Cryptocurrency - Can Micro Incentives Yield Macro Trust ?

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@ computational professor daniel martin katz danielmartinkatz.com BLOCKCHAIN, CRYPTOCURRENCY AND LAW professor nelson rosario CRYPTOCURRENCY - CAN MICRO INCENTIVES YIELD MACRO TRUST ? nelsonmrosario.com @ nelsonmrosario BLOCKCHAINLAWCLASS.COM

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DANIEL MARTIN KATZ E D U | I L L I N O I S T E C H + S TA N F O R D C O D E X B LO G | C O M P U TAT I O N A L L E GA L S T U D I E S . C O M PAG E | DA N I E L M A R T I N K AT Z . C O M C O R P | L E X P R E D I C T. C O M NELSON ROSARIO B LO G | L AWO F C RY P TO C U R R E N C Y. C O M PAG E | N E L S O N M RO S A R I O . C O M F I R M | S M O L I N S K I RO S A R I O L AW P. C . BLOCKCHAINLAWCLASS.COM L A B | T H E L AW L A B . C O M E D U | I L L I N O I S T E C H - C H I C AG O K E N T L AW

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CRYPTOCURRENCY BITCOIN AND BEYOND BLOCKCHAINLAWCLASS.COM

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BLOCKCHAINLAWCLASS.COM https://www.youtube.com/watch?v=sayeUq_LBEs WHAT IS BITCOIN? WATCH THIS VIDEO (NOTE THIS HAS BEEN EDITED)

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BLOCKCHAINLAWCLASS.COM ANOTHER ONE JUST FOR FUN … HTTPS://WWW.YOUTUBE.COM/WATCH?V=G6IDZSPBRMG WATCH THIS VIDEO

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BLOCKCHAINLAWCLASS.COM IN EARLIER MODULES, WE CONSIDERED SEVERAL BUILDING BLOCKS OF CRYPTO INFRASTRUCTURE

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BLOCKCHAINLAWCLASS.COM DECENTRALIZED NETWORKS DISTRIBUTED LEDGERS CRYPTOGRAPHY CROWDS + P2P CONSENSUS ECONOMICS INCENTIVES CRYPTO BUILDING BLOCKS

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BLOCKCHAINLAWCLASS.COM THE *KEY* IDEA HERE IS THAT WE USE INFRASTRUCTURE + MICRO LEVEL ECONOMIC INCENTIVES

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BLOCKCHAINLAWCLASS.COM IN ORDER TO BUILD MACRO LEVEL TRUST …

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BLOCKCHAINLAWCLASS.COM CRYPTOCURRENCY REQUIRES A REAL LEAP OF FAITH BUT SO DO LOTS OF OTHER THINGS…

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BLOCKCHAINLAWCLASS.COM WE ALSO TALKED ABOUT MONEY

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BLOCKCHAINLAWCLASS.COM VIRTUALLY EVERY CURRENCY IS A ‘FIAT’ CURRENCY

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BLOCKCHAINLAWCLASS.COM TODAY MANY TRANSACTIONS ARE CARRIED OUT USING PROCESSES WHICH ARE FAR REMOVED FROM EVEN THE CURRENCY ITSELF

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BLOCKCHAINLAWCLASS.COM ONLINE BANKING ONCE SEEMS IMPOSSIBLE …

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BLOCKCHAINLAWCLASS.COM AND THEN BECAME MAINSTREAM ….

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BLOCKCHAINLAWCLASS.COM WHICH ALL SETS THE STAGE FOR CRYPTOCURRENCY

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“...LIMITED ENTRIES IN A DATABASE NO ONE CAN CHANGE WITHOUT FULFILLING SPECIFIC CONDITIONS.” CRYPTOCURRENCY (WORKING DEFINITION) BLOCKCHAINLAWCLASS.COM

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CRYPTOCURRENCY IS THE FIRST VERIFIABLE UNIQUE DIGITAL PROPERTY (HERE ENTRIES IN A DISTRIBUTED LEDGER STORED ON A DECENTRALIZED NETWORK) BLOCKCHAINLAWCLASS.COM

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CRYPTOCURRENCY COMES IN MANY DIFFERENT VARIETIES Here are the Top 15 Coins by Market Cap coinmarketcap.com BLOCKCHAINLAWCLASS.COM

