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Blockchain Financial Networks

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Rethinking Finance as a spot and future contingency management system for assets and liabilities. Blockchains are an improved form of contingency management (precision, automation, lower-risk). The Internet transfers information, and now value; the Internet becomes a contingency management system with programmable money, smart contracts DACs, distributed ledger transactions. Ultimately, blockchain financial networks can automatically and independently confirm and monitor transactions, without central parties like banks or governments.

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Blockchain Financial Networks

  1. 1. Washington DC, October 2, 2015 Slides: http://slideshare.net/LaBlogga Melanie Swan Economic Theorist New School, New York NY melanie@BlockchainStudies.org Blockchain Financial Networks
  2. 2. October 2, 2015 Blockchain Financial Networks Blockchains: Overview 1 What is it? Blockchains are secure distributed ledgers and financial networks Why is it important? The next phase of the Internet (value transfer) (1) Already here: rapid institutional uptake (2) Pervasive: includes all cash, instruments & contracts (3) High stakes: re-shuffles existing financial system
  3. 3. October 2, 2015 Blockchain Financial Networks Blockchains: Overview 2 Benefits:  Quicker (immediate) secure asset transfer  Decrease Risk  Reduce Cost  Improve Liquidity  Instill Trust Risks:  Foreseeable  Scalability1, monopolies, too early, technical issues, low adoption, hacking scandals  Unforeseeable  Security  Ecosystem 1Particularly scalable independent consensus protocols; http://www.amazon.com/Bitcoin-Blueprint-New-World-Currency/dp/1491920491 http://www.slideshare.net/lablogga/blockchain-consensus-protocols
  4. 4. October 2, 2015 Blockchain Financial Networks 3 Melanie Swan  Economic Theorist, New School, New York  Founder, Institute for Blockchain Studies  Instructor, Singularity University; Affiliate Scholar, Institute for Ethics and Emerging Technology (IEET); Contributor, EDGE Traditional Markets Background Economic Theory Leadership http://www.amazon.com/Bitcoin-Blueprint-New-World-Currency/dp/1491920491 Book: Blockchain: Blueprint for a New Economy
  5. 5. October 2, 2015 Blockchain Financial Networks Fintech Investment 4 https://newsroom.accenture.com/news/fintech-investment-in-us-nearly-tripled-in-2014-according-to-report-by-accenture- and-partnership-fund-for-new-york-city.htm $9.89 billion in 2014, up from $3.39 billion in 2013
  6. 6. October 2, 2015 Blockchain Financial Networks R3 CEV Distributed Ledger Announcement Shared distributed ledgers $28 Tn in assets  Secure financial-grade ledger, ‘fabric,’ scalable to hundreds of billions of transactions per day  Benefits: fast-moving, reduce system-wide risk, core infrastructure development, high-profile, cost savings; could facilitate regulatory compliance, transparency to consumers  Risks: exclusionary access, fees-to-play; HFT or EDI?; greater world market interconnectedness and systemic shocks? 5 DTCC annual revenue $1.5 bn; CLS Bank $0.8 bn, http://www.huffingtonpost.com/stephen-g-cecchetti/virtual-frenzies- bitcoin_b_8228444.html; CEV: Crypto 2.0, Exchanges, Ventures (R3’s business lines)
  7. 7. October 2, 2015 Blockchain Financial Networks What is Blockchain Technology?  Secure (cryptographic) distributed ledger system  A ‘giant Google doc spreadsheet’ database of transactions, independently confirmed and validated by the software system  Secure, transparent, accessible, auditable, available 24/7  Batches (blocks) of transactions posted sequentially (chain)  Prevents double-spend of digital cash 6
