COVER STORY • Digital Society — Issues & Challenges • 5

Blockchain/Distributed Ledger
Technologies: Where They Came
From, Where They Are Heading
Author Shahid Yusuf

By Shahid Yusuf

A need to record transactions and contracts, as well as to maintainan inventory of goods, is of long standing. Five thousand years ago,merchants in the Sumerian city Uruk were inscribing a log oftransactions and tracking inventories on clay tablets using cuneiform
script. Record-keeping took a giant step forward with the creation by
Venetian merchants of double entry book-keeping in the 14th
century. This was codified by Luca Pacioli who published a major
survey of mathematics in 1494 that included a 27-page description
with examples of double entry book-keeping and its utility (Double
Entry, How the Merchants of Venice Created Modern Finance, byJane Gleeson-White, W.W. Norton, New York, 2011). The advent ofGutenberg’s movable type press facilitated the reproduction ofPacioli’s opus and the diffusion of knowledge about book-keeping
throughout the European and Middle Eastern business communities.
A decline in the cost of paper once the use of wood pulp became
widespread further incentivized record-keeping. And double entry
book-keeping became firmly entrenched in business practicefollowing the Industrial Revolution and the globalization of tradestarting in the latter part of the 19th century.
Fast forward to the last quarter of the 20th century that has
witnessed the progressive computerization of transactions and theabandonment of paper records. The Internet and digitization has also
substantially widened the scope for innovation. In particular, data
gathering, its management and analysis, the recording oftransactions, and the entry and execution of contracts, to name justa few, can all be done far more efficiently and swiftly using computer
files. But one thing did not change. As with paper ledgers, most if
not all financial transactions still involve an intermediary, frequently abank or the state, to maintain records, vouch for their accuracy,
safeguard their integrity and help consummate a transaction. Thus,
whenever a transaction involves an intermediary, all parties to atransaction need to put their trust in the integrity of the intermediary.
Not all intermediaries can be trusted to keep sound records or tofulfil the terms of a contract to the letter, hence the search for atechnology that would dispense with intermediaries while preserving
an inviolable record of transactions and of contracts.
Satoshi Nakamoto’s seminal nine-page white paper “Bitcoin: A
Peer-to-Peer Electronic Cash System” issued in May 2009 — theculmination of 18 months of software engineering — and thesubsequent launch of Bitcoin focused attention on distributed ledger
technologies (DLTs) that can do away with intermediaries yet provide
a potentially tamper-proof record of transactions. Nakamoto (a18 Japan SPOTLIGHT • November / December 2018

pseudonym of an individual or a team of researchers who devised
the blockchain protocol for computers participating in the Bitcoin
network) did not invent a new technology; instead he combined
several existing technologies to arrive at a permissionless blockchainthat could serve as the basis for a viable cryptocurrency, Bitcoin. The
elements that underpin DLTs were under development since the1980s. Public key cryptography and cryptographic signatures
emerged in the early 1980s; other elements such as cryptographic
hash functions, the hash chain used for proof of work, cryptographic
time stamps, the notion of a shared open repository of transactions,and peer-to-peer (P2P) networks all appeared in the 1990s.
Nakamoto’s blockchain strings together cryptographic blocks oftransactions that are time stamped using a proof of work protocol for
arriving at consensus among network participants.
The rest of this paper briefly unpacks the working of blockchain/
DLTs, examines their merits and weaknesses and discusses theircurrent applications and future uses.

Bitcoin’s Blockchain
A convenient entry point into the world of DLTs is Bitcoin. By
tracking a Bitcoin transaction one can gain an understanding of how
a blockchain works. To start with, Bitcoin’s blockchain ispermissionless, meaning that it is open access. Anyone with acomputer can join and all participants if they so choose can maintaincopies of the ledger recording each and every transaction —blockchain is a massively distributed ledger. Currently, centralized
networks that store information provide clients with services. The
blockchain used by Bitcoin works on the P2P principle whereby eachcomputer doubles as both server and client and none is a central
repository. In a distributed system each node (computer) or a groupof nodes (computers) holds a copy of the database. Furthermore,because the network is decentralized, there is no “single point of
failure” — i.e. it is more resilient, more expensive to attack and,because of the numbers involved, more likely to discourage collusive
behavior.
Bitcoin purchasers first download a Bitcoin wallet from one of thewebsites such as Blockchain.info. They can then acquire Bitcoin fromone of the exchanges such as Coinbase or Xapo, Bitstamp, or Kraken
using a standard payment method such as a debit card.
The worth of a blockchain comes into focus when the holder of
Bitcoin enters into a transaction involving the transfer of coin tohttps://www.jef.or.jp/journal/

