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BlockChain Technology
Beyond Bitcoin
Abstract
A blockchain is essentially a distributed database of records or public ledger of all transactions or digital events that have been executed and shared among participating parties. Each transaction in the public ledger is verified by consensus of a majority of the participants in the system. And, once entered, information can never be erased. The blockchain contains a certain and verifiable record of every single transaction ever made. Bitcoin, the decentralized peer to peer digital currency, is the most popular example that uses blockchain technology. The digital currency bitcoin itself is highly controversial but the underlying blockchain technology has worked flawlessly and found wide range of applications in both financial and non financial world.
The main hypothesis is that the blockchain establishes a system of creating a distributed consensus in the digital online world. This allows participating entities to know for certain that a digital event happened by creating an irrefutable record in a public ledger. It opens the door for developing a democratic open and scalable digital economy from a centralized one. There are tremendous opportunities in this disruptive technology and revolution in this space has just begun.
This white paper describes blockchain technology and some compelling specific applications in both financial and non financial sector. We then look at the challenges ahead and business opportunities in this fundamental technology that is all set to revolutionize our digital world.
Sutardja Center for Entrepreneurship & Technology Technical Report
Date: October 16, 2015
Authors Michael Crosby, Google Nachiappan, Yahoo Pradhan Pattanayak, Yahoo Sanjeev Verma, Samsung Research America Vignesh Kalyanaraman, Fairchild Semiconductor
This paper was created in an open classroom environment as part of a program within the Sutardja Center for Entrepreneurship & Technology and led by Prof. Ikhlaq Sidhu at UC Berkeley. There should be no proprietary information contained in this paper. No information contained in this paper is intended to affect or influence public relations with any firm affiliated with any of the authors. The views represented are those of the authors alone and do not reflect those of the University of California Berkeley.
Sutardja Center for Entrepreneurship & Technology Technical Report
The advantages of Blockchain technology outweigh the regulatory issues and technical challenges. One key emerging use case of blockchain technology involves “ smart contracts ”. Smart contracts are basically computer programs that can automatically execute the terms of a contract. When a pre-configured condition in a smart contract among participating entities is met then the parties involved in a contractual agreement can be automatically made payments as per the contract in a transparent manner.
Smart Property is another related concept which is regarding controlling the ownership of a property or asset via blockchain using Smart Contracts. The property can be physical such as car, house, smartphone etc. or it can be non-physical such as shares of a company. It should be noted here that even Bitcoin is not really a currency--Bitcoin is all about controlling the ownership of money.
Blockchain technology is finding applications in wide range of areas—both financial and non-financial.
Financial institutions and banks no longer see blockchain technology as threat to traditional business models. The world’s biggest banks are in fact looking for opportunities in this area by doing research on innovative blockchain applications. In a recent interview Rain Lohmus of Estonia’s LHV bank told that they found Blockchain to be the most tested and secure for some banking and finance related applications.
Non-Financial applications opportunities are also endless. We can envision putting proof of existence of all legal documents, health records, and loyalty payments in the music industry, notary, private securities and marriage licenses in the blockchain. By storing the fingerprint of the digital asset instead of storing the digital asset itself, the anonymity or privacy objective can be achieved.
In this report, we focus on the disruption that every industry in today’s digital economy is facing today due to the emergence of blockchain technology. Blockchain technology has potential to become the new engine of growth in digital economy where we are increasingly using Internet to conduct digital commerce and share our personal data and life events.
There are tremendous opportunities in this space and the revolution in this space has just begun. In this report we focus on few key applications of Blockchain technology in the area of Notary, Insurance, private securities and few other interesting non-financial applications. We begin by first describing some history and the technology itself.
