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MITOCW | 1. Introduction
The following content is provided under a Creative Commons license. Your support will help MIT OpenCourseWare continue to offer high-quality educational resources for free. To make a donation or to view additional materials from hundreds of MIT courses, visit MIT OpenCourseWare at ocw.mit.edu. GARY GENSLER: Welcome, welcome. If you have a desire to learn a little bit about blockchain and its intersection with the world of finance and money and you're looking for 15.S12, you're in the right place. If you're here to not do that and just hang out and have a good time, I guess you still hopefully are in the right place, because we're going to have a good time this semester. My name is Gary Gensler. I'm a Senior Lecturer here at MIT Sloan. I'm also an advisor over at the MIT Media Lab. And I've spent a lifetime around the world of finance, and money, and public policy. And I've been at MIT this last eight months. And we're going to learn a lot together about blockchain and money. We're going to have a little bit of fun here and see what we're going to do. So we're talking about blockchain and money. That's where we are. By the way, I do cold call. I do call on you-- so if you want to leave now, I understand-- because I want to have an interaction a little bit about it. So my first question for the class, for everyone, whether registered or not, how many of you have ever owned a cryptocurrency? Wait, wait, let's see. It seems like it's about 45% of you or so. All right, so it gives me-- Alin you want to keep your hand up long? And how many of you have ever worked on any blockchain-related projects, in an entrepreneurial setting, a corporate setting, anywhere? All right, good, so about a third in the room. All right, so you all know probably more than I do, but I'm going to give it a shot. I'm going to always start every week with what are the study questions for the week. How many of you actually got the syllabus? This is not going to be graded assignment. I just have to have a sense of who actually got this syllabus-- so a good many of you. And how many of you actually did the two readings? It's not graded. I've just got to gauge the class. Oh, thank you, thank you. Write those grades down, by the way-- [LAUGHTER]
[LAUGHTER]
--no, no. All right, so the two main questions for this week's lecture really is, what is blockchain? And why might it be a catalyst? And I emphasize the word "might" it be a catalyst for change in the world of finance. We could talk a lot about things outside of the world of finance. And blockchain may indeed have a lot of applications outside of finance, but I've chosen to try to just narrow the scope a bit. So this semester is really about blockchain and money or blockchain and finance. And secondly, you will see index cards on every one of these round tables. One assignment, by the end of the class-- you could do it now or later-- I would like each of you to anonymously write on the card what you want to achieve in this semester. It could be anything from this class, from learning about blockchain, from making money on Bitcoin, from-- I don't care if you tell me it's meeting your future spouse. Like, what do you want to achieve in this class? I can't help you on the third, but I will try to help you on the things I can help you on. And Sabrina and Talida will collect them later. And next Tuesday, we'll tell you the results. What is it that you want to achieve in this class? And then we'll see at the end of the semester if we've done that. So it's just a way to help guide me help you. So that's what we're trying to do. And so what were the two readings? One was a little thing I did. And one was a thing I did with some of my colleagues. And Tom, since I know you, what did you take out of the readings? AUDIENCE: That blockchain is essential to improved profitability [INAUDIBLE]. GARY GENSLER: Did you have a good summer? AUDIENCE: Mhm. GARY GENSLER: Did you raise your hand? Did you own Bitcoin? No. Who in the class read the readings and took something different than Tom? He said there was potential. And your first name? AUDIENCE: Alin. GARY GENSLER: Alin. AUDIENCE: Well, I'm coming from the technical side. So from the technical side, all I see is a bunch of hype. And 10 years have passed since the launch of Bitcoin with very little to show for it other
know what this scene is from? AUDIENCE: This is the first pizza sold by Bitcoin. GARY GENSLER: Good thought, good thought, first pizza sold by Bitcoin, but no. AUDIENCE: Is it from that movie Hackers or something? GARY GENSLER: All right, movie Hackers. AUDIENCE: I think it's from Net. GARY GENSLER: The Net? Have you ever seen the movie? It's not a good movie. So this is the opening scene of The Net. And yes, that's Sandra Bullock. And the year is 1995. It's a cyber thriller. You know, a president's involved. The Defense Department's involved, and so forth. But actually, Pizza Hut is associated with the very first sale, online sale anywhere in the world. They started something called PizzaNet. This was the screen, by the way. If you wanted to go on, you could order your pizza. But there was one problem. Does anybody know what the problem was with PizzaNet? I mean, maybe there were multiple problems. No, Alin I've called on you. AUDIENCE: You couldn't pay online. GARY GENSLER: You couldn't pay online. Nobody had figured out how to move money online. You had to pay when you showed up with the pizza. So now I'm going to talk a little bit about cryptography. We're going to spend a lot of time on cryptography. It's cryptocurrencies and the like. What's your name? AUDIENCE: Jihee. GARY GENSLER: Gigi? AUDIENCE: Jihee. GARY GENSLER: Jihee. Jihee, what's cryptography?
