Zbigniew Wiliński, Director of the FinTech Department at the UKNF

Over the past years modern information technologies have become an integral part of the economy. New solutions aimed to optimise business operations and processes continue to emerge. One technology worth highlighting is the blockchain. The interest in the blockchain results mainly from the popularisation of various types of digital assets, including virtual currencies, that have been created using this technology. Today, however, it has a much broader use. 

The blockchain, a general term for a chain of blocks, is a technology designed to send and store information on online transactions. It is a kind of online database or a digital ledger of transactions which is tasked with recording a list of transactions performed within a network. In a blockchain, information is recorded in a form of consecutive blocks of data, each of which marked with a timestamp, a cryptographically calculated checksum and the checksum of the preceding block, and any data or their modification are added to the preceding record (block). This means that such a chain stores the entire record history. To modify a current transaction you need to edit the previous blocks. Once made, a modification remains in the system forever, and any deleted data are not lost because of the trace that is left in the code. 

A computer network in a blockchain architecture is based on the peer-to-peer system: the data are not stored in a single master server (computer) but are distributed between many different servers. Each device that connects to the network can participate in sending the data. The blockchain is therefore a kind of a distributed, decentralised ledger. Often the notions of ‘blockchain’ and ‘distributed ledger’ are used interchangeably. This is not accurate, however, as not every distributed ledger can be called a blockchain. 

The history of the blockchain technology goes back to the beginning of the 1990s. In 1991, two scientists – Stuart Haber and W. Scott Stornetta – described in the Journal of Cryptology the idea of using a cryptographically secured chain of blocks marked with the so-called timestamps to store documents. A year later, in cooperation with Dave Bayer, the so-called Merkle trees, a tree-like data structures containing summaries of information on the data, were incorporated in the design. This improved the effectiveness of the concept by enabling the possibility of collecting many documents in one block. In 1998, another scientist, Nick Szabo, designed a mechanism for a decentralised digital currency that he named ‘bit gold’ and although his concept was never implemented, he has been considered to be the forerunner to the later designs. Two years later, Stefan Konst published his concept of a distributed ledger that relied on the idea of independence of each custodian of the ledger. 

The first practical use of the blockchain in history, however, was the release of the Bitcoin cryptocurrency in the beginning of 2009. The cryptocurrency combined the existing concepts of a distributed ledger with safe cryptographic functions. Still in 2008, an individual (or a group of individuals) acting under the nickname of Satoshi Nakamoto published a white paper presenting the concept of a distributed database named the ‘blockchain’ and of a blockchain-based Bitcoin cryptocurrency whose value was to be based on computing power. On 3 January 2009, Satoshi Nakamoto mined the first block and, on 22 May 2010, the first transaction using Bitcoin was executed: in the United States Laszlo Hanyecz bought two pizzas from a friend from an Internet discussion forum for approx. 10,000 bitcoins.  

In 2013, a computer programmer Vitalik Buterin started to work on a new platform for processing computer data based on the blockchain technology. The main objective of the platform was to expand the technological possibilities and to allow users to create decentralised apps. This project, named Ethereum, has become the second largest cryptocurrency project powered by the blockchain technology. It enabled the creation and management of the so-called smart contracts, referring to the concept developed back in 1996 by the already-mentioned Nick Szabo.  Smart contracts are programmes or scripts written in specialised programming languages and compiled into byte code which is then read by a decentralised, Turing-complete virtual machine. These contracts can be used, for example, for transactions that are executed once specified predetermined conditions are met. The Ethereum platform was launched on 30 July 2015. Since then, numerous decentralised applications (the so-called dApps) have been created in the blockchain Ethereum network, including social platforms, gambling apps and crypto exchanges. 

But the blockchain is not only about virtual currencies. Already today, this technology is used in practice, also in Poland, in many financial institutions. One solution which is more and more commonly used by banks is to use blockchain to fulfil the legal obligation of providing information to customers or entrepreneurs on a so-called durable medium. Several banks operating in Poland are already using blockchain-based solutions to deliver private documents to customers in a digital form and to store electronic documents online. Documents transmitted on a durable medium with the use of the blockchain are available to customers also after their agreements with the bank are terminated, are properly secured against unauthorised access, and the files, once created, cannot be modified. The immutability  of these files can be verified by customers at any given moment. 

The blockchain also started to be used in the process of issuing electronic money other than cryptocurrencies. The technology used for this purpose is based on the possibility of recording regulated currencies  and other data in a form of an uneditable file stored online. It is the current underlying technology of the Polish zloty and the British pound, among other currencies, and the blockchain-based currency can be exchanged for traditional cash at exchange points or through bank transfers as every app (blockchain node) has its own IBAN.   

The blockchain, due to its properties, can be applied not only in banking or finance sectors but also in energy, logistics, notary services, and all kinds of private or state registers. At present, this technology is used e.g. to execute transactions between small energy producers and consumers, since direct transactions lower the cost of buying energy. Although the dominant model of organisation of the energy market, based on centralised generation of energy, is not conducive to the development of distributed generation, first European energy companies have already carried out transactions using the blockchain technology. Work is also ongoing to apply the solution in billing owners for charging their electric cars.

