What are distributed and decentralized ledgers?

Introduction to Ledgers

What is a ledger? A ledger is a database of all accounts maintained in a summarized and classified form. This summarized and classified data of accounts help companies to generate their financial statements. The data is entered in ledgers through journals which consist of individual transactions made by the company. Every transaction data are supplied by journals to one or more ledgers. Book-keeping is the modern accounting system that follows a double-entry system which means every accounting record will have a dual nature of source & disposition and will comply with the basic accounting equation of Assets = Liabilities + Equity. Every transaction is entered twice in the accounting books reflecting the change in the debit and credit record. The total change made in the debit side must equal the change in the credit side.

Earlier the ledgers were classified on the basis of transactions. They are:

1. Sales (Debtors) Ledger – Financial transactions made by the customers to the company
2. Purchase (Creditors) Ledger –  Financial transactions of purchases made by the company
3. General Ledger – represents five main account types – Assets, Liabilities, Equities, Income, Expense, and Capital. (Wolf, Carl. “Types of General Ledger Accounts.” Bizfluent, https://bizfluent.com/list-6661809-types-general-ledger-accounts.html. 26 September 2017.)

But now, with the revolution of cryptocurrencies and Blockchain technology, the classification is now done on the basis of the number of parties who possess the power to make the changes to the ledgers (see figure 1). The classification can be done as follows:

What are Centralized Ledgers?

In this system, all the data is sent or received by one central node and all the changes in the ledgers can only be made by that node. The central node has the entire control of the data getting updated on the ledgers. These types of ledgers are updated manually as well as in a computerized system. The computerized system generally makes the use of Enterprise Resource Planning (ERP) tools where the general ledger works as a central repository for all the reporting data transferred to it through sub-ledgers. In a modern-day accounting system, it is the backbone of any organization which holds financial and even non-financial data.

 

What are Distributed Ledgers?

Distributed Ledger is a database where there are multiple nodes to control, update, and confirm the data entering into the database. The ledger can be shared between multiple participants and all the participants can have their own identical copy of the ledger. To make changes in the ledger, each copy of the ledger needs to be updated or every participant will be provided by the newly updated state of the ledger. The two parties involved in the transaction can make changes to the ledger and they will not need any node or an intermediary to update their ledgers. This removal of intermediary makes the distributed ledger system very appealing. Although, each and every node will process each and every transaction getting updated in the ledger, coming to their conclusions, and then validating the transaction by voting. The transaction needs to be voted by a majority of the participants to get updated in the ledgers. The state, security, and accuracy of the ledgers can be maintained cryptographically (generally using a technique called hashing).

 

What are Decentralized Ledgers?

Often misinterpreted with distributed ledgers, decentralized ledgers can be called as the distributed network of centralized ledgers. There is not one, but multiple nodes (not all) who control, update, and validate the state of the ledgers. Bitcoin’s ledgers are a type of decentralized ledger. Every time the new state is generated, each node (and only node) receives a copy of the new state of the ledger. Like distributed ledgers, the ledger will be updated only when the majority of the nodes validate the transaction. It will not be incorrect to say that the decentralized ledgers are a type of distributed ledgers where the power is distributed to lesser nodes but not the vice-versa.