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another party. Each participant has a private key that serves toembed a personal digital signature in a transaction. Bitcoin’s
blockchain consensus protocol then requires that the transaction bevalidated by all participating nodes of the system — that is the basisof trust. The process of verification using cryptographic tools
ensures that the individual entering into a transaction is credentialed
and in possession of the Bitcoin to be transferred to the other party.
It also eliminates the “double spend” risk that a cryptocurrency isused twice through a falsification of the records.
This transaction plus others are then consolidated into a “block”
by a subset of the nodes, the ones that do the “mining”, which is theprocess by which new blocks are added to the chain. Each blockincludes transactions that have been validated by the network. It istime stamped, contains a cryptographic link to the previous blockand requires miners to find an answer to a complex mathematical
puzzle generated by the Bitcoin program. This “proof of work” byminers is Nakamoto’s key innovation. Its purpose is to finalizetransactions, render them irreversible and eliminate or minimize therisk of tampering. Mining entails the application of energy intensive
computing power using customized ASICs, many produced by
Bitmain, a Chinese company and graphics processing units (GPUs)
produced by Nvidia Corp. and Advanced Micro Devices Ltd. (AMD).
Miners take a hash of the data in the block and combine it with arandom number and use a “hash function” to generate a result that
falls within a certain range. Miners have to guess the random
number and keep trying using other random numbers until they
arrive at the winning hash that starts with a pre-established string ofzeroes and cryptographically references all the data in the block. The
winner announces the new block to other miners who then add theblock to the chain. The update of the ledger is shared with all nodes.
The winning miner is compensated for the work performed with
newly minted Bitcoin keyed to the number of transactions in theblock. It is this proof of work that ensures the workability of thesynchronized consensus protocol and it accounts for the success ofa decentralized blockchain that has dispensed with a trusted
intermediary.
Every new block contains the hash of the previous block, hence
anyone modifying the contents of an earlier block changes andinvalidates the hashes of all blocks that follow. To hide evidence oftampering, the hashing and chaining together of all subsequent
blocks must be redone and completed before another miner adds a
new block. This is theoretically possible by a miner able to marshal agreat deal of computing power, but as the blockchain expands it
becomes increasingly difficult.

