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What is blockchain?

Blockchain technologies have the potential to disrupt the work of finance teams – particularly those focused on transactional tasks – by offering a system of universal entry bookkeeping, removing the need for independent verification. Here ICAEW’s IT Faculty and Deloitte outline the basics of this complex and developing technology.

Blockchain is simply a database that is distributed among a community of members, meaning that all the participants work together to maintain the log of entries. 

A blockchain is an ever-lengthening chain of blocks of data. Each block contains a record of a change or transaction that is locked in chronological order and secured using cryptography. 

Once added, records are in effect permanent and immutable. They cannot be lost or denied. If something is recorded on a blockchain it’s deemed by users to be true. Group verification removes the requirement for intermediaries, anyone can access the record to verify that a transaction took place. 

What may sound unwieldy and rigid in an era of fluid technology is useful for just that reason: in an infinitely editable environment, the blockchain represents a single, immutable truth.

Blockchain vs traditional ledgers

There are three key differences in how blockchain differs from more familiar ledgers:

  • Propagation: New transactions originate with one user, but propagate to a network of identical ledgers, without a central controller.
  • Permanence: All transactions and records are permanent, unable to be tampered with or removed.
  • Programmability: Many blockchains are programmable, allowing for automation of new transactions and controls via "smart contracts".

The block and the chain

 
Block chain
Data is stored digitally in a record called a ‘block’. This block contains:
- Block header: information about the block, such as a unique block reference number – the hash. The header also includes, the hash of the previous block and the time the block was created.
- Block content: the record itself, for example, information about a transaction. The block acts like a ledger entry for this transaction. 
The blocks form a chronological database of transactions that is shared between multiple nodes (computers/servers) in a network.  
Each block contains the reference of the block before it, meaning they link together to form a chain.
Altering the content of the block changes the hash of that block. This impacts previous blocks in the chain and alerts members. This ensures the blockchain is secure

Forming the chain

The chain is formed through a four or five step process:

  1. Transaction
    Two parties agree to make a transaction. It could be of any asset that can be described in a digital format, for example: money, contracts or deeds.
  2. Smart contracts (used in some blockchains)
    A smart contract is a piece of software that sits within a blockchain and acts as the digital contract for the transaction. At this stage data is entered relating to the contract, such as: the price, information about the product, order quantity and delivery date. When the agreed terms are met, the smart contract automatically triggers the action that requires verification.
  3. Verification
    The record of the transaction becomes a new block containing: the transaction details, a unique hash and reference to the previous block’s hash. It is the sequence of linked hashes creates a secure chain between blocks.
  4. Validation
    For a new block to become part of the chain, it must be validated by the group via an agreed “consensus mechanism”.
  5. Distribution and wider network.
    Once a block has been validated it is added to the blockchain and distributed to all the members of the network. The transaction is recorded in near real time without the need for a third party and is held in a distributed ledger that cannot be altered. 
Definition: Consensus mechanisms
Consensus mechanisms make blockchains more secure by making it labour intensive to tamper with blocks. Different blockchains use different mechanisms; one common mechanism is called “proof of work” – where servers within the network solve a mathematical puzzle derived from the block’s header to validate the record. To change a block would mean solving mathematical puzzles for all of the blocks in the chain. This would take a long time, giving members of the network time to identify the change taking place.

A distributed ledger

Rather than having one single owner, blockchain records are spread out among all their users. The genius of the approach is in using a complex system of consensus and verification to ensure that, even with no central owner and with time lags between all the users, there nevertheless remains a single, agreed-upon version of the truth.

Each participant in a blockchain (each “node”) keeps a copy of all the historical transactions that have been added to the ledger, and by comparing to the other nodes’ copies each record is kept synchronised.

Unlike in a traditional ledger system, there is no node with special rights to edit or delete transactions, in fact there is no central party at all. One of the situation in which blockchains can be useful is when a trusted central party is either unavailable or too expensive.

Find out more about blockchain

Learn more about blockchain by completing ICAEW and Deloitte's eLearning module. This resource includes more details on the technology and its potential impact on finance teams and businesses.

This summary also contains information from IT Faculty publications: The essential guide to blockchain and Blockchain and the future of accountancy.