AUDIENCE: I would assume that that's something cryptic? GARY GENSLER: Cryptic, all right, no, you got it. You've got a start there. Anybody want to help Jihee out? Does anybody want to help Jihee out? Yeah, tell me your first name. We're going to figure out how to have everybody have nameplates by next week, but we'll work with Ryan and do it that way. AUDIENCE: Addy GARY GENSLER: Addy AUDIENCE: Yeah-- it's the technology or the science behind encryption and decryption for fortification, so how do you encrypt a particular text such that it's not readable by someone else without having the decryption code. GARY GENSLER: OK, so it's how do you encrypt something so it's not detectable by others. Or in essence, it's communications in the presence of adversaries. You have an adversary who wants the communication. You want to communicate and not let your adversaries know that communication. And this is true for ancient times. So in ancient times, there was something called the cipher. And this was a way that you'd take a piece of leather or a piece of cloth and have a lot of letters. And both sides, you'd encrypt and decrypt, because they were different measurements of the cylinder. Has anybody seen the movie Imitation Games? AUDIENCE: Mhm. GARY GENSLER: All, right the Enigma machine-- now the movie was wonderful, because it said Turing cracked it. And he did help crack it in an automated way, but actually, the Polish government had cracked it in the 1930s before they fell to the Germans. And Turing built on all of that and cracked it further. And then in the 1970s-- and this was here at MIT, to some extent-- there is private-key public-key cryptography, which I'm not going to dive into today, but it's the heart of Bitcoin and blockchain. It's at the heart of the internet. But it's about-- the key thing is communications and the presence of adversaries. How do you keep a secret when everybody wants in and get that information? And there is a long history. And MIT is at the center of a lot of that. A lot of early cryptography failed on the internet. In the early '90s and late '80s, David Chaum
move value peer to peer without a centralized intermediary? And that's the core of blockchain technology. So who solved the riddle? Is anybody going to tell me who solved the riddle? Who solved this riddle? No, [INAUDIBLE]. You're wearing a t-shirt that says Quentin Tarantino. So I think Quentin Tarantino-- AUDIENCE: [INAUDIBLE] GARY GENSLER: --should solve a riddle. What's that? What's your name? AUDIENCE: Rufus. GARY GENSLER: Rufus-- and who solved this riddle? AUDIENCE: Satoshi Nakamoto. GARY GENSLER: Yeah. So a peer-to-peer cash-- this is the actual doc top of an email that was sent out on Halloween 2008 by Satoshi Nakamoto. We don't actually know who Satoshi Nakamoto is, but it's a study question a few lectures from now to ask you to tell me who you think Satoshi Nakamoto is. So I won't ask that now. And he started with a very simple sentence in his email. "I've been working on a new electronic cash system that's fully peer-to-peer with no trusted third party. It's kind of a modest statement. And so the question is, is this another internet layer? We're going to explore that this whole semester. I don't really have the answer. I don't think the best minds at MIT could really yet tell you. There are some who are maximalist and say, yes, it will be. And there are others who will say, no, no, no. And in this course, we're going to review the minimalist and the maximalist. We're not going to try to center it in one place. But that's the key kind of question. So what is a blockchain? We're going to do this and a lot of lectures, but I'm going to try to do it in a short version. So it's time-stamped append logs, meaning you can add a little bit of information to this. And it's time-stamped. So these are these blocks being added. Satoshi did not invent blockchain. It was way earlier. Does anybody want to guess when it
