Academic studies on aspects of blockchain technology often use complicated technical phrases such as – to name the most important ones – distributed network, decentralized network, DLT (distributed ledger technology), consensus algorithm, PoW (proof of work) or PoS (proof of stake). For this reason, it often remains a complicated, even incomprehensible part of the world of new technologies. In this article I will try to answer the question in an accessible way – what is blockchain?

Blockchain – a type of database

This technology is nothing more than a type of database. From the essence of the concept of block chain, so chain of blocks, it follows that further blocks of data can be attached to this database.

The essence of attaching successive blocks is that it is not possible to delete data previously stored. In addition, data blocks are linked to each other, in such a way that each block contains within itself a reference to the previous block – a so-called summary of its contents referred to as a “hash.” Therefore, it is not possible to modify the data in a block without modifying all the following blocks. For this reason, blockchain is often referred to as an “inseparable chain of blocks.”

The distributed nature of blockchain

Blockchain, in addition to being a type of database, is characterized by being distributed, or decentralized. This means that each user (participant) of a given blockchain-based solution has a copy of this distributed registry.

Unlike a centralized registry, no one has top-down control over a blockchain. Only the users of the system, each of whom has permanent access to the system, have control over the contents of the registers in the blockchain, using agreed-upon methods for writing consecutive blocks, i.e. consensus methods (consensus algorithms). Put another way, users of the system agree among themselves on rules for adding new data to the blockchain. These may include, for example, those mentioned in the introduction:

• proof of work done – proof of work (PoW);
• or proof of stake (PoS).

Thus, all users agree on the rules for adding any information to the blockchain (rules for so-called transactions).

Simultaneous recording of transactions in blockchain

The element that distinguishes blockchain from other types of registries and types of data exchange is that information and data are recorded simultaneously by all users participating in the exchange of information, unlike the implementation of business processes that involve sending information between participants, using centralized information technology.

Blockchain technology uses a network of interconnected nodes that exchange information and communicate directly with each other. In a centralized system, such nodes would send data to a central entity.

The use of distributed technology means that data is simultaneously stored in multiple locations, and each user has his own copy of all the system’s data. Therefore, in the event of a failure or removal of one of the nodes, the data will remain unchanged and resistant to any distortion.

Examples of blockchain use – a durable medium

Since its inception, blockchain has been used in finance, due to the most important feature of this technology – the recording of all business transactions in a distributed technology, in a permanent and uninterruptible blockchain. This leads to increased security of financial transactions. Thus, this technology ensures that the fundamental goal of any financial transaction – its security – is realized.

An example of the large-scale application of blockchain technology in customer relations has already boasted a major Polish bank creating a so-called durable medium based on blockchain technology. It was chosen for this purpose because of its features such as record integrity and resistance to unwanted tampering with the block structure.

Blockchain was used as a durable medium in this case, because it fits perfectly with the requirements for a durable medium under Polish regulations (for instance the definitions of a durable medium in the legal acts on payment services and consumer credit). The technology is also in line with the requirements placed on the durable medium by the polish Office of Competition and Consumer Protection (UOKiK). The Office has already issued decisions on the concept of a durable medium several times. According to the President of the UOKiK, a durable medium might be considered as such technology If ensures the integrity, immutability, authenticity and indelibility of the data. The durable medium should also allow the user to store information in an unchanged form without the possibility of unilateral change of the content stored in it by the provider.

The advantage of blockchain over other types of durable medium is therefore obvious, and we will see an increase in interest in this way of using the technology. However, this is not the only way to use blockchain technology in finance.

Global trends of blockchain application in finance – CBDC

The first noteworthy development in the area of the application of blockchain technology in finance is the development of so-called digital currencies – central bank digital currency, CBDC, or payment instruments issued by central banks.

Most such digital currencies are based precisely on blockchain. Digital currencies already have some countries. The digital yuan has been implemented by China since 2014, and it is already clear that China’s digital currency is among the most advanced in the world.

In a recent report on the involvement of the world’s central banks in the creation of their own CBDCs, as many as 80% of correspondent banks indicated that they are involved in work on a digital currency. The European Central Bank is also working on a digital euro.

Digital currencies – current challenges

The creation of digital currencies involves many challenges, such as:

• creating a payment system;
• determining what types of payments will be able to be made using the digital currency;
• determining which payment mechanisms will be adopted.

Central banks, also face challenges of:

• selecting the appropriate technology under which the digital currency will be created (analyses are underway as to whether the digital euro will be based on blockchain);
• as well as determining the issue of access to transactions made with the digital currency by the user of the currency.

It is known that blockchain technology was used to create cryptocurrencies such as Bitcoin and Ethereum. Today, however, we are seeing not only the development of cryptocurrencies, but also financial services using them. A very fast-growing application of blockchain technology is granting loans, secured by cryptocurrencies belonging to the borrower. Already today there are many platforms that enable such forms of lending.

Possible applications of blockchain

Another promising business process in banking and finance is the use of blockchain in bank clearing and settlement systems. Nowadays payment orders are processed by using the centralized SWIFT technique. Blockchain can successfully replace this model by enabling fast processing and settlement of transactions.

Blockchain technology can also help improve identity verification procedures and the application of KYC and AML processes in financial institutions, also supporting credit scoring processes.

Other applications of blockchain are the conclusion and settlement of commercial transactions, as well as peer-2-peer transfers. Each such transaction is directly recorded in blockchain and does not require a third-party verification process.

Blockchain in smart contracts

A very important area where blockchain technology is used is in document management and contract conclusion using so-called smart contracts.

Smart contracts are concluded and executed automatically, once the conditions set by the parties to the transaction have been met and agreed upon as conditions for the contract to come into force.

This method of contracting has undeniable advantages, such as:

• transparency;
• automation;
• speed of contracting.

Undeniably, smart contracts also have the advantage of economy, because their conclusion does not require the participation of third parties. Unfortunately, in the Polish legal system, they can be equated, at most, with contracts concluded electronically; they do not meet the requirements for recognition as a deed (contract under seal).

Blockchain in tokenization

A very important application of blockchain technology that should not be forgotten is tokenization. In simple terms, tokenization is the digitization of some good using blockchain technology. Today we can tokenize almost all goods.

I will take a closer look at the topic of tokenization as a companion issue to the virtualization of economic trading and the development of the metaverse in future parts of the series on blockchain.

Blockchain – summary

Blockchain technology undoubtedly presents huge opportunities for the development of the financial services industry, but not only. The undeniable benefits of its use are a driving force for the development of such projects. It is to be expected that most financial institutions will undertake implementation activities based on blockchain technology.

In Poland, with the exception of certain regulations for a simple joint-stock company, which stipulate that the register of the company’s shareholders may be maintained electronically in the form of a distributed and decentralized database, there is a lack of regulations pertaining to blockchain technology, but despite this, entrepreneurs are increasingly boldly reaching for business solutions based on blockchain technology in various areas of the economy. It is safe to say that blockchain is today part of a technological revolution.