Ovum blockchain for beginners

Blockchain for Beginners
Distributed ledger technology for the non-expert
Gilles Ubaghs, Senior Analyst, Financial Services Technology
gilles.ubaghs@ovum.com
IT0059-000071
September 2016

Ovum | TMT intelligence | informa2 Copyright © Informa PLC
 Catalyst
 Ovum view
 Cheat sheet
 Bitcoin helped ignite the distributed ledger market
 Blockchain technology is more important than Bitcoin
 Major blockchain players are now emerging
Contents

 Blockchain-related technologies are growing at a rapid pace with new developments,
announcements, and investments occurring on a near-daily basis. This activity is not
restricted to financial services and is now occurring across all industries.
 Despite the hype, many remain unsure of what blockchain, or distributed ledger
technologies, are and what they mean for their business.
 This slide deck aims to provide a broad overview of how this technology works, its
implications, and potential use cases in non-financial services businesses. It is aimed at
non-experts in blockchain technology.
Catalyst: Despite the hype, blockchain tech remains misunderstood

 Bitcoin and blockchain are not a consumer proposition and will not be anytime soon.
 Bitcoin is more than a currency – exchange rates are volatile, but it will not die easily.
 Blockchain is at an early stage of development. There are many parallels to the early-stage
Internet, such as its huge development potential and the huge hype surrounding it. The bubble will
likely burst at some point soon, if it has not already, but the technology will survive and evolve.
 Not everyone needs a blockchain yet and many never will. Many poor use cases are now being
developed where a standard database may prove to be more effective.
 Blockchain technology has implications for all types of transaction networks, particularly for
payments and any other secure transaction. Expect financial markets to lead on deployments.
 The huge rush in blockchain service launches is likely to lead to a lack of industry talent in the near
term and enterprises should focus on building up knowledge internally.
 Enterprises and vendors alike should now be investigating blockchain and distributed ledger
technology as it will likely play a major role in some form in the future. True disruption from
blockchain is still some way off, but disruption of some sort is likely in the medium term.
Ovum view: Now is the time to experiment with blockchain

Cheat sheet
Distributed ledger A broad term that encompasses blockchain technology, but may use alternative
consensus mechanisms than those found in the most popular blockchains. The term is
often used interchangeably.
Blockchain Blockchain technology is, in essence, a database technology that allows data to be
shared among users without the need for a centralized authority through the use of a
consensus mechanism.
Permissioned /
permissionless networks
Permissioned blockchain networks are open to users who abide by the protocols and
guidelines. In permissionless networks, only invited participants are able to take part.
Bitcoin A virtual or crypto currency using its own blockchain to enable the exchange of
Bitcoins. Intended to serve as a digital version of cash, but Bitcoins can be used as
markers for other forms of data.
Consensus mechanism The means by which an agreement is achieved across a distributed ledger. Bitcoin
uses a proof-of-work mechanism, but other mechanisms exist, such as proof of stake
and Byzantine fault tolerance.

Bitcoin led to the
boom in distributed
ledger technology

 "Bitcoin is a remarkable cryptographic achievement and the ability to create something
that is not duplicable in the digital world has enormous value.“ – March 2014
Eric Schmidt, CEO of Google
 "[Virtual currencies] may hold long-term promise, particularly if the innovations
promote a faster, more secure, and more efficient payment system.“ – November 2013
Ben Bernanke, former chairman of the US Federal Reserve
 "Bitcoin is evil.“ – December 2013
Paul Krugman, economist, Nobel Prize winner and New York Times columnist
 "Greece, Portugal, Spain, Italy. EU countries that won't pay debts. Citizens had enough.
Watch the banking system go down in flames. #Bitcoin“ – February 2015
Kim Dotcom, hacker and founder of Megaupload
Understanding Bitcoin is a useful starting point for understanding
blockchain technology
Bitcoin is among the most hyped and least understood technologies to emerge
this century:

Bitcoin's value is volatile and this has clouded understanding of the
technology
Source: www.coindesk.com
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Bitcoin closing price

Bitcoin is more than an asset or a currency – it is a technology at an
early stage of development
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$m
Venture capital investment funding in Bitcoin-related start-ups
Source: www.coindesk.com