Intensive attempts to implement blockchain solutions are also made in other industries. In logistics, thanks to ‘marking’ of objects, the blockchain enables tracking the movement of goods, a feature also used in the pharmaceutical industry to prevent counterfeit drugs from entering the supply chain. Also, the largest pharmaceutical companies are already working on the use of blockchain to build a new system for control of clinical trials of drugs placed on the market. The blockchain has the potential to help both in clinical trials, by tracking and marking data records, and to secure patient data, and ultimately speed up the entire process and reduce its costs.  

Work is also ongoing on the application of blockchain for digital signature in state administration – the blockchain enables a cryptographic abbreviation  of any document to be stored and therefore serves to confirm that a digital asset existed when a given block was added to the chain. It also makes it possible to unambiguously determine that a given thing belongs to a given person and this information is stored in a blockchain in a permanent and unmodifiable manner. Blockchain can also be used to create a settlement system, as well as a tool to provide a secure voting system. It enables identity verification and all participants in the process have access to control data, which increases the level of security, reliability and transparency of the process. A distributed database is considered by many to be more secure than a centralised one, and the possibility to execute transactions outside the existing system, directly between the parties to the transaction, creates a range of new possibilities. 

The invention of the blockchain in the 1990s and its popularisation through bitcoin in 2008 are now referred to by many as the revolution similar to that brought by the invention of the Internet. Experts predict that by 2025 the value of the global blockchain market will exceed USD 21 billion. One example of an international organisation that is already taking action to make wider use of the blockchain technology is the UN. As early as in 2022, the organisation announced more work to be performed on systems that use blockchain technologies in order to implement them to monitor carbon emissions, trade clean energy and allocate funds.

However, apart from these opportunities, the use of blockchain entails various constraints that should be considered when assessing this technology. One important limitation named is that the functioning of a blockchain network is a very energy-intensive process due to the need to involve many entities in each operation. Experts also point out performance limitations, as well as the fact that blockchain-based applications are still expensive to develop and maintain. It is stated that the blockchain network in its current form is unable to efficiently process a very large number of micropayments. The above-mentioned problems with blockchain technology are clearly visible in the case of cryptocurrencies. Bitcoin needs a huge amount of energy to process transactions in the blockchain network and to mine each subsequent block. Both ethereum and bitcoin are currently facing performance issues related to the increasing number of network users which affects the speed of transactions and their number per second. 

Importantly, trading in crypto-assets in itself is associated with various risks. The cryptocurrency market is characterised by a very high volatility. In recent years, we have seen significant fluctuations in the value of bitcoin and other cryptocurrencies, resulting in the lack of stability of trading. The speculative nature of cryptocurrencies caused by the lack of effective and proven valuation methods is also mentioned as one of the threats. It is still unclear how the prices of certain assets are set, as they are often based solely on consumer demand. Investors are often exposed to abuse resulting from the limited possibility of confirming the identity of counterparties, which continues to create a high risk of fraud and loss of funds, and the lack of full regulation makes it difficult for investors to pursue claims and weakens their position. Many operational risks also stem from the early development stage of this technology and its high complexity. An important problem may be consumers losing cryptographic keys to their assets, as well as cyber-attacks. All these risks have determined the fact that bitcoin and other cryptocurrencies are still not a viable alternative to traditional money and banks.

Another disadvantage of blockchain is its complexity, since a high level of technological knowledge is required to implement and maintain this technology. This may result in lower accessibility of this solution. Also, for any technology to be disseminated, it is necessary to ensure interoperability of systems, i.e. the possibility of communicating and interacting between separate blockchain networks. Due to the high diversity between their protocols and standards, it may be impossible to use many different platforms or cryptocurrencies simultaneously. For this reason, the use of blockchain may turn out to be inefficient and may block the free flow of information or data.

Despite the growing popularity of the blockchain, there is still no uniform regulation of this technology. However, this situation will change to some extent once Regulation (EU) 2023/1114 on markets in crypto-assets (MiCA Regulation) enters into force. The Regulation will impose licensing, organisational, prudential and disclosure obligations on professional crypto market participants, including issuers and intermediaries. Although the new legislation will introduce a certain supervisory framework for the market, it will not solve all the problems described above.

The blockchain technology, although relatively new, is already gradually bringing changes in how businesses and individuals function. By enabling direct economic relations between network members this technological tool creates new development opportunities for many industries. However, it is worthwhile to be aware of the risks it entails, especially with regard to the most popular blockchain-based product, i.e. cryptocurrencies.   

Also, despite much enthusiasm shown for this innovative technology, blockchain – so far – has not become as widespread as some predicted it would be back in the early days of its development. In the years to come blockchain is expected to find broader application both in the private and public sectors, and then, inevitably, citizens and states will face new challenges with which they will need to cope.