Slides I used for FinTech - Financial Innovation and the Internet 2023 Fall at Graduate School of Business and Finance, Waseda University on December 8, 2023.
XL Beta FinTech — Financial Innovation and the Internet 2023 Fall Lecture 9 : Blockchain Continued Kenji Saito, Graduate School of Business and Finance, Waseda University Lecture 9 : Blockchain Continued — FinTech — Financial Innovation and the Internet 2023 Fall — 2023-12-08 – p.1/34
used for research on (online) learning Transcribed for use and anonymized Will let you know when the necessity arises Lecture 9 : Blockchain Continued — FinTech — Financial Innovation and the Internet 2023 Fall — 2023-12-08 – p.2/34
automatic transcription for lectures will be posted at Discord Lecture 9 : Blockchain Continued — FinTech — Financial Innovation and the Internet 2023 Fall — 2023-12-08 – p.3/34
Lecture 2 10/13 Overview of FinTech (2) • Lecture 3 10/20 Internet Technology and Governance (1) • Lecture 4 10/27 Internet Technology and Governance (2) on-demand • Lecture 5 11/10 The World of Apps (1) • Lecture 6 11/17 The World of Apps (2) • Lecture 7 11/24 Basics of Cryptography and Blockchain • Lecture 8 12/1 Blockchain • Lecture 9 12/8 Blockchain Continued • Lecture 10 12/15 Smart Contracts (1) Lecture 11 12/22 Smart Contracts (2) Lecture 12 1/12 Cyber-Physical Society and Future of Finance Lecture 13 1/19 FinTech Ideathon Lecture 14 1/26 Presentations and Conclusions Online presence is possible but not recommended for non-online lectures for interactivity reasons Lecture 9 : Blockchain Continued — FinTech — Financial Innovation and the Internet 2023 Fall — 2023-12-08 – p.4/34
Last Will Understanding Blockchain Beaker/Newspaper Model (physical model of Bitcoin) Validity/Existence/Uniqueness layers Lecture 9 : Blockchain Continued — FinTech — Financial Innovation and the Internet 2023 Fall — 2023-12-08 – p.5/34
Impossibility and Challenges of Blockchain Brief Introduction to Upgrading and Governance of Blockchain Assignment — Science Fiction Prototyping Lecture 9 : Blockchain Continued — FinTech — Financial Innovation and the Internet 2023 Fall — 2023-12-08 – p.6/34
of liquid of no value to mankind Contained in a tank Individuals can hold as many beakers as they like, measuring down to 1 100 , 000 , 000 cm3 (it has a locked lid) Only “editor” selected every 10 minutes on average can pump now 6.25cm3 into their beaker Chosen by a special lottery The winning lottery is held in everyone’s box, and each person draws the lottery with all their strength → non-stoppable procedure Coordinate the proportion of winning lots so that someone is chosen every 10 minutes on average Volume pumped is reduced by half every about 4 years (every 210 thousand pages of “newspaper” described later) Started from 50cm3 in January 2009 Lecture 9 : Blockchain Continued — FinTech — Financial Innovation and the Internet 2023 Fall — 2023-12-08 – p.7/34
of fluid between beakers Recorded as “a signed article” by the pourer Post the article in the “newspaper” made by everyone Selected “Editor” verifies the articles and publishes them in the last page of newspaper (of which everyone has a local copy) Page carries the evidence of winning the lottery Editor also gets “overflow” of trades on the page If people publish a page with the same page number. . . Longer sequence of pages wins People sometimes lose the key of their beakers Create this digitally, and pretend that it’s a currency → Bitcoin There is no money or currency that does not need pretension Lecture 9 : Blockchain Continued — FinTech — Financial Innovation and the Internet 2023 Fall — 2023-12-08 – p.8/34
a digital signature of the party to which the referenced output is addressed Referenced output (= coin) is consumed → never double-spent (UTXO : Unspent transaction (TX) Output) Lecture 9 : Blockchain Continued — FinTech — Financial Innovation and the Internet 2023 Fall — 2023-12-08 – p.9/34
number : n page number : n+1 page number : n+2 Cryptographic digest of the previous page (must be less than or equal to the target value) some extra number (Nonce : Number used Once) (random value to make the digest less than or equal to the target) Page digest (output by a cryptographic hash function) must be less than or equal to target We don’t know how to manipulate the original data to get the right digest This is the principle of the lottery, which requires the same amount of cost to fake the history Lecture 9 : Blockchain Continued — FinTech — Financial Innovation and the Internet 2023 Fall — 2023-12-08 – p.10/34