Section I: BlockChain Technology
1. Short History of Bitcoin
Sutardja Center for Entrepreneurship & Technology Technical Report
In year 2008, an individual or group writing under the name of Satoshi Nakamoto published a paper entitled “Bitcoin: A Peer-To-Peer Electronic Cash System”. This paper described a peer-to-peer version of the electronic cash that would allow online payments to be sent directly from one party to another without going through a financial institution. Bitcoin was the first realization of this concept. Now word cryptocurrencies is the label that is used to describe all networks and mediums of exchange that uses cryptography to secure transactions-as against those systems where the transactions are channeled through a centralized trusted entity.
The author of the first paper wanted to remain anonymous and hence no one knows Satoshi Nakamoto to this day. A few months later, an open source program implementing the new protocol was released that began with the Genesis block of 50 coins. Anyone can install this open source program and become part of the bitcoin peer-to-peer network. It has grown in popularity since then.
- 2008
- August 18 Domain name "bitcoin.org" registered
- October 31 Bitcoin design paper published
- November 09 Bitcoin project registered at SourceForge.net
- 2009
- January 3 Genesis block established at 18:15:05 GMT
- January 9 Bitcoin v0.1 released and announced on the cryptography mailing list
- January 12 First Bitcoin transaction, in block 170 from Satoshi to Hal Finney
The popularity of the Bitcoin has never ceased to increase since then. The underlying BlockChain technology is now finding new range of applications beyond finance.
2. Blockchain Technology: How does it work?
We explain the concept of the blockchain by explaining how Bitcoin works since it is intrinsically linked to the Bitcoin. However, the blockchain technology is applicable to any digital asset transaction exchanged online.
Sutardja Center for Entrepreneurship & Technology Technical Report
before it is recorded in the public ledger. Verifying node needs to ensure two things before recording any transaction:
- Spender owns the cryptocurrency—digital signature verification on the transaction.
- Spender has sufficient cryptocurrency in his/her account: checking every transaction against spender’s account (“public key”) in the ledger to make sure that he/she has sufficient balance in his/her account.
Figure 2. Financial Transactions using the Blockchain technology.^2
(^2) http://www.ft.com/intl/cms/s/2/eb1f8256-7b4b-11e5-a1fe-567b37f80b64.html#axzz3qe4rV5dH
Sutardja Center for Entrepreneurship & Technology Technical Report
However, there is question of maintaining the order of these transactions that are broadcast to every other node in the Bitcoin peer-to-peer network. The transactions do not come in order in which they are generated and hence there is need for a system to make sure that double-spending of the cryptocurrency does not occur. Considering that the transactions are passed node by node through the Bitcoin network, there is no guarantee that orders in which they are received at a node are the same order in which these transactions were generated.
Figure 3. Double spending due to propagation delays in peer-to-peer network.
This means that there is need to develop a mechanism so that the entire Bitcoin network can agree regarding the order of transactions, which is a daunting task in a distributed system.
Sutardja Center for Entrepreneurship & Technology Technical Report
Bitcoin solves this problem by introducing a mathematical puzzle: each block will be accepted in the blockchain provided it contains an answer to a very special mathematical problem. This is also known as “proof of work”—node generating a block needs to prove that it has put enough computing resources to solve a mathematical puzzle. For instance, a node can be required to find a “nonce” which when hashed with transactions and hash of previous block produces a hash with certain number of leading zeros. The average effort required is exponential in the number of zero bits required but verification process is very simple and can be done by executing a single hash.
Figure 5 Mathematical race to protect transactions-I.^3
This mathematical puzzle is not trivial to solve and the complexity of the problem can be adjusted so that on average it takes ten minutes for a node in the Bitcoin network to make a right guess and generate a block. There is very small probability that more than one block will be generated in the system at a given time. First node, to solve the problem, broadcasts the block to rest of the network. Occasionally, however, more than one block will be solved at the same time, leading to several possible branches. However, the math of solving is very complicated and hence the blockchain quickly stabilizes, meaning that every node is in
(^3) http://www.imponderablethings.com/2013/07/how-bitcoin-works-under-hood.html
Sutardja Center for Entrepreneurship & Technology Technical Report
agreement about the ordering of blocks a few back from the end of the chain. The nodes donating their computing resources to solve the puzzle and generate block are called “miner” nodes” and are financially awarded for their efforts.
