Blockchain, Finance & Regulatory Development

Towards distributed ledgers, smart contracts & the
decentralization of finance
Alex Makosz
October 8th 2016
u3531054@connect.hku.hk
https://hk.linkedin.com/in/alexmakosz

Barney Frank discusses
why we need
regulations for future
financial technologies

HOW FAMILIAR ARE YOU WITH EACH
OF THE FOLLOWING?
BLOCKCHAIN
SMART CONTRACT
DISTRIBUTED
LEDGER
CRYPTOCURRENCY
DAO

What experts are saying about blockchain tech:
• “The implications are staggering, not just for the financial-services
industry but also right across virtually every aspect of society.” –
CEO Don Tapscott in interview w/ McKinsey
• “In distributed ledger technology, we may be witnessing one of
those potential explosions of creative potential that catalyse
exceptional levels of innovation.” – Distributed Ledger Technology:
beyond blockchain, A report by the UK Government Chief Scientific Advisor
• “we may be entering the peak of the hype cycle for blockchain
and distributed ledger technology. But here’s the thing: blockchain
is a major breakthrough.” – Mariana Dahan, World Bank’s Blog

What is blockchain?
A blockchain, distributed
across a network, is a
technology that effectively
replaces and decentralizes
traditional ledger systems.

What is blockchain?
A block is:
• A record of data
• Contains a digital
signature
• Uses cryptography to
ensure authority &
identity of those who
write the record
• Contains time
information for events
represented in the data
A blockchain is:
• A series of blocks of data
• Ordered chronologically
• All blocks have only
been added after
computational
confirmation of
correctness

Visualizing a Blockchain
Block 1
-events data
-signatures
-time data
Block 2
-events data
-signatures
-time data
Block 3
-events data
-signatures
-time data
Block 4
-events data
-signatures
-time data
Network of Peers/Devices
Every peer in the
network holds all
of the data of the
entire chain
Blockchain Ledger
Distributed
Ledger

How this changes the system of ledgers:
Central authority is
holder of main
ledger and is
ultimate authority.
Ledger is shared by
several authorities
who must confirm
with each other.
No central
authority.
Ledger shared by
all.

Qualities of Distributed Ledger Using
Blockchain
• Virtually impossible to change or erase data in any
block
• All of the data is shared by every computer in the
blockchain network
• No dependence upon any central node or authority
• Can be audited and confirmed
• Can be used in networks with many, many nodes

Differently permissioned distributed ledgers:
Because the system is made of code, permissions can be built directly
into the code governing the chain
Permissions determine:
1. Who can read the data in the chain
2. Who can write new lines for the chain
The future of financial infrastructure -The World Economic Forum, Aug 2016

Current activities surrounding distributed
ledger systems:

Use case 1
Cryptocurrencies
http://www.lordcameltoe.com/mine-dogecoin-asic-miners/

Despite being the most well-known
application of blockchain tech…

https://www.weusecoins.com/en/bitcoin-price/
What most people are familiar with

Examples of cryptocurrencies
Bitcoin was the first, most traded and the most
valuable cryptocurrency.
Bitcoin brought the blockchain into the
mainstream.

Bitcoin represented
a direct response to
these questions
following the world
financial crisis.
https://bitcoin.org/bitcoin.pdf
Big Idea: Enable transaction without using financial institutions

The broad concept
Cryptocurrencies are just digital cash

How does funds transfer actually happen?

Public Ledgers & Private Keys
Bitcoin Client Your Client Contains:
• Your address (analogous to account number)
• Your private key
Your Private Key
Allows you to make changes to the
ledger contents for your address
The Public Key
Allows others to confirm that the
change requests are truly sent from
your address
Both make use of cryptography to ensure
security

Ways to get Bitcoin
Have your friend send them directly to
your digital wallet!
…so, how did your friend get them?
http://money.cnn.com/infographic/technology/what-is-bitcoin/

Ways to get Bitcoin
Exchange your
fiat currency
for bitcoin on
an exchange!
…so, how did the people on the
exchange get them?https://en.wikipedia.org/wiki/
Bitcoin

Ways to get Bitcoin
Mine them
Mining is basically the process of
applying computing power to solve
the complicated computational
problems needed to verify each
new block in the chain is correct.
Mining was once easy with a regular
computer, but has now become the
domain of specialized, highly-
powered and resource intensive
mining industry.

http://wiki.p2pfoundation.net/Bitcoin

http://getbitcoinguide.com/mining-for-bitcoin
Because Bitcoin is:
• Distributed
• Public
• Permissionless
Miners are needed to perform the
computations involved in
confirming each transaction in a
block.
Miners are incentivized to do so
because the code provides them
with a reward of currency each
time a block is solved.

Pros and Cons
Pros
• Massive reduction in
bureaucracy
• Low transaction costs
• High level of ledger
security
• High level of
transparency
• Fraud prevention
• Use-specific currencies
• Privacy
Cons
• Low Uptake/High FUD
• Lose your key, lose your
coins
• Scaling
• Regulation – both
governmental and
within the blockchain
management
• Volatile

Key considerations for understanding further
applications of blockchain technologies:
Digital identity does not need to be tied to a
wallet in a phone or computer.
(think IoT & e-identity)
Because the blockchain is composed of code, it is
possible for it to contain executable commands
that function in response to required conditions.
(think smart contracts)
Data recorded in blockchain ledgers need not
only be financial in nature.
(think titles of ownership, voting records etc.)