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BLOCKCHAINLAWCLASS.COM ONE KEY DIFFERENCE BETWEEN THE TWO MOST WELL KNOWN CRYPTOCURRENCIES UNSPENT TRANSACTION OUTPUT MODEL ACCOUNT MODEL BTC ETH

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BLOCKCHAINLAWCLASS.COM UNSPENT TRANSACTION OUTPUT MODEL ACCOUNT MODEL USES A BLOCKCHAIN EVERY TRANSACTION CONSISTS OF UNSPENT TRANSACTION OUTPUTS SMART CONTRACTS ARE LIMITED MOSTLY TO LOCKING UNLOCKING FUNDS USES A BLOCKCHAIN TWO TYPES OF ACCOUNTS EXTERNALLY FACING HOLDS CRYPTO CONTRACT ACCOUNTS SMART CONTRACTS SMART CONTRACTS ARE EXECUTED BY ALL NODES ON THE NETWORK

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BLOCKCHAINLAWCLASS.COM SOME THINGS TO KNOW ABOUT BITCOIN WHY ARE TRANSACTIONS SECURE ONCE ADDED? HOW ARE TRANSACTIONS CONSTRUCTED? HOW ARE TRANSACTIONS COMMUNICATED? HOW ARE TRANSACTIONS VALIDATED? HOW ARE TRANSACTIONS ADDED?

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LETS SEE HOW NELSON MIGHT TRANSFER FOUR BITCOINS TO DAN … BLOCKCHAINLAWCLASS.COM DAN NELSON TRANSACTION MESSAGE FROM: NELSON (3Nxwen… TO: DAN (18rnfoQgGo… AMOUNT: 4 BTC

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BLOCKCHAINLAWCLASS.COM TRANSACTIONS ARE SENT TO THE HASH OF A PUBLIC KEY, OR TRANSACTIONS ARE SEND TO PUBLIC KEY OF THE RECIPIENT (DIFFERENCE BETWEEN THE TWO IS FOR SIZE PURPOSES)

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BLOCKCHAINLAWCLASS.COM WHAT IS A TRANSACTION IN BITCOIN? “WE DEFINE AN ELECTRONIC COIN AS A CHAIN OF DIGITAL SIGNATURES. EACH OWNER TRANSFERS THE COIN TO THE NEXT BY DIGITALLY SIGNING A HASH OF THE PREVIOUS TRANSACTION AND THE PUBLIC KEY OF THE NEXT OWNER AND ADDING THESE TO THE END OF THE COIN. A PAYEE CAN VERIFY THE SIGNATURES TO VERIFY THE CHAIN OF OWNERSHIP.” SATOSHI NAKAMOTO BITCOIN.ORG/BITCOIN.PDF

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https://spectrum.ieee.org/image/MjA3NDM1OA.jpeg

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BLOCKCHAINLAWCLASS.COM BITCOIN TRANSACTION ARCHITECTURE

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BLOCKCHAINLAWCLASS.COM

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SOME IMPORTANT POINTS …

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BLOCKCHAINLAWCLASS.COM TRANSACTIONS ARE BROADCAST TO ANY NODE ON THE BITCOIN NETWORK A NODE ON THE BITCOIN NETWORK RECEIVES THE TRANSACTION THE NODE VALIDATES THE TRANSACTION AND PROPAGATES IT TO THE NODES IT IS CONNECTED EVERY NODE INDEPENDENTLY VALIDATES ALL TRANSACTIONS THEY RECEIVE

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BLOCKCHAINLAWCLASS.COM TRANSACTIONS ARE VALIDATED BY NODES TRANSACTIONS ARE PACKAGED INTO BLOCKS AND ADDED TO THE BLOCKCHAIN

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BLOCKCHAINLAWCLASS.COM AS TRANSACTIONS GET DEEPER AND DEEPER IN THE BLOCKCHAIN THEY ARE MORE DIFFICULT TO CHANGE

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BUT WHAT IS IT THAT MAKES ALL OF IT WORK ? MINERS BLOCKCHAINLAWCLASS.COM

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BITCOIN MINING PROOF OF WORK MAKES THE SYSTEM GO ROUND MINERS SOLVE A MATHEMATICAL PUZZLE MINERS ARE INCENTIVIZED WITH A COIN REWARD BLOCKCHAINLAWCLASS.COM

