Block by blockchain: what it all means

In the first of a three-part series of articles on blockchain in the insurance claims context, our Head of Research and Development, Karim Derrick, outlines the definition of distributed ledger technology.

As the hype has built around blockchain; as the value of bitcoin has soared; as the amounts that businesses have raised from so-called initial coin offerings (or ICOs); as the amount that venture capitalists have invested in anything with the word blockchain in it; so too has the confusion and mystery around the definition of blockchain.

Fundamentally, blockchain is about chains of blocks. Each block contains a list or ledger of information in relation to whatever the context in which the blockchain is being used. For bitcoin, the blocks are a ledger of all bitcoin transactions. Everytime a bitcoin moves between one person and another, an entry is made on the ledger to record it. But, of course, a ledger can contain anything. For example, it can be a ledger of diamond identities and transactions, or it can be a record of World Cup ticket transactions.

So, at the heart of a blockchain is the concept of a ledger. And ledgers are really nothing new. In actual fact, ledgers are a common feature of nearly all pre-capitalist societies, where they served as community memories. For a community without any currency, there needs to be some means of ensuring that the efforts of individual community members are recorded and remembered to ensure all community members pull their weight. Documents dating back more than 7,000 years have been uncovered revealing lists of goods that were traded. These lists were kept in temples that served as ancient equivalents of our banks. The 2,700-year-old document that is the earliest reference to Jerusalem outside of the Bible was a wine ledger.

In 500AD, according to Natalie Smolenski, a blockchain advocate and cultural anthropologist, the people of the tiny Micronesian island of Yap used huge limestone stone discs as currency and maintained de-centralised mental ledgers of who owned which stone. If somebody wanted to trade a stone they had to update every community member.

So a blockchain is a new solution to an old problem. However, we have yet to mention why it is that we have a chain of blocks: what is the chain component? This is where we have to consider a computer science concept known as ‘hashing’.

The idea of a hash is one way encrypt a piece of data. The nature of the hashing algorithm means that when applied to a text of some description, it will produce a code of fixed length whenever it is applied to the same piece of text. It is also the nature of a hash that it is very difficult to reverse. For example, I can encrypt a sentence to produce a code of fixed length, but I cannot then reverse the process to reveal the original word.

In blockchain, a hash is used in the following way. When I have filled a block with ledger entries and there is space for no more, the entire block is hashed. So now I have a code of fixed length, which cannot be reversed, but that will always be produced by the exact sequence of ledger entries described by the block. And now for the clever bit. When I create the next block for the new sequence of ledger entries at the top of the block, I put the hash of the previous block. This is what creates the chain. Each block is bound to the next block because it contains a hash of the predecessor, which contains a hash of its predecessor and so on, all the way down the chain. This technique is also what makes the blockchain immutable - or difficult to change. If any single ledger entry is changed, so too will the hash of the block, which will change the hash of the previous block, and so on, making it impossible to change a ledger entry. Just as the stone ledgers of ancient civilisations could not be changed easily and unlike modern databases, which are easily changed.

Arguably, that is all there is to blockchain. Bitcoin’s blockchain also uses game theory and cryptography to incentive people to mine the blocks. It is the act of mining, which of course is a form of work that then creates value and so allows bitcoin to act like a currency. Many believe that the use of ‘proof of work’ processes are a necessary part of a blockchain, but I beg to differ. Ancient ledgers had no need for it, so I don’t see a need for it now.

When we come to look at insurance, we just need to identify where there is value in a ledger to see the value of blockchain to insurance. Ledgers can be used to record policies. Ledgers can be used to capture events: aircraft landing and taking off, weather, and smart home sensor readings can all be used to trigger smart contracts that are recorded on a ledger. By combining hashing techniques and ledgers, multiple insurers can capture their claim data on a single distributed ledger in order to combat fraud. More on that in our next article. Insurance value chains for goods in transit, especially shipping, can see huge benefit from ledgers, which can combat the up to 40% of transactional costs that make up shipping insurance premiums.

This article was first published by Claims Media on 3 September 2018.