What does this imply?
What this
fundamentally
represents:
A way to transfer a
digital asset or
record without the
use of a third party
intermediary and
potentially
including self-
executing
commands.
http://www.pwc.com/us/en/financial-services/publications/cryptocurrency-evolution.html

Expanding Use Cases
Distributed Ledger
Blockchain
Real Estate
&
Property Holdings
Ensuring Authenticity
Diamonds &
Sneakers Decentralized
Autonomous
Organizations
Proxy
Voting
Automated
Compliance
Connection w/
e-identity
(Estonia)
Cryptocurrency
Insurance
Claims
Processing
And many more…

1. Financial Institutions – reduce the back office
2. Ensuring Authenticity of Precious Goods
3. Decentralized Autonomous Organizations

Smart Contracts
Contracts can be coded which include:
• the terms of an agreement
• the legal restrictions upon execution of the agreement
• the ability to recognize whether or not terms have been reached
• the capacity to execute the contract
All of this can be done without a 3rd person intermediary
https://blockchainhub.net/smart-contracts/

https://ripple.com/insights/santander-distributed-ledger-tech-could-save-banks-20-billion-a-year/
Financial Institution Incentives
Current back office system works well, but is very costly
Blockchain promises to:
• Massively reduce back office costs
• Reduce transaction settlement time
• Reduce risk

https://www.scribd.com/doc/310534422/Smart-Contract-Templates-1
Financial Institution– Current Example

Estonia Indonesia
Nasdaq is helping other financial markets to use
blockchain in modernizing their financial markets
Estonia now implementing blockchain for
shareholder proxy voting

Among seven firms
that are currently
collaborating on a
blockchain-based data
management trial
system

Ensuring Authenticity
1. Provide physical objects with unique digital
identifiers
2. Include the unique digital identifiers in the
blockchain
3. Track all objects involving that physical object

Ensuring Authenticity– Current Example
http://www.everledger.io/

Ensuring Authenticity– Current Example
http://www.chronicled.com/

Decentralized Autonomous Organization
Features of DAOs
• No central control
• Administered entirely
on the web
• Relationships regulated
through smart contracts
• Does not need
traditional contracts
• High efficiency
• High transparency
• Scalable
• Impartial https://www.linkedin.com/pulse/government-dao-blockchain-
decentralized-autonomous-smart-tori-adams

DAO – Current Examples
Venture Capital firm
• Launched June 2016
• Received USD $150M
in crowdfunding
• Hacked & lost $50M
• Collapsed & returned
remaining funds

Regulator Responses
• Recognize existence of systemic problems
post WFC
• See potential for risk reduction
• Imposed identity requirements on
cryptocurrency exchanges
• Allowing space for financial innovation
Responses will vary by region and by
application of the technology

http://www.internetlivestats.com/internet-users/
Critical Trends – Internet Use

https://en.wikipedia.org/wiki/Global_Internet_usage
Critical Trends – Internet Use

Critical Trends
World Bank Data http://datatopics.worldbank.org/financialinclusion/

http://www.mckinsey.com/industries/financial-services/our-insights/cutting-through-the-noise-around-
financial-technology
High fin-tech
representation
in retail
applications
Low fin-tech
representation
in large
corporate
applications

It is still very early days of blockchain

Historical Analogies
Old Giants New Giants

Historical Analogies
Old Giants New Giants
Startups backed by VC investment
are rushing to fill this gap

http://www.i-scoop.eu/internet-of-things/
Critical Trends

Converging
Emergent
Technologies
Quantum
Computing
Cloud
Computing
Predictive
Analytics
Robotics/AI
Cognitive
Computing
Bioinformatics
Distributed ledgers

http://historyofbitcoin.org/
What has this
started?

What has this
started?
Expert panels and other excellent videos
Blockchain: Transforming the Future of Global Business
A $1.6 Quadrillion Opportunity - Securities Clearing and Settlement
Barclays’ Smart Contract Templates - presented by Dr Lee Braine,
introduced by Brad Novak
Beyond bitcoin: The future of blockchain and disruptive financial technologies
What's Wall Street Doing With Blockchains?
The future will be decentralized | Charles Hoskinson | TEDxBermuda

What has this
started?
Publications and articles well-worth reading
The future of financial infrastructure
-The World Economic Forum, Aug 2016
Distributed Ledger Technology: Beyond block chain
-A Report by the UK Government Chief Scientific Advisor

What has this
started?
Publications and articles well-worth reading
• Central Bankers Told They Should Be Sprinting Toward Blockchain
• How blockchains could change the world
• 90 Central Banks Seek Blockchain Answers at Federal Reserve Event
• Santander: Distributed Ledger Tech Could Save Banks $20 Billion a Year
• A Strategist’s Guide to Blockchain
• Money is no object: Understanding the evolving cryptocurrency market
• Amazon China’s president on ‘transformative’ technologies
• The Math Behind Bitcoin
• A SIMPLE MODEL FOR SMART CONTRACTS
• The Blockchain Explained to Web Developers, Part 1: The Theory
• Formalizing and Securing Relationships on Public Networks
• e-Estonia initiative progresses with blockchain partnerships
• NASDAQ'S BLOCKCHAIN TECHNOLOGY TO TRANSFORM THE REPUBLIC OF
ESTONIA'S E-RESIDENCY SHAREHOLDER PARTICIPATION

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