  8. 8. October 2, 2015 Blockchain Financial Networks Phased Roll-out of Blockchain Technology  Decide: public or private, centralized or decentralized?  Centralized confirmation by U.S. Treasury  Private internal test implementation; modernize current operations; move traditional ledgers to cryptographic ledgers  Public-facing hybrid implementation; digitize interactions with external parties; centralized confirmation  Decentralized confirmation by blockchain financial networks  Automated secure financial network operations obviate need for centralized intermediaries; software-confirmed transactions 7 Phase II: Automate Phase I: Modernize
  9. 9. October 2, 2015 Blockchain Financial Networks U.S. Department of the Treasury Mission: Maintain a strong economy and create economic and job opportunities by promoting the conditions that enable economic growth and stability at home and abroad, strengthen national security by combating threats and protecting the integrity of the financial system, and manage the U.S. Government’s finances and resources effectively Operate and maintain systems that are critical to the nation's financial infrastructure 8
  10. 10. October 2, 2015 Blockchain Financial Networks U.S. Treasury Application Areas 9  Currency and Coinage Operations  Government Operations: managing federal finances  Revenue/Expenditure: revenue/tax collection; payment disbursement and bill-paying  Managing government accounts and the public debt  Securities operations: federal borrowing  Supervisory and Oversight  Supervise national banks and thrift institutions  Consumer protection  Safeguarding Financial Systems  Policy advisory; national security: monitoring, investigation, enforcement; international interactions
  11. 11. October 2, 2015 Blockchain Financial Networks Blockchain Financial Applications Examples 10  Cash replacement/complement: issue digital cryptocurrency (e.g.; UScoin, UStoken)  Blockchain Treasury securities operations  Securities: Treasury bonds, bills, notes, TIPS  Register and administer as blockchain-based smart-assets possibly via smart-contract DACs: issuance, exchange, redemption, tracking, audit, attestation, interest payments  Secure accounting ledger operations  Internal and governmental operations (Federal Reserve, Government-sponsored Enterprise (FNMA, FHLMC, SLMA))  Back-office: clearing, settlement, compliance, audit, QA  Front-office: cash, payment, securities operations, contracts DAC: Distributed Autonomous Corporation – package of smart contracts executing programmed functions as an entity
  12. 12. October 2, 2015 Blockchain Financial Networks Application Digital Identity System  Blockchain-based digital identity cards, passports  Identity confirmation, validation, assurance  Unify: identity, payment, insurance information  Financial payments, transfers  Income tax, social security transfer payments  Automated pay-in, pay-out  U.S. securities investment  Link to digital health wallet  Technical details  Public and private keys  Data hashing  Multi-factor authentication 11
  13. 13. October 2, 2015 Blockchain Financial Networks Blockchain Financial Applications Advanced  Forecasting, budgeting, reporting  Growth, inflation, monetary policy, sector activity, consumption  Inflows/outflows: tax receipts, transfer payments  Blockchain-based Ricardian contracts  Ricardian contract: A type of value for issuance over the internet, a contract that defines a set of conditions for the instrument that can be read by both humans and computers and is signed with the Issuer’s public key  Real-time economic indicators  Economic data and statistics collection and aggregation as distributed ledger meta data  Open risk-models (transparent, anticipative, big data-predictive) 12 http://www.systemics.com/docs/ricardo/issuer/contract.html
