
to being centralised
• Permissioned vs. Unpermissioned
– Unpermissioned are open to everyone to contribute
data on the ledger and cannot be owned
– Permissioned ledgers may have one or many owners
and only they can add/verify records
– Bitcoin operates on an Unpermissioned basis
– Govt./Corporate systems may consider Permissioned
to control access
 Unpermissioned Ledger
• Unpermissioned ledgers such as Bitcoin have no single
owner — indeed, they cannot be owned. The purpose of an
unpermissioned ledger is to allow anyone to contribute
data to the ledger and for everyone in possession of the
ledger to have identical copies. This creates censorship
resistance, which means that no actor can prevent a
transaction from being added to the ledger. Participants
maintain the integrity of the ledger by reaching a
consensus about its state.
• Unpermissioned ledgers can be used as a global record that
cannot be edited: for declaring a last will and testament, for
example, or assigning property ownership. But they also
pose a challenge to institutional power structures and
existing industries, and this may warrant a policy response.
 Permissioned Ledger
• Permissioned ledgers may have one or many owners. When a new
record is added, the ledger’s integrity is checked by a limited
consensus process. This is carried out by trusted actors —
government departments or banks, for example — which makes
maintaining a shared record much simpler that the consensus
process used by unpermissioned ledgers. Permissioned block chains
provide highly-verifiable data sets because the consensus process
creates a digital signature, which can be seen by all parties.
Requiring many government departments to validate a record could
give a high degree of confidence in the record’s security, for
example, in contrast to the current situation where departments
often have to share data using pieces of paper. A permissioned
ledger is usually faster than an unpermissioned ledger.
 Distributed Ledgers
• Distributed ledgers are a type of database that is spread
across multiple sites, countries or institutions, and is
typically public. Records are stored one after the other in a
continuous ledger, can only be added when the participants
reach a quorum.

• A distributed ledger requires greater trust in the validators

or operators of the ledger. For example, the global financial
transactions system Ripple selects a list of validators
(known as Unique Node Validators) from up to 200 known,
unknown or partially known validators who are trusted not
to collude in defrauding the actors in a transaction. This
process provides a digital signature that is considered less
censorship resistant than Bitcoin’s, but is significantly faster.
 Distributed Ledgers
• Distribution (of ledger) can be controlled
• Can be setup as Permissioned or
Unpermissioned
• Changes made by participants (with
permission) are immediately reflected in all
copies of ledgersa
• Robust in rejecting unauthorised changes,
corrupting ledger becomes difficult.
 Smart Contracts
• Are applications layered on top of Distributed Ledgers
• Smart contracts are contracts whose terms are
recorded in a computer language instead of legal
language. Smart contracts can be automatically
executed by a computing system, such as a suitable
distributed ledger system. The potential benefits of
smart contracts include low contracting, enforcement,
and compliance costs; consequently it becomes
economically viable to form contracts over numerous
low-value transactions.
 Block Chain
• A block chain is a type of database that takes a number of records and puts them
in a block (rather like collating them on to a single sheet of paper). Each block is
then ‘chained’ to the next block, using a cryptographic signature. This allows block
chains to be used like a ledger, which can be shared and corroborated by anyone
with the appropriate permissions.
• There are many ways to corroborate the accuracy of a ledger, but they are broadly
known as consensus (the term ‘mining’ is used for a variant of this process in the
cryptocurrency Bitcoin) — see below.
• If participants in that process are preselected, the ledger is permissioned. If the
process is open to everyone, the ledger is unpermissioned — see below.
• The real novelty of block chain technology is that it is more than just a database —
it can also set rules about a transaction (business logic) that are tied to the
transaction itself. This contrasts with conventional databases, in which rules are
often set at the entire database level, or in the application, but not in the
transaction.
• The key features of DLT/Blockchain, as distinct from other databases, are
associated with its distributed nature. Multiple copies of the ledger are held by
different parties, with data added by consensus and without the need for a third
party. DLT/Blockchain offers …
• An immutable record: Data added to the ledger is in theory unchangeable, secure
and preserved for the life of the ledger, with the agreement of all participants as to
the contents.
• Disintermediation: Nodes are able to interact directly, without the need for an
intermediary. This includes the ability to initiate direct transactions of data or
digitised assets (which may be a dedicated cryptocurrency, such as Bitcoin, or a
digital representation of real-world assets, such as land titles or fiat currency).
• A lack of central control by one party. Additions to the ledger or changes to the
governing structure are decided on a consensus basis by multiple participants.
• New opportunities for management and sharing of data. These opportunities are
achieved by facilitating the storage and access of various forms of data for
participants.
