Blockchain, in its simplest form, is a network like any other network. Like email and the internet, blockchain can transmit and receive data. Where blockchain differs from other network types is with its distributed ledger concept. The distributed ledgers that resides within the blockchain network are very similar to an accounting ledger that record every transaction that takes place on the network. A copy of this distributed ledger is kept by every node of the network. Transactions are grouped into blocks which are then chained together to form a blockchain, also known as the distributed ledger. Using email as an example, this would be akin to everyone that participates in the email network having a copy of every email that was ever sent and in chronological order. Now that may sound a bit scary, but within the blockchain network there are ways to encrypt and validate data so that only the parties that need to see the contents of a transaction have the ability to do so and everyone can agree to the validity of the data within blockchain. The distributed ledger provides the ability to ensure that everyone is in agreement with the chronology and the content of all transactions that have occurred on the network without the need for a central party to validate any claims.

Types of Blockchain Networks

Although many people associate blockchain with bitcoin, there are actually several types and instances of blockchain networks. Now that we understand what a blockchain network is, let's talk about a few different implementations and the usefulness they provide.

Private – As the name applies, private blockchain networks restrict participation and therefore are also sometimes referred to as permissioned. This is in contrast to bitcoin's blockchain network which is open and does not restrict access (aka permission-less).

Centralized – Blockchain networks can be implemented to have a central authority. This centralized authority can control many aspects of a network, such as who can participate and what data can be sent, and who can read and validate the data on the network. These centralized or controlled networks work well in situations where all of the parties are known to each other and agree to the rules by which the network is intended to be used. This is in contrast to a decentralized blockchain implementation like the one utilized by bitcoin. In the bitcoin implementation of blockchain, there is no governing authority and no one party can deny entry or change the rules within the network. In the bitcoin network, participants called miners fill the role of a central authority. Miners perform the task of building the blockchain and validating the data in place of a central authority. Decentralized blockchain networks provide open and free access to anyone that wishes to participate and is free of any one party dominating the network or changing the rules. 

Why Do We Need Distributed Ledger Networks?

In many circles it is believed that bitcoin/blockchain feels like a great tool without a problem to solve. With all the buzz surrounding these topics it is certainly worthy of that discrimination. However, what we are beginning to see in the marketplace is an evolution in the blockchain network to make it more adaptable to real world problems, not only in financial services, but across governments and other industry segments as well. The real benefits of a blockchain-type network seem to be coalescing around a few central themes.

Sharing of Data – The unique ability for blockchain networks to share data among all participants while maintaining data validity has many real world applications. Blockchain provides a network where the data is available for all participants to see at little to no cost. There are many problems that society faces today around the availability of data, where the data-sharing nature of blockchain networks may be able to help solve. This includes digital healthcare records, transferring and verifying title and ownership of assets, and the collection and sharing of data in scientific research.

Open Access – Blockchain network's open-access feature provides the ability to transact and share data with any party regardless of where they are and how they typically conduct transactions. Blockchain networks can break down the walls of our siloed, proprietary, and centralized networks that we use today. In fact, some of the more successful applications of blockchain networks do nothing more than connect closed networks to open them up to other networks around the globe. In essence, blockchain is opening up new markets that were previously not viable to reach due to high transaction cost, transaction latency, or complete inaccessibility.

Provide Trust – Another unique ability of blockchain networks is the trust inherent within the network. Because all participants have a copy of all the transactions on the network, it is very difficult for any one party to hijack the network for individual gain. This allows the network to verify transactions without the need for all parties to come to an agreement on a central authority to validate all conditions of the transaction. This may lessen the burden on financial institutions and governments in the execution of contracts and transfer of assets in the future. Smart contracts, which can be executed in a blockchain network, allow parties to agree to terms and have the contract executed automatically on the network. This will allow exporters of goods and services to be paid automatically once goods are received, without escrow accounts and other expensive and lengthy constructs that we use today.

In the end, the unique ability for blockchain networks to provide a decentralized, open-access transaction network, while still maintaining a resemblance of a central authority to self-police the validity of the data on the network has many real world applications. This provides a network where anyone can transact with anyone in a free and open manner, available for all to see and validate at little to no cost and little risk of fraud and manipulation. 

Is Blockchain Safe?

Just like any other network, it is important for participants of blockchain networks to understand the vulnerabilities that are inherent in the system. Depending on the type of blockchain network, these vulnerabilities can change. For example, private (permissioned) and centralized blockchain networks mitigate the risk of identity theft and fraud, whereas open or decentralized networks may be more concerned with open access and therefore do little to know the actual identity of a participant. It is also important to understand the impact on regulation and compliance when looking at various networks. Can data privacy laws be maintained? Are transaction insurance coverages voided when using various network types?

Many blockchain networks employ SHA-256 cryptography to protect data within the network. Use of public and private keys allow those participants on the network to see what they are allowed to see, while protecting the data from the rest of the network. Even if encryption is employed, it may be important to understand what data elements within the network are encrypted, and what data elements are not.

While the consensus confirmation process does make tampering very difficult, it is still not foolproof. Blockchain networks can be vulnerable to a 51% Attack, in which entities on a blockchain network band together to take over 34% the network and form a majority with the intent to defraud the minority. Private blockchain networks and very large blockchain networks can minimize this risk.

What Should a Credit Union Be Doing About Blockchain?

While it is easy to get caught up in the excitement and the opportunity created by blockchain, it is important to understand the goals of any initiative and give consideration to the many options that may be available, not just blockchain. After all, blockchain is a means to an end. In most cases, blockchain concepts require scale and acceptance for their business models to work. There are many innovators doing the work for us. Some of these innovators are specifically targeting credit union issues. These credit union-specific innovators may have insight into our industry that allow them to understand how blockchain's strengths can benefit our unique issues. Their outside perspective may also give them the unique ability to generate the scale where a single credit union would be more challenged to do so.

In a recent article by CUNA, they feel that someone is going to capitalize on blockchain's financial services potential (the big banks), and that credit unions cannot afford to be excluded from the conversation. CUNA also says credit unions who ignore blockchain, do so at their own peril and they suggest that you follow where the smart money is going. With credit unions working together, blockchain may be a solution in the near future.

You can learn more about blockchain technology and bitcoin by downloading a copy of CSCU's new whitepaper, "Bitcoin and Blockchain. What CUs Need to Know."

Tom Davis is SVP of Technology and Finance for CSCU.