Bitcoin’s Progeny & Blockchain Innovation

the issuance of currencies. Although Bitcoin and its cousins areunlikely to displace fiat currency issued by the state — because no
cryptocurrency has proven to be a store of value or is widely
accepted as a medium of exchange and a unit of account — thenumber of cryptocurrencies has mushroomed. To overcome thestore of value problem, fully (or partly) collateralized
cryptocurrencies such as Tether pegged one-to-one to the dollar are
increasingly popular. Some such as Bitcoin Cash and Litecoin haveemerged following a “hard fork” from Bitcoin. A hard fork involves apermanent switch to a different blockchain protocol software that is
adopted by participating nodes. In the case of Bitcoin Cash, theadvantage to users is that it permits larger transactions. Litecoin
speeds up transactions to four times the 3-4 transactions per second
rate achieved by Bitcoin (up to a maximum of 60). However, boththese cryptocurrencies and others such as XRP (1,500 transactions
per second), NEO and EOS are more centralized and use different
consensus protocols. Ripple uses XRP Ledger settlement
technology, the Chinese cryptocurrency NEO employs a “delegated
Byzantine fault tolerance” protocol so as to attain speeds
approaching 10,000 per second, and EOS relies on a consensus
protocol based on “proof of stake” that requires users to establish
their trustworthiness by virtue of the amount of cryptocurrency thatthey hold, for example. Proof of stake does not achieve security
through the “burning of energy” as with Bitcoin mining but by
demanding that those on the network lock up and put their capital atrisk, maintain their nodes and take precautions to protect theirprivate key.
Arguably of greater longer term significance than the standard
cryptocurrency-based networks is Ethereum. It too uses a
distributed permissionless blockchain protocol similar to that of
Bitcoin but is piloting a proof of stake protocol (Casper FFG) that
initially involves a parallel functioning of both protocols (proof ofwork and proof of stake), with proof of stake becoming the solesystem protocol two years hence. In addition to issuing acryptocurrency called Ether, Ethereum also includes a programming
language (Turing Complete) that permits users to embed “smart
contracts” into the blocks. According to Vitalik Buterin, the developerof Ethereum, the blockchain functions like a large computer —known as the Ethereum Virtual Machine (EVM) — that stores andexecutes contracts between two or more parties. Contracts executedin the EVM can include the reading of data, computations, andestablishing links with other contracts. These functions are
simultaneously executed by each of Ethereum’s nodes. In theprocess, much energy (or “gas”) is consumed and paid for bycontracting parties via Ether and deducted from their accounts. The
price of gas varies dynamically and the system places an upper limiton the amount of gas that can be used for each transaction.

Bitcoin not only triggered the cryptocurrency mania, it also
highlighted the utility of blockchains and DLTs for uses other thanJapan SPOTLIGHT • November / December 201819

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Blockchain in the Making
Blockchain technology is still in its infancy with many innovations
to come that will tackle a number of salient concerns. Eight deserve
to be singled out:First, when a blockchain/DLT is used, whether for cryptocurrencytransactions or others, data privacy and confidentiality can becompromised when the data is linked to a particular party whose
identity could be revealed to all network nodes — for example, whena transaction makes known an individual’s title to a property. Manyorganizations are unwilling to put valuable data on a widely accessedblockchain. Moreover, although transactions for some blockchainsare in theory anonymous, the record is available, permanent andtrackable. Thus, depending on how easy it is to compromise a node
in a permissionless blockchain (and thereby access data), the lattercan be more or less secure than a permissioned one that limits thenumber of users.
Second, blockchain cannot verify the accuracy of information thatis entered, for example with respect to property ownership. It can
only minimize the risk that the information will be tampered with.
Likewise, a permissionless, distributed blockchain can instruct that acontract be executed but it cannot enforce a contract. A breach ofcontract has to be remedied through the intermediation of the legal
system.
Third is the vulnerability to attack and to the risk of theft. Since
cryptocurrencies first appeared, it is estimated that $15 billion worthof coins have been stolen from exchanges — $800 million worth ofcryptocurrencies were stolen in Asia during the first half of 2018
alone. One of the heists, amounting to $400 million, led to thecollapse of a major Japan-based exchange called Mt. Gox.
Blockchain’s intrinsic security derives from the widespread
distribution of copies of transactions and the proof of work protocol.
The bigger the network, the harder it is for any one party to mobilize
the computing power to subvert the entire system. But it is notbeyond the realm of possibility — and becoming easier. Attack
cartels can coalesce and marshal the computing muscle using theirown computers and by renting others. Once the attacker has
acquired hashing power that is more than one half that of the entire
network, the stage is set for a “51% attack” that can altertransactions, modify the protocol, double spend crypto currencies
and hold accounts to ransom by making their contents unusable.
Smaller coins and exchanges are at greatest risk but Bitcoin andEthereum are by no means invulnerable. According to research by
Ittay Eyal and Emin Gün Sirer (“Majority is not enough: Bitcoin
mining is vulnerable”, Communications of the ACM, 2018), theBitcoin mining protocol is not necessarily incentive compatible: aminority of miners who create a Selfish Mining Pool can pursue
strategies that enlarge their share of the revenues earned at the costof honest miners. Ethereum is no different, with well over half of the
20 Japan SPOTLIGHT • November / December 2018mining being conducted by three operations.
Looking ahead, another problem looms, which is the advent of
quantum computing that will undermine cryptography in current use
by making it easy to break cryptographic locks. As Vitalik Buterinstates, “Quantum computing will make a lot of cryptography that’sused in modern times just not work anymore. Digital signaturealgorithms won’t work anymore. Public key encryption won’t work
anymore. Zero-knowledge proof SNARKS (Succinct Non-interactive
ARgument of Knowledge), software for privacy protection, won’t
work anymore. The good news is that for everything that doesn’t
work anymore, people have already come up with replacements forthem over a decade ago. You have hash-based signatures, youhave virtual currency STARKS for zero-knowledge proofs, you have
fancy elliptic curve isogeny-based public key encryption. So I think it
will force a transition, but ultimately, we do know how to adapt. The
cryptocurrencies that will suffer the most are just the ones whose
governance is the most stalled and dysfunctional and won’t be able
to figure anything out in time.” (Cryptoeconomics and Markets inEverything (Ep. 45) at https://medium.com/conversations-with-tyler/vitalik-buterin-tyler-cowen-cryptocurrency-blockchain-tech3a2b20c12c97).
Fourth, large permissionless blockchain/DLT networks confront
governance issues that make it difficult to resolve problems thatarise and to promote the further development of the network.
Governance involves three sets of participants: developers, miners
and users, each with differing interests. Coordination of the decisionmaking process involving thousands of members whether online oroffline can be time intensive, slowing down necessary changes andinnovations that can improve network capabilities. Because there arefew mining pools, they can form coalitions, increase transaction
costs and dominate decision-making to advance their own interests.
Developers also have a stake in the network but as they do notreceive a financial reward from improving network capabilities —and can be bribed by miners — they are less likely to be proactive.
Bitcoin that relies on offline communication has suffered from acumbersome and centralized governance structure that has inhibited
desirable innovation. Any Bitcoin Improvement Proposals (BIP) must
be approved by a bloc of participants commanding 95% of mining
power. Ethereum is attempting to reduce the risk of excessive
centralization by shifting to “proof of work” that will increase thevoting power of coin holders and counterbalance that of miners. The
network is also attempting to promote innovation by encouraging
new developers to play a more active role, and lessening its reliance
on Ethereum’s creator. Other networks are experimenting withvarious forms of on-chain and off-chain governance so as tomaximize the participation of users and at the same time permit the
rapid testing and incorporation of changes to the code when theneed arises or to facilitate network enhancing innovation. The speedwith which a network adjusts its governance mechanisms andCOVER STORY 5