page number : n+1 page number : n+2 page number : n+3 page number : n+1 page number : n+2 page number : n+3 page number : n+4 This history is valid Sometimes page sequences are split when someone else wins the lottery at about the same time A history is the hardest to tamper with when the cumulative cost of lottery for the whole sequence is the highest Everyone agrees that such history is the official one (strict consensus is not achieved because it can be overturned) Lecture 9 : Blockchain Continued — FinTech — Financial Innovation and the Internet 2023 Fall — 2023-12-08 – p.11/34
n+1 block_no : n+2 block_no : n+3 block_no : n+1 block_no : n+2 block_no : n+3 block_no : n+4 Histroy with the largest cost to record or modify (history the most difficult to alter) is chosen Cryptographic digest of the previous block Transactions are digitally signed To create a block, its cryptographic digest needs to be below some certain number (Proof of Work) or one needs to win by voting weighted by the stakes in cryptocurrency (Proof of Stake) [both costly] Creator of a block can record the reward in cryptocurrency in the block, which is effective only when the block is included in the chosen history Means are provided to confirm existence of transactions validity existence uniqueness In case of Proof of Work, the cost of power is balanced against the market value of the native currency Everyone confirms that records are not tampered with by the mechanism protected by the price of the native currency Lecture 9 : Blockchain Continued — FinTech — Financial Innovation and the Internet 2023 Fall — 2023-12-08 – p.12/34
data unrelated to Bitcoin in the free space of transaction (TX) data Text string embedded in the 1st TX of the 1st block “The Times 03/Jan/2009 Chancellor on brink of second bailout for banks” Anyone can verify this Specify 0 in the search field of https://www.blockchain.com/explorer , proceed to BTC Block See the input for the only TX in the block that came up Use “Hex to ASCII Text Converter” for example What is the intention? Lecture 9 : Blockchain Continued — FinTech — Financial Innovation and the Internet 2023 Fall — 2023-12-08 – p.13/34
access (no need for mediation), agreed real-time settlements, business rule descriptions, and confidentiality Corporate behavior (automating corporate management, especially in financial matters) Real-time execution and confidentiality control of share splits, capital reductions and consolidations, share transfers and exchanges, mergers, third-party allocation of new shares, etc. Supply Chain Traceback of materials, and record and search from production, storage to sales (beware of linkage problem) Master Data Management Only authorized personnel can update and designated reviewers approve it Sharing Economy and IoT Smart cities/towns, transportation, healthcare/fitness, retail, architecture, education, etc. (implicitly real-time and on a large scale) where trust is not necessarily established Red letters denote parts that blockchains are not good at Within the problems we want to solve, there are sub-problems that have not been solved yet Lecture 9 : Blockchain Continued — FinTech — Financial Innovation and the Internet 2023 Fall — 2023-12-08 – p.15/34
. . Remittances that bypass banking networks That’s a huge impact Proof of Existence Ex. Proof of Existence, Everledger (in the past), . . . Embed arbitrary digests in a blockchain (piggybacking hack) There is also a method of embedding a single digest of a large number of records Proof that a record has existed and has not been tampered with Origin Certification (traceability, tracking and accounting) This is the originally intended application category of blockchain (an alternative to “newspaper”) Lecture 9 : Blockchain Continued — FinTech — Financial Innovation and the Internet 2023 Fall — 2023-12-08 – p.16/34
EJHFTU EJHFTU EJHFTU EJHFTU EJHFTU EVQMJDBUFJO DBTFPGPEE OVNCFS 6QPOSFDFJWJOHEPD "MJDFBMTPSFDFJWFTEJHFTUTTIPXOJOCMVFBOEXIFUIFSUIFZBSFPOUIFMFGUPSSJHIU 4UBSUJOHXJUIUIFEJHFTUPGEPD "MJDFXJMMLOPXUIFTFSJFTPGEJHFTUTUPCFDPODBUFOBUFE TPTIFDBOSFQSPEVDFUIFDBMDVMBUJPOTVQUP UIF.BSLMFSPPUBOEDPOpSNUIBUUIFSFTVMUJOH.BSLMFSPPUNBUDIFTUIFWBMVFSFDPSEFEJOUIFCMPDLDIBJO "OZPOFDBOSFQSPEVDFUIFQSPDFTTBOEWFSJGZUIFFYJTUFODFPGEPDTJGUIFZVOEFSTUBOEUIFQSJODJQMFBOEIBWFOFDFTTBSZJOGPSNBUJPO SFDPSE DBOSFUSJFWFJOGPSNBUJPO *OGPSNBUJPOEJTDMPTFE UPQBSUJFTSFRVJSJOH QSPPGT QVCMJDJOGPSNBUJPO .FSLMFSPPU .FSLMFUSFF LFQUCZUIFTFSWJDF BOETFOUQBSUJBMMZUPFBDIDMJFOU ʜʜ ʜʜ ʜʜ ʜʜ ʜʜ EJHFTU EJHFTU EJHFTU EJHFTU EJHFTU EJHFTU CMPDLDIBJO ʜ ʜ EPD EPD EPD EPD O Merkle trees are also used within blocks in blockchain to record transactions or states Lecture 9 : Blockchain Continued — FinTech — Financial Innovation and the Internet 2023 Fall — 2023-12-08 – p.17/34
