Understanding Blockchain

Understanding Blockchain
Technology ‘Teach-In’ & Introduction
Tony Willenberg, Co-founder/CTO, Neocapita
tony.willenberg@neoapita.com
PGP: 716E E331 2D94 51AC 6FFE 9B67 5772 7AB5 F78A 4920
Finance Watch, FinTech Workshop #1
Leopold Hotel, Rue du Luxembourg 35, 1050 Brussels, Belgium
09:00-10:30, 14th November 2017

Outcomes
I The Bitcoin Story • Understand what got us to this point.
II Distributed Ledger Technology
• Understand the implications this technology has for
our world.
III Key Concepts
• Understand the key concepts, sufficiently well, so as
to think through the impact on citizens, businesses,
and governments.
IV Issues to Explore • Understand the current issues in the debate.

A long time ago…
(in Internet time, that is)

Transactions
• Trusted third parties intermediate long-range transactions
(strangers).
• Trust is centralised: Visa, Sony, SWIFT, central bank, government.
• These actors provide us with valuable services.
• Intermediation involves clearance, settlement, verification, escrow,
privacy, integrity, authentication, non-repudiation.
• Intermediation is friction. Friction is inefficient. Friction can be
frustrating.
• Data and logic are independent.

August 2008
bitcoin.org is registered

November 2008
Bitcoin paper is published

January 2009
“The Times 03/Jan/2009 Chancellor on
brink of second bailout for banks.”
Satoshi Nakamoto → Hal Finney, 10 BTC
First bitcoin transaction takes place

January 2009
• Bitcoin software, free/open
source.
• a.k.a. Node, Bitcoin Software,
Node Software, Wallet Software,
Reference Client, Satoshi Client.
• Originally called: Bitcoin, then
Bitcoin-Qt, then Bitcoin Core.
• Need about 145 GB of disk
space.

Bitcoin
“Bitcoin is a collection of concepts and technologies
that form the basis of a digital money ecosystem.
Units of currency called bitcoin are used to store and
transmit value among participants in the bitcoin
network.”
Source: Antonopoulos, M. (2014)

Revolutionary
• Mathematical relationships to relate transactions to people/machines
• Arrange transaction data so transactions are tamper-proof
• Algorithm to replicate the ledger of transactions globally
• Method for arriving at a consensus on the global state of the ledger
• Become a user of bitcoin by downloading a wallet
• Proving you have done “work” shows your investment in the network
• Transaction fees mean it costs you to be mean to the network

Adoption
• Bitcoin (BTC); Litecoin (LTC); Ethereum (ETH); Zcash
(ZEC); Dash (DASH, formerly Darkcoin); Ripple (XRP);
Monero (MXR); more than a thousand digital currencies
now in existence
• Total market capitalisation: US$ 200B (or in the top 25 on
the S&P 500)
• Chicago Mercantile Exchange establishes a
cryptocurrency futures trading fund (US), the Bitcoin
Reference Rate (BRR) and the Bitcoin Real Time Index
(BRTI)
• Commodities Futures Trading Commission sets up
Derivatives Clearing Organisation with Swap Execution
Facility for fully collateralised digital currency swaps (USA)
Source: https://coinmarketcap.com, updated: November 8 2017 @ 6:02 pm

Adoption
• One can buy bitcoin in all post offices (source)
(Austria)
• FinCEN Fines levied $700,000 fine against
Ripple Labs Inc. for violation of requirements
under the Bank Secrecy Act (source) (USA)
• Regulatory limitations on use of
cryptocurrencies to prevent money flight
(China)
• Countries encourage cryptocurrencies for
legal commerce (Japan, South Korea, Russia)
Source: https://www.blockchain-austria.gv.at/; https://blockchainhub.net/blog/tag/blockchain/

Extended Bitcoin Network
Source: Figure 8-3, Antonopoulos, M. (2014)

II. Distributed Ledger Technology
(DLT)

DLT
Source: Based on Birch (2016) cited in “Distributed Ledger Technology: Beyond Blockchain”, Government Office for Science, Government of the United Kingdom.
How many copies?
Who can use the copies?
Who integrates the ledger?
[anyone]
[group of owners] e.g. a clearing and settlement
network
[one]
e.g. personal bank account
[many]
[any user, by untrusted consensus]
[trusted ledger owners or by validation] e.g. Ripple (XPR) (a global
financial transactions system),
consortium chains
Bitcoin (BTC), Ethereum (ETH), Litecoin
(LTC), Monero (XMR)

Functional Components
Distributed Ledger Technology
1. Shared Ledger 2. Smart Contracts 3. Tokens

Shared Ledger
• Transactions are linked together into blocks (Merkle Tree | Binary Hash
Tree).
• Blocks are chained together into the blockchain.
• Tampering with a transaction, invalidates the block and the blockchain from
the falsified transaction onwards.
• The blockchain is replicated (think of BitTorrent).
• Every record in the ledger is timestamped and cryptographically signed, thus
making the ledger an auditable history of all transactions in the network.
• Transactions can be anything, but there is a size limitation.
• It is not necessarily a database.

