In the traditional payment system, the bank is the trusted third party between a buyer and a seller, an employee and an employer. The financial institution is responsible for verifying that a check beneficiary has not already cashed the funds and that the payer has sufficient balance to honor the payment instruction.
However, the intermediary-type financial system is no longer the only way people move money around and pay for goods and services. This article discusses the technology for validating payment transactions outside a central authority.
Distributed Ledger Technology (DLT) — Explained
A distributed ledger technology (DLT) is the logic behind a system where incoming and outgoing transactions are verifiable via a network of shared participants as each user maintains a synchronized copy of the data from anywhere. It is a peer-to-peer (P2P) network enabling simultaneous access and records validation in an immutable manner and without the need for an intermediary.
Summarily, DLT is all about the idea of an autonomous record-keeping system as opposed to the traditional centralized data validation method. Notably, the concept of a distributed ledger is not entirely novel, but it rose to fame with the advent of Bitcoin (BTC).
How Does DLT Technically Work?
DLT enables the safe and accurate storing of electronic data through cryptography, which is accessible only to authorized users via cryptographic signatures. Individuals called nodes technically control this process. Also, before a valid transaction becomes accepted into the ledger, all nodes vote.
The new transaction will successfully go into the database if at least 51% of nodes concur. After that, the nodes update the database versions to ensure that every device or node runs similarly. Furthermore, once the data goes live into the network, it becomes irreversible and unchangeable.
Conventionally, central databases are susceptible to cyber exploits as their data rests in a precise location. However, decentralized ledgers are impervious to cybercrime by their very design because an attacker must simultaneously target every copy stored throughout the network to be successful. Therefore, it is nearly impossible and uneconomical for anyone to manipulate a DLT-based system for any gain.
Categories of Distributed Ledgers
Distributed ledgers can be private or public and, alongside, permissioned or permissionless. Private and permissioned networks offer no decentralization, as participants join the system via invitation after satisfying specific requirements and KYC. Experts contend that distributed ledgers must be public, permissionless networks to achieve complete decentralization.
Blockchain VS Distributed Ledger
As Bitcoin promulgated the idea of decentralization, people synonymously refer to DLT as blockchain technology. However, blockchain is merely an example of what a distributed ledger represents. Additionally, blockchain is the technology powering virtual currencies like Bitcoin, Ethereum (ETH), and other cryptocurrencies.
Consequently, all crypto transactions are publicly accessible on the internet to any party of interest since they work based on the distributed ledger concept. On the other hand, the financial dealings one makes with a bank are out of public scrutiny because they are within the control of a central authority.
More Applications of DLT
According to the financial market research firm Investopedia, DLT can assist with tax collection, passport issuing, land registration and license recording, the payment of Social Security benefits, and voting procedures.
Furthermore, many large corporations, including Meta, IBM, and Microsoft, as well as start-ups, have tested blockchain technology. Illustratively, the New York-based capital market firm Axoni introduced a distributed ledger platform in 2020 for handling stock swap transactions. BlackRock, Goldman Sachs Group, and Citigroup utilize the platform to compare and reconcile post-trade data on stock swaps.
Presently, the usefulness of distributed ledger technology is observable in many industries, including finance, health, music, entertainment, art, and more. The most popular enterprise-level distributed ledger protocols transforming these sectors include Bitcoin, Ethereum, and Ripple.
Bitcoin is the first successful electronic cash system to function independently of a central bank. Its founder, Satoshi Nakamoto, intended the virtual currency to substitute the traditional cash system, where users make non-reversible payments with meager transaction fees to anyone anywhere in the world without delays.
Ethereum is the second most famous example of distributed ledger protocol, especially among programmers. With its native token, Ether (ETH), developers build custom, self-executing applications called smart contracts. Additionally, ETH functions similarly to BTC as a store of wealth, a payment method, and collateral.
Another example of a distributed ledger that focuses on payments, particularly cross-border transactions, is Ripple. The developers of Ripple (XRP) intended it for banks to help them facilitate intercontinental payment.
Distributed ledger technology is a revolutionary concept where systems agree on a single fact and where saved data are tamper-proof. The technology's high level of transparency will fundamentally alter how businesses, organizations, and governments operate.
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This article should not be taken as a piece of financial advice. It is essential to conduct your research before making investment decisions.