What is a blockchain?

Fact-checked by Eric Rose (Head of Digital Asset Execution)

Understanding blockchain technology in financial markets

Blockchain is a distributed ledger – in other words, a digital record shared across a network of computers. It is most commonly associated with cryptocurrencies like Bitcoin, but blockchain’s applications extend beyond digital currencies to decentralized finance (DeFi) applications and smart contracts.

The key features of blockchain technology are its decentralized nature, immutability, and consensus mechanisms.

Decentralization

Decentralization in blockchain refers to distributing control across a network of participants. In public blockchains, this helps improve transparency by distributing control across multiple participants, reducing reliance on a central authority. However, private blockchains retain governance by a select group.

In traditional financial systems, intermediaries like banks and clearing houses are needed to process transactions or verify data. Blockchain eliminates these middlemen by distributing control across a network of participants that each has access to the same data. This promotes transparency and helps prevent participants from using authority or control in ways that could harm the network’s functionality.

For example, businesses can use blockchain technology to facilitate faster and more cost-efficient cross-border transactions, reducing reliance on traditional banking intermediaries.

Immutability

Immutability refers to the inability for something to be changed. When a transaction is recorded on a blockchain, it cannot be altered. If an error is made, a new transaction must be recorded to reflect the correction as previous blocks are unchangeable. This means both the error and the correction are visible to everyone in the network.

The immutability of blockchain technology is valuable in financial markets as it can reduce the risk of fraud or tampering.

Consensus mechanisms

For new data or transactions to be added to the blockchain, the majority of participants in the network must agree, or reach a ‘consensus’. This ensures that no single participant can unilaterally alter the ledger, making the system inherently secure.

Different blockchain networks use different consensus mechanisms, with the most common being Proof of Work (PoW) and Proof of Stake (PoS). Some blockchains also use alternative models like Delegated Proof of Stake (DPoS), Byzantine Fault Tolerance (BFT), or hybrid mechanisms.

Traditional Finance vs. Decentralized Finance (DeFi) – Comparison Table

Key components of blockchain architecture

The core elements of blockchain technology are its distributed ledger technology, smart contracts, and public key cryptography.

Distributed ledger

The distributed ledger acts as a shared database that provides every participant with the same up-to-date, immutable record of transactions. This creates transparency for all blockchain users,  including buyers, sellers, and financial institutions.

Smart contracts

Smart contracts are self-executing programs stored on a blockchain. They automatically perform actions, like releasing funds or transferring assets, when predefined conditions are met.

Public key cryptography

Blockchain security relies on public key cryptography, where each participant has two keys:

• A private key that's kept secret and used to sign transactions
• A public key that's shared with others and used to verify transactions.

These keys work together to unlock data in the ledger.

How does a blockchain network operate in B2B transactions?

For B2B transactions, the blockchain acts as a shared, tamper-proof ledger that records the movement of both tangible and intangible assets. Here’s a step-by-step breakdown of how a transaction works in the blockchain network:

Step 1: Recording the transaction

When a transaction is made, it is recorded as a ‘block’ of data. This block contains essential information about the transaction, such as:

• Who was involved (e.g. supplier and distributor)
• What was exchanged (e.g. a shipment of raw materials or intellectual property rights)
• When the transaction occurred
• Where the transaction took place
• How much of the asset was transferred
• Conditions met (e.g. temperature thresholds for perishable goods).

Step 2: Achieving consensus

Before the transaction is finalized and added to the ledger, it's broadcast to the blockchain network and must be validated. This is where the consensus mechanism comes in.

The specific method of achieving consensus depends on the type of network. For example, the Bitcoin blockchain network uses a Proof of Work (PoW) mechanism.

In this process:

• The transaction enters a pool of pending transactions
• Miners (powerful computers) compete to solve a cryptographic puzzle to add a block
• The first miner to solve the puzzle proposes a new block
• Other miners verify the solution before it can be added to the blockchain.

Different blockchain networks use different consensus mechanisms, for example Ethereum uses a Proof of Stake (PoS) mechanism, which can be faster and more energy-efficient compared to PoW.