was? You're going to have a reading about this later, but early 1990s. AUDIENCE: Stuart Haber. GARY GENSLER: What's that, Madars? AUDIENCE: Stuart Haber. GARY GENSLER: Stuart Haber, Stuart Haber-- worked for Bell Labs, right? So one of your assignments-- it's not going to be a graded assignment. It's just going to be a fun assignment. Could any of you, I'm going to say by next Thursday, just because, have some fun, find the longest, and time wise, longest-running blockchain. It's not Bitcoin. And it's been running since the mid '90s. And your clue is The New York Times. And we'll discuss it next Thursday. But this time-stamped block, block, block, block of data creates a database, an auditable database. And we'll talk about ledgers, particularly next week, but we'll talk about ledgers all throughout this course, and how it changes the world of finance. Now, it's secured by cryptography, because cryptography, remember, is communications and making sure adversaries can't pick you off. We're going to learn about hash functions. And hash functions are a really important part of cryptography, and initially for databases, and how to search and store information in databases, but in this circumstance, hash functions were the way to not only append the next block to the prior blocks, but really importantly, to compress data, to make it more manipulable, and to verify it, and as I've written here, tamper resistance and the integrity. Digital signatures, which has to do the public-key private-key cryptography-- there is no prerequisite to this course. You do not had to have taken computer science, cryptography, algorithms. If I can learn a little bit about hash functions and asymmetric cryptography, these are the two key important sides. And we have enough computer scientists in this room that can sort us out if I say the wrong thing. Right, Madars? Hopefully. And then consensus-- so there is a really important part of blockchain is, how do you decide who appends that next block? Because when I went back here, there is block and block. Each of these blocks, somebody has to decide who appends, who gets to pick the next block. And that's what's called consensus protocol. And there is wide debates about consensus protocol. And we'll talk a lot about consensus protocol. But in essence, it addresses
So what is blockchain technology? These are my words but they're sort of picked from the literature and so forth. It verifiably moves data on a decentralized network. And the economics of blockchain technology are really around that, verification, and the economics of verification, and the economics of networking. And in many ways, blockchain adds certain costs to the verification through this consensus protocol that we'll be studying, but it lowers some other costs of verification, because you're not relying on a centralized authority. So it's really a trade off of cost to verification. I don't think it's-- I'm not a purist that says it's better or worse, but it's a trade off of cost and verification through decentralized networks. The data can be value. Like, Bitcoin was a money system. Or the data can be actually computer code. And we'll learn a lot about smart contracts. And you could have the data being verified computer code and algorithms. My world, finance, this directly goes to the plumbing of finance, because finance is fundamentally about moving money and risk through a network. And that network is the 7 billion people that live in this world. It's moving money and risk. And you've all taken finance courses. Or many of you have. And it's the intermediation of money and risk throughout our economy. But there is a whole host of challenges. And over the course of this semester, we'll talk about those challenges, technical, commercial, and public policy hurdles. Will they be solved? Will they not be solved? But it could be a catalyst-- but we're not sure yet-- for a change in the world of money and finance. So does anybody want to tell me that the role of money in society? And tell me your first name. AUDIENCE: Thomas. GARY GENSLER: Thomas. AUDIENCE: Basically it's a way exchange things and services between people-- GARY GENSLER: All right, medium of exchange, got that one. AUDIENCE: --without doing bartering, I mean. Exchange [INAUDIBLE].
