Even savvy investors often misunderstand what happens when they confirm a transaction on an online trading account. Many people believe that placing an order or bid results in that order being processed and recorded immediately. In fact, any number of things can delay an order, impacting both the transaction cost and the price paid for the service. With a global financial system dominated by centralized applications and data servers, intermediary services, and long periods of ‘shut-down’, the fair ordering and recording of transactions is anything but guaranteed. Participants in the financial system have no choice but to take these centralized players’ words on faith.
Could a new tool solve this old problem? Distributed ledger technology (DLT) offers promising solutions to traditional finance’s reliance on intermediaries and the frequent imposition of painful shut-down periods. Instead of hoping that centralized financial institutions are trustworthy and fair, users of DLT systems can leverage applications that run across a collection of computers, each administered by a different organization. Each organization wants the network to function properly, but none of them has exclusive or even majority control. The dispersion of functions and power inevitably leads to a stable, reliable network.
However, even though DLT has enormous potential, logging data records on a decentralized, public ledger has, to date, been slow and expensive. Many DLTs struggle to guarantee the order of transactions. The best-known networks, Ethereum and Bitcoin, suggest their network timestamp as being accurate within two hours, leaving significant time and space for error.
In traditional distributed ledger systems, the “miners” that perform calculations to verify transactions can also manipulate event order and priority. These machines can potentially manipulate the order of transactions in the process of being sealed onto the record. Worse, some miners have the ability to alter timestamps on past confirmed transactions.
No manipulated ledger can serve as a legitimate record or as the basis of valid transactions. Consider example of a stock exchange or online trading platform. Institutional investors and financial firms may spend millions on the market in a matter of seconds. It is absolutely integral to the legitimacy of the stock exchange that all transactions are instantly recorded in the exact order in which they were performed. Any uncertainty puts both parties at legal and financial risk.
Any stock exchange, whether centralized or decentralized, must be able to guarantee fairly ordered transactions. Any delay in communicating bids or payments can result in assets ending up in the wrong portfolio. The fundamental flaw in blockchain’s data archiving design means it cannot operate a stock exchange, a fair auction, a payments platform, or any use case that relies on fair ordering.
Numerous solutions have been proposed to tackle the issue of confirming transaction orders, as it becomes a growing impediment to the development of the DLT industry. The inability of distributed ledgers to guarantee the order of transactions for a number of hours has given rise to an ancillary industry attempting to solve this issue. Projects, like OpenTimestamp, have been built to reduce the window to seconds. However, projects like these cannot solve the problem of miner manipulation.
Another supplemental option is Apache Kafka, which despite becoming the growing standard for transaction ordering, must be centrally controlled, and therefore faces the same security and efficiency challenges as centralized systems. Even Kafka has difficulty guaranteeing order as it scales to multiple partitions.
The industry, unfortunately, still lacks a native solution to transaction ordering and fairness. Hedera Hashgraph recently released a new whitepaper, co-authored by Bryan Gross, Principal Product Manager IBM, unveiling its consensus servicing offering, which enables developers to build decentralized applications in which transactions are processed in order of arrival. There is no possibility of manipulating the priority of transactions. This provides all transactions with guaranteed, fair ordering with finality, in seconds.
DLT can make the financial world more efficient, faster, less costly, and minimize the level of trust required by any individual actor within a system. This will only happen if the industry exceeds the high standards it has set for itself. Both traditional finance and decentralized challengers struggle to guarantee transaction orderings. Until the day this is achieved, DLT lacks the fundamentals to support a fair financial system. Fintech’s advancements will let consumers take back control from centralized institutions. Distributed ledgers have the possibility of reshaping the financial system into something more fair, secure, and humane. The distributed ledger technology industry has the responsibility of making this bright future tomorrow’s reality.