Many participants and evangelists for the cryptocurrency industry love to tout the benefits of the field and emphasize its disruptive potential. One of the biggest aspects they highlight is blockchain—the revolutionary backbone for most cryptocurrencies—and its use of a distributed ledger. Nevertheless, few understand what a distributed ledger truly is, and how its beneficial qualities define what makes bitcoin and its contemporaries so unique.
The idea of ledgers is not new, as humans have needed to keep track of their assets for millennia. However, decentralized—or distributed—ledgers are a relatively novel concept, and have only been made possible by advances in computer technology. With blockchain-based solutions emerging as a major trend, distributed ledgers are finally getting the spotlight. Understanding what makes them special is an important gateway towards comprehending cryptocurrencies value.
From Paper Ledgers To Digital
Ledgers are the foundational block on which accounting and bookkeeping have evolved. A ledger, in simplest terms, is simply a book that records a person or organization’s incoming and outgoing transfer of assets. For most of their existence, ledgers were paper-based and kept in an individual location—one book meant no one could alter or steal it. However, the advent of computers meant that ledgers, while still functioning essentially the same, could be placed on computers and stored on digital networks.
The new digital ledger brought with it some problems, however. Namely, placing it on a computer connected to a network made ledgers less safe, as anyone could theoretically access them. Nevertheless, advances in networking systems—especially the feasibility of decentralized and mesh networks—gave ledgers a new ability.
By taking advantage of this distributed paradigm, developers created a decentralized ledger that shares information across every point in a network instead of hoarding it within a single node. This spreading of information is not slapdash, but rather employs a sophisticated system that means information is always verified and current across every node in a network.
Distributed ledgers update transactional data to every single node simultaneously. To ensure that every node has the right data, ledger networks have means of achieving consensus about data. In its most basic form, this means that every node votes on the version of data they have, and the version that is most voted on (usually requiring full consensus) becomes the exclusive version of the ledger. This consensus and distributed nature are what give cryptocurrencies some of their most defining characteristics: trustlessness, transparency, and true decentralization.
How The Distributed Ledger Defines Cryptocurrencies
One of the most important characteristics of many cryptocurrencies is their use of blockchain as an infrastructure. The reason many claim the technology is used is its distributed ledger capabilities. Blockchain is itself a type of distributed ledger, albeit one that was designed specifically to support cryptocurrencies. Because it is the building block for most digital coins, blockchain also provides bitcoin and other cryptos the same advantages that define distributed ledgers.
The first major benefit cryptocurrencies derive from blockchain’s distributed ledger is the removal of trust from transactions. In the current economic model, a transaction requires two parties to trust that the other is being truthful and transparent. To ensure this, we have added lawyers, accountants, notaries, payment processors, banks, and other layers of intermediaries to reduce the possibility of fraud.
This need for trust stems from the fact that users cannot independently verify transactions to avoid double processing of each transaction. Since information is placed in a specific location, it is difficult for parties to know with certainty the outcome of their transactions. Concurrently, the impact of including all these intermediaries in the process raises the costs of transactions.
Cryptocurrencies avoid this problem thanks to the way blockchain distributes and stores information about transactions. When two parties agree to exchange value, information about that transaction is distributed to every single node in the blockchain. Once transactions are verified via consensus, they are added to a distributed ledger held by every network participant that is immutable and publicly visible.
This simple process can take seconds and removes the need for intermediaries by providing an irrefutable log of every transaction made. Users can simply verify their ledger to ensure transactions, and trust is no longer needed to complete a deal. Similarly, blockchain’s immutable ledger makes cryptocurrencies significantly more transparent than their fiat counterparts.
Even as users can enjoy anonymity with cryptocurrency, the distributed ledger means that anyone can track existing coins to a particular wallet address (which is used in lieu of a public identity) and see where they were spent. Moreover, anyone can verify a history of transactions, meaning that fraud, shady dealing, and double spending are much harder to get away with.
Finally, this removal of intermediaries and distributed ledger mean that cryptocurrencies completely break free from the outdated centralized model. Because records no longer need to be kept in one location, and communities can vote on the accuracy and verification of transactions, banks, lawyers, and other financial institutions become obsolete. Blockchain’s distributed ledger means that networks are truly decentralized informationally, and completing transactions requires only two parties.
Distributing Data and Power
In the end, cryptocurrency’s real value goes far beyond the monetary. More so than a new way to pay for goods and services, cryptocurrencies provide a paradigm of a more egalitarian and democratic financial system. By taking advantage of distributed ledgers’ inherent benefits, blockchain and cryptocurrencies have built a system that can improve trust in transactions while making them faster, easier, and ultimately cheaper.