GARY GENSLER: So a medium of exchange. Somebody give me a second-- yellow shirt. AUDIENCE: Yeah, medium of savings. GARY GENSLER: Savings, all right, so that would be a store of value. AUDIENCE: Yeah. GARY GENSLER: Third-- I'm sorry, the gentleman here. AUDIENCE: Unit of account. GARY GENSLER: Unit of account-- wow, all right, there we go. There we go. So we're going to spend some time next Tuesday talking more about money, and the role of money, in the history of money, which I think it sort of lays a foundational piece of this. What about the role of finance? I've already sort of said a few things about that. And I'm sorry. I don't know your name, but right here, the woman, yeah-- role of finance? It's all right, I'm not going to tell any financial finance professor what your answer is. AUDIENCE: To raise money. GARY GENSLER: To raise money-- so keep going. Anybody else want to-- AUDIENCE: Connect savers and borrowers. GARY GENSLER: Connect savers and borrowers-- so connecting is sort of moving money, moving. AUDIENCE: The valuations. GARY GENSLER: Valuations-- so that's the pieces of it. So there is moving, making valuations. I use the words, moving, allocating, and pricing. Pricing is the valuations of money. But let's not forget, it's also about risk. When you buy insurance, that's a transference of risk. When you buy an equity stock, that's a transference of risk. If you enter into a complex credit default swap, that's a transference of risk. So finance is not just the movement of money. It's the movement of risk as well, throughout the economy. And I always think, finance, I always-- I've thought this when I was at Goldman Sachs for 18 years-- that finance sits at the neck of an hourglass. And it's why it collects so much economic
performance, scalability. A modern payment system, you need to be able to move about 100,000 payments a second. A modern securities clearing, the Depository Trust Corporation, the Securities and Exchange Commission says, you do about 30,000 transactions a second, but we need you to scale. And your computers and everything have to be resilient to 100,000 transactions a second. Bitcoin, you can do about seven transactions a second. Visa currently-- it depends on the second-- does anywhere from 20,000 to 70,000 a second. So it's just a sense of scalability and performance. We might get there. It might be three to seven years away. I'm optimistic, but there is still a bunch of performance and scalability issues. Privacy and security-- blockchains, by their nature, are public. So they're not fully censorship- resistant, but there is a lot of innovation about making them more private. But then that makes the public sector a little nervous. Interoperability-- they don't necessarily work yet with other legacy systems or with each other. The internet, one of the great innovations of the internet, it became interoperable, that all of these different websites could kind of speak with each other. Governance is a very big issue we'll talk about. And one of the things about governance is, it's hard to update the software of a blockchain, because if you create a decentralized where no one's in control, no one can collect economic rents, you also don't have sort of somebody with the ability to necessarily update the software. And we'll talk later about how Bitcoin updates its software, and what Bitcoin core developers are, and so forth. But Facebook, you do know one thing-- though they're a company that collects a lot of profits and economic rents off of their two billion members, they know how to update their software. It's a governance issue that's a real, live challenge. And that's why the financial sector says, I'm not sure this works, this is ready yet for me. And then thus, what are the commercial use cases? And what are the public policy issues? So right now, the financial sector favors permissioned blockchains versus permissionless. About four weeks from now, we'll kind go through these two differences, but I want to just frame this briefly. Permissioned blockchains have a known group of people who actually participate. The half of you that said you've owned Bitcoin, you know it to be something where anybody can update the ledger. Permissioned blockchains, you can't do that, in essence. You pick the 3
or 20. The Australian Stock Exchange is updating their clearing and settling. They announced they're doing a blockchain project. They're doing it with digital assets. And they're using the Hyperledger blockchain, which is an IBM software, open-source software. But the Australian Stock Exchange is going to put it on three computers, which is called three nodes, that they control all three of them. The Depository Trust Corporation is looking at blockchain-inspired solutions for some of their data warehouses, but they, too, are going to control the nodes. I'm just giving you-- that's permissioned blockchain. So there is nothing wrong with that. That's just how they are looking at this. Permissionless blockchains are like Bitcoin, unknown participants, securities based on incentives, a cryptocurrency, and crypto economics. Crypto finance is about $200 billion. But you know, you have to update these slides daily. Two days ago, it was $230 billion. And this little pie chart is-- a little over half is Bitcoin. The next slice is something called Ethereum, and then Ripple, and down the line. We're not going to spend a lot of time in this semester-- if your goal is to how can you profit, and day trade Bitcoin, and day trade Ether, god bless. Go prosper. You can stay in the class. I just won't give you much advice on it. This is not a crypto-investing- centered class. But I'm OK if that's what you're doing. Does anybody know what the worldwide capital market size is? Does anybody want to guess? You know, this is $200 billion. What's it look like? I've already said it's modest. AUDIENCE: Hundreds of trillions. GARY GENSLER: Hundreds of trillions-- global equity, about $80 trillion, global bond and debt markets, $ trillion, so it's still quite modest compared to that broad breadth of capital formation. And gold? If Bitcoin is digital gold, what's the value of gold? All the gold that's ever been-- Tom? AUDIENCE: About $6 or $7 trillion. GARY GENSLER: Yeah, $7 trillion-- so just to give you a sense of scale. So there is also something that's interesting about this space, is that it's outsized public attention, even as evidenced by the hundred of you in this room, versus the size it is relative to the capital markets today. There is a bunch of public policy issues. We'll have a lecture.
