Ideas & Updates

Distributed Ledger Technology: What Is It and Why Do We Care?

Blockchain Series: Blog 1

Distributed Ledger Technology (DLT), often referred to as blockchain, has garnered a lot of attention in the past few years. Is it just “a solution in search of a problem” or, does it offer answers for real-world policy questions such digital identity and remittances? This six-blog series, by Rodrigo Mejia Ricart and Camilo Tellez, aims to foster a better understanding of the technology. The first three blogs discuss what is DLT, the debate around key stated benefits and the evidence around different use cases. The last three blogs discuss DLT for digital identity, supply chain and remittances in detail.

Bitcoin is the most famous use-case for DLT and it boomed in 2017. The price of the cryptocurrency started the year at US$900 and peaked at nearly US$20,000 per bitcoin. Other cryptocurrencies also experienced exponential growth. Many DLT enthusiasts saw this rush as confirmation of the huge potential and bright future that awaited the technology. Conversely, the subsequent “bitcoin crash”—which saw its value plummet to US$3,217 by December 2018—was evidence to skeptics that the technology at best was hugely unpredictable, and at worst, had no future. Both conclusions reveal a fundamental misunderstanding that conflates bitcoin, or cryptocurrencies generally, with one of its enabling technologies.

Bitcoin was born in the midst of the global financial crisis and the widespread recession that followed. The period was characterized by diminishing trust in financial and regulatory institutions, and frustration with existing digital payments infrastructure. Against this backdrop, bitcoin presented the world with two technological breakthroughs that must be clearly distinguished: first, a cryptocurrency or crypto-asset—that is, a digital or virtual instrument of value exchange that uses cryptography for security and verification; and second, a blockchain or distributed ledger that serves as a shared, synchronized and tamper-proof record of transactions that enables trust and coordination between participants without the need for a central authority. Importantly these two technologies may or may not be implemented together.

Definitions

Distributed Ledger Technology (DLT): DLT refers to a fast-evolving approach to recording and sharing data across multiple data stores (or ledgers).This technology allows for transactions and data to be recorded, shared and synchronized across a distributed network of different network participants (see Figure 1 below). More than a single technology, DLT refers to a range of technologies that, while similar in structure, may be implemented in different ways and following different rules. DLTs can be broadly categorized as public or private depending on whether the ledgers can be accessed by anyone or only by the devices (also known as nodes) participating in the network. They can also be classified as permissioned or permissionless based on whether the participants in the network need permission from a specific entity to be able to make changes to the ledger.

Blockchain: A “blockchain” is a particular type of data structure used in some distributed ledgers, which stores and transmits data in packages called “blocks” that are connected to each other in a digital “chain.” Blockchains employ cryptographic and algorithmic methods to record and synchronize data across a network, ensuring ledger is immutable—that is, it cannot be altered.

Source: Natarajan, H. et al, (2017) Distributed Ledger Technology and Blockchain, FinTech note no. 1, Washington, D.C.: World Bank Group

Figure 1. Types of Networks

Source: Based on Baran (1962), On Distributed Communications Networks. https://www.rand.org/content/dam/rand/pubs/papers/2005/P2626.pdf

Why we care: Keeping abreast of innovation in digital payments and financial inclusion

Beyond the bitcoin fever of 2017, interest in distributed ledgers has also been driven by a growing appreciation of the wide range of potential use cases and applications of this data architecture. Distributed ledgers have created unique digital assets that do not need a central authority to ensure that they cannot be duplicated or “spent” twice. From digital identification to self-enforcing “smart contracts,” from property registries and electoral voting systems to supply chain management, from health records to financial services, new potential applications for distributed ledgers have been emerging at a breakneck pace, although the scalability of many potential applications remains an open question.

The Better Than Cash Alliance (BTCA) is interested in this topic, as many DLT-based initiatives have the potential to replace the use of cash. A recent report by the Stanford Graduate School of Business conducted a global landscaping of DLT-based initiatives, examining their social impact across countries and sectors. The report assessed 194 initiatives, of which 25% were focused on payments and money transfers. The report also showed that only the health sector has attracted more initiatives than financial inclusion. Initiatives focused on DLT-based financial inclusion are frequently ambitious in terms of scale, with 68% of such initiatives aiming to reach over 1 million people.

The authors of the Stanford report underline DLT’s potential, estimating that 20% of the initiatives studied proposed solutions for problems that could not have been otherwise solved, and 86% set out clear performance improvements compared to existing solutions, providing another illustration of why the subject is of such importance to the Alliance.

Indeed, some members of the Alliance are already experimenting with distributed ledgers to advance digital payments and financial inclusion. For instance, Sierra Leone and UNCDF have recently launched an initiative to pilot a digital identification system designed with financial inclusion in mind. Other key actors in this space include the World Bank and USAID, which have recently published primers on the technology and the relevance of blockchain to international development, and the World Food Programme (WFP), which has developed a DLT-based solution known as Building Blocks to deliver cash-based assistance digitally. This solution has been successfully tested in Pakistan and Jordan, with preliminary results from the initiative already enabling important enhancements. In particular:

WFP reports improvement in management of beneficiary data, and now has an internal record of transactions
WFP has achieved savings reconciliation of balance sheets between institutions
WFP reports 98% savings in bank fees
WFP no longer needs to advance funds to financial service providers
Beneficiaries’ experiences have remained constant

74% of the DLT initiatives analyzed in a 2018 Stanford University report were still at the concept or pilot stage

However, it should also be noted that many DLT-based applications are still at an early stage, as indicated by the Stanford report. Of the 194 initiatives analyzed in the report, 34% were launched in 2017 and 74% are still at the conceptual or pilot stage. Further, DLT-based technology has shown a tendency to generate hype that can lead to misinformation, making it difficult to assess the technology on its merits. At the same time, there has been a heavy focus on the use of the technology, rather than the problem that needs to be solved. It may seem at times as if the use of the technology becomes an end in itself, perhaps as a means to signal innovation, rather than a tool than can help solve the problem in question.

Some key questions that can underpin a more informed and robust debate about the technology might include:

What can DLT solve that cannot be solved with other digital solutions, or at least not with the same efficiency and effectiveness?
What are the types of problems that can be solved with DLT?
Why use a shared ledger instead of a single ledger with multiple backups and other security measures?
What are the challenges associated with the use of the technology based experiences to date?

These questions motivate the ambition of this blog series. We hope that by keeping these questions in mind, we are able to stir a more productive conversation, distancing ourselves from both the hype and unreasonable pessimism.