• MDL – Mutual Distributed Ledger
• Blockchain Explorer – morden.ether.camp
allows users to view content of blockchain
• For example, Pinna and Ruttenberg (2016), from the
European Central Bank (ECB), envisage three potential
future scenarios: one in which DLT is adopted to
improve cluster/internal efficiency while business
practices largely remain as they currently are; another
in which core players deploy DLT in specific markets,
with some players becoming redundant; and a third
one where DLT is fully implemented, allowing a peer-
to-peer (P2P), largely dis-intermediated system for
securities transactions. Similar ideas are also echoed in
a number of discussion papers from a variety of private
institutions with the views of market incumbents
typically being more cautious and less optimistic
• In traditional centralized database architecture, information is located, stored, and maintained in a
single location and is controlled by a central administrator, who ensures its integrity. The data is
usually stored in raw form and there is some sort of security perimeter which protects the database
from external attacks.
• Distributed databases provide an alternative configuration where the database (or copies of it) is
spread across the network and is stored at different physical locations. Although the database is
shared across nodes, the control of it is usually centralized and the integrity of the database relies
on a central administrator. A centralized application is used to manage the database and
synchronize the data. The nodes are inside the security perimeter, are trusted, and access is
controlled by the network administrator.
• A distributed ledger (DL)9 is a distributed database, in the sense that each node has a synchronized
copy of the data, but departs from the traditional distributed database architectures in three
important ways:
– Decentralisation: The control of the database (read/write access) is decentralized; that is, it is
performed by multiple (or all) network participants. There is no need for a central
administrator to ensure the integrity of the data or its consistency across nodes. Instead, this
is achieved through some consensus mechanism or validation protocol.
– It is reliable in trust-less environments: The consensus mechanism ensures the consistency
and integrity of the database even if the parties involved do not fully trust each other.
– Cryptographic encryption: The ledger uses cryptographic encryption tools to deliver (1) and (2)
above.
• It is not a-priori clear how DLT might affect the structure of the settlement
industry. In the near term, it is more likely that existing CSDs and other
intermediaries might use DLs in an attempt to lower their operating costs without
significantly changing their business models. In this case, settlement costs for
market end-users may not change substantially as any savings resulting from DLs
could be internalized and simply translate into higher profits for incumbents.
However, given that DLT can in principle facilitate peer-to-peer settlement, in
theory it has the potential to fundamentally alter the structure of the industry over
the longer term by decentralising it. For this reason, we explore here the economic
properties of a hypothetical decentralized DLT-based settlement environment.
• In this new environment, there would likely be no settlement service providers per
se but instead providers of technological solutions that facilitate bilateral
settlement. In other words, end-users would purchase software, technical support
and participation rights in a given DL network, all of which would enable them to
engage in bilateral, decentralized settlement. As such, participation in a DL
settlement network would likely be excludable and therefore, contrary to the DL
know-how itself, constitute a private good.
• Therefore, in traditional blockchain systems the cost of processing transactions includes a variable
component associated with transaction validation and an, at least approximately, fixed component
associated with transaction uniqueness
• PoW involves solving a hash problem,46 the difficulty of which does not depend on the size of the
transaction block. This process is massively computationally intensive, but the computational effort
in mining does not vary ssignificantly with transaction throughput
• It is highly unlikely, however, that future DLT systems for securities clearing and settlement will
utilize traditional blockchain technology. The primary reasons have to do with privacy requirements
of financial market applications and the need for settlement finality.48 Moreover, there is general
recognition that the benefits that proof-of-work provides, such as trust-less validation and
censorship resistance, are neither required nor desired when it comes to securities settlement.
• As such, alternatives to proof-of-work such as Corda’s “Notary” architecture have now emerged
that are driven by requirements around scalability, privacy and usage assumptions. The notary
design differs from other consensus models in that it utilizes a trusted authority, which is
acceptable in many financial market applications. This allows consensus to be reached on an
individual transaction basis, rather than in blocks, with limited information sharing. Other non-
PoW protocols such as Hyperledger Fabric or Intel’s Sawtooth Lake “Proof of Elapsed Time”
algorithm preserve the blockchain structure, but modify the consensus process in order to allow
enhanced confidentiality and scalability.
• DL systems that do not rely on proof-of-work have significantly lower costs of ensuring transaction
uniqueness than traditional blockchain systems. Moreover, transaction validation can be done using
a partial history of DL transactions and hence the costs to perform this function do not increase
proportionally with the size of the network or the number of transactions.
