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Blockchain Investing: Economics Implications of Distributed Ledgers


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The investment market for cryptocurrencies is becoming increasingly institutional. In July 2017 (in the wake of the “ICO dotcom bubble”), the SEC signaled its stance on ICOs. “Stock-like” ICOs are likely to be deemed securities, and as such, would need to be registered offerings, which by implication, would target institutional investors. Also in July 2017, the CFTC granted a derivatives clearing license to New York-based LedgerX for cryptocurrency derivatives, and options listings may appear on the CBOE later in 2017. Since derivatives markets are already part of the institutional ecosystem, this means that cryptocurrency derivatives might be a more accessible, liquid, and large-scale means of obtaining exposure to crypto asset classes than investing in the underlying cryptocurrencies themselves. Finally, there is greater emphasis on institutional liquidity aggregation platforms for large-size cryptocurrency trading (i.e. $20+ million positions), with Genesis Trading, Cumberland Mining, Circle, and Project Omni.

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Blockchain Investing: Economics Implications of Distributed Ledgers

  1. 1. Blockchain Investing FinTank, Chicago IL, August 24, 2017 Slides: Blockchain Investing Economic Implications Melanie Swan Philosophy Department, Purdue University
  2. 2. 24 August 2017 Blockchain 1 Melanie Swan, Technology Theorist  Philosophy and Economic Theory, Purdue University, Indiana, USA  Founder, Institute for Blockchain Studies  Singularity University Instructor; Institute for Ethics and Emerging Technology Affiliate Scholar; EDGE Essayist; FQXi Advisor Traditional Markets Background Economics and Financial Theory Leadership New Economies research group Source:,,
  3. 3. 24 August 2017 Blockchain Blockchain 2 Source:  To inspire us to build this vision of the world
  4. 4. 24 August 2017 Blockchain Agenda  Blockchain Investing  Blockchain Economics  Blockchain Economic Theory  Smart Network Convergence  Blockchain and Deep Learning 3
  5. 5. 24 August 2017 Blockchain 4 Blockchain is the tamper-resistant distributed ledger software underlying cryptocurrencies such as Bitcoin, for the secure transfer of money, assets, and information via the Internet without a third- party intermediary Source: What is Blockchain/Distributed Ledger Tech?
  6. 6. 24 August 2017 Blockchain Context of the Blockchain Revolution  Internet all over again  Blockchain supplies crucial functionality for the secure transfer of money and assets over networks that allows the only sectors not yet re- engineered for the digital era to modernize  Financial services; Legal and governance services  Involves money and assets, likely to take longer  Information Internet: 20-40 years (corporate email)  Money Internet could take longer (2050-2075)  More profound impact  Computationally-based society has much smaller need for brick-and-mortar institutional footprint 5 Source:
  7. 7. 24 August 2017 Blockchain Blockchain Investment Thesis 6 Source:
  8. 8. 24 August 2017 Blockchain Blockchain Investment Thesis  Market becoming more institutional  ICO and exchanges: regulated entities  Cryptocurrency option approval (LedgerX)  Institutional demand for cryptographic assets  Institutional exchanges  Risks  Too early: infrastructure not ready yet, bubbles; only invest “black swan” money  Scalability: Consensus algorithms 7 Source:
  9. 9. 24 August 2017 Blockchain ICOs (Initial Coin Offerings)  ICO: fundraising method, more liquid than equity  Conceived as project finance / capital-budgeting solution  $1.74 bn cumulative ICO funding (Coindesk)  ICOs 4x size of VC funding 1H2017 (PitchBook)  ICOs: $1.3 bn, VC funding: $358 mn 8 Source:
  10. 10. 24 August 2017 Blockchain High-profile ICOs  Filecoin; $186 mn, Aug 2017  Registered (exempt) small offering CoinList (AngelList); Reg D 506(c)  Tezos $232 mn, Jul 2017  Brave, BATs (basic attention tokens), $35 mn, 30 seconds  Gnosis; $12.5 mn, Apr 2017  Self-regulating mechanisms  Known % of money supply in the ICO offering  Lock-up: No lock-up on ICO founders coins (usually 1 year IPO), could have time-lock-up 9 Source:
  11. 11. 24 August 2017 Blockchain ICO Regulatory Stance  US: investor protection; must be regulated  ICOs and exchanges; what about smart contracts?  Betting as a related example: limited  ICOs vs token sales (network utility) vs crowdfunding  Howey Test: is it a security? 1. Investment of money 2. Expectation of profits from the investment 3. The investment of money is in a common enterprise 4. Any profit comes from the efforts of a promoter or third party  UK: caveat emptor; safer if regulated, not regulated  Betting as a related example: ubiquitous  EC, Japan, China, India (currently more open) 10 Source:
  12. 12. 24 August 2017 Blockchain Investor demand for cryptographic assets  Institutional investors must invest in cryptographic asset classes  Cryptographic assets: currently valued at $150 billion, estimated to grow to $2 trillion over the next 10 years  Global invested capital market by asset class must include cryptographic assets  Cash, stock, bonds, gold, real estate, crypto  Cryptographic asset growth could become tied to general rate of economic progress (global GDP) 11 Source:
  13. 13. 24 August 2017 Blockchain Cryptocurrency Options  NY-based LedgerX CFTC approval  Provide clearing services for fully collateralized digital currency swaps  License to operate as a swap execution facility, initial plans to clear Bitcoin options  Clearing house for derivatives contracts settling in digital currencies  LedgerX options to trade on the CBOE  Significance: cryptocurrency derivatives possibly more accessible and liquid means of gaining exposure than trading the underlying cryptocurrencies 12 Source:
  14. 14. 24 August 2017 Blockchain Cryptocurrency Market Capitalizations (8/17) 13 Source:,; List of countries by GDP (nominal) - Wikipedia  S&P 500: $22.2 tn; US GDP $18.8 tn  Bitcoin market cap: $68 bn (≃ top 70/200 countries)
  15. 15. 24 August 2017 Blockchain Indirect Cryptographic Asset Exposure  Default exposure through equity/mutual funds (same argument as emerging market)  50% S&P 500 sales from overseas  S&P internal implementation of foundational technology like blockchain digital ledgers 14 Source:  Large cap investing is a proxy for blockchain investing  Free ride the search problem, vetting, selection process
  16. 16. 24 August 2017 Blockchain Direct Cryptographic Asset Exposure 15 Source:  Invest “Black Swan” money  Small percent of portfolio  Willing to lose  Convexify (e.g.; manage) exposure  Diminish downside  Maximize upside exposure to “black swan” rare outsize returns (VC, movies)
  17. 17. 24 August 2017 Blockchain Institutional Exchanges  Large liquidity ($20 mn and up)  Institutional services  Daily auctions, large-value selling, credit-risk hedging  Institutional exchanges  Genesis Trading, Cumberland Mining, Circle, Project Omni, Gemini Exchange 16 Source:
  18. 18. 24 August 2017 Blockchain Blockchain risks? ISSUE 17 Regular global technical meetings (Satoshi Roundtable); vociferous debate/proposals (democratic power struggle) PoW: not scalable, PoS: validator model too complicated Cybersecurity Hacks Mt Gox, Ethereum DAO, Bitfinex Silk Road, drug dealers, terrorists, criminals Scalability Block size, Consensus method Mining Centralization 51% Attack RESPONSE Temporary; mining is collusive; attack unsustainable, cannot steal coins, confirm transactions or change protocols Building resilient system constantly under open attack 24/7 (remember early Internet DNS attacks) Blockchains are a universal technology available to all; non-criminal activity predominates PoW: Proof of Work (mining), PoS: Proof of Stake (validated voting) – mechanisms for establishing ledger state consensus Early Internet: “this will never scale, insecure, not resilient;” Yahoo, AltaVista down for days due to DNS attacks Technology Risk Perception Risk Regulatory Risk, Economic Risk Government regulation, bans; Exchange rules Governments modernizing economic infrastructure with blockchains too; licensing, open dialogue
  19. 19. 24 August 2017 Blockchain Two big investment risks  Too early, cart before the horse  Blockchain network infrastructure is immature  Same lesson as 90s dotcom boom: Webvan, Dogster: too early  Network economy models require the network to be in place to obtain network benefits  Technical/scalability risk re: consensus algorithm  Achieve Visa-scale transaction processing (2000/second) needs alternative consensus mechanism 18 Source:
  20. 20. 24 August 2017 Blockchain Infrastructure Risk Blockchain Network Infrastructure Immature 19 Source: TCP/IP Blockchain AppsAppsApplication Layer Protocol Layer  Issue: no one wants to fund basic infrastructure build- out, but “shiny new” network apps will fail without it
  21. 21. 24 August 2017 Blockchain Scalability Risk Bitcoin vs. other payment networks 20 Source: Statista / Coinmetrics, 1,667 7 Average daily transaction volume ($US mn) Average transaction volume per second  Visa: 2,000 transactions/sec; Bitcoin: 7/sec  Visa: $18bn/day; Bitcoin: $300mn/day