  14. 14. October 2, 2015 Blockchain Financial Networks Rethinking Risk per non-linear causality: Risk Regimes 13 Lloyd’s of London Sea-faring Trade Black–Scholes CAPM, Beta Efficient Frontiers Support Vector Machines Complexity Math Docker VM Containers Deep Learning Algorithms Blockchain Decentralized Risk Models1 Black Swan Risk Models Classical Portfolio Theory Risk Models Traditional Mutuality Risk Models Mutual Insurance: Liability, D&O, Auto, Life, Health Actuarial Tables Extreme Value Analysis ‘Global warming for Markets’ Higher-magnitude, increasingly frequent unpredictable outsized events ‘World is flat’ interconnected financial markets New forms of Exchange Emergent self- determined economies Economic Model Plurality Minimize/maximize downside/upside exposure to black swan events Value-at-Risk Open Risk Models2 1http://ieet.org/index.php/IEET/more/swan20150914; 2http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2320562 Machine Learning Algorithms Distributed Consensus Algorithms Portfolio Theory Trinomial Trees Heteroscedasticity Convexity Big Data Crunching Eigen Values & Matrices Analysis Tools: Reflexivity
  15. 15. October 2, 2015 Blockchain Financial Networks Rethinking Finance Internet of Information -> Internet of Finance 14 http://www.amazon.com/Bitcoin-Blueprint-New-World-Currency/dp/1491920491  What is Finance?  Spot and future contingency management system for assets and liabilities  Blockchains: improved form of contingency management (precision, automation, lower-risk)  Internet transfers information, and now value  Internet becomes a contingency management system with programmable money, smart contracts DACs, distributed ledger transactions  Blockchain financial networks automatically and independently confirm and monitor transactions, without central parties like banks or governments
  16. 16. October 2, 2015 Blockchain Financial Networks  Distributed ledgers allow a more serious move into the Automation Economy, via secure value transfer previously unavailable with the Internet  Fair and orderly transition from the Labor Economy to the Automation and Actualization Economy Bigger Picture: Automation Economy 15 Information & Entertainment Manufacturing Health Economics & Finance Government & Legal Internet: Transfer of Information Internet: Secure Transfer of Value Sectors
  17. 17. October 2, 2015 Blockchain Financial Networks Evaluating Blockchain Ecosystem Risk 16 Network Infrastructure Organizational Paradigm  Bitcoin and blockchain consensus mechanisms are the initial but perhaps not final positions in the build-out of the decentralized value-transfer infrastructure Decentralization Consensus Mechanism Blockchain-based Distributed Ledgers Cryptocurrency Value-exchange Token Bitcoin Platform Level: Current Leader:
  18. 18. October 2, 2015 Blockchain Financial Networks Blockchains: Overview 17 What is it? Blockchains are secure distributed ledgers and financial networks Why is it important? The next phase of the Internet (value transfer) (1) Already here: rapid institutional uptake (2) Pervasive: includes all cash, instruments & contracts (3) High stakes: re-shuffles existing financial system
  19. 19. October 2, 2015 Blockchain Financial Networks Blockchains: Overview 18 Benefits:  Quicker (immediate) secure asset transfer  Decrease Risk  Reduce Cost  Improve Liquidity  Instill Trust Risks:  Foreseeable  Scalability1, monopolies, too early, technical issues, low adoption, hacking scandals  Unforeseeable  Security  Ecosystem 1Particularly scalable independent consensus protocols; http://www.amazon.com/Bitcoin-Blueprint-New-World-Currency/dp/1491920491 http://www.slideshare.net/lablogga/blockchain-consensus-protocols
  20. 20. Washington DC, October 2, 2015 Slides: http://slideshare.net/LaBlogga Melanie Swan Economic Theorist New School, New York NY melanie@BlockchainStudies.org Blockchain Financial Networks Thank you! Questions?