 In a brief and elegant nine-page document, the
author(s) suggested the means to enable a peer-to-
peer electronic cash system using a cryptographic
distributed network.
 The key goal was to enable an electronic transaction
over a communications channel without the need to
go through a financial institution.
 Rather than a trust-based model, Nakamoto
proposed a cryptographic math-based model.
 The Bitcoin Protocol model remains open source and
is not controlled by any single agent or agency.
Bitcoin was first described in a 2009 white paper by an anonymous
writer(s) known as Satoshi Nakamoto
Source: www.newsweek.com

A Bitcoin is a code comprised of dynamic signature data that is
secured through cryptography
 Each Bitcoin contains the electronic signature of its previous owner, and a cryptographically
secure record or "hash" of its previous transactions.
 On any subsequent transaction the current owner will then electronically sign the Bitcoin and
the hash changes as it passes to its next owner.
 Bitcoins are not purely fungible and hold a record of their ownership history.
 Each Bitcoin is digital and can be copied, but also remains unique and can only be spent once.
However, they can also be stolen, destroyed, or lost.
Owner 0
Signature + Hash
Owner 1
Signature +
Hash
Owner 2
Signature +
Hash
Owner 1 Owner 2 Owner 3

The challenge, however, is how to ensure the same coin is not
double spent
Bitcoin
A
Bitcoin
A
Kanye
Kim
Bitcoin
A
Taylor
Which transaction
is legitimate?

Nakamoto's solution was a time stamped cryptographic ledger of
all transactions, later called the blockchain
Block one
Transaction log
Hash
Block two
Transaction log
Hash
Block three
Transaction log
Hash

But how does the blockchain network reach consensus? This is
sometimes known as the Two Generals' Dilemma
Secure
message?
Message
Message
Secure
message?
 Without a centralized authority,
how can two agents know the
validity of a message they have
received, or whether their sent
message has been received?
 This is an established thought
experiment in computing theory
that ties in with broader
networking concepts.

The blockchain's breakthrough is in the use of proof of work
cryptography, rather than trust
 Nodes within the Bitcoin network, known as
miners, compete to reach a mathematical
solution, which enables them to organize
transactions and time stamp a blockchain block
as complete.
 This mathematical solution is relatively simple,
but requires brute computing power to achieve
and is the equivalent of trying every
combination on a lock (to an exponential
power).
 Once a solution is found, it is broadcast to the
network and verified, and the miner receives a
reward of 12.5 Bitcoin. The network then moves
to solving the next block.
Proof-of-work solution: The finish line

The linked nature of the blockchain ensures security through the
use of the network's consensus
Time
Less secureMore secure
 An attacker's attempt to change an existing block would be rejected as it would change the
hash of all following blocks.
 An attack at the newest end of the blockchain means an attacker would subsequently require
any attacker to outpace the rest of the blockchain network.

As the blockchain grows in scale, the possibilities of attack become
diminished
 A successful attacker would need to control at least 51% of the network.
 As of July 2016, the entire blockchain's processing power stood at more than 1.4 million
terahashes per second, which is equivalent to 18.4 million petaflops.
 In comparison, the world's fastest super computer, the Sunway TaihuLight, has a theoretical
maximum processing speed of 93 petaflops.

Bitcoin, however, faces severe challenges in scalability
 Bitcoin averages a processing capability of fewer than 10 transactions per second (tps),
compared to Visa and MasterCard, which typically handle between 2,000–4,000tps (Visa's
capacity is approximately 56,000tps), while PayPal averages 115tps.
 Low-level tps capacity is leading to an internal war in the Bitcoin community over whether
the size of a block in the blockchain should be scaled up above 1MB, which is likely to lead to
a "forking" across Bitcoin.

Bitcoin also faces severe challenges in sustainability
 Bitcoin mining has lead to the emergence of Bitcoin
pools where miners aggregate computing power,
alongside the rise of Bitcoin farms, which mine coins
using specialized ASIC hardware.
 The resource-intensive nature of Bitcoin – in terms of
electricity, heating, and cooling – means much of the
mining market is now concentrated in select regions,
such as western China, where electricity costs are low
due to cheap hydroelectric energy.
 As mining becomes more difficult, the economics of
Bitcoin become more challenging and will be strongly
influenced by the value of Bitcoin, along with external
factors such as the cost of electricity.
 Low oil prices globally leads to lower energy costs and
helps support mining. However, any increase in
electricity costs could have a profound effect on the
sustainability of mining.
A typical Bitcoin farm (Source: Coindesk)