The incumbents, like this lioness in the corner, are eyeing this space, because there is a lot of volatility. And Wall Street makes money on volatility. Volatility is the friend of Wall Street. It may not be the friend of investors, but it's a friend of Wall Street. And they also like the trading volumes and the spreads. Coinbase, the largest crypto exchange here in the US, has 20 million accounts. They might not all be active, but that's the size of Fidelity's membership or account list and twice DE Shaw. And Robin Hood-- how many of you have ever used Robinhood as a trading app? Wow, half of you. So you know, free trading, five million members-- for those who don't know, you can download Robinhood. And you can trade stocks for free, no commission. And if anybody is interested, show up and I'll do office hours on how Robinhood commercializes-- they commercialize your order flow. And they make money without charging you commissions. But it's a sort of wonderful app. Millennials love it, 5 million members already. So you better believe DE Shaw and the incumbents are worried about things like that. The startups are also more willing to beg for forgiveness from regulators. They're willing to sort of take risks and beg for forgiveness, whereas incumbents tend to have to ask for permission. So there is an unlevel field, that always, it's asymmetric business set of risk about regulatory risk-- not always. I'm not crying for JP Morgan. I mean, the big incumbents have also-- they have their advantages. And Coinbase is becoming an incumbent rather than just a startup, in a sense. And we'll talk during the semester about some of the incumbents. We're probably going to get Jeff Sprechers here in mid-November. He's going to talk to you about what Intercontinental Exchange and the New York Stock Exchange is doing with Starbucks, and Microsoft, and the like. The financial sector use cases-- I'm not going to go through these, but this is the second half of the course, is going to go through each of these. And we'll do one to two sessions on each, payment systems, central bank digital currency, secondary market trading. The venture capital and initial coin offering space, we'll do two course on that, and move through. So what are we going to do in this whole course? Basically, our goal is to learn the fundamentals-- that's about roughly the first half of the course-- pivot to two sessions on the economics. We're going to be talking about the economics throughout the whole course, but I
want to really just focus, drill down on the economics, on two of the discussions. And then riff through the financial space for the second half-- that's our journey together. To me, it's for anybody who wants to gain critical reasoning skills. This is not just kind of a, hey, this is going to change the world and revolutionize everything class. And so I basically think of an old Defense Department term called ground truths. It's when the general doesn't really know what's going on but needs to figure it out and needs to talk to that corporal on the ground who has got dirt all over him and has been shot up and says, here is the real ground truth. We're going to try to talk about ground truths in this class and separate the mere assertion from the hype. And some of your readings will be some real Bitcoin and blockchain minimalists, from Nouriel Roubini that uses words I'm not supposed to repeat on a recording about this stuff, to Paul Krugman who-- and Joe Stiglitz, and other Nobel laureates who say, no, it's not going to work, or Warren Buffett, to maximalists. We're going to try to cover both sides. Larry Lessig is honoring me because he's in the back of the class-- who is an enormously esteemed professor from Harvard. I didn't know Larry was going to be here. And I did this slide before. But in 1999, I think, you wrote this book, Larry. Is that right? AUDIENCE: [INAUDIBLE] GARY GENSLER: Code and Other Laws of Cyberspace, I put you in the-- but I think it's worthwhile to think about Larry's four bits here. And I don't know, Larry, if you want to say anything, but I'm going to try to infuse this course in just how you think about this. The tech-- we're at MIT. The technology-- and we're going to get you a lot of technology. If you want more than I can give you as a former finance sort of type my whole life, there is going to be a bunch of computer science people in the class. We're going to hook you up together with the folks from the Media Lab and C cell and try to connect you to the technology side if you want to swim deeper in that pond. But the technology really, really matters. And that's why we are going to go through hash functions, and go through asymmetric cryptography, and so forth. From a business perspective, markets matter. Why is it that incumbents or startups are or are not doing this and that? Why is it 10 years in and nobody has got an enterprise-wide solution yet to payments that use blockchain? The law matters. The public policy side matters.