responds to challenges is a source of competitive advantage in amarketplace crowded with blockchain-based coins.
A fifth issue faced by blockchain networks is the difficulty ofscaling a network while retaining the benefits of decentralization andsecurity. As the number of users and transactions increases, block
sizes tend to grow unless hard capped, which in turn raises energy
costs and mining fees, especially during peak periods. Furthermore,
P2P verification of each transaction slows down the creation ofblocks. Bitcoin, for example, builds a block every 10 minutes. A pointis reached when a blockchain network becomes too large, unwieldy
and slow to be competitive, at which point a hard fork is needed thatspawns a new and independent system with a differentiatedsoftware. A hard fork from Bitcoin led to the creation of Bitcoin Cash.
These hard-forked creations are tackling the problem of transaction
size and scalability in a variety of ways: by trimming the data in eachtransaction; by using software called SegWit to compress
transactions; by conducting verification through a separate channel;
by employing the Lightning P2P Network that sits on top of the
Bitcoin blockchain and permits micro transfers between users; andby using a technique called sharding that enlarges throughput by
partitioning the network with nodes in each of the shards that are
created processing a subset of the transactions. Bit by bit, theconstraints are being eased but the problem of scalability is many
innovations away from being solved.
Energy use by cryptocurrency miners who need to demonstrate
proof of work is a sixth issue confronting governments. As of 2018,
Bitcoin miners were consuming an estimated 20 terawatts of power
globally or about 0.1% of total global electricity. When othercurrencies are included, the share of global consumption is in excess
of 0.5%. A variety of innovations could contain the increase as could
rising energy fees and regulations, but when combined with theenergy consumed by data centers, the implications of thistechnology for power use and GHG emissions are non-trivial.
The use of cryptocurrencies for the purposes of money laundering
or evading government controls is a seventh worry — albeit specificto currencies. The use of bitcoins on the darknet TOR-enabled
platform Silk Road aroused concerns that cryptocurrencies
anonymously acquired and traded on shadowy exchanges could
provide cover for criminal activity. Although the threat of money
laundering and the financing of covert activities using
cryptocurrencies remains, evidence that they are being widely used
for money laundering is scarce. Bitcoin, for example, could facilitate
money laundering because it is portable and safe from confiscation,and the public address of Bitcoin wallets is anonymous; but everytransaction is monitored and recorded by the blockchain. The real
problem for a money launderer arises when an attempt is made toconvert Bitcoin into fiat money at a coin exchange such as Gemini.
Law enforcement officials tracking a Bitcoin address suspected ofengaging in illegal activity can demand that the exchange reveal theidentity of the account holder and have the authority to confiscate theproceeds of the Bitcoin conversion into cash. But loopholes remain.
For example, when either Bitcoin or Ethereum is converted by awilling online exchange into an untraceable cryptocurrency such as
Monero, it disappears from the radar of regulators and cansubsequently resurface as clean Bitcoin on yet another exchange thatis not especially scrupulous in monitoring suspicious transactions.
Finally monetary authorities and regulators are concerned as tothe implications of cryptocurrencies for monetary policy andfinancial stability. While this has stirred much debate andconsiderable research — including into the issuance of digital fiat
currency by central banks — as yet there appears to be little
likelihood that cryptocurrencies, even collateralized ones, willovershadow fiat money. Moreover, regulators are busy devising rules
to control the issuance and circulation of cryptocurrencies, tradingon exchanges and Initial Coin Offerings (ICO). China has taken thehardest line and other countries are also adopting a cautious attitude.