of trial and error In fact, a lot of new designs are being tested If we do not have governance for (or if we do not know how to accommodate) technological changes, we cannot use it in society Lecture 9 : Blockchain Continued — FinTech — Financial Innovation and the Internet 2023 Fall — 2023-12-08 – p.18/34
participants gain half of the hash rate, blockchain cannot be guaranteed to work correctly Risky in principle if the hashrate is doubled quickly → It has happened On the other hand, what if it doesn’t double rapidly? → Dilemma of providing room for malicious participants What if it suddenly halves? → Very risky in principle, and it also happened Lecture 9 : Blockchain Continued — FinTech — Financial Innovation and the Internet 2023 Fall — 2023-12-08 – p.19/34
decentralized investment fund built on Ethereum Split (fund split) was recursively called, and 360,000 ETH (5 to 6 billion yen) was stolen (2016/6/17) Choices Do nothing Soft fork (maintains compatibility → freezes the address of the thief) Funds are not returned Hard fork (No compatibility → rewrites history; who controls the present controls the past) Worst occurrence of “Oneness Trap” (described later) in a sense Community chose “hard fork” ! (executed on 2016/7/20) “Most interesting. Gravity’s silhouette remains, but the star and all its planets have disappeared. How can this be?” “Because someone erased it from the archive memory.” — from Star Wars: Episode II – Attack of the Clones So the incident never happened Lecture 9 : Blockchain Continued — FinTech — Financial Innovation and the Internet 2023 Fall — 2023-12-08 – p.20/34
10 people in line Sorry if you are in an advanced environment, and you don’t know what we are talking about (or even wonder what an ATM is) ;) What happens to the number of people in the queue if we add one ATM? Other conditions remain the same cf. Daisuke Yamazaki, “Rethinking Scaling Out” (in Japanese) http://www.slideshare.net/yamaz2/ss-58813038 Performance problems can be solved by adding a server ⇒ The system scales out Blockchain does not scale out in its bare form (because everyone makes and maintains a replica) Improvement is possible if you see it as a KVS (Key-Value Store) Because of the distributed KVS technology But you might lose autonomy Lecture 9 : Blockchain Continued — FinTech — Financial Innovation and the Internet 2023 Fall — 2023-12-08 – p.21/34
the cost of maintaining data structures rises linearly as transactions increase It does not scale out Lecture 9 : Blockchain Continued — FinTech — Financial Innovation and the Internet 2023 Fall — 2023-12-08 – p.22/34
nodes does not solve or mitigate performance challenges Must be “the world is one” to work System does not work correctly if the network is partitioned by a large-scale disasters or political change Difficulty of governance to advance technology You cannot “try something different partially, and if it works, apply it to the whole” Impossibility of governance : Agreement by the “whole” must be maintained, but the “whole” cannot be defined ⇒ Powered few changes the technology instead ⇒ Those are disadvantages of non-decentralized nature of blockchain Conversely, there are great expectations and potential for truly decentralized “record fixation device in the air” Lecture 9 : Blockchain Continued — FinTech — Financial Innovation and the Internet 2023 Fall — 2023-12-08 – p.23/34
ETH as a currency crashes and declines Supported by validators’ motivation to get ETH When the value of ETH drops, validators withdraw Can people who want to run apps (smart contracts) buy ETH to maintain the price? If ETH’s market participants are primarily app users, may be . . . (but they aren’t) The design of the raw Bitcoin is goal-consistent, but . . . In other words, “Bitcoin cannot survive if BTC declines” would be fine But as proof applications such as Proof of Existence advance, similar problems arise Either way, the future of the system depends on the interests of the miners/validators ⇒ Need to separate application platforms from currency systems That is where the recent ledger technology is going, hopefully (because many still aren’t) Lecture 9 : Blockchain Continued — FinTech — Financial Innovation and the Internet 2023 Fall — 2023-12-08 – p.24/34