Blockchain technology
is more important
than Bitcoin

Blockchain is a nascent technology, but it has created a paradigm
shift that others are building on
 Bitcoin is not the first distributed ledger, but it is arguably the most successful and has helped to
ignite the development of a broader distributed ledger market.
 Bitcoin is only one application to use blockchains, and there are many other use cases and
blockchains out there. Any form of data could be exchanged and maintained via a blockchain.
 Central to this is a blockchain's ability to remove the need for a centralized authority.
Centralized network Distributed network

New services and use cases are now being developed using
existing or new blockchains
 Altcoins are alternative currencies using their own blockchain, which
hold different design features and characteristics to Bitcoin. More
than 450 altcoins exist, including the Dogecoin, which is based on a
popular online meme (see image at right).
 Colored coins are specific Bitcoins that have been marked with data
to act as a token for another object of value. Specifically, they are
used as an asset management tool using Bitcoin for shares, bonds,
and so on.
 Sidechains are offshoots of the Bitcoin blockchain in which Bitcoins
can be frozen and pegged to alternative currencies. Bitcoin would,
therefore, become the dollar base of the virtual currency world.
 Potential uses for the blockchain are constantly expanding into
other areas. These areas include remittances, micropayments,
domain name registration, legal documents, smart contracts, voting,
record keeping, gambling, asset trading, identity management, smart
devices, and corporate governance.

Alternative consensus mechanisms and distributed ledger
technology (DLT) designs are now taking hold
 Not all DLT applications need a full blockchain – particularly where complete autonomy from
intermediaries is not at issue – thereby giving rise to new kinds of DLTs:
 Permissionless: like Bitcoin, anyone can take part, with no need for trust
 Permissioned: preferred by banks and regulators, as only invited members can take part
 Permissioned networks are seeing by far the most development by established enterprises and
major IT vendors. This is largely being driven by the need for greater security and regulatory
compliance. Being censor proof, however, holds no benefit to most businesses.
 Other consensus mechanisms are gaining in popularity and do not face the challenges in
sustainability or scalability that Bitcoin faces.
 This includes proof of stake, whereby mining is only carried out by stakeholders in the network.
The bigger their stake, the bigger their role.
 A Byzantine fault tolerance-based consensus is based on the use of known and trusted nodes
within a network. This mandates some form of central authority to mandate a node, but can be
beneficial due to the equal distribution between nodes, meaning small players are equally as
important.

Blockchain technology has applications beyond financial services
 At its most basic, blockchain-enabled identity can store
unfalsifiable and accessible proof of identity, which remains
secure through cryptographic hashing, and cannot be lost or
destroyed.
 This removes the need for storing secure information with
third parties and, in theory, reduces the risk of identity theft.
Cryptographic keys are harder to hack than guessing user
passwords.
 Issues remain, however, in terms of initial registration of
identity and verification.
 Potential applications range from online sign-ins and e-
commerce, through to government identification and
passports.
 Several starts-ups have emerged for blockchain identity
registration, such as ShoCard and Onename. There is interest
among non-profits and government organizations in
developing the technology for use with refugee
identification. This includes the ID2020 project and the
Bitnation Refugee Emergency Response initiative.

Blockchain tech can help in authenticating the provenance of goods
 Maintaining a shareable source database of the provenance of an item and its history
throughout its supply cycle can be made more scalable using blockchains.
 This has potential applications in various industries, including FMCG (fast-moving
consumer goods), food, pharmaceuticals, copyrighted goods and services, and diamonds
(as currently being undertaken by Everledger).
Source: www.provenance.org

The blockchain is impacting thinking across technology
development and design
 In 2015, IBM and Samsung issued a white paper detailing a
proof-of-concept of a blockchain-enabled Autonomous
Decentralized Peer-to-Peer Telemetry (ADEPT) network. This
combines the blockchain with the IoT.
 This would enable smart objects such as dishwashers, cars, and
televisions to interact autonomously without the need to refer
to a central authority server, ensuring scalability.
 For instance, a smart washing machine could automatically
negotiate in real time with other devices in the house and local
power companies, in order to form a temporary contract to
purchase electricity at an ideal price, and set itself to wash at an
appropriate time.

However, despite the hype, most sectors remain in a proof-of-
concept phase
 Financial markets remain by far the most advanced in their development of blockchain
technology, in most instances using permissioned networks designed for very specific functions,
such as Nasdaq's development of private share trading driven by the blockchain.
 The broader financial services space is also seeing rapid development through the growth of
major distributed ledger technology consortiums and key enterprises such as Ripple, Data Asset
Holdings, and the R3 consortium.
 Numerous government agencies have also expressed interest in the blockchain as a means of
enabling a range of functions, including smarter benefits and aid distribution, and legal
document repositories.
 However, most sectors, including telecoms and the broader enterprise IT space, remain in a
proof-of-concept phase of development.
 Many, but not all, of the highly publicized activity from major enterprises revolve around
investing in start-ups, investment, and incubation activity.