• VCs can be centralised, decentralised or hybrid (ripple)
• The operation of VC schemes includes three components: (i) the issuance and
redeemability of the VC; (ii) mechanisms to implement and enforce internal rules
on the use and circulation of the currency; and (iii) the payment and settlement
process. Each area of operation may be managed by a trusted central (and private)
party or in a decentralized manner among participants. Hybrid schemes also exist,
where some functions are performed by a central authority, while others are
distributed among market participants
• In decentralized systems, there is no central party (for example, a central bank)
administering the system or issuing VCs. Rather, the central party is replaced by a
framework of internal protocols that govern the operation of the system and allow
the verification of transactions to be performed by the system participants
themselves. As payments and transactions are made through the system, these
participants (often referred to as “miners”) are rewarded in newly minted
“currency” for performing the payment processing function (referred to as
“mining”). This approach serves two purposes: it introduces newly minted VCs into
the system and enables the decentralized operation of the VC scheme. In contrast
to fiat currency, a cryptocurrency does not represent a liability on anyone.
• Distributed ledger technologies have the
potential to change finance by reducing costs and
allowing for wider financial inclusion. In principle,
they could be applied independently of a VC to
any area that requires fast, accurate, and secure
record keeping (for example, land and credit
registries, and payment and settlement
infrastructure for transactions in existing
currencies, securities, and other assets).17 In
particular, it is possible to design distributed
ledgers for transactions denominated in fiat
currencies, instead of in VCs.
• Transaction Verification and Recording
• A transaction may be initiated by any party on the network that owns assets on that network or has
access to the assets on the owner’s behalf. When a transaction is initiated, it is verified on the
network based on a pre-determined verification process. The verification process generally involves
confirmation from one or more nodes10 on the network that the buyer and seller are the rightful
owners of the assets they seek to exchange, based on transaction history records on the DLT
network. The time required to verify and record a transaction on the DLT network can vary
depending on the process employed. If the network uses a consensus-based11 or proof-ofwork-
based12 verification method, it may create some latency depending on the time required to
achieve consensus and solve for proof-of-work requirements.13 Some private networks are
exploring alternative verification methodologies that would reduce the time needed for verification
and recording. The settlement of the transaction may be contemporaneous with the verification
process, whereby the new ownership of the asset or funds is reflected on the DLT network.
• Once a transaction is verified, the information is “cryptographically hashed”14 and permanently
recorded on the DLT network. The records are time stamped and displayed in a sequential manner
to all arties on the network who have the appropriate access levels. It is claimed by many that this
cryptographic hashing process secures the integrity of the data, such that once it is recorded on the
network it cannot be modified; any errors would need to be fixed with new correcting amended
entries. However, some technologists are reportedly exploring ways to create functionalities to edit
DLT transaction records in certain circumstances. One vendor has reportedly developed a prototype
of the capability to edit blockchain records in private DLT networks.
• Governance
• Operating Structure
– Participant Access, On-boarding, Off-boarding
– Transaction Validation
– Asset Representation
– Data and Transparency Requirements
• Network Security
• 12 For overview of the role of
rehypothecation and commingling of assets in
the Lehman failure see (Deryugina, 2009).
• 19 (Vigna & Casey, 2016) is one lucid
statement of this point of view. (Wright & De
Filippi, 2015) discuss the legal consequences
of such a profound change in economic
relationships. Sharing Economy
• Digital Assets on a DLT Network - A DLT network frequently
contains assets that are digitally represented. The digital
assets may be created on the network (e.g.,
cryptosecurities, cryptocurrencies), or may be a digital
representation on the network of a traditional asset that is
stored offline (referred to as “tokenized assets”)
• Assets on a DLT network, whether public or private, are
cryptographically secured using a publicprivate key
combination. A public key is the “address” where the digital
asset is located on the network. A private key is the code
that gives the holder access to the asset at the address
represented by the corresponding public key. The private
key is designed to be retained by the asset holder or its
agent to access the asset.
• Cost Savings
• New rev. opportunities
• Cost reduction – simplify, rationalise infra… simple more rationalised platform
across participants..
• Upgradation of central market infra to Block Chain …
• Gradual evolution – DTCC upgrade –
Trade Repository for CDS.., then advance developments, shared ledgers, shared
ledgers as single point of proof..also CLS
• ISDA Common Domain model – common ind std, process on which block chain will
work
• Sharing of Hash es will allow keeping data private but improve transparency
• New networks and their interoperability
• Simpler cases first .. Complex later .. Securities netting settlement – 10 yrs from
now .. Etc
• Standards are crucial in the coming years … adopting these for systems without
native token. Common virtual machines, common code.. As if built from scratch
across companies..
• Limitation - HFT – low latency & high
throughput – challenge in consensus mech-
BC/DTL is not suitable for everything
• Exotic Products –Struct derivatives – has many
manual interventions etc – counterparty
confirmations , terms sheets are different …
single ledger eliminates these inefficiencies