Distributed Ledger Technology and Governance Issues

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Table of Contents

Distributed Ledger Technology
Central Bank Digital Currencies
Governance of Distributed Ledger Technology
Reference List

The idea of Distributed Ledger Technology (DLT) is believed to have existed over the past years however it was not as efficient as it is now. In the past, the aspect of achieving a general agreement on the data, decentralization, distribution, and trustlessness was the major issue that made the concept remain unfit and reliable. The introduction of Bitcoin provided the solution to the problem by creating a unified protocol known as the proof-of-work (POW). The POW innovation proved vital in facilitating the process since it enabled the DLT to overcome the key issues associated with its operations. Properly exploring the DLT concept such as its strengths, weaknesses, types, and governance issues pertinent to the product will enhance an effective understanding of its impact and application in the system.

Distributed Ledger Technology

Understanding the Concept of DLT

By definition, DLT refers to a technological infrastructure having specified protocols that enhance simultaneous access, authentication, and updating records in a manner that cannot be easily imitated across the network and is spread through multiple locations. DTL is essential because it facilitates the secure performance of a decentralized digital database. Furthermore, through the facet of distributed networks, DTL is capable of eliminating the demand of having centralized management to regulate and manage possible manipulations (Zheng et al., 2019). The aspect of cryptography enables DTL to effectively and efficiently store information in a more protected and accurate way.

Even though the concept of DLT has been there over the past years, the innovation came to the limelight during the emergence of Blockchain technology under its most common cryptocurrencies, especially Bitcoin. Dragonchain (2019) iterates that all DTL encompasses features of a Blockchain technology while not all Blockchain can be categorized as a DTL. The system allows individuals and business organizations to undertake quick and secure transactions. DTL innovation eliminates the need for a middleman thus promoting a reliable, cost-efficient, and easily accessible transaction platform as compared to the traditional methods that have a centralized authority. DTL majorly relies on a distributed database that acts as the ledger in which the transaction records are recorded. There are various types of DTL namely; Holochain, Directed Acyclic Graph, Blockchain, and Hashgraph (Dragonchain, 2019). The mentioned DTL operates almost similarly with some slight differences making them unique from each other.

Properties of the DTL system

Generally, DTL encompasses shared recordkeeping whereby various users have the ability to collectively create, update, and maintain a given authoritative record. Furthermore, it is a multi-party agreement in that it allows individuals to have a common consensus on a shared set of ledgers (Tasca and Tessone, 2018). In other words, it can either operate without having to rely on a specific participant’s permission or it works through having a well-structured agreement that binds multiple users. In addition, the DTL system is capable of promoting independent validation. Using the platform, each party has the potential to verify their transactions as well as the integrity of the whole system. Based on the properties, the DTL system aims to develop synchronized authoritative electronic records that are easily validated and performed through a multi-party agreement involving the participation of various separate individuals without relying on a central authority.

Strengths of the DTL

The adoption of DTL arrangements instead of using a master ledger or centralized authority is prompted by a number of capabilities offered by the system. In the financial sector, the aspects of resilience and reliability are essential and must be guaranteed to the parties involved. DTL has the potential to ensure that the payment system is flexible and dependable by users (Akhtar et al., 2021). Unlike the centralized approach, the distributed nature of DTL design and the presence of several processing nodes and synchronized ledgers enable the system to reduce the facet of single-point malfunction. Having multiple functioning ledgers and nodes in the setup makes it easier for the transaction process to continue even if one of the nodes or ledgers is compromised. The feature is useful in ensuring the payment system remains resilient and reliable for users despite possible attacks by unauthorized people.

The payment process entails significant fluctuation in volumes following numerous settlements and clearing thus requiring a system that allows scalability. DTL provides adequate operational capacity that is capable of enabling parties to process large volumes daily. Furthermore, the platform has the potential to handle peak changes associated with market stress and volatility. The features make DTL a suitable system that allows the participants to adjust the payment agreements to meet their transactional needs.

The security of the payment system is a major concern for all parties involved in any transactional agreement. It is central to the financial system and thus must be addressed effectively to enhance the confidence of participants. A DTL contains cryptographic tools that allow users to encrypt data either through private or public keys. The aspect is essential is ensuring the safety and soundness of the payment system is guaranteed as well as maintained. Therefore, the facet makes the DTL arrangement remain effective and secure thus possible access by an authorized person.

Generally, financial records should not be tampered with to ensure the accuracy of the transaction data. DTL arrangements provide an immutable ledger that cannot be altered. This facet makes the system effective in handling sensitive information such as payment details (Hamilton, 2020). For any party to make changes, DTL will require the individual to collude with many people which automatically complicates the process. The algorithm ensures and guarantees participants that the data present in the system are original and no aspect of manipulation benefits a section of the people.