Major players are now
emerging in the
blockchain space

Ripple is emerging as among the biggest players to bring the
blockchain to financial services
 The Ripple Protocol from Ripple Labs is a universal
payments system enabling users to transfer funds in
any currency, including fiat, digital, or other assets,
electronically and internationally, with near-real-
time clearing and settlement.
 This includes real-time offers on buying or selling
currencies and assets, making Ripple the world's
first distributed exchange.
 Ripple is aimed at financial institutions to enable
them to offer these cross-border payment services,
by integrating into banks' existing payment stack. It
is a financial services back-office function and not a
consumer-facing technology.
 In May 2014, Germany's Fidor Bank became the first
to integrate the Ripple Protocol into its payments
infrastructure.
 In 2016, Ripple announced a partnership with SAP
to develop a cross-border payment proof-of-
concept between Canada and Germany using SAP's
HANA cloud platform.
Source: Ripple Labs

The distributed ledger market is now seeing the rise of
consortiums and pan-blockchain services
 R3: A London-based start-up operated by well-connected bankers
aiming to create a benchmark blockchain standard across a growing
number of participating banks. Focused on the financial services space,
the R3 consortium now has major momentum with more than 40 major
banks internationally.
 Digital Asset Holdings: Run by high-profile former Goldman Sachs
bankers, Digital Asset Holdings has been acquiring major blockchain
platform start-ups with a focus on delivering distributed ledger
technology to major institutions, which includes the Australian
Securities Exchange (ASX).
 Interledger: A cross-ledger protocol developed by Ripple that enables
automated distributed escrow services between distributed ledger
networks and interoperability between any blockchain network.

Ethereum aims to add functions to the blockchain to enable any
type of contract
 Start-up Ethereum is building a blockchain-based network that would
enable the inclusion of more complex contractual obligations and
functions into its blockchain protocol.
 This would allow for complex items to be exchanged and maintained
beyond currency, including voting systems, domain name registries,
financial exchanges, self-enforcing contracts and agreements, and
smart property.
 Theoretically, it would enable distributed autonomous corporations
that could perform and decide business activity automatically using a
set of predefined business rules.
 Ethereum is gaining major momentum among developers, including
for distributed apps.
 In 2016, Ethereum suffered a major crisis due to theft of its
underlying currency, which in turn led to a "rewinding fork" to undo
the damage.
 This was a major blow to Ethereum and it is unclear whether the
protocol will survive.

Major IT and consulting companies are now ramping up their
blockchain capabilities
 Many of the big IT and consulting service providers are now launching blockchain practices,
including Ernst & Young, Capgemini, Accenture, Deloitte, ConsenSys, and PwC.
 Microsoft has added blockchain-as-a-service capabilities to its Azure platform. This is intended
to aid organizations in developing their own industry consortia, along the lines of the R3
consortium.
 IBM has been highly proactive in developing its blockchain capabilities, including involvement in
major initiatives and consortiums, such as Hyperledger. It is active in numerous proof-of-
concept trials with other organizations, including for blockchain security and identity services.
IBM operates numerous development labs and industry conferences, and in 2016, announced it
was working to develop the merging of blockchain with AI via its Watson platform.
 IT services company Cognizant offers blockchain services. In 2016, it announced it was
developing a blockchain-based solution for sharing and storing enterprise documents with
Mizuho Financial Group.

Appendix
Further reading
Blockchain in Financial Services, IT0059-000069 (July 2016)
"PSD2, instant payments, and Blockchain: Three problems or one opportunity?," IT0059-000065 (June 2016)
"The hype around blockchain is only adding to the confusion," IT0001-000013 (February 2016)
"Musical artists and firms look to the blockchain to reform a 'broken' system," ME0002-000621 (October 2015)
Author
Gilles Ubaghs, Senior Analyst, Financial Services Technology
gilles.ubaghs@ovum.com
Ovum Consulting
We hope that this analysis will help you make informed and imaginative business decisions. If you have further
requirements, Ovum’s consulting team may be able to help you. For more information about Ovum’s consulting
capabilities, please contact us directly at consulting@ovum.com.

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