DLTs for All SeasonsWorries over cryptocurrencies do not undermine the potential
utility of blockchain and other DLTs in safeguarding information andreducing administrative costs. These technologies have many uses
beyond the narrow realm of cryptocurrency. However, it is likely that
there will be more permissioned DLTs than permissionless ones,
with one or a few trusted intermediaries responsible for determining
design, managing the ledger, validating its integrity, and resolving
disputes (Blockchain and Economic Development: Hype vs. Reality,
Michael Pisa and Matt Juden, CGD Policy Paper, Washington, DC,
July 2017). This goes against the grain of Nakamoto’s original
protocol, which attempts to strip out the trusted intermediary, and is
the likely route that the mainstreaming of DLTs might follow.
Among the many uses of blockchain/DLT, the following deserve
prominence:
Securing and protecting property rights to digital products andcontent and to land. Blockchain can establish and safeguard
ownership history by distributing it across a network. With landed
property, the transferring of records onto a blockchain would be
most effective where a reliable system for recording land rights
already exists. This would ensure the accuracy of the informationentered.
Blockchain enabled e-voting already in use in a few countries suchas Estonia could empower voters and protect against the all too
frequent instances of fraud, especially in developing countries. Thesesystems would need to be tailored to the specifics of voting systems
and electorates, and for the blockchain to provide maximum security,
e-voting would need to be widespread.
Blockchain-based user-centric digital ID systems that allow
individuals more control over personal data while at the same time
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reducing the risk of a central repository being hacked. Michael Pisa
makes the case for the storing of certified information provided by atrusted authority on a blockchain-linked digital wallet (Reassessing
Expectations for Blockchain and Development, July 10, 2018, https://www.mitpressjournals.org/doi/abs/10.1162/inov_a_00269). But henotes that buy-in by governments and other organizations would becritical and the loss of a key by an individual would entail a rebuildingof a digital identity.
Registering, certifying and tracking goods moving through supply
chains could be rendered much more efficient and rigorous with thehelp of blockchains. Moreover, the recording of transactions at every
juncture could also streamline fulfillment and settlement of dues.
With the help of Everledger, companies trading in diamonds canfollow the path a diamond takes from the mine to a retail outlet andin the process circumvent problems of documentation and insurance
fraud.
Permissioned DLTs are likely to be favored by users who wish to
restrict access to data and enjoy a degree of mutual trust. Providersof financial and non-financial services that engage in a multitude oftransactions including payments, settlement of accounts andclearing arrangements have already begun experimenting with DLTs.
The R3 consortium’s Corda platform is geared towards companies
that are looking for DLT solutions in the interest of greater system
resilience, to automate certain processes, to develop new lines ofbusiness and much else.
Healthcare is another sector that could profit from DLTs tomaintain patient health records, while allowing patients to exercise
more control over their data. A system called MEDREC devised by
the Massachusetts Institute of Technology uses a blockchain that
does not store patient records that remain on provider databases,
but it facilitates the granting of permission by patients to access thedata. DLTs can help the pharmaceutical industry protect IP and theintegrity of its supply chain which would reduce the penetration ofcounterfeit drugs. DLTs also have the potential of enhancing theefficiency of drug distribution.
Last but not least, there is the public sector that in most countries
could benefit from DLTs that improve inter-departmental
coordination and the sharing of data, allow departments to tracktransactions and thereby minimize fraud, and open the door to theuse of smart contracts, which would reduce bureaucratic delays andred tape.