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BITCOIN MINING MINERS GATHER VALID TRANSACTIONS AND FORM BLOCKS ONCE THEY HAVE HOWEVER MANY TRANSACTIONS THEY WANT THEY WILL START TO SOLVE THE CRYPTOGRAPHIC PUZZLE BLOCKCHAINLAWCLASS.COM

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BITCOIN MINING MINERS SPEND COMPUTATIONAL CYCLES TO GUESS A NONCE NUMBER THE NETWORK IS CONFIGURED SO THAT SOMEONE SHOULD SUCCESSFULLY GUESS A NONCE ONCE EVERY 10 MINUTES BLOCKCHAINLAWCLASS.COM NOTE: A NONCE IS AN ARBITRARY NUMBER THAT CAN BE USED JUST ONCE IN A CRYPTOGRAPHIC COMMUNICATION ( HTTPS://EN.WIKIPEDIA.ORG/WIKI/ CRYPTOGRAPHIC_NONCE )

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BITCOIN MINING THE DIFFICULTY OF THE PUZZLE CHANGES EVERY 2016 BLOCKS BASED UPON A BACKWARD LOOKING FORMULA DIFFICULTY = DIFFICULTY_1_TARGET / CURRENT_TARGET (TARGET IS A 256 BIT NUMBER) BLOCKCHAINLAWCLASS.COM https://en.bitcoin.it/wiki/Difﬁculty

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BITCOIN MINING AVERAGE TIME TO FIND A BLOCK CAN BE APPROXIMATED BY CALCULATING: TIME = DIFFICULTY * 2**32 / HASHRATE ONCE A MINER GUESSES A CORRECT NONCE THEY TRANSMIT IT WITH THEIR NEW BLOCK TO THE NETWORK BLOCKCHAINLAWCLASS.COM https://en.bitcoin.it/wiki/Difﬁculty

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BLOCK VALIDATION IS HOW THE NETWORK ACHIEVES CONSENSUS BLOCKCHAINLAWCLASS.COM

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BITCOIN CONSENSUS BLOCKCHAINLAWCLASS.COM

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BLOCKCHAINLAWCLASS.COM JUST LIKE TRANSACTIONS MINERS VALIDATE BLOCKS IN BITCOIN, THE LONGEST BLOCK WINS THE ASSUMPTION IS THAT THE LONGEST BLOCK REPRESENTS THE MOST PROOF OF WORK BITCOIN CONSENSUS

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MANY OTHER CRYPTO CURRENCIES FOLLOW THE BITCOIN MODEL BLOCKCHAINLAWCLASS.COM

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BLOCKCHAINLAWCLASS.COM ETHEREUM IS DIFFERENT

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BLOCKCHAINLAWCLASS.COM ETHEREUM ETHEREUM HAS TRANSACTIONS THAT INVOLVE “ETHER” (THE NATIVE TOKEN TO THE ETHEREUM NETWORK) ETHEREUM USES ACCOUNTS AT PRESENT ETHEREUM USES PROOF OF WORK TO ACHIEVE CONSENSUS

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https://www.coindesk.com/a-multi-million-dollar-bet- ethereums-proof-of-stake-isnt-coming-soon “I DON’T KNOW IF [ETHEREUM] WILL OR WILL NOT SWITCH TO PROOF-OF- STAKE … PROOF-OF-STAKE HAS A LOT OF PROBLEMS.” CHEN MIN CEO AND FOUNDER OF LINZHI BLOCKCHAINLAWCLASS.COM

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BLOCKCHAINLAWCLASS.COM ETHEREUM ACCOUNTS AN EXTERNALLY OPERATED ACCOUNT IS CONTROLLED BY PRIVATE KEY HAS A BALANCE DENOTED IN ETHER A CONTRACT ACCOUNT STORES CODE HAS A BALANCE DENOTED IN ETHER

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BLOCKCHAINLAWCLASS.COM ETHEREUM ACCOUNTS ALL THE ACCOUNTS ON ETHEREUM ARE REPLICATED ACROSS ALL NODES IN THE NETWORK AND TOGETHER FORM THE STATE OF THE NETWORK

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BLOCKCHAINLAWCLASS.COM ETHEREUM ACCOUNTS SMART CONTRACT ACCOUNTS IN ETHEREUM EXECUTE ACCORDING TO TRIGGERING CONDITIONS TYPICALLY THE CODE EXECUTES WHEN ETHER IS SENT TO THE ACCOUNT WHERE THE CONTRACT CODE IS STORED CODE IS DISTRIBUTED ACROSS THE ETHEREUM NETWORK ABLE TO BE EXECUTED ETHER IS USED AS GAS TO FUEL THE EXECUTION OF SMART CONTRACTS