Weakness of the DTL

Even though the implementation of DTL is prompted by its ability to facilitate effective transaction processes, the technology has some significant downsides that have the potential to jeopardize the payment system. For instance, the presence of many nodes in the DTL arrangements creates several entrances where malicious intruders may access the system to compromise its integrity, and confidentiality (Kannengießer, Lins, Dehling and Sunyaev, 2020). Despite the effectiveness of multiple nodes, it makes the payment system vulnerable to possible attacks that are more likely to tamper with the available ledgers.

Generally, DTL systems tolerate both unreliable and malicious actors that are actively trying to hack the platform. With the rapid advancement in technology, such attempts might have a significant impact on the financial transaction supposing the intruders manage to crack the codes. The aspect makes DLT exposed to about a 51% chance of an attack because the large numbers of actors have control over a significant portion of the DTL network (Naudts, Aerts, and Pieterse, 2021). Even though in areas of cryptocurrency it is impossible, small networks are at great risk.

The immutable nature of DTL arrangements can further be categorized as a weakness of the Blockchain because the feature has the potential to prevent parties from reversing the transactions. The aspect is a challenge especially when the sender mistakenly pays a large amount of money to the recipient, the payment cannot be reversed. Assuming the transaction was facilitated by the element of fraud, it is automatic that the sender will lose the cash.

Furthermore, due to the large number of users accessing the system, the DTL might become inefficient due to a slow network as a result of congestion thus inconveniencing participants. In such cases, the transaction fees might increase making the individuals incur significant costs. In addition, the technology requires a significant amount of energy to operate effectively hence maintaining its activity is a challenge (Gourisetti et al., 2021). The need for computing power results in the emission of carbon footprint.

Central Bank Digital Currencies

Sand Dollar -Bahama’s CBDC

The Central Bank of Bahamas issued the Sand dollar as the digital version of the Bahamian Dollar through authorized financial institutions such as the Bahamas Financial Services Board. The Bahamian Central Bank digital currency was launched in October 2020 to match the evolving global payments (Agur, Ari and Dell’Ariccia, 2022). The Sand Dollar was adopted to widen the narrow banking system in the Bahamas, which resulted in financial instability and regional banking operations. The CBDC was successfully launched to give Bahamian locals and internationals an alternative mode of payment when debit or credit cards are unavailable. Bahamas adopted a Two-Agent, New Keynesian (TANK) model to assess the impact of fiscal and monetary policies on the Sand Dollar.

Jam-Dex- Jamaica’s CBDC

Jam Dex digital currency Jamaica’s central bank digital currency has played a milestone in promoting transparency in the flow of money within the country. Introduced in July 2021, Jam Dex won the legal tender to become the first CBDC in the Caribbean. During the research period, the concept of Jam digital currency was to provide a convenient way of paying for goods and services and reduce the overdependence on the physical mode of cash transfers. The Bank of Jamaica CBDC is guided by monetary policy in interests and taxation (Náñez Alonso, Jorge-Vazquez, and Reier Forradellas, 2020). The Lynk wallet is the most recent innovation that enables people to connect bank details to their mobile devices easily. Jam Dex acts as a revolutionary project since it has improved the tracking of transactions, an initiative that has helped marginalized communities find their way into the mainstream economy.

E-peso Uruguay’s CBDC

In the finance sector, technology is constantly changing. Therefore, the e-peso project was introduced to diversify the money flow in Uruguay. The primary concept of the plan central bank digital currency was to promote financial inclusion within the rural regions, promote traceable money transfers that lead to transparency, and complement the physical money transfers that are inadequate and ineffective. The central bank of Uruguay set monetary and fiscal policies such as blockchain technology that enables banks to share financial informatics with credit bureaus to promote sufficient financial data analysis. The success of a digital currency depends on the central bank’s reputation (Bank, 2022). E-peso digital currency emphasized reputational and cybersecurity risks in its development.

Merits of Issuing the CBDCs on Monetary, Functional, and Fiscal Policies

Transparency, financial equity, and inclusion are the main advantages promoted by functional, fiscal, and functional policies. Monetary policies have led to the introduction of point-on-sale terminals and automatic teller machines. E-peso acts as a complementary mode of payment since people and the central bank limited the use of digital currency to large amounts only. The distributed ledger technology available in cryptocurrencies was used in the e-peso development. The technology has promoted security since digital wallets are encrypted, and only the user can open them. Bills paid through the e-peso digital currency are unique; a code is generated once a purchase is made to avoid double-spending. Regarding the merits of Digital currency, Sand Dollar has promoted anonymity in the Bahamas, which is key to financial privacy. Central bank digital currencies are easily subject to monetary policies that make them flexible compared to physical cash. The Sand Dollar has reduced the rates of money deposits and has drastically reduced the constraints in the Bahamian markets. The adoption of Bahamian digital currency has increased the profits achieved through lending by the banks due to its risky nature. The risky lending has reduced funding costs, increasing the Bahamas’ financial stability.