Smart Contract
• A.k.a. cryptocontract.
• Is a program that contains instructions for transfer of cryptocurrency.
Data inside the program & logic for how to change the data are now
indivisible, sealed in a cryptographic unit on the blockchain.
• Live on the blockchain at a unique global address, are open for
reading, but cannot be tampered with.
• Transactions represent either: (a) transfer of token to a person, or (b)
transfer of token to a cryptocontract to execute.

Tokens
• Bitcoin is a token.
• You get tokens by mining them, receiving them in transaction fees, created
in a smart contract, or someone sends (pays) them to your address (A)
• Virtually implemented by virtue of the UTXO and wallet software.
• Private keys enable spending, public keys enable receiving.
• The ERC20 token standard can represent anything that can be digitised.

The Double-Spend Problem
• Is the Byzantine General’s Problem (1982): solutions attempted before,
largely centralised solutions.
• Solved with novel tools (at least 4):
• (a) proof-of-work (game theory),
• (b) cryptography (mathematics),
• (c) peer-to-peer database replication (computer science),
• (d) transaction fees (economics).
Source: http://marknelson.us/2007/07/23/byzantine/

Proof-of-Work
• A way of signalling an investment in and concern about the best interests
of the ecosystem.
• Do a computation and if you find the solution first, the network mints
Bitcoin and gives it to you as a reward.
• “A proof-of-work (POW) system (or protocol, or function) is an economic
measure to deter denial of service attacks and other service abuses such
as spam on a network by requiring some work from the service
requester, usually meaning processing time by a computer.”
Source: https://en.wikipedia.org/wiki/Proof-of-work_system

Proof-of-Stake
• In Proof-of-Stake-based cryptocurrencies the creator of the next block is
chosen via various combinations of random selection, wealth, and age (i.e.
their stake in the ecosystem).
• Those guarding the coins, own the coins.
• NXT, Blackcoin, Peercoin, Ethereum

Private-Public Key
• Symmetric Cryptography = both parties must know
a shared secret first;
• Asymmetric Cryptography = parties keep a
personal secret (private key) linked mathematically
to something that can be shared (public key).
• Private keys are just big numbers: 1 up to ≈2256-1.
The size of bitcoin’s private key space, (2256) is an
unfathomably large number. It is approximately
1077 in decimal. For comparison, the visible
universe is estimated to contain 1080 atoms.
Your Private Key

Private-Public Key
Private
Public
ECDSA

Elliptic Curve Multiplication
• Using a special set of curves,
move from initial point k to a final
location on the curve K => trapdoor
function.
Source: https://en.bitcoin.it/wiki/Secp256k1; Standard for Efficient Cryptography 2 (SEC 2), Certicom Corp. (2010).
• Can be performed on mobile and
IoT devices. We have used it in
WAP security. NIST/Certicom Corp.

Hash Functions
• “fingerprints” = hash codes = hashes = digests = hash values = message
authentication codes => integrity
• Cryptographic functions (1-way) are a subclass of hash functions (2-way).
• Examples:
• SHA: Secure Hashing Algorithm
• RIPEMD-160: Research and Development in Advanced Communications
Technologies in Europe (RACE) Integrity Primitives Evaluation
• The ideal hash function has three main properties:
1. easy to calculate a hash for any given data.
2. computationally difficult to reverse.
3. unlikely that two slightly different messages will have the same hash.

Hash Functions
Example (SHA-256)
Input Output
the quick brown fox jumps
over the lazy dog
1153a4080f1fcb04425aa0b8
41c2b14606fe6df25d9076d2a
1face2d5af57129
the quick brown fox
jumped over the lazy dog
57385e0f6d48919ae32d0b15
5c86210a74a0a477b8260ad2
1eae65b13f146df6

Addresses
• A has built-in checks to make transcription easier.
• A comes from the k (via K).
• (Bitcoin address) A => Allows receiving bitcoin.
• (Private key) k => Allows spending bitcoin.

