class: center, middle, inverse, title-slide # DSBA 20598 – FinTech and Blockchains ## Lecture 7: Distributed Ledgers // Facebook Libra ### Prof. Silvio Petriconi ### Department of Finance, Bocconi University ### 2019-10-17 (updated: 2019-10-17) --- class: inverse, left background-image:url("img/network-3539325.jpg") background-position: left background-size: cover #Distributed Ledgers // Facebook Libra -- ### | Database vs. Blockchain ### | Commercial Applications ### | Hyperledger ### | JPM Coin ### | Facebook Libra ### | Central Bank Digital Currency --- class:inverse,center,middle #Database vs. Blockchain --- # Private blockchains With blockchain technology maturing, many firms have started wondering whether to adopt Blockchain for real-time documentation of inter- and intra-firm processes. For many of those processes, blockchain's immutability and shared writability is much more important, payment functionality is irrelevant, and the parties that should have write access to the chain (typically, business partners) are known upfront. This has led to the emergence of __private blockchains__, i.e. blockchains that are using a permissioned access system and are only shared between a closed number of business partners, each of which can identify by some cryptographic authentication. In a private blockchain with identity management, consensus can be attained e.g. by voting. No proof of work is needed to prevent Sybil attacks. --- #Private blockchains: some economic reasons Economists have long been emphasizing the impact of the __costly state verification problem__ on the contractual relations between firms ([Townsend, 1979](https://doi.org/10.1016/0022-0531(79%2990031-0)): it can be very costly to verify the actually realized state of nature which limits state-contingent contracting. An unforgeable record of actions and state history can help reduce the costly state verification problem and increase efficiency. Of course, another economic friction that can be alleviated by private blockchains is __moral hazard__, i.e. the existence of asymmetric information about hidden actions of a contract partner; essentially, blockchain can serve as a monitoring device to generate information about such actions. An excellent reference for anyone who wants to think about the impact of blockchain on corporate governance is the 2017 paper by David Yermack, you can find it [here](https://doi.org/10.1093/rof/rfw074). Read it! --- # Do you even need a Blockchain? Like with any new technology, blockchain is * poorly understood by managers, * fueling unrealistically high expectations on some ends, whilst * having greatly underestimated potential along other dimensions. Some people who didn't even understand blockchain bought a private blockchain solution for their business for lots of money just to discover that a distributed database would have served their purpose much better. We're now going to read and discuss [this](https://medium.com/block-chain/why-blockchain-must-die-in-2016-e992774c03b4) article by Bart Suichies which has been actually quite influential for practitioners nowadays in how they think about reasons for (and against!) blockchain adoption. We also look at [this](https://eprint.iacr.org/2017/375.pdf) research paper on the same topic. --- class:inverse,center,middle #Commercial applications --- #Example: Walmart, IBM and the food chain <iframe width="640" height="480" src="https://www.youtube.com/embed/SV0KXBxSoio" frameborder="0" allow="accelerometer; autoplay; encrypted-media; gyroscope; picture-in-picture" allowfullscreen></iframe> --- #Blockchain totally does(n't) make sense Sometimes you can literally see from looking at a document that some boss has asked top $ consultants to write up "something" about the blockchain future. The report always comes on glossy paper and may not be as informative as it should. For example, IATA (the association of airline industry) has published [this](https://www.iata.org/publications/Documents/blockchain-in-aviation-white-paper.pdf) study about the use of Blockchain in aviation. It is in my view representative of many other documents that I've seen about commercial blockchain applications (and many business debates about blockchain). Without wanting to offend the authors, I'd claim that the study isn't really very deep and is missing important points. Let's dig deeper, let's now have a critical discussion whether blockchain is really a good approach for the kind of problems that are mentioned here, such as * frequent flyer programs * passenger identity/preference management * certification of crew * certification of airframe airworthiness --- # Blockchain and DRM Digital rights management (DRM) is often used for ebooks, music, games etc. The idea basically is that in order to use the digital good, its "owner" must prove that the good is genuine by connecting to a central database in which the ownership is recorded. The problem is that sellers of digital goods have been unable to commit to keep the database running forever (at cost). Even Microsoft recently [shut down its ebook DRM server](https://www.wired.com/story/microsoft-ebook-apocalypse-drm/), essentially