transform the way financial markets work. The challenge is to reducethe cost of trust, to protect against criminal interference — money
laundering and terrorism, for instance — and to ensure that thetechnology is appropriately adopted, utilized and governed. Whenand if these problems are solved, blockchains could provide
enormous economic, social, and political benefits to society.”
In less than a decade since they appeared, the value of crypto
assets amounted to $193 billion on Sept. 1, 2018 — with tokens
other than bitcoin accounting for 56%. Three thousand ICOs haveraised over $20 billion and 200 crypto coin exchanges have been
established. There is also plenty of churning and failures as the newtechnology enters adolescence. A majority of ICOs have failed themarket test or are on the brink. Clearly, in the financial sector and inother fields DLTs need more time to innovate, improve and provetheir worth. Furthermore, at least in the realm of finance but also inother areas, blockchain/DLTs need to be more fully brought withinpublic policy and legal frameworks. They cannot solely be governedby the rules of code but need to be pulled within the ambit of
traditional systems of control that establish liability andresponsibility. All participants must remain subject to the rule of law.
They cannot coexist in a cyber sphere governed only by code
(Blockchain and the Law: The Rule of Code by Primavera De Filipi
and Aaron Wright, Harvard University Press, Cambridge MA, 2018).
That said, the intensity of innovation — and numbers ofblockchain/DLT patents filed — suggest that these technologies
could spread across and enhance the efficiency of a range ofactivities from finance to agriculture. Like cloud computing,blockchain could in its own small way be transformative. More than
70 of the world’s largest banks have begun using blockchain to
speed up payments by reducing delays caused by compliancechecks, inaccurate addresses and missing data. Walmart, forinstance, already uses blockchain to track 1.1 million items on sale instores. Maersk has joined forces with IBM to pilot technology that
follows the movement of its containers. Louis Dreyfus usedblockchain to finalize the sale of soybeans to a Chinese processor,
Shandong Bohi, with financing from ING, Societe General and ABN
Amro. And Dubai has declared its intention to become a “blockchainpowered government by 2020”. Computer-mediated transactions will
only grow and depending on how the remaining challenges aretackled, the role of DLTs could expand alongside them.

Conclusion
In their foreword to the 21st Geneva Report on the World
Economy (CEPR Press, 2018), Tessa Ogden and Charles Wyplosz
comment on the role that blockchain technology can play in thesphere of finance and in other areas. They state, “Despite its infancy,
blockchain technology presents an opportunity to fundamentally
22 Japan SPOTLIGHT • November / December 2018

Dr. Shahid Yusuf is chief economist, Growth Dialogue, George Washington
University, adjunct professor, SAIS, Johns Hopkins University and non-resident
fellow at the Center for Global Development.