Figure 6. Mathematical race to protect transactions-II^4
The network only accepts the longest blockchain as the valid one. Hence, it is next to impossible for an attacker to introduce a fraudulent transaction since it has not only to generate a block by solving a mathematical puzzle but it has to at the same time mathematically race against the good nodes to generate all subsequent blocks in order for it make other nodes accept its transaction & block as the valid one. This job becomes even more difficult since blocks in the blockchain are linked cryptographically together.
Section II: Existing Market
Blockchain technology is finding applications in both financial and non-financial areas that traditionally relied on a third trusted online entity to validate and safeguard online transactions of digital assets. There was another application “Smart Contracts” that was invented in year 1994 by Nick Szabo. It was a great idea to automatically execute contracts between participating parties. However, it did not find usage until the notion of crypto currencies or programmable
(^4) http://www.imponderablethings.com/2013/07/how-bitcoin-works-under-hood.html
Sutardja Center for Entrepreneurship & Technology Technical Report
Companies such as IBM, Samsung, Overstock, Amazon, UBS, Citi, Ebay, Verizon Wireless to name a few are all exploring alternative and novel uses of the blockchain for their own applications. Nine of the world’s biggest banks including Barclays and Goldman Sachs have recently ( Sept.^5 15, 2015) joined forces with the New York based financial technology firm R3 to create a framework for using the blockchain technology in the financial market. This is the first time banks have come to work together to find applications of blockchain technology. Leading banks like JPMorgan, State Street, UBS, Royal Bank Of Scotland, Credit Suisse, BBVA and Commonwealth Bank of Australia have joined this initiative.
Next, we give a short description of what kind of interesting applications and projects innovative and visionary companies are doing in this space.
Section III: Applications of Technology Compelling Use
Cases in both Financial and Non Financial Areas
1. Financial Applications:
1.1. Private Securities It is very expensive to take a company public. A syndicate of banks must work to underwrite the deal and attract investors. The stock exchanges list company shares for secondary market to function securely with trades settling and clearing in a timely manner. It is now theoretically possible for companies to directly issue the shares via the blockchain. These shares can then be purchased and sold in a secondary market that sits on top of the blockchain. Here are some examples:
NASDAQ Private Equity: NASDAQ launched its Private Equity Exchange in 2014. This is^6 meant to provide the key functionalities like Cap table and investor relationship management for the the pre-IPO or private companies. The current process of trading stocks in this exchange is inefficient and slow due to involvement of multiple 3rd parties. NASDAQ has joined hands with a San Francisco based Start-up called chain.com to^7 implement private equity exchange on top of BlockChain. Chain.com is implementing BlockChain based smart contracts to implement exchange functionality. This product is expected to be fast, traceable and efficient.
(^5) http://www.reuters.com/article/2015/09/15/us-banks-blockchain-idUSKCN0RF24M (^6) https://www.nasdaqprivatemarket.com/ (^7) http://chain.com/
Sutardja Center for Entrepreneurship & Technology Technical Report
Medici is being developed as a securities exchange that uses the Counterparty implementations of Bitcoin 2.0. The goal here is to create a cutting edge stock market. Counterparty is a protocol that implements traditional financial instruments as the self-executing smart contracts. These smart contracts facilitate, verify or enforce the negotiation of contract and eliminate the need for a physical document. This eliminates the need for an intermediary, such as broker, exchange or bank.
Blockstream is an open source project with focus on sidechains--interoperable blockchains--to avoid fragmentation, security and other issues related to alternative crypto-currencies. Uses can range from registering securities, such as stocks, bonds and derivatives, to securing bank balances and mortgages.
Coinsetter is a New York based bitcoin exchange. It is working on a Project Highline, a method of using the blockchain to settle and clear financial transactions in T+ 10 minutes rather than the customary T+3 or T+2 days.
