Distributed Ledger Technology (DLT): Definition and How It Works (2024)

What Is Distributed Ledger Technology (DLT)?

Distributed ledger technology(DLT) is the technological infrastructure and protocols that allow simultaneous access, validation, and record updating across a networked database. DLT is the technology blockchains are created from, and the infrastructure allows users to view any changes and who made them, reduces the need to audit data, ensures data is reliable, and only provides access to those that need it.

History of Distributed Ledgers

Distributed computing is not new—businesses and governments have been using the concept for several decades. In the 1990s, it became possible for multiple computers and users in different locations to solve problems and return the solutions to a central location.

Advances in data science, computing, software, hardware, and other technologies have made ledgers much more capable. Improved connectivity through intranet and internet protocols allowed for much more data to be collected, analyzed, and used. However, because there can now be many users with access to data, it is necessary to have someone verify the changes.

Computer and data scientists developed programs that reduced the need for auditing data. These programs used automation and data encryption techniques to verify database transactions or changes in a database's state. This is called consensus—the act of automated majority agreement on transaction validity, where a transaction is simply a change made to a database's state.

Distributed ledgers evolved into scalable and programmable platforms, as seen in Ethereum and HyperLedger, where solutions can be created to use a database, or ledger, for everything from tokenizing physical assets to streamlining manufacturing and other business processes.

How Distributed Ledger Technology (DLT) Works

DLTs allow information to be stored securely and accurately using cryptography. The data can be accessed using "keys" and cryptographic signatures. Once the information is stored, it can become an immutable database; the rules of the network, written into the coding of the database programming, govern the ledger.

Because they are decentralized, private, and encrypted, distributed ledgers are less prone to cybercrime, as all the copies stored across the network need to be attacked simultaneously for the attack to be successful. Additionally, the peer-to-peer sharing and updating of records make the whole process much faster, more effective, and cheaper.

Every device on a distributed ledger network stores a copy of the ledger. These devices are called nodes—a network can have any number of nodes. Any changes to the ledger, such as moving data from one block to another, are recorded across all nodes. Because each node has a copy of the ledger, each one publishes its version with the latest transactions.

If the network reaches a consensus about the validity of the latest ledger, the transactions are finalized, encrypted, and used as a basis for the following transactions. This is how blockchains develop—each block contains encrypted information about the proceeding block, which makes them impossible to change.

Industries Using Distributed Ledger Technology

Distributed ledgers are created for many different purposes, but one of the most used ways is as a platform for others to scale and use. One of the more well-known distributed ledgers is Hyperledger Fabric. It is a modular and scalable DLT platform several businesses have used to create solutions that span many industries. Some industries that have implemented DLT solutions include aviation, education, healthcare, insurance, manufacturing, transportation, and utilities.

Supply chains can benefit greatly from DLT. Many factors make these chains inefficient, inaccurate, and susceptible to corruption or losses. Fujitsu, a global data and information technology company, has designed distributed ledger technology to enhance supply chain transparency and fraud prevention by securing and tracking data.

Fujitsu's Rice Exchange was created to trade rice, ensuring data regarding sources, prices, insurance, shipping, and settlement are recorded on the ledger. Anyone involved can look at any data and find accurate information regarding the entire process because it cannot be changed. All data is entered and secured automatically by the platform—it will eventually provide tracking information for rice shipping containers as they are shipped to their final destinations.

Uses of Distributed Ledger Technology

Aside from specific industries, there are also specific situations where DLT solutions have proven to add value. Some examples of specific DLT uses include:

• Record transactions: DLT enables secure, transparent, and decentralized transactions without the need for a central authority. As DLT is a ledger, it records inputs and outputs. Though this naturally lends itself to financial records, DLT can record any type of transaction, not just financially based ones.
• Secure identities: DLT can be used to create a secure and tamper-proof digital identity for individuals, as the technology can provide a reliable way to verify identities and prevent identity theft.
• Collect votes: DLT can be used to create a secure and transparent voting system that can prevent voter fraud and ensure the integrity of the voting process. As mentioned above, as transactions (financial or non-financial) are recorded, a transparent, immutable, open ledger of interactions with users is saved. This enhances the equity and believability of a collection of opinions.
• Enter contracts: DLT allows for smart contracts, programs that automatically execute or complete based on prevailing conditions. For example, an insurance claim may automatically release funds once it has been processed and approved. This limits errors, and DLTs make it more difficult for bad actors to alter information.
• Demonstrate ownership: DLT can be used to record property transactions, creating a tamper-proof and transparent record of ownership and transfer of property. Though there are some limitations on translating real-world ownership of physical assets to a distributed ledger, the ledger may be able to convey an unchangeable source of truth regarding ownership.
  

Advantages and Disadvantages of Distributed Ledger Technology

Pros of DLT

DLT holds many benefits over more traditional centralized ledger systems. Because DLT is a decentralized system, there is no central point of control or failure. This makes DLT more resilient to attacks and less vulnerable to system-wide failures. Also, because DLT uses cryptographic algorithms to secure data, it is nearly impossible to tamper with or forge records. This enhances the trustworthiness of the data and reduces the risk of fraud.

DLT allows for transparent access to data and transactions, allowing all users greater visibility into the operations of the system. This may lead to greater buy-in from users due to transparency and accountability of records.

DLT can streamline processes by removing intermediaries and automating transactions through smart contracts. Because smart contracts may automatically execute when contract conditions are met, there may be less need for human interaction or administration. This can reduce costs and increase efficiency.