  22. 22. 24 August 2017 Blockchain Scalability Risk Consensus Algorithms (BFT)  Proof of Work  Bitcoin blockchain  Proof of Stake  Ethereum, Tezos, DFINITY, Tendermint/Cosmos, Stellar  Complicated scheme of tiered voting by staked participants  Issue: recreation of human-based power structures, is not a computational Searle’s Chinese Room  Other solutions  IOTA Tango automata  Proof of Computational Completeness  Complexity-complete computational entropy  Brownian motion and Crutchfield’s statistical complexity measure  Using network entropy-generation to solve BAP 21 Source: BFT; Byzantine fault tolerance;
  23. 23. 24 August 2017 Blockchain Agenda  Blockchain Investing  Blockchain Economics  Blockchain Economic Theory  Smart Network Convergence  Blockchain and Deep Learning 22
  24. 24. 24 August 2017 Blockchain New Economic World Order 23 Source:  Not just cryptofinance, multiple sectors of the digital economy: storage, banking, healthcare, financial services, technology platform companies, fundraising
  25. 25. 24 August 2017 Blockchain Smart Network Thesis Two fundamental eras of network computing 24 Source: Expanded from Mark Sigal, I. Transfer Information II. Transfer Value 6 7 2020s 2030s Simple networks Smart networks  Pushing more and more complexity through the global Internet pipes
  26. 26. 24 August 2017 Blockchain Scalability and Financial Inclusion  Hierarchy does not scale  Next leap-frog tech: fintech  Like cell phones vs. POTS, it does not make sense to build out brick-and-mortar banks in a world of digital finance  Decentralized networks + digital finance = the power of the printing press in banking, credit, and money  Access to credit and financial services as a basic human right (2 billion under-banked) 25 Source: POTS: Plain Old Telephone Service,
  27. 27. 24 August 2017 Blockchain Long-tail economics and governance  One size does not fit all  Any two parties can meet and transact on the blockchain 26 Source: One size fits all Personalized Long-tail Systems  Long-tail economics  “Amazon or eBay of money”  Personalized banking, credit, mortgages, securities  Long-tail governance  “Amazon or eBay of government”  Personalized governance services, pay for consumption
  28. 28. 24 August 2017 Blockchain Personalized governance services Crypto-enlightenment 27 “One ought to think autonomously, free of the dictates of external authority” - Immanuel Kant Kant, I. "Answering the Question: What Is Enlightenment?" (German: Beantwortung der Frage: Was ist Aufklärung?). 1784. Hayek, F. The De Nationalization of Money. 1976. (paraphrased) “Multiple private currencies should compete for customer business” - Friedreich Hayek Personalized economic services
  29. 29. 24 August 2017 Blockchain 28 Source: Blockchain: Fintech and beyond AssetsImmediate cash transfer Applications Payments Money Remittance Financial instruments Unified ledger Mortgages, loans Titling: house, auto Inventory Commercial trade Payments Financial Services Logistics & Supply Chain Energy, IoT Healthcare Government Humanitarian Non-profit Industry adoption Time Complexity Stocks, bonds Goods transfer Assurance, provenance Identity Driver’s License Passport, Visa Contracts Registries Marriage licenses Public Documents Birth/death registries BoL, Forfeiting Insurance Cash Smart Assets Smart Contracts
  30. 30. 24 August 2017 Blockchain Agenda  Blockchain Investing  Blockchain Economics  Blockchain Economic Theory  Smart Network Convergence  Blockchain and Deep Learning 29
  31. 31. 24 August 2017 Blockchain 30 Better horse AND new car New Technology
  32. 32. 24 August 2017 Blockchain 31 Smart networks are computing networks with intelligence built in such that identification and transfer is performed by the network itself through protocols that automatically identify (deep learning), and validate, confirm, and route transactions (blockchain) within the network Smart Network Convergence Theory
  33. 33. 24 August 2017 Blockchain Smart Network Convergence Theory  Network intelligence “baked in” to smart networks  Deep Learning algorithms for predictive identification  Blockchains to transfer value, confirm authenticity 32 Source: Expanded from Mark Sigal, Two Fundamental Eras of Network Computing
  34. 34. 24 August 2017 Blockchain 33 Conceptual Definition: Deep learning is a computer program that can identify what something is Technical Definition: Deep learning is a class of machine learning algorithms in the form of a neural network that uses a cascade of layers (tiers) of processing units to extract features from data and make predictive guesses about new data Source: What is Deep Learning?