  21. 21. October 2, 2015 Blockchain Financial Networks Private and Public Blockchains 20 http://www.slideshare.net/lablogga/blockchain-consensus-protocols Charts per: http://www.ofnumbers.com/wp-content/uploads/2015/04/Permissioned-distributed-ledgers.pdf Public Permissionless Ledgers • Censorship-resistant (pseudonymous) • Anonymous validators (network vulnerable to anonymous attack) • “Car” Private Permissioned Ledgers • Identity known/confirmed, legally-compliant • Value transfer VPNs, Decentralized SaaS • “Better horse” Stellar
  22. 22. October 2, 2015 Blockchain Financial Networks Byzantine Generals Problem, Byzantine Fault Tolerance (BFT), Byzantine Agreement (BA)  Distributed network security problem  Problem: achieving consensus in a distributed network with potentially faulty nodes  How to coordinate among distributed nodes to come up with a consensus (a truth state; a common view of the world) that is resistant to attackers trying to undermine that consensus  How to add new nodes 21 Swan, M. Blockchain Consensus Protocols, 2015, http://www.slideshare.net/lablogga/blockchain-consensus-protocols
  23. 23. October 2, 2015 Blockchain Financial Networks Approaches to Consensus/BFT 22  Byzantine Agreement Protocol (synchronous)  Microsoft/Lamport: Paxos (state machine replication)  Google: Chubby (serve strongly consistent files)  POW (Bitcoin) ‘Nakamoto Consensus’ – expensive, high latency  POS (Tendermint) – requires resource ownership, risk of ‘nothing-at-stake’ attacks per revoked escrow  Pebble: ARBC (Asynchronous Randomized Byzantine Consensus)  UT: BAR (Byzantine, altruistic, rational) protocol  Stellar: SCP Quorum Slicing  Other: Prediction Markets (Augur), Meta (Factom) http://research.microsoft.com/en-us/um/people/lamport/pubs/paxos-simple.pdf http://www.cs.utexas.edu/users/lorenzo/papers/sosp05.pdf
  24. 24. October 2, 2015 Blockchain Financial Networks POW ‘Nakamoto Consensus’ Shortcomings  Sybil attack-resistant compromise for decentralized consensus but not the final solution for distributed network fault-tolerant security for scalability and performance, key issues: 1. Expensive, excessive energy consumption 2. Poor scalability for widespread blockchain use especially for IOT 3. Slow: high latency (1-10 minutes to confirm transactions); only eventually consistent 23 https://medium.com/a-stellar-journey/on-worldwide-consensus-359e9eb3e949 http://crypto.stanford.edu/seclab/sem-14-15/williams.html
  25. 25. October 2, 2015 Blockchain Financial Networks Pebble: Asynchronous Randomized Byzantine Consensus (Concept) 24 http://crypto.stanford.edu/seclab/sem-14-15/williams.html https://www.youtube.com/watch?v=8iEgjqIMtVQ  Asynchronous Byzantine consensus for decentralized networks using cryptographic randomness, combine  Nakamoto chains (randomness source, Merkle roots log) with …  conventional consensus techniques (produce consensus by agreeing upon data transitions through a new generation of highly-tuned and optimized conventional consensus protocols) to …  produce fast and scalable decentralized networks
  26. 26. October 2, 2015 Blockchain Financial Networks Pebble: Asynchronous Randomized Byzantine Consensus (Method features) 25 FLP: Fischer, Lynch and Patterson Friedman et al. 2003. Simple and efficient oracle-based consensus protocols for asynchronous Byzantine systems. http://ieeexplore.ieee.org/xpl/articleDetails.jsp?arnumber=1353024 Maji et all. Exploring the limits of common coins using frontier analysis of protocols. 2011. http://dl.acm.org/citation.cfm?id=1987298  Asynchronous (resist attack)  Fully asynchronous (no timing assumptions) and leader-free (no one node orchestrates)  Randomized (improve efficiency)  Address FLP impossibility result (in asynchronous networks, if only one node fails, cannot be sure remaining nodes will reach consensus)  Randomized protocols get around this by terminating with a probability approaching 1  Need a common source of randomness, so use blockchains (constant source of randomness; cannot predict who finds the next hash) to organize the network  Use deterministic homomorphic threshold signatures to create cryptographic randomness without having a trusted dealer
  27. 27. October 2, 2015 Blockchain Financial Networks Pebble: Asynchronous Randomized Byzantine Consensus (Example) 26 http://crypto.stanford.edu/seclab/sem-14-15/williams.html https://www.youtube.com/watch?v=8iEgjqIMtVQ  Fast-throughput (achieve scalability)  Run massive numbers of binary leader-free asynchronous randomized consensus protocols in parallel to quickly agree a combined data set from the inputs of large numbers of processes  Proof of concept  Focus on messaging efficiency, decentralized network scalability and confirmation speed  Enable 500 distributed processes to simultaneously present their data sets to the group and quickly reach strongly consistent agreement on an accepted superset  Pass only 0.5-1MB of protocol messages  A network reaching consensus every 5 seconds would have spare bandwidth to process many thousands of transactions per second