Chinese digital currency, e-CYN, has positively impacted the country’s economic status and financial stability. Financial crimes have been rising in the Chinese government due to the lack of money caused by physical currency. E- CNY has enhanced money tracking in China (Xu, 2022). Electronic recording in transactions has promoted banking both in rural and marginalized areas. The online inclusivity program, a functional policy in Chinese digital currency, has brought the unbanked population into the mainstream economy. The demand for central bank digital currencies can be easily regulated to align with monetary and fiscal policy. The adjustments to CBDC policy rates make the currency appropriate for retail and wholesale transactions.

The main advantage of Jam Dex CBDC was to broaden access to money since Jamaica had a centralized financial system. Government parastatals are authorized to use Jam Dex digital currency since the transactions are easy to audit; public funds are easily managed. Jamaica’s digital currency has improved financial stability due to its ultra-liquid nature (Náñez Alonso, Jorge-Vazquez, and Reier Forradellas, 2020). Rollover risks are significantly reduced through liquid currency since one can easily evade personal losses by directing them to the central bank. Finally, Jam Dex is flexible about how monetary and fiscal policies affect the financial market rates.

Demerits of Issuing the CBDCs on Monetary, Functional, and Fiscal Policies

Due to its dependability on technology, digital currency has both technological and operational demerits. Cybersecurity issues have increased as a result of the set currency transmission policies. Access to sand dollar digital currency has been determined by the monetary and fiscal policies that determine the interest rates subjected to the coin. Due to the risky nature of the money, the Central Bank of the Bahamas imposes high rates on loans over physical loans, reducing its use scale (Agur, Ari and Dell’Ariccia, 2022). Also, authorized digital currency agents operate in the daytime, unlike physical currency. Cybersecurity is a significant operational challenge in the sand dollar digital currency. Clearing, settlement, and payment systems in digital currency are prone to fraud and malware.

On the operational challenges, the e-CNY is burdened by the legal shortcomings that have narrowed down the authorized distributors of the currency. The central bank’s initiative to reduce the number of banks has reduced the availability and access to money, affecting its dependability. The retail digital banking approach adopted by China has reduced the importance of commercial banks through reduced profitability due to reduced lending services (Xu, 2022). Chinese central bank digital currency negatively affects the stock market through reduced value in bank stocks.

Jam Dex central bank digital currency faces financial market, economies, and technological disadvantages. Security breaches are operational risks that negatively impact digital currency payment systems since the digital currency is subject to malware and promotes money loss. Larger balance sheets are required to implement monetary policies on digital currency rather than physical currency (Náñez Alonso, Jorge-Vazquez, and Reier Forradellas, 2020). Therefore, Jam Dex assets require intensive financial calculations compared to physical assets.

In every development stage of the E-peso, fraud is a significant cybersecurity risk. The distributed ledger technology is not end-to-end encrypted, and a third party could access and alter the transactions, destroying the CBDC’s reputation (Sarmiento, 2022). The financial inclusion policy, at the center of the E-peso digital currency, provides functional limitations for people willing to make huge payments through cash. Uruguay has an underdeveloped financial system; therefore, operation risks such as payments to the unintended people associated with the e-peso digital currency make people prefer the physical currency.

Governance of Distributed Ledger Technology

Increased cybersecurity risk is the first pertinent governance issue to Distributed Ledger Technology (DLT). A DLT is permissible for many security risks, such as the 51% attack, stolen keys, smart contracts, and external vendor and third-party applications (Naudts, Aerts, and Pieterse, 2021). 51% attack is one of the methods hackers use to attack smaller blockchain networks. By dominating more than half of the network’s mining capacity, a group of users can theoretically take over the ledger and record new blocks that block any additional transactions from anyone outside the group. ‘51% of assaults’ are typically the result of poor security procedures (Naudts, Aerts and Pieterse, 2021). The reliability of the underlying network is crucial to the presumption that no entity, present or future, could control more than half of the computational power of any servers on a specific blockchain. It is essential to analyze and monitor the apps created to communicate with these DLTs. An attacker might be able to get access to a permissionless system, collect identity information, and then succeed in expanding until they have control over the majority of network users (Naudts, Aerts, and Pieterse, 2021). Additionally, future advancements in computation, such as quantum computing, are expected to make current encryption techniques easy to crack. These security issues affect the user’s privacy, and data security should be dealt with appropriately.