Augur is a decentralized prediction market that will allow users to buy and sell shares in anticipation of an event with the probability that a specific outcomes will occur. This can also be used to make financial and economic forecasts based on the “wisdom of crowds”.
Bitshares are digital tokens that reside in the blockchain and reference specific assets such as currencies or commodities. The Token holders may have the unique feature of earning interest on commodities, such as gold, and oil, as well as dollars, euros and currency instruments.
1.2. Insurance Assets which can be uniquely identified by one or more identifiers which are difficult to destroy or replicate can be registered in blockchain. This can be used to verify ownership of an asset and also trace the transaction history. Any property (physical or digital such as real estate, automobiles, physical assets, laptops, other valuables) can potentially be registered in blockchain and the ownership, transaction history can be validated by anyone, especially insurers.
Everledger is a company which creates permanent ledger of diamond certification and the transaction history of the diamond using blockchain. The characteristics which uniquely identify the diamond such as height, width, weight, depth, color etc are hashed and registered in the ledger. The verification of diamonds can be done by insurance companies, law enforcement agencies, owners and claimants. Everledger provides a simple to use web service API for looking at a diamond, create/read/update claims (by insurance companies) and create/read/update police reports on diamonds.
Sutardja Center for Entrepreneurship & Technology Technical Report
This is where the blockchain can play a role by maintaining a comprehensive, accurate distributed database of music rights ownership information in a public ledger. In addition to rights ownership information, the royalty split for each work, as determined by “smart contracts” could be added to the database. The “smart contracts” would define relationships between different stakeholders (addresses) and automate their interactions (see Appendix for more details).
2.3. Decentralized proof of existence of documents
Validating the existence or the possession of signed documents is very important in any legal solution. The traditional document validation models rely on central authorities for storing and validating the documents, which present some obvious security challenges. These models become even more difficult as the documents become older.
The blockchain technology provides an alternative model to proof-of-existence and possession of legal documents. By leveraging the blockchain, a user can simply store the signature and timestamp associated with a legal document in the blockchain and validate it anytime using native blockchain mechanisms.
Proof of Existence is a simple service that allows one to anonymously and securely store online proof of existence of any document. This service simply stores the cryptographic digest of the file, linked to the time in which a user submits his/her document. It is to be noted here that cryptographic digest or fingerprint--not the actual document- is stored in blockchain, so user need not be worried about the privacy aspect.
This allows then a user to later certify the existence of a document that existed at a certain time.
The major advantages of this service is security and privacy that allows a user to give decentralized proof of the document that can’t be modified by a third party. The existence of the document is validated using blockchain that does not depend on a single centralized entity. Proof of Existence webservice is available at https://proofofexistence.com/.
2.4. Decentralized Storage
Cloud file storage solutions such as Dropbox, Google Drive or One Drive are growing in popularity to store documents, photos, video and music files. Despite their
Sutardja Center for Entrepreneurship & Technology Technical Report
popularity, cloud file storage solutions typically face challenges in areas such as security, privacy and data control. The major issue is that one has to trust a third party with one’s confidential files.
Storj provides a blockchain based peer-to-peer distributed cloud storage platform ( see Appendix for detailed description) that allows users to transfer and share data without relying on a third-party data provider. This allows people to share unused internet bandwidth and spare disk space in their personal computing devices to those looking to store large files in return for bitcoin based micropayments.
Absence of a central control eliminates most traditional data failures and outages, as well as significantly increasing security, privacy and data control. Storj platform depends upon a challenge algorithm to offer incentivization for users to properly participate in this network. In this way, Storj platform can periodically cryptographically check the integrity and availability of a file, and offer direct rewards to those maintaining the file.
Here, bitcoin based micropayments serve as both an incentive and payment while a separate blockchain is used as a datastore for file metadata.