Step 3: Linking blocks

Once the transaction is validated, it’s added to a new block. Each block contains:

• The list of confirmed transactions
• A unique cryptographic hash that acts like a digital fingerprint
• A reference to the previous block’s hash.

If someone tries to alter a past block, the hash will change and make all subsequent blocks invalid. This makes manipulation immediately evident and practically impossible.

Step 4: Sharing the ledger

Once a new block is added, it's instantly updated across all network participants. Every participant (node) holds an identical, real-time version of the blockchain, eliminating the need for traditional intermediaries and promoting trust and transparency.

The Lifecycle of a Blockchain Transaction in business Payments

Benefits of blockchain technology

Blockchain technology offers numerous potential benefits for businesses and financial institutions, including:

High accuracy

Instead of relying on humans for verification, blockchain transactions are approved by thousands of computers across the network. This results in highly accurate blockchain records with reduced risk of human error.

Even if one computer on the blockchain network was to make a mistake, it won’t affect the rest of the blockchain since other copies remain correct. This system of distributed verification helps ensure data integrity and reliability.

Reduced costs

Blockchain reduces reliance on some intermediaries for validating transactions, which can potentially result in cost savings. For example, businesses typically pay fees to banks and payment processors when they accept credit card payments. With blockchain-based systems like Bitcoin, however, there is no central authority and transaction fees are minimal.

Decentralization

Blockchain spreads copies of information across a network of computers instead of storing it on a central server. Whenever a new block is added to the blockchain, all network participants update their copies automatically. This decentralized structure makes it difficult for hackers to tamper with data as they’d need to manipulate every copy on the network simultaneously.

Fast transactions

Transactions through traditional financial systems can take days to settle, particularly when it comes to cross-border transactions or those placed outside working hours. Blockchain, on the other hand, operates 24/7 and can process transactions in minutes depending on the network. This round-the-clock availability is particularly valuable for international payments, which can typically experience delays in traditional systems.

Security

Blockchain provides a highly secure system for recording financial transactions. Each block contains its own unique identifier, called a hash, and the hash of the previous block. This creates a secure, permanent record that cannot be altered or deleted by anyone – not even administrators.

Blockchain Security – How Cryptographic Hashing Works 

Types of blockchain networks

There are four main types of blockchain networks:

• Public blockchain networks: Public blockchains are open for anyone to join and participate in. These include Bitcoin, Ethereum, and Litecoin. These networks are typically used for cryptocurrency mining, trading, and decentralized applications.
• Private blockchain networks: Private blockchain networks are governed by a single organization that determines who can participate. These networks are only partially decentralized because they require access permissions. An example of a private blockchain network is Hyperledger.
• Hybrid blockchain networks: Hybrid blockchain networks combine features of both public and private networks. These allow companies to control access to specific data while keeping the rest of the blockchain public.
• Consortium blockchain networks: Consortium blockchain networks are managed by a group of organizations who share responsibility for maintaining the blockchain and setting access permission. An example is the Global Shipping Business Network Consortium.

Types of Blockchain Networks – Comparison Table 

Why is blockchain technology relevant for institutional finance?

In institutional finance, blockchain technology enhances efficiency, reduces settlement times, and minimizes fraud risks in institutional finance by enabling transparent and secure transaction records.

For example, while traditional banking operates only during business hours, the blockchain exists 24 hours a day, meaning transactions can be processed at any time – including weekends or holidays. The blockchain system can also reduce settlement times, allowing institutions to exchange funds quickly and securely, even across borders. Its decentralized nature and immutability also helps prevent the risk of fraud in financial markets. 

Can blockchain networks improve cross-border payments?

Yes, blockchain networks can improve cross-border payments by eliminating the need for intermediaries. This means international transactions can be executed faster and more securely, reducing costs and delays.

How is blockchain transforming trade execution and settlement?

Blockchain is transforming trade execution and settlement by eliminating manual reconciliations and reducing the time and risk associated with clearing and settling trades. For these reasons, blockchain technology is increasingly being utilized in the digital assets securities market.

This material is for informational purposes only and should not be considered as an investment recommendation or a personal recommendation.