  35. 35. 24 August 2017 Blockchain Next Phase  Put Deep Learning systems on the Internet  Deep Learning Blockchain Networks  Combine Deep Learning and Blockchain Technology  Blockchain offers secure audit ledger of activity  Advanced computational infrastructure to tackle larger-scale problems  Genomic disease, protein modeling, energy storage, global financial risk assessment, voting, astronomical data 34
  36. 36. 24 August 2017 Blockchain Deep Learning Chains Example: Autonomous Driving  Requires the smart network functionality of deep learning and blockchain  Deep Learning: identify what things are  Convolutional neural nets core element of machine vision system  Blockchain: secure automation technology  Track arbitrarily-many fleet units  Legal accountability  Software upgrades  Remuneration 35
  37. 37. 24 August 2017 Blockchain Agenda  Blockchain Investing  Blockchain Economics  Smart Network Convergence  Blockchain and Deep Learning 36
  38. 38. 24 August 2017 Blockchain Blockchain Strategies Leadership Edge  Start or join industry consortium  Implement digital ledgers  Automate transfer of money, assets, bids, quotes, RFPs, ERP, supply chain  Value chain process mapping  Revenue-generating  Offer blockchain-based services to clients  Example: banks targeting larger customer base through blockchain-based eWallet solutions  Cost-saving  Finance, treasury, accounting, GL/AR/AP  Quality assurance, regulation, compliance, audit 37 Source:
  39. 39. 24 August 2017 Blockchain 38 Source: Stock Transaction Real Estate Purchase/Sale Health Insurance Billing 2. Steps that can be automated with blockchain 1. Steps with human decision-making Energy Contract International Trade Shipment  Reengineering economics and governance  Any complex transaction has two kinds of activities Blockchain automation economy Economics Governance
  40. 40. 24 August 2017 Blockchain Conclusion  Blockchain is a fundamental IT for secure value transfer over networks  For any asset registered in a cryptographic ledger, the whole Internet is a VPN for its confirmation, assurity, and transfer  Reinvent economics and governance for the digital age  Long-tail structure of digital networks allows personalized economic and governance services  Smartnetworks are a new form of automated global infrastructure for large-scale next-generation projects 39 Personalized Long-tail Systems One size fits all IT: Information Technology
  41. 41. 24 August 2017 Blockchain Conclusion  Next-generation global infrastructure: Deep Learning Blockchain Networks merging deep learning systems and blockchain technology  Smart Network Convergence Theory: pushing more complexity and automation through Internet pipes  Blockchain Deep Learning nets: Ability to identify what something is (machine learning) and securely verify and transact it (blockchain) 40
  42. 42. Blockchain Investing FinTank, Chicago IL, August 24, 2017 Slides: Blockchain Investing Smartnetworks and the Blockchain Economy Melanie Swan Philosophy Department, Purdue University Thank you! Questions?
