The document discusses how blockchain technology is reshaping the finance industry. It provides several examples of major companies like Daimler Benz, Maersk, and AXA implementing blockchain solutions for bond issuance, marine insurance, and flight insurance respectively. It also discusses how blockchain could reduce banks' infrastructure costs by $20 billion annually by enabling faster transaction settlement. The document outlines key innovations of blockchain like recording transactions on a decentralized ledger validated through cryptographic consensus instead of trust in a third party. It analyzes the implications of this emerging technology on different areas of finance from payments and exchanges to smart contracts and derivatives.

1. ASEAN Global Leadership Program
How the blockchain
is reshaping finance
David Yermack
NYU Stern School of Business
National Bureau of Economic Research
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2. The hype
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3. Daimler Benz’s blockchain bond issue
June 2017
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4. Maersk’s blockchain marine insurance
September 2017
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5. AXA’s smart contract flight insurance
September 2017
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6. The cost of financial transactions
A long view: 1886-2015
• 2% per transaction, unchanged for 130 years
Source: Philippon (2016)
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7. Intelligent redesign
of the financial system
Bitcoin network is launched, January 3, 2009N
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8. What is Bitcoin?
• A stateless, decentralized, “algorithmic”
currency
• That exists only in cyberspace
• Bitcoin / USD exchange rate:
– July 17, 2010 1 Bitcoin = $0.05
– April 9, 2018 1 Bitcoin = $6,744.55
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9. Bitcoin’s open network of 12,000 nodes
November 6, 2017
https://bitinfocharts.com/bitcoin/nodes-active/
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10. Three major innovations that Nakamoto
designed into Bitcoin
• Recording of new data sequentially in a write-only, indelible
ledger, the “blockchain” (IBM, 1976)
• Decentralization of the ledger to provide transparency of data
to all users and interested third parties (Haber & Stornetta,
1991)
• Validation of new data by cryptographic “consensus” proof, in
recurring 10-minute open competitions, instead of reliance
upon a trusted third party (Nakamoto, 2008)
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11. Bitcoin’s blockchain:
the first major use caseN
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12. A disruptive technology
“. . . The blockchain has been increasingly
eyed by mainstream financial institutions as
a breakthrough.
. . . it could enable financial institutions to
settle trades in seconds rather than two or
three days
. . . blockchain technology could reduce the
bank’s infrastructure costs . . . by as much
as $20 billion a year by 2022.”
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13. Wall Street discovers the blockchain
The gold rush begins, late 2015
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14. High profile examples:
ASX stock exchange, Sydney
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15. High profile examples:
BHP Billiton supply chain management
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16. High profile examples:
IBM’s “blockchain garage,” Manhattan
• 400 clients testing blockchain
solutions to logistics and supply chain
management
• 650 staff dedicated to this technology
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17. High profile examples:
Authentication of gems, art, luxury goods
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18. High profile examples:
Bank of Canada (and many other governments)
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19. High profile examples:
Peer-to-peer distribution of electric power
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20. What could become unnecessary
in a world with blockchains?
• No more banks
• No more stock exchanges
• No more government property registers
• No more accountants and auditors
• Far fewer lawyers
• Etc…
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21. Peer to peer
• The early breakthroughs
• Now
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22. Peer to peer payments
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23. Peer to peer payments:
who guarantees and regulates them?
Credit card companies
Mobile phone companies
Consensus of the network
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24. The original blockchain
Authenticating digital documents – Haber & Stornetta (1991)
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25. Using a blockchain for payments
Nakamoto (2008)
Source: SolidX Partners Inc.
“Commerce on the Internet has come to rely almost exclusively on financial
institutions serving as trusted third parties to process electronic payments . . . What
is needed is an electronic payment system based on cryptographic proof instead of
trust.”
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26. Grouped into blocks every 10 minutes
About 1,500 transactions currently in each Bitcoin block
Source: bitcoin.stackexchange.com
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27. How the blocks are chained
The hash code of each previous block is included in the next;
changes to data in any block ripple through the entire chain
Source: bitcoin.stackexchange.com
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28. Who updates the blockchain?
• Haber and Stornetta (1991)
– A trusted third party takes responsibility for coding blocks
– The chain is posted publicly, becoming a distributed ledger
that can be verified by anyone
• Nakamoto’s (2008) crowd-sourcing solution
– Network members compete to create new blocks
– Anyone can join the network and take part
– A reward goes to the fastest
(seigniorage of new coins)
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29. A distributed ledger
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30. Why eliminate the
“trusted third party”?
• No gatekeeper controls access
– Could exclude certain agents
– Could play favorites, in exchange for side payments
• No monopolist transaction fees
• No ability to change the ledger arbitrarily
• No single point of failure vulnerable to hacking, operator error or hardware
failure
• No rationing of market hours; available 24-7-365
• Greater user control over data
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31. Two kinds of blockchains
Open
• Anyone can opt in
• Decentralized governance
• Size is endogenous
• Blocks updated via competition
– Organic rewards to miners
– Bidding by users to advance in
queue
Permissioned
• Participation restricted
• Powerful gatekeeper
• Size is limited
• Blocks updated by central
authority
– User fees charged
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32. A blockchain with “proof of work”
Nakamoto (2008)
• A valid “nonce” must be discovered by trial-and-error, so that
the hash for the entire block is below a pre-specified target
value. This raises the cost for hackers.