Lastly, DLT can enable greater financial inclusion. Some people may not have access to traditional banking services. As DLT often relies only on an internet connection, individuals who would be otherwise limited may have access to a greater range of services. This extends to the use of different platforms and networks via interoperability.

Cons of DLT

Due to DLT's infancy, there are still considerable downsides to the technology. DLT is still complex and difficult to implement and maintain. Leveraging the solution often requires specialized knowledge and expertise, especially to implement.

DLT can struggle with scalability as the number of participants and transactions increases. As a result, DLT processes may lead to slower processing capabilities or higher use costs. In addition, some DLTs, such as Bitcoin, require a significant amount of energy to maintain the network and process transactions. This can have negative environmental impacts.

The lack of regulation and standardization in the blockchain industry (blockchains are derived from DLT) can lead to risk for users and investors. By extension, DLT requires widespread adoption to be effective, and many industries and organizations may be hesitant to adopt new technologies due to these security concerns.

Distributed ledgers might be immutable, but this benefit also comes with a significant downside—if mistakes are made, they cannot be changed unless there are users with permission to do so. In a public DLT like the Bitcoin blockchain, this can be problematic. For instance, if a user typed an erroneous address in their wallet and sent the wrong person some Bitcoin, they cannot reverse the transaction.

Why Distribute Ledger Technology Is Important

DLT is important because it has the potential to transform how information is recorded, stored, and distributed. The importance is often cited across three pillars: security, transparency, and accessibility.

Security

Traditional ledger technology often has a central point of control, with one single entity often in charge of the ledger. DLT makes the ledger more resilient to attacks and less vulnerable to system-wide failures. As DLT uses cryptographic algorithms to secure data, it also makes it more difficult to tamper with or forge records.

Consider a traditional banking system where a banker is the central point in ensuring your transaction is recorded correctly. In contrast, consider a DLT solution built on a consensus mechanism where all distributed ledgers must be in agreement about how a transaction is recorded. This validation of transactions allows greater trust among users and removes the power an individual might have to alter data.

Transparency

Centralized, traditional ledgers often restrict access to specific individuals. Though this still holds value for sensitive information, there are many use cases where it is more beneficial for all when data and information are broadly distributed and transparent. Consider the example above of voting; having digitally distributed, undisputable, verifiable records of voting may enhance the believability of results.

DLT is also important as it holds the theory of reducing fraud and increasing accountability in the long term. Note how all transactions within a DLT system are able to be viewed by anyone with access to the DLT. The information may be "audited" by anyone at any time, potentially demotivating bad actors from entering into nefarious activity in such a public sphere.

Accessibility

Last, DLT may eventually be critically important to developing and emerging countries or regions where centralized technologies are limited. Think about the banking limitations of different countries around the world. DLT boasts the ability to store and record transactions using only a network connection as opposed to a very niche (and expensive) connection, such as a bank account at a specific bank.

As DLT is a relatively new technology that is still being explored and developed, this presents opportunities for innovation and the creation of new applications and use cases. In general, because of the easier access to DLT solutions, there are many positive implications. Notably, the broad public's ability to communally access a shared network often has fewer bureaucratic hurdles.

Distributed Ledger Technology Consensus Mechanisms

A central facet of DLT is how transactions are "approved" when consensus needs to be reached among a disparate user base. Without a universally agreed-upon system of how items are accepted within the DLT, users of the DLT would be unable to agree on the validity of information.

This process of reviewing transactions is called a consensus mechanism, and a DLT may leverage any of the following processes (not all DLT applications will require a consensus mechanic). Note that consensus mechanisms are constantly evolving, and only the more common approaches are listed below:

• Proof of Work (PoW): In PoW, miners compete to solve cryptographic puzzles to validate transactions and create new blocks. This type of consensus mechanism requires computational power, making it a less environmentally friendly method. The concept behind PoW is that miners must financially invest and commit resources to approve transactions, so they are incentivized to be "good actors."
• Proof of Stake (PoS): In PoS, validators hold a stake in the network and are chosen to validate transactions based on the amount of the stake they hold. Seen as a more environmentally friendly option, it is very expensive to become a full validator and earn rewards.
• Delegated Proof of Stake (DPoS): DPoS is a variant of proof of stake where the network selects a limited number of validators by delegating their tokens to a particular staking pool or candidate. This variation reduces the computational resources required to secure the network. In many ways, a DPoS system is seen as a more democratic means of selecting approvers and, in some instances, might offer better scalability.
  

Distributed Ledgers vs. Blockchain

Several key factors distinguish blockchain from distributed ledgers. In general, blockchain is a specific type of DLT. DLTs may take various forms, while a blockchain uses one specific infrastructure: a linear system of blocks that records information.

Blockchains often leverage a proof of work or proof of stake consensus mechanism, whereas a DLT has a much broader range of mechanisms available. In addition, DLTs are often more broadly used across industries as they can be leveraged for problems in those industries. Blockchain has historically been most associated with the financial sector as a means of recording a payment system. The security behind either may also vary, with blockchain having a very defined set of criteria within the DLT realm.

The Bottom Line

Distributed ledger technology uses databases stored on separate, connected devices in a network to ensure data accuracy and security. Blockchains evolved from distributed ledgers to address growing concerns that too many third parties are involved in too many transactions.

Distributed ledger technology is becoming necessary in modern businesses and enterprises that need to ensure accuracy in financial reporting, manage supply chains, prevent fraud, and identify inefficiencies. It has many more use cases in time-consuming and costly business activities.

The comments, opinions, and analyses expressed on Investopedia are for informational purposes online. Read ourwarranty and liability disclaimerfor more info.