  43. 43. 24 August 2017 Blockchain Agenda  Technical Overview  What is Bitcoin Mining? 42
  44. 44. 24 August 2017 Blockchain How does blockchain work? 43  eWallet app: holds keys, not money  Using PKI (public key infrastructure): electronic wallet software issues a public-private key pair (public address is a 32-character alphanumeric code)  Scan public address (QR Code) & submit transaction  Private key confirms access and funds availability, transaction validated and posted to blockchain
  45. 45. 24 August 2017 Blockchain Why is it called blockchain? Ledger (chain) of sequential transaction blocks  Each new block starts by calling the last block, so a cryptographic chain of transactions is created  Every 10 minutes, the latest block of submitted transactions is validated (by cryptographic mining) and posted to a single distributed ledger 44 Source: Satoshi Nakamoto whitepaper:, Block 10 Block 11 Block 12
  46. 46. 24 August 2017 Blockchain How robust is the p2p software network? 45 p2p: peer to peer; Source:,  7340 Global Nodes running full Bitcoind (6/17); 100 gb Run the software yourself:
  47. 47. 24 August 2017 Blockchain What is Bitcoin mining? 46  Mining is the software-based accounting function to record transactions, fee-based  Mining hardware/software “finds new blocks”  Network regularly issues random 32-bit nonces (numbers) per specified cryptographic parameters  Mining software constantly makes nonce guesses  At the rate of 2^32 (4 billion) hashes (guesses)/second  One machine at random guesses the 32-bit nonce  Winning machine confirms and records the transactions, and collects the rewards  All nodes confirm and append the new block of transactions to their copy of the distributed ledger  “Wasteful” effort deters malicious players Sample code: Run the software yourself:
  48. 48. 24 August 2017 Blockchain Scalability  Transactions/block: 400 (2014) vs 2,000 (2017)  Current Bitcoin block size limit: 1 mb  Change proposals  SegWit (Segregated Witness): 2-4 mb  Emergent Consensus / Bitcoin Unlimited: no limit  (Former): BIP 100 (adjustable block size), BIP 101 (8 mb)  Second-layer solutions: batch posting to blockchain  Factom, Storj, Lightening Network  Democracy: 5 constituencies decide  Developers, miners, exchanges, wallets, merchants 47 Segregated Witness: move non-critical “witness” data off the blockchain; BIP: Bitcoin Improvement Proposal Source: Bitcoin transactions per block (
  49. 49. 24 August 2017 Blockchain Agenda  Distributed Ledger Applications 48
  50. 50. 24 August 2017 Blockchain 49  Secure information exchange  Asset confirmation and transfer  Automated coordination  Example: fleet management of drones, autonomous driving, robotics, clinical trial patients, cellular therapeutics  Blockchain: automated, secure coordination system with remuneration and tracking Key blockchain functionality Source: Swan, M. Philosophy of Social Robotics: Abundance Economics. Sociorobotics, 2016.
  51. 51. 24 August 2017 Blockchain Financial services  Shared ledger  Instantaneous transaction validation (t=0, not t+3)  Settlement, clearing,  Custody, insurance  Secure, lower risk, cheaper  Financial assurity  Securities asset registries  Automated clearing  Quoting, deal placement  Billing, settlement 50 Source: Shared Ledger
  52. 52. 24 August 2017 Blockchain Supply chain and logistics  Asset transfer and customs clearing  Provenance, assurance, release  Inventory management  Custody, insurance, damage  Automated tracking and notification  Pallets, trailers, containers  Trade finance and documentation  Track purchase orders, change orders, receipts, shipment notifications  Custody and product certification  Link physical goods to serial numbers, bar codes, RFID tags 51
  53. 53. 24 August 2017 Blockchain Energy  Blockchain energy projects  Enerchain: trading (NE Europe)  BTL Interbit blockchain energy platform: trading (Vancouver CA)  PONTON: DSO, TSO, aggregator, generation power-balancing (Austria)  Automatic markets  “Energy Internet” - smart buildings on regional energy smartgrids  Smart resource self-pricing  Load-balancing  Source fungibility: wind, solar power  Energy price and trade validation 52 Sources:,
  54. 54. 24 August 2017 Blockchain  EMR (electronic medical record)  Personal health records  Users key-permission doctors to records  Digital health wallet  Identity + EMR + health insurance + payment  Health insurance billing chains  Automated claims processing  Price-quoting for medical services  Health Data Research Commons  Biobanks, QS (DNA.bits), genome files 53 Source: Healthcare Digital health wallet
  55. 55. 24 August 2017 Blockchain Politics: governance services 54  Blockchain weddings (Bitcoin, Ethereum)  Public document registries  Titling Registries  Local government RFPs for home, auto, land  Legal services: register and attest  Contracts, IP, agreements, wills registries  Proof of Existence: hash + timestamp + blockchain record  Voting  Quadratic voting (interest), PageRank (relevance)  Delegative democracy, random sample elections  Opt-in personalized governance services  Composting vs education Sources:,, , World’s First Blockchain Marriage: David Mondrus and Joyce Bayo, 10/5/14, ConsenSys wedding : Kim Jackson and Zach LeBeau, 11/2/15
  56. 56. 24 August 2017 Blockchain Humanitarian  Refugee identity system  Phone access: smartphone eWallet, SMS  Object access: card, paper wallet, pendant, ring, keychain, tattoo, implantable chip  Biometric access: word phrase, fingerprint, iris, facial scan  Financial inclusion, access to learning  Smart contracts for literacy  Bitcoin MOOCs “Kiva for literacy”  Open-source FICO scores  Decentralized credit bureaus  Remittance, blockchain-tracked aid 55