2.5. Decentralized IoT
The IOT is increasingly becoming popular technology in both the consumer and the enterprise space. A vast majority of IOT platforms are based on a centralized model in which as broker or hub controls the interaction between devices, However, this approach has become impractical for many scenarios in which devices need to exchange data between themselves autonomously. This specific requirement has lead to efforts towards decentralized IoT platforms.
The blockchain technology facilitates the implementation of decentralized IoT platforms such as secured and trusted data exchange as well as record keeping. In such an architecture, the blockchain serves as the general ledger, keeping a trusted record of all the messages exchanged between smart devices in a decentralized IoT topology.
IBM in partnership with Samsung has developed a platform ADEPT (Autonomous Decentralized Peer To Peer Telemetry) that uses elements of the bitcoin’s underlying design to build a distributed network of devices-a decentralized Internet of Things (IOT). ADEPT uses three protocols-BitTorrent ( file sharing), Ethereum ( Smart Contracts) and TeleHash ( Peer-To-Peer Messaging)-in the platform.
Sutardja Center for Entrepreneurship & Technology Technical Report
The characteristics of the BlockChain can help address some of the limitations of the PKI by using Keyless Security Infrastructure (KSI). KSI uses cryptographic hash function, allowing verification to rely only on the security of hash functions and the availability of a blockchain.
Section IV: Risks for Adoption
BlockChain is a promising breakthrough technology. As we described before, there are vast array of applications or problems that can be solved using BlockChain based technology. That spans from Financial ( remittance to investment banking ) to non-financial applications like Notary services. Most of these are radical innovations. As it happens with adoption with radical innovations, there are significant risks of adoption.
Behavior change: Change is constant, but there is resistance to change. In the world of a non-tangible trusted third party, that BlockChain presents, customers need to get used to the fact that there electronic transactions are safe, secured and complete. The present day intermediaries like Visa or Mastercard ( in case of a credit cards ) will also go through change roles and responsibility. We envision that they will also invest and move their platforms to be BlockChain-based. They will continue to provide the customer relationship kind of services.
Scaling: Scaling of the current nascent services based on BlockChain presents a challenge. Imagine yourself executing a BlockChain transaction for the first time. You will have to go through downloading the entire set of existing BlockChains and validate before executing your first transaction. This may take hours or longer as the number of blocks increase exponentially.
Bootstrapping: Moving the existing contracts or business documents/frameworks to the new BlockChain based methodology presents a significant set of migration tasks that need to be executed. For example in case of Real Estate ownerships/liens, the existing documents lying in County or Escrow companies need to be migrated to the equivalent BlockChain form. This may involve time and cost.
Government Regulations: In the new world of BlockChain-based transactions, Government agencies like FTC, SEC, etc may slow down the adoption by introducing new laws to monitor and regulate the industry for compliance. In USA, this may in a way help adoption as these agencies carry customer trust. In more controlled economies like in China, the adoption will face significant headwind.
Sutardja Center for Entrepreneurship & Technology Technical Report
Fraudulent Activities: Given the pseudonymous nature of BlockChain transactions, coupled with ease of moving valuables, the bad guys may misuse this for fraudulent activities like money trafficking. That said, with enough regulations and technology support law enforcement agencies will be able to monitor and prosecute them.
Quantum Computing : The basis of BlockChain technology relies on the very fact that^8 it is mathematically impossible for a single party to game the system due to lack of needed compute power. But with the advent of Quantum Computers ( in future ), the cryptographic keys may be easy enough to crack through sheer brute force approach within a reasonable time. This will bring the whole system to its knee. The counter-argument would be for keys to become even stronger so that they may not be easy to crack.
Section V: Corporate Funding & Interest
In 2015, the bitcoin currency has reached yearly highs in both volume and price over the course of September-October. The digital currency is gaining traction both in the consumer marketplace, as a tradeable security, and with regulators. It isn't just digital-currency enthusiasts that are bullish. Equity research firm Wedbush expects it to rise to $600 because of the growing adoption.
(^8) http://www.makeuseof.com/tag/quantum-computers-end-cryptography/