• Difficulty of the problem is recalibrated every two weeks, so
that the time to solve each block remains at c. ten minutes
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33. Miners: successors to accountants
“Competitive bookkeeping”
• Mining is computationally
intensive, with supercomputers
specially configured to look for
nonces at very high “hash rates”
• Generally located in bunkers
where electric power is cheap
– Iceland
– Inner Mongolia
– Venezuela
Icelandic bitcoin mining farm
The New York Times
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34. Bitcoin mining farms
Life Inside a Secret Chinese Bitcoin Mine:
https://www.youtube.com/watch?v=K8kua5B5K3I
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35. Hash rate of bitcoin network
Trillions of hashes per second
https://blockchain.info/charts/hash-rate
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36. Indelibility of data on a blockchain
Source: Mark Montgomery / IEEE Spectrum
• Fraud = rewriting old
transactions
• Implication: transactions
are indelible, but also
irreversible
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37. Mining difficulty
Recalibrated automatically every 2,016 blocks, or two weeks
https://blockchain.info/charts/difficulty
On February 18, 2017, hash target value was reduced from
0000000000000000029ab9000000000000000000000000000000000000000000
to
0000000000000000027e93000000000000000000000000000000000000000000
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38. Mining revenue / value processed
7 day moving average
https://blockchain.info/charts/cost-per-transaction-percent
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39. What else can be tracked
on a blockchain?
Source: SolidX Partners Inc.
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40. Do companies need the stock exchange?
• Permissioned blockchain: operated by the
company
• Open blockchain: operated competitively
– Issuance of new shares to competitive miners
– User fees to competitive miners
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41. The reaction of industry
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42. What would be different on a
blockchain stock exchange?
• Much lower cost
• Quicker speed of trading and settlement
• More accurate record-keeping
• Transparency of ownership
• Autonomous “smart contracts” for debt and
contingent securities
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43. Clearing and settlement
The current system
Source: Deposit Trust Clearing Corp.
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44. Clearing and settlement
A peer-to-peer system with “miner” nodes
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45. Voting on the blockchain
• Every shareholder automatically gets
a “token” for each corporate election
• Shareholder then sends it to a
blockchain address
• Vast improvement over current
system
– Certainty in tabulation of votes
– No need for proxy system
– Empty voting would be
transparent
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46. Impact on corporate elections
• Participation and
interest might increase
and lead shareholders to
demand votes on more
topics
– See e.g., Wright &
DeFillipi (2015)
• Harder for management
to manipulate election
outcomes
Source: Listokin (2008)
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47. Smart contracts: Szabo (1997)
http://ojphi.org/ojs/index.php/fm/article/view/548/469
• “The basic idea behind
smart contracts is that many
kinds of contractual clauses
(such as collateral, bonding,
delineation of property
rights, etc.) can be
embedded in the hardware
and software we deal with,
in such a way as to make
breach of contract
expensive. . .”
Nick Szabo
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48. Example:
Two ways to purchase a coke
The vending machine was
introduced in London in 1883.
or
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49. What problems
can smart contracts solve?
• Guaranteeing specific performance
– Is this always a good idea?
• Economizing on contracting costs
• Economizing on enforcement costs
• Deterring strategic behavior
• Removing the need for trust
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50. Vitalik Buterin
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51. Smart contracts in consumer finance:
auto loans
https://www.youtube.com/watch?v=2rLNbd6MQXg
https://dealbook.nytimes.com/2014/09/24/miss-a-payment-good-luck-moving-
that-car/
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52. Smart contracts in consumer finance:
Internet of Things
• Devices will provide real-time driver
coaching and feedback
– to law enforcement
– to insurance company
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53. Smart contracts in consumer finance:
auto insurance
• Problems with auto insurance now:
– Fraudulent reporting
– Adverse selection by customers
– Moral hazard behavior
– High verification costs
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54. Good cases for smart contracts:
Derivative securities
• Warrants, options, convertibles that exercise
themselves automatically at the optimal time
• State-contingent payoffs that are made
automatically
– Catastrophe bonds
– Weather bonds
– Co-co (“bail in”) bonds
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55. Good cases for smart contracts:
Insurance industry
• Dynamic pricing adjustments based on IoT data
• Claims assessment and settlement
• Mutualization of local risk pools
• Risk assessment via “big data” strategies
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56. Blockchain Insurance Industry Initiative
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57. What could go wrong – Example I
Theft from Bitfinex, followed by a bail-in
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58. The threat from hackers
Andreas Antonopoulos weighs in
10% of all Bitcoins are reportedly
in the hands of criminals who
have stolen them
“a vast improvement over the
rest of our economy, where
80% is in the hands of
criminals – and that’s the
banks.”
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59. How big is the problem?
Source: satoshilabs.com/news/bitcoin-thefts/
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60. Will banks be safer without blockchains?
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61. What could go wrong – Example II
Hacking of TheDAO, followed by a re-set
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62. Ethereum’s hard fork
July 20, 2016
The “hard fork” re-started the Ethereum
blockchain at block 1920000.
About 15% of miners refused to participate,
continuing to work on the “Ethereum classic”
blockchain.
A schism has now existed for almost two months.
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63. The way forward: what industry wants
Incremental upgrading of the current system
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64. The way forward
Three potential channels of disruption
• Challengers
– wildcat firms bypassing the status quo
• Collaboration
– consortia of existing market participants
• Mandates by regulators or legislatures
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65. UBS’s trading floor
Stamford, Ct., USA
2005 2016
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66. Learn more
White papers circulated by Goldman Sachs,
UK Government, many others . . .N
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