BlockChain

for the banker

Bohdan Szymanik, March 2016

It’s a fair assessment…

http://www.businessinsider.com/what-is-blockchain-barclays-2016-3

Many of the concepts are not simple; the subject matter expertise to make choices is extremely rare; the impact to conventional business and banking in particular is very poorly understand apart from …. ‘it’ll be big!’

The BlockChain 101

Distributed (peer to peer) ledger that is made fully transparent and inherently accurate thanks to the magic of cryptography.

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Blocks of transactions . Linked together . Cryptographically signed (tamper proof)

The whole point is to have all transactions ordered such that no double-spending can occur.

Peers have strong identity (private/public key pairs)

All peers have access to all transaction blocks and all transactions contained therein.

The task of chaining blocks together is made purposely hard but easily verifiable by using the concept of Proof of Work.

Why?

To stop fraudulent creation of transactions and blocks.

Why do proof of work? You get to earn a bit of digital cash for your efforts.

Just to be clear, when we say transaction here, consider that a settlement transaction. What we have is a distributed, transparent ledger with settlement. This means the end of

the traditional backoffice settlement function.

http://www.afr.com/technology/data-wars-the-banks-awaken-20160319-gnmfac

https://www.gov.uk/government/publications/distributed-ledger-technology-blackett-review

https://www.linkedin.com/in/leannekemp , http://everledger.io - diamond tracking with

distributed ledger and smart contracts

Corporate actions resulting from company announcements currently handled manually. Ripe for smart contract application based on

information flowing from payers to payees via blockchain.

The bankers view

http://www.pwc.co.nz/financial-services-industry-sector/publications/blurred-lines-how-fintech-is-shaping-financial-services-global-fintech-report-2016/ “…544 CEOs, heads of innovation, CIOs and top mgmt. across 46 countries including NZ…”

Really!

Looks like they have a bit to learn.

So basically they know nothing

PwC advise that “This lack of understanding may lead market participants to underestimate the potential impact of blockchain on their activities.”

Proof of Work, Proof of Stake, Consensus by bet and Prediction Marketshttps://blog.ethereum.org/2015/12/28/understanding-serenity-part-2-casper/

The whole point of Proof of Work has been to achieve consensus over transaction ordering.

Proof of Work is something computationally hard to do but easy to verify. Common method being brute force discovery of a hash (SHA256 etc).

Are there other ways to get ordering easier, faster?

Proof of Stake says give greater accountability to those with the most to lose. It’s like modelling the blockchain mining process as a probability game. But…

Here’s an interesting observation:

Proof of Work is just a specialised case of making a bet on a block. You can achieve consensus by betting.In general,

A BlockChain is a prediction market on itself.

(Straight copy from Ethereum blog follows)https://blog.ethereum.org/2015/12/28/understanding-serenity-part-2-casper/

Mining a block means spending electricity on proof of work.

Every second this might cost E,with chance of succeeding in that second being p,for which you get reward R in all forks containing your block and zero rewards in other chains.

Odds look like this: E : p*R-E.Eg:

p = 1 in 1 million chances per second of succeedingE = $0.007R = 25BTC ~ $10,000 USD

Þ 0.000001 * 10000 – 0.007 = 0.003Cf electricity cost of 0.007

=> 7:3 odds ie 70% probability of the chain your working on will win.

Which is why we can represent Proof of Work with Proof of Stake.

Not only are blockchains prediction markets in and of themselves, but you can use them to run prediction

markets.

https://azure.microsoft.com/en-us/blog/azure-blockchain-update-6

Battle of the BlockChains

Digital currency with a distributed ledger. The

original distributed ledger. Token: BitCoin

Market value: $6.5b6,000 nodes

BitCoin holders: 13mTransactions/day: 250,000

Max TPS: 7Years in existence: 7¼

Distributed ledger with a VM specification for the

operation of smart contracts. Focussed on

building distributed apps.

Token: Ether (which converts to ‘gas’ to drive

apps)Market value: $1bn

5,100 nodesEther holders:?

Transactions/day: 25,000Max TPS:?

Years in existence: 2¼

Distributed ledger that works with international currency gateways.

Linux Foundation open community distributed ledger made up of contributions from IBM (Open Blockchain), Ripple (Ripple ledger and Ripple NuDB), Digital Asset Holdings (blockchain server), and Blockstream (“elements”). Aims to support smart client apps a la Ethereum.

The (BitCoin) scalability challenge

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If every peer has every transaction block from the very beginning, then is this thing gonna scale?

Nope.BitCoin Blocks are 1MB with 4000 txns@ (current) 7 tps => 151 Blocks to transfer to nodes/day @ global 70,000 tps => 1.5 million Blocks/day or 1.5TB/day data

This is too hard.Transactions wouldn’t be instant.Costs would force very high transaction fees.You couldn’t do micropayments.

Seriously, does everyone in the world need to know I bought a coffee?

To scale, something’s gotta give.