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BLOCKCHAINLAWCLASS.COM MANY NEW PROJECTS ARE BILLING THEMSELVES AS THE NEXT ETHEREUM …

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BLOCKCHAINLAWCLASS.COM HUNDREDS OF COINS/ TOKENS NOW

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IT CAN BE THOUGHT OF IN PART AS A ‘MARKET FOR GOVERNANCE RULES’ WHERE DIFFERENT OFFERING EMBODY DIFFERENT CONFIGS BLOCKCHAINLAWCLASS.COM

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JUST SOME OF THE GOVERNANCE RULES LEVEL OF ANONYMITY PROOF OF WORK VS PROOF OF STAKE EXPLICIT MONETARY POLICY ENCRYPTION (SHA 256, LYRA2RE, ETC.) ‘SMART’ CONTRACT FUNCTIONALITY TRANSACTION PROCESSING SPEED CONSENSUS MECHANISM BLOCKCHAINLAWCLASS.COM

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BLOCKCHAINLAWCLASS.COM GOT THIS GREAT TECH, BUT HOW DOES IT WORK IN REAL LIFE ?

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BLOCKCHAINLAWCLASS.COM THE CRYPTO CURRENCY ECOSYSTEM IS IN CONSTANT FLUX …

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BLOCKCHAINLAWCLASS.COM

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BLOCKCHAINLAWCLASS.COM CRYPTOCURRENCY WALLETS ‘WALLETS ARE PIECES OF SOFTWARE THAT HELP MANAGE THE CONTROL OF CRYPTOCURRENCY’ https://blockgeeks.com/guides/cryptocurrency-wallet-guide/

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BLOCKCHAINLAWCLASS.COM CRYPTOCURRENCY WALLETS AS DISCUSSED - WHEN YOU OWN CRYPTOCURRENCY YOU OWN A PAIR OF KEYS THAT ALLOWS YOU TO SEND AND RECEIVE THAT CRYPTOCURRENCY WALLETS MANAGE THE KEYS FOR YOU https://blockgeeks.com/guides/cryptocurrency-wallet-guide/

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BLOCKCHAINLAWCLASS.COM CRYPTOCURRENCY WALLETS ONLINE WALLETS DESKTOP WALLETS OFFLINE WALLETS HARDWARE WALLETS https://blockgeeks.com/guides/cryptocurrency-wallet-guide/

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BLOCKCHAINLAWCLASS.COM CRYPTOCURRENCY EXCHANGES EXCHANGES ARE BUSINESSES WHERE PEOPLE CAN TRADE FIAT CURRENCY FOR CRYPTOCURRENCY USUALLY REQUIRE EXTENSIVE ONBOARDING TO FIGHT MONEY LAUNDERING SIMILAR TO EXISTING FINANCIAL EXCHANGES

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BLOCKCHAINLAWCLASS.COM CRYPTOCURRENCY EXCHANGES (VOLUMES ARE NOW LOWER THAN IN 3/2018) https://www.bloomberg.com/news/articles/ 2018-03-05/crypto-exchanges-raking-in- billions-emerge-as-kings-of-coins

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BLOCKCHAINLAWCLASS.COM https://bitcoinmagazine.com/articles/report-crypto- exchanges-saw-trading-volumes-plummet-january/ JANUARY 2019 WAS A BAD MONTH FOR TRADE VOLUME

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BLOCKCHAINLAWCLASS.COM CRYPTOCURRENCY ECOSYSTEM OTHER BUSINESSES PROVIDING SERVICES ACCOUNTING LAWYERS COMPLIANCE SUCH AS KNOW YOUR CUSTOMER/ ANTI-MONEY LAUNDERING

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BLOCKCHAINLAWCLASS.COM ALSO SOME BUSINESSES LETTING CONSUMERS PAY IN CRYPTO

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BLOCKCHAINLAWCLASS.COM ALSO SOME BUSINESSES LETTING CONSUMERS PAY IN CRYPTO BUT DO THEY LIKE IT NOW? BTC FROM 19.5K TO 3.5K

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BLOCKCHAINLAWCLASS.COM HOWEVER, SOMETHING IS ROTTEN IN THE STATE OF CRYPTO...

