Distributed ledger technology has the potential to dramatically change multiple operations and industries. This is how it is evolving the finance industry
As financial institutions and governments explore the transformative potential of distributed ledger technology (DLT), it’s clear the innovation promises to revolutionise everything from cross-border payments to digital identity systems.
The Evolution of Distributed Systems
At its core, DLT represents a fundamental shift in how digital information is stored and shared.
Unlike traditional centralised databases where a single authority maintains and controls data, DLT creates multiple identical copies of a ledger across a network of computers, known as nodes.
Each node maintains a complete, up-to-date copy of the ledger, with new entries requiring consensus from the network before being added.
These consensus mechanisms vary significantly between implementations.
In permissionless systems like Bitcoin, 'proof of work' requires miners to solve complex mathematical problems, with the network calibrated to produce valid proof-of-work approximately every 10 minutes.
This process currently consumes electricity equivalent to Ireland's consumption and could reach Denmark's level by 2025.
In contrast, permissioned networks used in financial services employ more efficient mechanisms like 'proof of stake', which rewards seniority over computing power.
The cryptographic foundation of DLT relies on sophisticated hash functions and digital signatures. Each transaction is "hashed" to create a unique digital fingerprint that cannot be altered without changing the underlying data.
The World Bank Group notes that “the hash enables detection of any tampering of the underlying transaction data, as when a hash is computed again, it will produce a different hash than the originally generated hash”.
Smart Contracts and Financial Innovation
Smart contracts represent a significant evolution in DLT capabilities, enabling self-executing agreements that automatically implement terms when predefined conditions are met.
The World Bank Group describes them as “programs that are written on the underlying distributed ledger and are executed automatically by nodes on the network”.
Ethereum, the second-largest blockchain platform, specialises in smart contract applications and has attracted significant institutional interest.
However, the technology's risks were highlighted in 2016 when the Decentralised Autonomous Organisation (DAO) lost US$50m through a code vulnerability, leading to a controversial 'hard fork' in the Ethereum blockchain.
This incident underscores the European Securities and Markets Authority’s (ESMA’s) warning that “errors in the coding of smart contracts could create widespread risks”.
The financial services sector is particularly focused on DLT's potential to streamline operations.
Ripple has developed a network for near-instantaneous international transfers, with the Shanghai Huarui Bank implementing its technology for USA-China corridor remittances.
Likewise, the Australian Stock Exchange is partnering with Digital Asset Holdings to revolutionise its clearing and settlement processes, while the Depository Trust and Clearing Corporation (DTCC) has joined forces with IBM to develop DLT-based software for post-trade processing of credit default swaps.
Industry estimates suggest DLT could save the financial industry approximately US$15-20bn annually through reduced infrastructure costs and improved efficiency.
ESMA notes that “DLT could bring several benefits to securities markets, notably more efficient post-trade processes, enhanced reporting and data management capabilities and reduced costs”.
Beyond Traditional Finance
Enterprise adoption is being driven by consortiums like R3, which has attracted over 100 financial institutions, and the Hyperledger Project, supported by more than 170 organisations including IBM and Intel.
These initiatives focus on permissioned networks, which ESMA notes “have advantages over permissionless systems when it comes to governance issues, scale or the risk of illicit activities”.
Government applications are expanding rapidly. For instance, Estonia's e-Residency platform uses DLT to verify government database records and offer digital identity services globally.
Elsewhere, the Republic of Georgia has partnered with Bitfury for land registry management, while Sweden's Lantmäteriet is testing blockchain-based property transactions.
In supply chain verification, London-based Everledger has recorded 980,000 diamonds on their blockchain, while Walmart uses DLT to track food safety and provenance.
The World Bank Group highlights that DLT applications extend to “collateral registries, movable asset registries, digital identity platforms and storage of personal records including birth, marriage and death certificates”.
This breadth of application demonstrates the technology's potential beyond its financial origins.
Technical Challenges and Market Evolution
Despite DLT’s promise, scalability remains a significant hurdle.
The World Bank Group notes that “current iterations of permissionless distributed ledgers face issues related to scalability of blockchains”.
Bitcoin can only process 4-7 transactions per second, compared to Visa's capacity of thousands per second. The limitation of block size to one megabyte has sparked controversy within the Bitcoin community, as larger blocks would take longer to propagate through the network.
Security considerations are paramount. While the core technology has proven robust, the World Bank Group reports that “statistics show there are around 15-50 bugs per 1000 lines of code”.
Recent incidents at Mt. Gox and Bitfinex demonstrate vulnerabilities in the application layer, even when the underlying technology remains secure.
Interoperability presents another challenge. ESMA emphasises that “DLT networks will need to be able to interoperate with each other and with legacy systems”, requiring harmonised technology standards and universal reference data standards.
Integration with existing financial infrastructure requires industry-wide coordination and substantial investment, with some estimates suggesting implementation costs could reach billions of dollars.
Regulatory Landscape and Future Outlook
Regulatory approaches to DLT vary significantly. The UK's Financial Conduct Authority has implemented a regulatory sandbox for testing DLT applications, while Hong Kong's Securities and Exchange Commission has approved DLT-based crowdfunding platforms.
In the US, the Delaware General Assembly passed amendments in 2017 recognising blockchain as an acceptable form of corporate recordkeeping.
A scattered global regulatory approach has not deterred central banks worldwide from exploring DLT-based digital currencies.
The Bank of England suggests potential savings through reduced real interest rates and lower transaction costs, while China's central bank has tested a blockchain-based digital currency.
The World Bank Group notes that “any central bank-issued digital currency would likely look substantially different from Bitcoin's open, decentralised, peer-to-peer model”.
Looking ahead, ESMA anticipates that “the early applications of DLT focus on optimising processes under the current market structure”, with adoption targeting less automated processes in low-volume market segments.
The World Bank Group emphasises that success requires not just technological development but also “financial literacy and capability, a sound financial consumer protection framework, interoperability with traditional payment and financial services and infrastructure, and effective oversight”.
As the technology matures, its impact is likely to be evolutionary rather than revolutionary. The key to successful implementation will lie in addressing technical challenges while ensuring regulatory compliance and maintaining market stability.
The World Bank Group concludes that while waiting for perfect DLT solutions is not ideal, “understanding the true potential of DLT for development objectives requires not just research but also real-life applications and trials”.