expropriating their ebook buyers. The ex-ante anticipation of the lack of ability to commit to operate costly DRM infrastructure makes buyers hesitant to buy DRM protected digital goods in first place. [This](https://medium.com/smartz-blog/can-blockchain-and-smart-contracts-protect-copyright-267e105a9ee) article argues that blockchain has a good chance of becoming the cornerstone of solutions that effectively address the copyright licensing problem. I strongly agree. It also fits with the setting that led to the initial invention of Blockchain by [Haber and Stornetta (1991)](https://doi.org/10.1007/BF00196791). --- # Blockchain and B2B sales One area of application of blockchain which I personally believe to be very promising in the future is business to business transactions. Relative to retail sales, B2B sales are greatly complicated by * the lack of instant price quotes because suppliers use first degree price discrimination, charging one customer a multiple of what they charge another for the same good or service * the importance of due diligence (limiting the risks from the counterparty) * the absence of buyer protection regulations that protect final good consumers (e.g. reversal of burden of proof for warranty claims) * customization of purchase contract conditions * frequent involvement of several jurisdictions and international law All of this is a costly burden for firms, but they can't delegate it to intermediaries. Why? Because intermediaries' access to firm core data would give it dangerous power over the firm. Blockchain, when combined with privacy technologies like zero knowledge proofs (more later), can offer a way to facilitate B2B trade without creating an omnipotent intermediary. We will now discuss how. --- class:inverse,center,middle #Hyperledger --- # Blockchain technology for everyone How do IBM and all the others go about implementing blockchain solutions for their customers? They could write a blockchain from scratch. Better business model: develop a good blockchain solution once, publish it as open source, let others find more bugs, and deploy the open source solution everywhere, charging for expertise and certification rather than software itself! In this way, [several](https://www.hyperledger.org/projects) commercially developed __permissioned blockchain implementations__ have found their home in the [Hyperledger umbrella project](https://www.hyperledger.org), which itself lives under the roof of the [Linux Foundation](https://www.linuxfoundation.org)*. Some important blockchain implementations in the Hyperledger project are: * Hyperledger Fabric * Hyperledger Sawtooth * Hyperledger Iroha * Hyperledger Besu .footnote[*The Linux foundation is the same non-profit entity that also supports development activities around the Linux kernel.] --- # Hyperledger Fabric With the variety of available solutions it's not always easy to have a clear overview of what's best for which purpose. If you're new to hyperledger, [this](https://www.hyperledger.org/wp-content/uploads/2018/05/Hyperledger-Overview_May-2018.pdf) slide set will give you the first orientation, but there's quite some learning involved before you can deploy one of the ledgers. The most popular permissioned distributed ledger so far remains __Hyperledger Fabric__. IBM is using Fabric in most of its consulting projects (like the Walmart food certification that we saw earlier). Unlike Ethereum, smart contract logic ("chaincode") runs not in a distributed VM, but in isolated Docker containers; supported chaincode languages are node.js, Java or Golang. Chaincode is installed and maintained by ledger sysadmins. I'll discuss now on the whiteboard the functioning of a basic Hyperledger Fabric system. If you're not attending class, you can get up to date by skimming over [this](https://medium.com/swlh/hyperledger-chapter-1-foundation-7ad5bd94d452) ten-piece series of articles, focusing only on the points how Fabric works, and skipping the actual setup instructions*. .footnote[*unless you want to set up your own Hyperledger Fabric system, which would of course be great. But be aware that Docker and VirtualBox don't coexist peacefully on the same computer, which is why I'm refraining from bringing Hyperledger Fabric live in the lab.] --- class:inverse,center,middle #JPM Coin --- # Banks as issuers of private money .pull-left[ ![Free banking note](https://upload.wikimedia.org/wikipedia/commons/9/96/1_Dollar_-_Salem_%26_Philadelphia_Manufacturing_Co.