BlockChain history thus far: >60GB

The BitCoin Lightening Network

Process some of the transactions off chain inside Payment Channels and provide a net settlement mechanism.

Payment channels enable commerce between two parties for a period of time with just the net position managed on the BlockChain. It’s an example of a Smart Contract.

The involved parties open a payment channel – the information is stored on the BlockChain.The involved parties operate the payment channel for a period of time.The involved parties settle the net amount and close the channel on the BlockChain.

What Lightening Network does is follow the pattern of legacy financial systems. Managing the period of time to clear net positions is just… clearing. We do it with inter-bank settlement each day. Clearing provides a managed window for dispute resolution – credit card schemes like VISA have a particularly long dispute periods like 180 days.

In addition, proposals to groom/prune the

How do you govern a peer to peer network?

Developers Miners Users

BitCoin Foundation want 75% of miners to agree

BitCoin Classic – hey, what’s that cf BitCoin Core? You’re confused? I’m very confused!

BitCoin Core team want ‘near-universal agreement’

What’s required to implement a change to BitCoin?

China’s BitCoin community want 90% of the network hash-rate to agree

Who is Satoshi Nakamoto?”

Who controls Ethereum?

IMHO it all seems pretty unsatisfying at the moment!

Smart contractsWhat if, in the definition of a transaction, you could embed some rules?Effectively some programs that define what you do with the transaction?

This is a smart contract.

Example,

errant car driver + Internet of Things device + Smart Contracts

=> rapidly worsening insurance.

Digital rights and event management can be simplified through smart contracts.

Micropayment for every action.

Pay just for what you use.

Meter ticks over when you take a ride or watch some content.

What’s the smart contract end game?

What’s commerce really?

Isn’t it just about the execution of contracts?

AI + Smart Contracts + IoT

http://recode.net/2016/03/15/amazon-echo-the-invisible-platform/ http://www.theverge.com/2016/3/15/11213518/alphago-deepmind-go-match-5-result

Ethereum takes Smart Contracts into a generalised computing platform = Web3

Ethereum Virtual MachineTuring complete ie general purpose computing

Contract defining languages: Solidity, serpent or LLL

Examples:Create an Open auctionCreate a Blind auctionCreate your own digital currency (a la BitCoin)

Nightmare scenario: we replace CTO's and CEO's with machines and we get the same behaviours capitalism with transnational companies but without any accountability. Decentralized autonomous

corporations pay no taxes, respect no environmental laws and instantly migrate to places where labour laws are lax and humans are cheaper. They fund pirates and hire autonomous mercenary drones to

protect their fleets of drug trafficking autonomous submarines. Since robots aren't afraid of death, can't be jailed and don't spend money on prostitutes and caviar, DACs soon outcompete all mafia bosses and

drug cartels lords. https://www.reddit.com/r/ethereum/comments/2dxruc/can_someone_come_up_with_some_examples_on_how/

Example:voting contract

Web3 refers to ‘the decentralised web’. On Ethereum there are no web servers. Everything is decentralised. Frontends have HTML/Javascript encoded UIs and the backend is on the blockchain.

Lending in a Web3 world

What’s the point of the blockchain again? It’s a distributed database of connected information that is intrinsically accurate.

OK, what’s a loan contract? It’s a financial contract that varies over time between two or parties. The variation is the result of rules related to:

Origination andRepayment.

So we can use the blockchain to hold information from the time of prospect enquiry through to fulfilment to the completion of repayment.

We could extend the blockchain out to associated parties like the lawyers and store documentation and of course… get related party signatures.

Or, we can just remove the lawyers and the bankers…

If the blockchain and smart contract were broad enough to include information to wills/land registers/companies office etc – then what point the bank?

Event risk modelling and estimation could simply be considered part of the smart contract.

Any other examples of potential use? Plenty…

Authenticating academic certificates - https://www.holbertonschool.com/faq

Voting processes such Denmark’s Liberal Alliance internal election process and West Virginia University’s student body (interesting transcript).

Online music

What about the regulators?

http://www.theguardian.com/technology/2016/mar/14/facebook-google-whatsapp-plan-increase-encryption-fbi-apple

Regulators and cryptography aren’t a match made in heaven.

The anonymity of BitCoin really does make it a platform for crime.

https://www.cryptocoinsnews.com/report-two-venezuelans-arrested-mining-bitcoin/

So just what are the impacts on banking again?

1. We know BlockChains give us a mechanism to have accurate, transparent representations of ledgers. This will remove cost in expensive payment processing eg international/wholesale and possibly equity trades.

2. We know there are scalability challenges but with Proof of Stake and off chain processing like the BitCoin Lightening Network we can lift TPS up to retail volume.

3. We know that Ethereum is showing us a new approach to distributed applications – Web3 – which could enable distributed, smart contracts.

4. We know that the smart contracts can be very smart – eg they could include risk model development and execution.

5. Gosh, it really could be very big!