A Primer on the Blockchain

Dr. Maria Chetcuti Cauchi | 31 Mar 2017

Fintech

Background

The first generation of the digital revolution brought us the Internet of information. The second generation — powered by blockchain technology — is bringing us the Internet of value: a new platform to reshape the world of business and transform the old order of human affairs for the better.

Don Tapscott (author of The Digital Economy & Wikinomics)

Blockchain is disrupting the world of payments, the field of contracts, intellectual property, smart contracts and identification processes. Indeed, every time a third-party is involved to process a transaction, the blockchain could replace it. Just as Google disrupted the Internet, and Napster changed the face of the recording industry, blockchain technology, together with its related ecosystem, will ultimately oblige financial regulators and institutions to re-evaluate and modify their traditional status quo and infrastructure.

 

 

How ironic that such promising technology is based on the more archaic, analogue technology of the past – ledger systems. From transfer of property deeds to births, marriages, and deaths registers; to loans, mortgages, claims and liens records; bank account management; financial transaction administration; to election polls and results records; case-law and legal rulings lists; imports & exports accounts as well as buying and selling directories, blockchain technology is likely to affect all.

Originally starting off as the platform on which the ‘much-debated’ currency of bitcoin was based, put crudely by the Fintech industry, blockchain is nothing but a distributed ledger. It encompasses a method in which information is recorded and shared by an accepting community. Each member in the so-called ‘chain’ maintains his or her own copy of the information and all members must validate any updates collectively. Each update is a new “block” added to the end of the “chain.” In other words, it is a very secure ledger of digital events, shared between all parties that choose to participate in the events. Parties’ identities and data are protected by cryptography and recording of new ‘blocks’ or changes in events can only be updated after there is at least 51% or more participant consensus. With such entry of such information, erasing thereof is not possible. Entries are permanent, transparent, and searchable, which makes it possible for community members to view transaction histories in their entirety. This has resulted in transactions being disintermediated and doing away with a central, monitoring and certification authority.

The platform/protocol manages how new edits or entries are initiated, validated, recorded, and distributed. Blockchain is the ‘tech-charged’ equivalent of the public ledgers of the past, with the added value of permanence, transparency, searchability and the elimination of third-party intermediaries. The inception of blockchain saw the replacement of the intermediary and keepers of trust with complex algorithms and technological verification methods. Blockchain can be used in all types of transactions, including those related to contracts, assets, liabilities, identities, or practically anything else that is usually publicly available but can be described in digital form.

The Issue to be Solved

For the past two decades or so, we have experienced the Internet of Information. This has revolved around the dissemination of information. We are now facing a new phenomenon, the Internet of Value. The difference between the two is critical. In the former, remittance of information deals with the delivery of a copy of the original. In the case of the latter, one has to be able to send the original asset over a network, be it currency, IP, vote, stocks, bonds.

In the past, this problem has been dealt with through the use of the ‘middleman’, i.e. banks, financial intermediaries, governments, who would carry out all the KYC, verification, clearing, settling steps and would ascertain that the asset can, and has really passed on from the remitter and has been received by the receiver.  This system has presented various problems, such as hacking, exclusion of certain categories of people, slow transactions and high costs since such intermediaries are paid large cuts from such transactions.

Blockchain deals with the issue above. It is a sort of universal ledger whereby every form of asset, be it currency, art, certificates, and so on, is stored, moved, managed and controlled through the individual players themselves and not through some financial intermediary. In this scenario, stakeholders would be able to transact peer-to-peer and trust is established not by some large institution but by collaboration, partnership, secure technology (cryptography) and skilful coding.

 

 

How does it Work?

Whilst having the identities of parties to the transaction being protected through cryptography, blockchain presents a very secure ledger of digital events that is shared between all parties that participate in the events. Data in a blockchain is stored in fixed structures called ‘blocks’. When a transaction is conducted, it is posted globally across millions of computers. This information is then caught and verified by miners.

Technically the most vital elements of a block are the header and the content. The header would typically include metadata, such the exclusive block reference number, the time the block was generated and a link back to the preceding block. The content usually presents a validated list of digital assets and instruction statements, such as transactions, their amounts and the addresses of the parties to those transactions.

From the latest validated block, one would be able to access all previous blocks that are inter-linked in one particular chain, with the blockchain database maintaining the entire assets history and instructions information all through the very initial one. This makes such data verifiable and autonomously certified.

With the growth of participants in the chain, malicious or erroneous transactions are easily caught and overcome as certification by the majority becomes the norm. This turns the network into a robust and secure set of actions without the need of having a central moderator/intermediary.

Market participants admit that blockchain can potentially revolutionise the financial services world. Some postulate that a complete disintermediation of middle and back office processes is underway, while others contend the impact of this emerging technology will be less forceful.  In any case, it definitely has the potential to create a reporting system that is not only more effective than current solutions but also more transparent and safe. It could eventually become a standard for financial transactions and real-time settlements, hence increasing transparency and efficiency in a highly fragmented industry. 

As Winklevoss put it

We have elected to put our money and faith in a mathematical framework that is free of politics and human error.

Tyler Winklevoss, Co-creator of Facebook, top investor in Bitcoin.

 

 

Our Fintech Practice

Chetcuti Cauchi Advocates is a leading law firm within the Fintech industry, where Senior Partner Dr Priscilla Mifsud Parker, and Head of Corporate & Fintech, Mr Steve Muscat Azzopardi are actively advertising and assisting clients to navigate through the new regulatory regime. Should you be interested in setting up your tech company and attaining recognition from the regulatory, launching your ICO under Maltese regulatory framework, setting up a Crypto Exchange or a Crypto Fund, we would be happy to guide you through the regulatory processes.


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Key Contacts

Dr Maria Chetcuti Cauchi

Senior Partner & Founder, Global Property Investment

+356 22056875

Mr Steve Muscat Azzopardi

Senior Manager, Corporate & Fintech

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