the thing you can never do without blockchain? Ex1 : Digitizing the last will and testament (in a thought-experiment sense) After the death of the person, the private key used for the digital signature may no longer be a secret Can’t believe a notary saying, “it is as signed before the death” (possible collusion with malicious heir) Ex2 : Online banking passbook data as proof (for the liabilities of banks) If you download it as a CSV file, the data anyone can create is not considered as evidence Even with the digital signature of the bank, once the private key is leaked, the data can be created by anyone Prove “data digitally signed at cetain past date has not been tampered with” (instead of believing those who insist so) “The Last Will Test” is to ask them if they can do that with their blockchain A test to see if something that someone has been pitching as “it’s a blockchain” really makes sense An idea (hash-chain with proof of work) that may satisfy this true worth, combined with existing technologies around the idea is the Bitcoin blockchain Lecture 9 : Blockchain Continued — FinTech — Financial Innovation and the Internet 2023 Fall — 2023-12-08 – p.25/34
that can pass the “last will test”? Public blockchain may pass the test while the market value of the native currency is high Defense such that it would cost a lot to tamper with When the price of the native currency drops or crashes it becomes unreliable Private ledger systems in general only insist, so they do not pass the test Mostly, “blockchain made and operated by XXX Inc.” is meaningless ← please be careful We are building new technology to make it pass the test BBc-1/BBc-2 (Beyond Blockchain One/Two; https://github.com/beyond-blockchain) (just an example) There is an inherent challenge of linkage between records and entities Includes areas that cannot be solved by engineering alone (does the public key really belong to the person?) Including the openness of the source code, it is roughly the problem of . . . “How can we trust automated mechanisms?” Lecture 9 : Blockchain Continued — FinTech — Financial Innovation and the Internet 2023 Fall — 2023-12-08 – p.26/34
not left untouched, but continue to be improved But governance issues remain Lecture 9 : Blockchain Continued — FinTech — Financial Innovation and the Internet 2023 Fall — 2023-12-08 – p.27/34
fork) Interpret transaction data in a specific way so that quantities independent from BTC can be defined and used Bug fix – Segregated Witness (SegWit) (soft fork) Signatures are separated from the transaction body Better privacy and conciseness – Taproot (and Schnorr signatures) (soft fork) Scripts can be partially disclosed by expressing them in Merklized Abstract Syntax Trees (kind of Merkle trees) Quickness – Payment channels (no fork) Only write to the blockchain when the channel is opened and closed, and in between you can make fast payments Conceptually, connected payment channels form a Lightning Network How do we upgrade? Soft fork : miners vote by setting a bit in a block header Wait, voting? Is it an Internet way? Lecture 9 : Blockchain Continued — FinTech — Financial Innovation and the Internet 2023 Fall — 2023-12-08 – p.28/34
UP"# UP# UP" UP" MPDLUJNF QBZUSBOTBDUJPOGFFUPNJOFS PQFODIBOOFM pOBMQBZNFOUDMPTFDIBOOFM QBZ QBZ QBZUSBOTBDUJPOGFFUPNJOFS UP# UP" UP# UP" MPDLUJNF Alice pays fast by sending Bob transactions to pay, which are cut out of the deposit addressed to Alice and Bob Lecture 9 : Blockchain Continued — FinTech — Financial Innovation and the Internet 2023 Fall — 2023-12-08 – p.29/34
on or disguised as the thoughts and ideas of science and technology The world with existing science and technology is the real world Ex1 : Medical drama Ex2 : Economic novels The world with science and technology unknown to the real world → Fiction Ex1 : Medical drama with nano-machines Ex2 : Drama with digital currency that depreciates (my book “NEO in Wonderland”) Designing new media and putting it into society = living science fiction To work out plans for that = to write science fiction Lecture 9 : Blockchain Continued — FinTech — Financial Innovation and the Internet 2023 Fall — 2023-12-08 – p.31/34
of the word “smart contract” to fantasize a specific application example, and state the application briefly That is, go ahead and write a very short science fiction Deadline and how to submit December 12, 2023 at 17:59 JST From Moodle (mandatory) (Q&A forum) So that your classmates can read your report, refer to it, and comment on it Optionally, you can also post to #assignments channel at Discord So that anyone in our Discord can read your report, refer to it, and comment on it Just plain text, and be concise, please You may want to apply Kent Beck style for abstracts (4 sentences) (problem) (why it is a problem) (startling sentence) (consequences) of a story Lecture 9 : Blockchain Continued — FinTech — Financial Innovation and the Internet 2023 Fall — 2023-12-08 – p.33/34
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