%2C_Salem%2C_New_Jersey%2C_USA_%281820%27s-1830%27s%29_Anything_Anywhere.jpg) One Dollar note of Salem & Philadelphia Bank, 1829. .tiny[Source: [wikimedia](https://commons.wikimedia.org/wiki/File:1_Dollar_-_Salem_%26_Philadelphia_Manufacturing_Co.,_Salem,_New_Jersey,_USA_(1820%27s-1830%27s%29_Anything_Anywhere.jpg)] ] .pull-right[In the U.S. [Free Banking](https://en.wikipedia.org/wiki/Free_banking) era, private banks regularly issued notes as claims against bank deposits. These bank notes played a currency-like role, but in sharp contrast to currency they were privately issued money. Usually a note would circulate at a discount that was greater at larger geographical distance to the bank where it could be redeemed. ] In hindsight it is not very surprising that a large U.S. bank with long-standing tradition became the first bank to issue in 2019 claims on its deposits in the form of a blockchain-operated digital currency! --- # JPM Coin Technologically, JPM Coin runs on a private blockchain called [__Quorum__](https://www.goquorum.com) which is basically a fork of Ethereum that includes important modifications: * private, __permissioned__ distributed ledger, controlled by the bank itself * support for __private transactions__ that are not visible to anyone except the parties involved in the transaction. Crucial e.g. for financial market trading applications where you can get fried if others know or infer the market position that you've been taking. * __backed 1:1__ by the bank's fiat reserves In early 2019, JPM Coin was rolled out for use by other banks and firms. So far, it is not (yet) open for use by the general public: >_"JPM Coin is currently designed for business-to-business money movement flows, and because we are still in a testing phase, we don’t have plans to make this available to individuals at this stage. That said, the cost-savings and efficiency benefits would extend to the end customers of our institutional clients."_ Personally, I believe that JPM will have less difficulty than [Ripple](https://www.ripple.com) to convince business to join. They have decades of history and reputation. --- class:inverse,center,middle #Facebook Libra --- # Understanding Libra's technological base For Bitcoin and Ethereum, the White Paper was a good starting place to go to learn what's going on. Not so with Libra. Their [White Paper](https://libra.org/en-US/white-paper/) leaves more things more vague than we would like at our stage of understanding, but it's simply meant not to scare blockchain newcomers. A more useful paper is the technical paper of Libra which can be found [here](https://developers.libra.org/docs/assets/papers/the-libra-blockchain.pdf). We'll go over some of its main insights. If you're not attending class, please read the paper carefully. --- class:inverse,center,middle #Central Bank Digital Currency --- # The worries A currency like Libra bring central banks into a difficult situation: * it's a currency that might soon become more attractive than many of the smaller world currencies. * yet it's issued by a private entity with no cental bank having any control * widespread adoption of Libra will lead to large accumulation of safe assets in hands of its operators, scarcity of safe assets outside. * it may interfere with transmission of monetary policy, central banks may lose control of stabilizing national currency value. Why not issue a central bank backed digital currency? As [this]( https://www.bis.org/cpmi/publ/d174.pdf) report of the BIS points out, there are major concerns as well, including that * programmable currency could greatly increase risks to financial stability: bank depositors could quickly flee to ultimate currency, greatly __exacerbating bank run risk!__ * international competition of digital national currencies Events will force central banks to move soon. In August 2019, [news breaks](https://www.bloomberg.com/news/articles/2019-09-10/why-china-s-rushing-to-mint-its-own-digital-currency-quicktake) that China will soon issue digital Yuan, putting its currency on a path to take a leading position in the digital world of tomorrow... --- class:center,middle,inverse #Outlook --- #Outlook .left-column[ ![Hayek](https://upload.wikimedia.org/wikipedia/commons/7/7f/Friedrich_Hayek_portrait.jpg) Friedrich von Hayek .tiny[Image: Wikimedia, license [CC-BY-SA 3.0](https://creativecommons.org/licenses/by-sa/3.0/). The original uploader was DickClarkMises at English Wikipedia. ] ] .right-column[ Sometimes, new technologies bring old ideas back to new relevance and glory. The issuance of private currency by players like JPM or Facebook makes one wonder what a world in which several flavors of private currency, with different properties, coexist. The Nobel price winning economist [Friedrich von Hayek](https://en.wikipedia.org/wiki/Friedrich_Hayek) had been wondering nearly half a century ago what a world with several competing private currencies might look like. The outcome of his thinking is a small but very insightful little book entitled "Denationalization of Money: The Argument Refined" that you can download freely [here](https://mises.org/library/denationalisation-money-argument-refined). Highly recommended! ] --- class: center, middle # Thanks! More material on [https://silviopetriconi.github.io](https://silviopetriconi.github.io). For questions, comments and suggestions regarding these slides please contact the author, [`silvio.petriconi@unibocconi.it`](mailto:silvio.petriconi@unibocconi.it). <br></br> [![CC-BY-NC-SA](https://i.creativecommons.org/l/by-nc-sa/4.0/88x31.png)](http://creativecommons.org/licenses/by-nc-sa/4.0/) <br></br> This work is licensed under a [Creative Commons Attribution-NonCommercial-ShareAlike 4.0 International License](http://creativecommons.org/licenses/by-nc-sa/4.0/).