The second governance issue pertinent to DLT is its leaderless system. It is questionable whether the decisions made in these DLT systems are made in the best interests of all parties involved and the general public, including the regulatory authority. Concerns regarding guaranteeing efficient control of the entire infrastructure arise from the lack of a centralized system and a central entity. Historically, financial sector authorities have implemented efficient governance structures for central infrastructures and other regulatory enterprises (Naudts, Aerts, and Pieterse, 2021). However, it is frequently ambiguous to whom governance mechanisms pertain in the setting of permissionless DLT. Even for the permissioned DLT, where particular governance frameworks can bind the administrator, the system’s administrator might sometimes need more tools for enforcing these agreements among network users. Therefore, there is a need for a way to make decisions concerning DLT in a consensus manner.

The third governance issue relevant to the DLT is the environmental cost. When proof-of-work is employed as a consensus mechanism, electricity is consumed during the “mining” process (Inacio, 2021). It is specifically an issue with the permissionless that employ proof-of-work algorithms. Since most cryptocurrencies use the Proof-of-work technique, which has a significant energy cost, to reach an agreement, this evolution has also brought forth environmental issues (Inacio, 2021). The social and ecological costs of mining will soon surpass the income facilitated by this new technology if steps are not taken to prevent the adoption of energy-intensive procedures.

The last governance concern for DLT is the need for legal clarity over ownership and jurisdiction. Regulations or laws may require that faulty or illegal transactions be unraveled due to the nature of blockchain records. There are particular worries in payment and settlement systems about how a transaction’s “moment of completion” will be determined in a DL setting. People are worried about the jurisdiction of the fundamental data and transactions and cross-border DL systems. Since no legal entity controls the distributed ledger, controlling open, permissionless networks is particularly challenging. As a decentralized ledger, the blockchain’s nodes can be found in numerous places worldwide. It implies that any transaction recorded on the blockchain may be subject to the laws of every state where a node of the network is located, thereby subjecting the blockchain network to an unmanageable number of laws and regulations.

Reference List

Agur, I., Ari, A. and Dell’Ariccia, G. (2022) ‘Designing central bank digital currencies,’ Journal of Monetary Economics, 125, pp.62-79. Web.

Akhtar, M.M., Khan, M.Z., Ahad, M.A., Noorwali, A., Rizvi, D.R. and Chakraborty, C. (2021) ‘Distributed ledger technology based robust access control and real-time synchronization for consumer electronics,’ PeerJ Computer Science, 7. Web.

Bank, N. R. (2022) ‘Central Bank Digital Currency (CBDC): Identifying appropriate policy goals and design for Nepal: A Concept Report,’ Web.

Dragonchain. (2019) ‘What different types of blockchains are there?’ Web.

Gourisetti, S.N.G., Cali, Ü., Choo, K.K.R., Escobar, E., Gorog, C., Lee, A., Lima, C., Mylrea, M., Pasetti, M., Rahimi, F. and Reddi, R. (2021) ‘Standardization of the distributed ledger technology cybersecurity stack for power and energy applications,’ Sustainable Energy, Grids and Networks, 28. Web.

Hamilton, M. (2020) ‘Blockchain distributed ledger technology: An introduction and focus on smart contracts,’ Journal of Corporate Accounting & Finance, 31(2), pp.7-12. Web.

Inacio, I. (2021) ‘Environmental costs related to cryptocurrency mining: Ensuring that innovation does not happen at the expense of the environment,’ Web.

Kannengießer, N., Lins, S., Dehling, T. and Sunyaev, A. (2020) ‘Trade-offs between distributed ledger technology characteristics,’ ACM Computing Surveys (CSUR), 53(2), pp.1-37. Web.

Náñez Alonso, S.L., Jorge-Vazquez, J. and Reier Forradellas, R.F. (2020) ‘Detection of financial inclusion vulnerable rural areas through an access to cash index: Solutions based on the pharmacy network and a CBDC. Evidence based on Ávila (Spain),’ Sustainability, 12(18), p.7480. Web.

Naudts, E., Aerts, T. and Pieterse, A. (2021) ‘Governance in systems based on distributed ledger technology (DLT): A comparative study,’ 718. Web.

Sarmiento, A. (2022) ‘Seven lessons from the e-Peso pilot plan: the possibility of a Central Bank Digital Currency,’ Latin American Journal of Central Banking, 3(2), p.100062. Web.

Tasca, P. and Tessone, C. (2018) ‘Taxonomy of blockchain technologies. principles of identification and classification,’ Web.

Xu, J. (2022) ‘Developments and implications of central bank digital currency: The case of China e‐CNY,’ Asian Economic Policy Review, 17(2), pp.235-250. Web.

Zheng, X., Sun, S., Mukkamala, R.R., Vatrapu, R. and Ordieres-Meré, J. (2019) ‘Accelerating health data sharing: A solution based on the internet of things and distributed ledger technologies,’ Journal of medical Internet research, 21(6). Web.

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