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BLOCKCHAINLAWCLASS.COM https://www.nature.com/ articles/s41893-018-0152-7 https://cointelegraph.com/news/study- crypto-mining-consumes-more- energy-than-mineral-mining

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PROOF OF STAKE VS PROOF OF WORK

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BLOCKCHAINLAWCLASS.COM PROOF OF WORK “PoW idea was originally published by Cynthia Dwork and Moni Naor back in 1993, but the term “proof of work” was coined by Markus Jakobsson and Ari Juels in a document published in 1999. Proof of work [combined with the other Blockchain building blocks] is maybe the biggest idea behind the Nakamoto’s Bitcoin white paper – published back in 2008 – because it allows trustless and distributed consensus.” https://blockgeeks.com/guides/proof-of-work-vs-proof-of-stake/

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BLOCKCHAINLAWCLASS.COM STEPS IN A TRANSACTION ‘Transactions are bundled together into what we call a block; Miners verify that transactions within each block are legitimate; To do so, miners should solve a mathematical puzzle known as proof- of-work problem; A reward is given to the ﬁrst miner who solves each blocks problem; Veriﬁed transactions are stored in the public blockchain’ https://blockgeeks.com/guides/proof-of-work-vs-proof-of-stake/

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‘This “mathematical puzzle” has a key feature: asymmetry. The work, in fact, must be moderately hard on the requester side but easy to check for the network. “All the network miners compete to be the ﬁrst to ﬁnd a solution for the mathematical problem that concerns the candidate block, a problem that cannot be solved in other ways than through brute force so that essentially requires a huge number of attempts.’ BRUTE FORCE COMPUTING IS THE ‘WORK’ AND IT NECESSARY TO SOLVE THE GIVEN CRYPTO PROBLEM https://blockgeeks.com/guides/proof-of-work-vs-proof-of-stake/ BLOCKCHAINLAWCLASS.COM

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BLOCKCHAINLAWCLASS.COM PROOF OF STAKE https://blockgeeks.com/guides/proof-of-work-vs-proof-of-stake/ BLOCKCHAINLAWCLASS.COM “Proof of stake first idea was suggested on the bitcointalk forum back in 2011, but the first digital currency to use this method was Peercoin in 2012, together with ShadowCash, Nxt, BlackCoin, NuShares/NuBits, Qora and Nav Coin. Unlike the proof-of-Work, where the algorithm rewards miners who solve mathematical problems with the goal of validating transactions and creating new blocks, with the proof of stake, the creator of a new block is chosen in a deterministic way, depending on its wealth, also defined as stake.”

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BLOCKCHAINLAWCLASS.COM WHY IS PROOF OF STAKE CHALLENGING? https://blockgeeks.com/guides/proof-of-work-vs-proof-of-stake/ BLOCKCHAINLAWCLASS.COM There is no mining award but rather just transaction fees … Sometimes PoS system participants are thus called forgers Instead, the underlying PoS algorithm must be as bulletproof as possible because, without especially penalties, a proof of stake- based network could be cheaper to attack. To solve this issue, Buterin created the Casper protocol, designing an algorithm that can use the set some circumstances under which a bad validator might lose their deposit.

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BLOCKCHAINLAWCLASS.COM WHY IS PROOF OF STAKE CHALLENGING? https://blockgeeks.com/guides/proof-of-work-vs-proof-of-stake/ BLOCKCHAINLAWCLASS.COM To solve this issue, Vitalik Buterin created the Casper protocol, designing an algorithm that can use the set some circumstances under which a bad validator might lose their deposit. He explained: “Economic ﬁnality is accomplished in Casper by requiring validators to submit deposits to participate, and taking away their deposits if the protocol determines that they acted in some way that violates some set of rules (‘slashing conditions’).” Notwithstanding signiﬁcant issues remain with PoS

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BLOCKCHAINLAWCLASS.COM GOVERNANCE FORKS ATTACKS ON BLOCKCHAINS KEY MANAGEMENT SCALING USER EXPERIENCE PUMP AND DUMP SCHEMES ADDITIONAL OUTSTANDING ISSUES IN CRYPTO

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@ computational professor daniel martin katz danielmartinkatz.com BLOCKCHAIN, CRYPTOCURRENCY AND LAW professor nelson rosario CRYPTOCURRENCY - BITCOIN AND BEYOND nelsonmrosario.com @ nelsonmrosario BLOCKCHAINLAWCLASS.COM