The requirements of the course-- class participation is a hard thing to judge as a faculty member when I have this many people. But I always think class participation matters. We made it 30%, which if you have any advice on this next semester-- 30% two individual write ups, one in the first half, which is up to, I think, lecture 10, which is basically the blockchain fundamentals. You pick a topic. I don't care which one, but you'll get a much better grade if it's about critical reasoning, if it's really taking whatever those sets of writings are and not just repeating that which is in the readings, but really going the next step and saying, here is what's going on. And this isn't business school. You don't have to convince me that something about computer science. It's like critical reasoning about the economic opportunities, the strengths, the weaknesses, the opportunities, the threats, that old business school sort saying of swats with regard to that week's-- whether it's about hash functions early on, cryptography, or you sort of wait during the foundational period to permissioned versus permissionless. You pick-- but to please hand it in before that class' lecture, because I might during the lecture say, who wrote today? Do you want to tell us what you think? And it might help spur the class participation-- and then a second write up in the second half when we're riffing through the use cases, again, critical reasoning. And then lastly, the usual approach of teams of up to four-- no, I don't want teams of five, to handle that right now, three or four. And somewhere in the second half of this semester, we'll talk about more of the content. And there is a couple of you in here that worked with me last semester in a smaller group. You know, I want you to do well so I'm going to sort of give you a sense of what do we want to do, but it's basically, the idea is, you're an entrepreneur or you're an incumbent. And what sort of use case are you going to pick? And whether it's permissioned or permissionless, sort of make a proposal. Do a use case. Use your critical reasoning around this new technology somewhere in the broad world of finance. I mean, you know, and I'm glad to define finance really broad. You'll pick. So that's kind of the piece. Act one are the fundamentals. I won't go through each of the pieces, but you know, that's in the syllabus, of course. Act two is the pivot of the economics, and act three, our financial
sector use cases. And hopefully throughout, we'll have a lot of fun. So the study questions for next Tuesday, real quick, what are the roles and characteristics of money? So I really want to sort of dig behind money. Money is but a social construct or a social convention, medium of exchange, a store of value, unit of account. There is some readings about the debate, whether money first came from the barter system, or a really good set of anthropologists and archaeologists and everything say, no, it actually came as a ledger system. And no one knows for sure 10,000 and 15,000 years ago whether money came from the-- out of the barter system or more as a unit of account, keeping account of credits and ledger. But I'd say, when you read through some of those readings, you start to think, well, this is just a societal construct. And so we'll get behind that. What is fiat currency? Fiat currency, which is an invention, really, only of the last few hundreds years that we take for granted now. But how does that fit into that whole history? And importantly, how do ledgers-- accounting ledgers, I know, boring stuff, but it's probably why we came out of the dark ages about 500 or 600 years ago with double-entry bookkeeping. Sorry, I like ledgers. We'll talk a little bit about ledgers and how that fits into money, and securities, and so forth, and then layering in how Bitcoin fits on top of that history. Next Tuesday is not deeply about Bitcoin. It's just a little dollop on that. There will be five or six readings. One of them is a three-minute video, the third one. It's fun. Watch. It's just a funny little video on what money is. There is no need to read Nakamoto's full paper. When I said the email, I mean just the cover email. It's one paragraph. My goal in the readings each week was not-- and each session was, by and large, try to keep less than 50 pages. You say, you're going to look sometimes and you'll go, it looks like it's more. And maybe it is. I figure you're all going to figure out for yourself how to sort through the depth of your knowledge. But I will predict that some of you, maybe as much as a quarter or a third of you, are going to go down a rabbit hole one day. And you're going to be doing blockchain for the next 48 hours. And you won't know where the time went, because it is an addiction at some point that some of you will get, because there is this curious notion.
