Blockchain Financial Networks

Washington DC, October 2, 2015Slides: http://slideshare.net/LaBlogga

Melanie SwanEconomic Theorist

New School, New York [email protected]

BlockchainFinancial Networks

October 2, 2015Blockchain Financial Networks

Blockchains: Overview

2

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

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/1491920491http://www.slideshare.net/lablogga/blockchain-consensus-protocols

October 2, 2015Blockchain Financial Networks 4

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


Fintech Investment

5https://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


R3 CEV Distributed Ledger AnnouncementShared 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?

6DTCC 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)


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

7


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

8

Phase II: Automate

Phase I: Modernize


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

9


U.S. Treasury Application Areas

10

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


Blockchain Financial ApplicationsExamples

11

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


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

12


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)

13http://www.systemics.com/docs/ricardo/issuer/contract.html


Rethinking Risk per non-linear causality: Risk Regimes

14

Lloyd’s of London

Sea-faring Trade

Black–Scholes

CAPM, Beta

Efficient Frontiers

Support Vector Machines

Complexity MathDocker 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 AlgorithmsDistributed Consensus

Algorithms

Portfolio Theory

Trinomial Trees

Heteroscedasticity

Convexity

Big Data Crunching

Eigen Values & MatricesAnalysis Tools:

Reflexivity


Rethinking FinanceInternet of Information -> Internet of Finance

15http://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


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

16

Information & Entertainment Manufacturing Health Economics &

FinanceGovernment &

Legal

Internet: Transfer of Information Internet: Secure Transfer of Value

Sectors


Evaluating Blockchain Ecosystem Risk

17

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

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

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/1491920491http://www.slideshare.net/lablogga/blockchain-consensus-protocols

Washington DC, October 2, 2015Slides: http://slideshare.net/LaBlogga

Melanie SwanEconomic Theorist

New School, New York [email protected]

BlockchainFinancial Networks

Thank you! Questions?


Private and Public Blockchains

21http://www.slideshare.net/lablogga/blockchain-consensus-protocolsCharts 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


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

22Swan, M. Blockchain Consensus Protocols, 2015, http://www.slideshare.net/lablogga/blockchain-consensus-protocols


Approaches to Consensus/BFT

23

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


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

24https://medium.com/a-stellar-journey/on-worldwide-consensus-359e9eb3e949http://crypto.stanford.edu/seclab/sem-14-15/williams.html


Pebble: Asynchronous Randomized Byzantine Consensus (Concept)

25http://crypto.stanford.edu/seclab/sem-14-15/williams.htmlhttps://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


Pebble: Asynchronous Randomized Byzantine Consensus (Method features)

26FLP: 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


Pebble: Asynchronous Randomized Byzantine Consensus (Example)

27http://crypto.stanford.edu/seclab/sem-14-15/williams.htmlhttps://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


Stellar: Quorum Slicing (Concept)

28https://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


Federated Quorum Slice Network


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


Stellar graphic novel explains Quorum Slicing

30https://www.stellar.org/stories/adventures-in-galactic-consensus-chapter-1/


Stellar: Context of Byzantine Agreement


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)


Stellar: Consensus Protocol Comparison

32SCP: Stellar Consensus Protocolhttps://medium.com/a-stellar-journey/on-worldwide-consensus-359e9eb3e949


Enterprise Blockchain Apps by Sector (selected)

33http://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