  28. 28. October 2, 2015 Blockchain Financial Networks Stellar: Quorum Slicing (Concept) 27 https://medium.com/a-stellar-journey/on-worldwide-consensus-359e9eb3e949  Objective: distributed consensus  Nodes update their states/ledgers  Avoid Byzantine failure (when individual nodes act arbitrarily, maliciously or not)  Distinguish between  Quorum: the set of nodes required to reach agreement across the whole system  Quorum Slice: the subset of a quorum that can convince one particular node of agreement  Result: federated network of quorum slices, continually testing the network  Do not need to trust the whole system/network, just your neighbors, you do not know who to trust initially, join the network, and try before you trust, the system grows organically, each party makes a slice of others from the whole to trust
  29. 29. October 2, 2015 Blockchain Financial Networks Federated Quorum Slice Network 28 https://medium.com/a-stellar-journey/on-worldwide-consensus-359e9eb3e949  Resilient network  Overall network health is preserved even if there are a few bad nodes, and some good nodes slicing the bad nodes  Unanimous consent from the complete set of system nodes is not required to reach agreement, or tolerate faulty nodes
  30. 30. October 2, 2015 Blockchain Financial Networks Stellar graphic novel explains Quorum Slicing 29 https://www.stellar.org/stories/adventures-in-galactic-consensus-chapter-1/
  31. 31. October 2, 2015 Blockchain Financial Networks Stellar: Context of Byzantine Agreement 30 https://medium.com/a-stellar-journey/on-worldwide-consensus-359e9eb3e949  Traditional Byzantine agreement protocol (BAP)  Membership is set by a central authority or closed negotiation (Sybil attack-resistant)  Update BAP for decentralized group admission  Ripple: publish a ‘starter’ membership list that participants can edit for themselves  Divergent lists invalidate network safety; users fail to update  Tendermint: base membership on proof of stake  Ties trust to resource ownership; revoked escrow attacks  Stellar: open membership, participants affirm trust  Quorum is still vulnerable to Sybil attack, malicious parties can join many times and outnumber honest nodes. So majority-based quorums do not work, but a federated network of quorum slices can  Each node selects and tests quorum slices based on safety and liveness; voting to accept statements (of network state)
  32. 32. October 2, 2015 Blockchain Financial Networks Stellar: Consensus Protocol Comparison 31 SCP: Stellar Consensus Protocol https://medium.com/a-stellar-journey/on-worldwide-consensus-359e9eb3e949
  33. 33. October 2, 2015 Blockchain Financial Networks Enterprise Blockchain Apps by Sector (selected) 32 http://www.amazon.com/Bitcoin-Blueprint-New-World-Currency/dp/1491920491 Crucial Blockchain Properties • Cryptoledger • Decentralized network • Trustless counterparties • Independent consensus-confirmed transactions • Permanent record • Public records repository • Notarization time- stamping hashes • Universal format • Accessibility Government & Legal • Transnational orgs • Personalized governance services • Voting, propositions • P2P bonds • Tele-attorney services • IP registration and exchange • Tax receipts • Notary service and document registry Economics and Markets • Currency • Payments & Remittance • Banking & Finance • Clearing & Settlement • Insurance • FinTech • Trading & Derivatives • QA & Internal Audit • Crowdfunding IOT • Agricultural & drone sensor networks • Smarthome networks • Integrated smartcity, connected car, smarthome sensors • Self-driving car • Personalized robots, robotic companions • Personalized drones • Digital assistants • Communication (messaging) • Large-scale coordination • Entity ingress/egress • Transaction security • Universal format • Large-scale multi- data-stream integration • Privacy and security Real-time accessibility Health • Universal EMR • Health databanks • QS Data Commons • Big health data stream analytics • Digital health wallet • Smart property • HealthToken • Personal development contracts • Large-scale infrastructural element for coordination • Checks-and- balances system for ‘good-player’ access • Community supercomputing • Crowd analysis • P2P resourcenets • Film, dataviz • AI: blockchain advocates, friendly AI, blockchain learners, digital mindfile services Science, Art, AI

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