Signing & Validating
Signing: Private Key + Transaction = Signature
Validating: Public Key + Transaction = Valid Signature

Wallets
• Wallets contain private keys, not coins.
• Wallets can be web, hardware, software, or paper.
• Early wallets were “random” wallets. Bitcoin Core uses a random wallet.
• The latest and safest wallets are “hierarchically deterministic”: effectively a
keychain, e.g. Ledger, Trezor, (see BIP-32, 39, 43, 44).
• Wallets need to be backed up to “cold storage”.
• Generate the private keys (k), the corresponding public key (K), and then
the easy-to-remember bitcoin addresses (A).

Wallets
Wallets know which transactions on the blockchain have been
sent to bitcoin addresses the wallet controls - wallets read the
blockchain, tally up unspent transactions and, in this way,
know how much bitcoin is held in the wallet.

Wallets
Source: Based on Figure 2-4, Antonopoulos, M. (2014)
tn-2
tn-1
tn
Alice’s Wallet Balance: 0.1000 BTC

Mining
• Proving that you’re honest by doing work that benefits the
ecosystem.
• Earn coinbase & transaction fees.
• Application specific integrated circuits (ASIC) dedicated to
mining.
• Mining pools group resources, shared rewards and fees.

Consensus
5 Steps...
1. Propagation of transactions.
2. Verification of transactions (long list of criteria).
3. Aggregation into new blocks based on a proof-of-work.
4. Verification of new blocks and assembly into chain.
5. Selection of the most computationally intensive chain.

Forks
• Occur regularly, any time two miners find a block at nearly the same time.
• Occur intentionally when node software is modified with new rules (e.g. 1st
August 2017 => BTC and BCH (BIP 91)).

Smart Contracts
• Can be simple logic, such as “pay at time” (say, BTC) or complex logic
such as a Decentralised Autonomous Organisation (DAO) (say, ETH).
• The vision of Ethereum (ETH) is “an unstoppable censorship-resistant self-
sustaining decentralised world-scale computing platform”.
• Computer programs live on the blockchain, they compute whenever they
are given ‘gas’ (via a transaction), and change the state of entities that live
on the blockchain.
• Smart contracts are also known as “dApps” or Distributed Applications.

Classification
• Store of value?
• Finite supply (21 million by 2140). Algorithmically determined.
• Investment? Token?
• Unbacked, but so are most floating fiat currencies.
• No monetary policy “levers” - no fractional reserve banking.
• Volatile now, but steadily decreasing.

Identity
• ‘Permissioned’ networks critical for delivery of government services. Who
is permitted to get what and how much?
• Therefore, citizen identity will be fundamental to adoption.
• Maintenance of privacy precarious in centralised model - distributed gives
back citizen control over information (which we try to mirror in our systems
today, anyway).

Complexity
• Perhaps obviously, it was not until an application my Grandmother could
use to make voice-over-IP calls, could one say: voice-over-IP technology
has gone mainstream.
• Wallets need to be easy to use: HD-wallets (BIP-32, 39, 43, 44).
• All or nothing - lose the keys, lose the cryptocurrency, forever.

Legal Coding
• New jobs will emerge, like legal coding.
• Judicial branches of government will need systems, training, resources.
• Contracts will span one or more jurisdictions regularly.
• Digital audit trails will often be presented as evidence.
• Constitutions, laws, regulations will need re-thinking.
• Lawyers will need to understand the technology.
• Countries will need to adopt or be unable to participate.

Capital Raising
• Only a few dozen working finished products & platforms.
• Concepts are attracting millions in seed funding.
• Initial Coin Offerings (ICO) not regulated in the same way that IPOs are.

Data Custodianship
• Data lives “everywhere”, no departments, no divisions, global jurisdiction.
• Private-public Keys and Smart Contracts provide the “garden wall”.
• If we accept cryptocurrency, then physical boundaries are moot.

Energy
• Mining puts computers to work on a problem, but the problem is
meaningless outside the cryptocurrency network => wasted energy.
• “Environmental disaster”
• = Slovakia, Ireland
• Homes: 2,479,349 (Bitcoin) v 50,000 (Visa)
• SETI @ Home (UCB), Einstein@Home (Max Planck Institute),
Folding@Home (Stanford) => uses what would otherwise be, wasted
energy.
Source: https://digiconomist.net/bitcoin-energy-consumption
26.78 TWh projected for 2017

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