How DLT works and how to distinguish it from blockchain

DLT

Since the appearance of the cryptocurrencies, it is very common to refer indifferently to DLT networks and blockchain. Both are technologies based on distributed ledgers, but they are not exactly the same. In fact, the later is a particular use case from the former. Today we will define the DLT networks, we will analyze their relation with blockchain and we will finally see the basic features of this technology to know the different types that exist nowadays.

What are the DLT networks?

Let us begin by the name. DLT means Distributed Ledger Technology but, what is a distributed ledger? According to the Bank of Spain, a distributed ledger is a decentralized and unique database which is managed by several participants. This is the same that a database replicated for every participant which are synchronously updated by consensus among the nodes.

We can differentiate three basic elements in the DLT networks. In the first place, they use cryptography to secure the transactions and anonymize the participants. Additionally, these networks are peer to peer (p2p) which means that the nodes are, at the same time, clients and servers, and so the network is distributed. This way, there is no central authorities to define which transactions should be registered. This decision is taken by the whole set of participants through the consensus algorithm. This allows the network to keep updating itself even without any trust among the participants.

DLT

It happens also that is quite easy to locate the primary origin of any transaction. This is due to the fact that all the nodes own a complete copy of the network. Using the traceability of any transaction, we can move back in the network to the origin message. Therefore, anytime a new transaction is registered, this is stored sequentially and the whole database is updated. Now that we know what are the DLT networks, let’s analyze how they work.

How the DLT works?

We have a huge database which is safe, anonymous and decentralized. It is anonymous because, thanks to the cryptography, the participants are not clearly identified in the network. In fact, you can only see a bunch of letters and numbers, which is known as the public key. At the same time, every participant has his own private key, and uses it to sign and send the transactions.

This database is safe because all the information is replicated in every node. This means that, in case of any kind of attack, all the nodes must be attacked simultaneously, or the attack will fail. The database is also decentralized because it is necessary to reach a consensus to add a new transaction to the network.

The process begins when any participant (known as node) starts a new transaction. This transaction is signed digitally with the private key, and then it is sent to the rest of nodes to be processed. In that moment, the validating nodes must confirm the identity of the participant and the validity of the transaction. This is done through the consensus algorithm, which could be the Proof of Work or any other. Once the transaction has been validated, it is included in the network, and this is updated and sent to rest rest of nodes.

With this process all the nodes participate in taking the decision. Furthermore, the bigger is the network, the safer becomes, because the number of nodes supporting it increases. Last but not least, it is important to know that not all the nodes are equal. Depending on the network, some nodes may specialize in sending the transactions, and the rest of them in the validation process. In order to make it easier to understand, we will assume that all the nodes behave equally.

Differences between DLT and blockchain

Now it is the turn to clarify what are the main differences between DLT and blockchain. Both share the concept of the distributed ledger, but the DLT is much broader. A DLT network is any database shared and decentralized, while the blockchain is a specific use case of the DLT. In fact, the DLT networks does not have to be structured into blocks. In a blockchain, the blocks have identifiers and they are sequentially linked. Each block has several transactions grouped, as well as an identifier to locate the block in the main chain. The new block can only be created once the previous block has been successfully registered in the chain.

This technology is he base for the Bitcoin protocol and many other cryptocurrencies, and it is also the first successful use case of a DLT network. In blockchain, the chain created is unchangeable, and its register is what allows the traceability of every transaction. Both DLT and blockchain networks use p2p protocols, and we can find in both cases different degrees of decentralization.

Types of DLT

According to this, the DLT can be classified in two different ways. On one side, by the degree of decentralization. By this classification, shared by the Spanish Banking Association, we can find three different types:

  1. Completely decentralized – these networks are well known because they are used in Bitcoin. Every user can become a node and contribute to the shared register. Additionally, these networks avoid completely any intervention of a central authority.
  2. Public permissioned – in these cases, any user can access the network and see the transactions, but only some pre-selected nodes can contribute to the register of them. These networks are more focused on private companies projects.
  3. Private permissioned – this case would be far away from the original idea of DLT networks. Just some nodes can access and contribute to the network, but thanks to that, the network works faster and becomes more scalable. In these cases we would need a third trusted party to secure the network, so it would not be really decentralized.
DLT types

Apart from the previous classification, we can make the difference also according to how the network works. In this classification we can find the following types:

Blockchain

We have already explained in this article what the blockchain networks are. Basically they are DLT networks where the information is grouped in blocks registered sequentially and where the transactions are traceable. Furthermore, these blocks are unchangeable because they do not allow any type of modification. This is the reason why blockchain is a system very reliable and compatible with many different consensus algorithms. The best example of this kind of network is Bitcoin, but we may find others like Ethereum, etc.

DAG

DAG is an acronym from Directed Acyclic Graph. The main characteristic is that the scalability of this kind of network is nearly infinite. Because of its way of working, the process velocity increases when the number of transactions is higher. This allows the scalability to be much higher than in Blockchain, where is a problem still pending to be solved. The best example of this network is IOTA.

Hashgraph

In Hasgraph we can find two principal elements. In the first place, this kind of network allows the registration of several transactions at the same time, which improves the scalability. Additionally, the system of communication among the nodes is really fast, allowing a higher velocity in the network than blockchain, but maintaining the security. The main weak spot of this network is the lack of experience, due to the very few examples currently developed. Hedera is the main example of these platforms.

Holochain

The differentiating element of this DLT is the independence among its nodes. In Holochain, every node is independent and work which its own record. In fact, the consensus protocol does not have to be the same for the whole network. Each node can have its own algorithm. This allows a higher flexibility in Holochain, so its becomes a true distributed system. The negative element is that the independence of the nodes affects directly to the velocity of the common record, which harms the scalability.

Tempo

The last kin of DLT networks is Tempo. This DLT allows the integration between public and private projects without any distinction. The main characteristic is that each node is in charge of managing a sub segment of the main record, for which it will have a unique identifier. Additionally, the nodes do not store the time of the transaction itself, but the time of its validation. This way, the record is lighter and the scalability improves. The best example of this network is Radix.

Challenges and opportunities for DLT networks

Once we have seen what the DLT networks are and the different types of them, it is time to see what challenges will be faced in the future. On one side, we can talk about the lack of regulation in most of the countries. Also, there is no any uniform environment to integrate the DLT based projects. To fix this, some initiatives in Europe as MiCA or the DLT Pilot Regime may be of help.

On the other side, it is important to notice the security problems. All the DLT networks are designed to avoid security breaks and the security of the protocols is getting higher over the time. However, we have seen several situations in which a mistake in the underlying code has allowed external attacks.

security

In the last place, we need to analyze the scalability problems. A public DLT network, for example, with a high number of participants, will be very limited at registering the entering transactions. However, if the network is not fully public (what means at some point permissioned), then the validation velocity will be higher, at the cost of renouncing to part of the essence of this technology. The alternatives for this problem are not mature enough, so it is still a problem to solve by the community.

However, and despite the mentioned difficulties, the DLT can become a great technological advance. The distributed design allows to think in fast and decentralized processes which could be, in the future, quite scalable. In many industries, technologies of this type can be used to save money and improve the efficiency. Furthermore, part of its potential has been already showed in the leisure sector, thanks to the metaverse for example. On the other side, from the public sector can also use these technologies for the CBDC.

Conclusion

To sum up, the DLT networks are huge and anonymous databases where the transactions are registered based on the consensus of the participants. However, their current impact is limited because their own configuration works like a break in comparison with the classic transaction systems. Until now several alternatives have arisen to solve the initial problems of this technology, but they are still in a very early stage of development.

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