Where do we go from here? Challenges in the era of crypto

Andreas Veneris

University of Toronto Department of Electrical and Computer Engineering and Department of Computer Science Introduction Crypto economic foundation, standardization Smart contracts: language and verification Scalability Privacy, governance, regulation, law Stable coins and monetary policy What’s next? is a digital of monetary transactions in the form of a A transaction is a message like “Me, Bob sent 5 BTC to Alice” but requires certain properties: 1. Non‐repudiation: Bob can’t later disavow it 2. Authentication: Only Bob could have sent it, only Alice can receive it 3. Immutability: Transaction can’t be modified later • Cryptographic digital signatures ensure features 3 The transaction is broadcasted and diffuses through a peer‐to‐peer network But this doesn’t mean the transaction has “happened” What if Bob sent conflicting messages to different peers? The network puts the transactions into the ledger certified in a decentralized manner

4 Transactions are grouped into blocks by miners Each block contains: A list of transactions A nonce used for mining A commitment to the ledger’s prior entries in the form of a hash of the previous block in the chain

5 Blocks form a hash‐linked chain (the blockchain) An unambiguous head of the blockchain precisely determines the contents of the ledger But how do we determine the head?

6 Mining determines the head Miners race to perform proof‐of‐work Game theoretical guarantees by computing power The winner gets the right to create a new block The concept of winning is auditable via the nonce The longest valid chain is the true chain

7 Bitcoin ledger: trust in monetary transaction state Smart contracts: programs “executing” on the blockchain ledger: trust in software execution 1. Send money

2. Create a contract

3. Call code in a contract

8 Example : Every 1st day of month deduct $450 for car lease Place the money into bank account If money not available give 24 hrs notice to: Bank Insurance Client If money not available 2nd day of month When car is inactive “disable” key entry Compare with current costly process today Lawyers, credit agencies, letters, phone calls, etc 9 There are also over 800 “altcoins” (according to coinmarketcap) with a variety of goals Forks: Humor: Competition: Privacy: Decentralized Domain Names: Useful proof‐of‐work: Use in particular industries: Potcoin

10 Permissionless ledger: Bitcoin, Ethereum Cryptographic mining = power consumption intensive Permissioned ledger: between approved entities Fabric is a permissioned blockchain for enterprises Linux Foundation (supported by IBM, Intel, Deutsche bank, JP Morgan, CME, SWIFT,…) Smart contracts, higher throughput, lower cost Corda (R3): permissioned for financial services

11 Global crypto economy exceeded the $300B mark $750B in Dec’17 x20 market cap explosion in 2017 90% of it dominated by Bitcoin, Ethereum and derivatives Bitcoin: tight platform Ethereum: wide platform

Source: https://coinmarketcap.com/ More than $3.7B capital investment in 2017 3x job demand in 2017 (faster than any tech sector) Gartner May 2018: 23% of interviewed CIOs say “blockchain R&D requires new skills to implement”… …yet none of this technology (P2P, , game theory, etc) is new. So what is the deal?

CULTURAL/MIND SHIFT: • Eliminate “trusted” middle man

• Blockchain immutability 13 Blockchain: epitome of triple‐entry accounting1: Accounting agreed on objective economic reality Accounting congruent by two external parties is now sealed cryptographically Blockchain entry is both a receipt and a transaction Falsifying or deleting a blockchain entry is impossible Instead of two independent ledgers (i.e., double‐entry accounting), entry is recorded on a public, distributed, interlocked, permanent and transparent ledger

1: Ian Grigg, Triple Entry Accounting, 2005, http://iang.org/papers/triple_entry.html 14 This is great news! But: Most innovation led by “hackers” + “cypherpunks” Vulnerabilities and loopholes now surface $ $ Regulation: pending $ $$$ $$ $$

? Where/How do we go from here?

15 Nov 30 Dec 4 16 Introduction Crypto economic foundation, standardization Smart contracts: language and verification Scalability Privacy, governance, regulation, law Stable coins and monetary policy What’s next?

17 A unified game theory of crypto‐economic mechanisms: , reputation systems, verification systems Challenge‐response games with equilibriums Escalation games: Deterrence and credibility of threats Algorithmic incentives for distributed fault tolerance Behavioral economics of distributed/decentralized systems

Standardization:

ERC-20: 18000+ ERC‐20 tokens exceeding $3B in market cap! ERC-780 (registry) and ERC-725 (identity) Existing adoption of ERC standards proves benefit of standardization Need decentralized IEEE/ACM‐like agencies to set standards for protocols, cryptographic principles, game theory principles, etc. Introduction Crypto economic foundation, standardization Smart contracts: language and verification Scalability Privacy, governance, regulation, law Stable coins and monetary policy What’s next?

19 Smart contracts ‐ epitome of the blockchain revolution: Allow computations that reduce cost/time of real‐life transactions Smart contracts + IoT = 21st century transactional trust

What language to use for smart contracts? Bitcoin smart contracts: a virtual impossibility Ethereum: Turing‐complete but language landscape remains fluid (Viper, , etc …) Why is the type of language important? BecauseBecause you one need needs toverify verify it! it!

20 Verification of computer programs is an intractable problem If Microsoft did not solve it in 40 years, don’t attempt to solve it! Why is verification so important? DAO: $60M USD theft. Parity: $280M USD “locked”. Mt. Gox: 650,000 still “missing” ($2B equivalent today)

21 Verification of computer programs is intractable problem If Microsoft did not solve it in 40 years, don’t attempt to solve it! Why verification is important? DAO: $60M USD theft. Parity: $280M USD “locked”. Mt. Gox: 650,000 bitcoins still “missing” ($7B equivalent today)

What are the options? Needed: “constrained” languages that are easy to verify Needed: verification methodologies Development of formal verification methods Assertions, protocols, etc: verification methodologies Smart contracts “correct by construction”: Ricardian contracts (i.e., R3’s Corda) 22 Introduction Crypto economic foundation, standardization Smart contracts: language and verification Scalability Privacy, governance, regulation, law Stable coins and monetary policy What’s next?

23 Why does tech-advocate Al Gore frown upon us?

He just got briefed on what “” is … Bitcoin consumes as much electricity as Ireland Bitcoin is responsible for 0.12% of world’s electricity Ethereum is responsible for 0.05% of world’s electricity Bitcoin + Ethereum = close to 2% of computing power Medium Transactions per second (tps) Bitcoin 3‐7 tps Ethereum 15‐40 tps Paypal 200 tps Mastercard 42,000 tps (peak)

Scalability progress: tps vs. power consumption

Bitcoin: lighting network for micropayments (side chain) Ethereum: Proof‐of‐Stake (Casper), State channels, Plasma, Sharding, Raiden for micro‐payments Randomization, 0‐knowledge proofs and Proof‐of‐Stake: Algorand, Cardano: Is money calling the shots? Hyperledger: message passing aiming for 500K tps 25 Introduction Crypto economic foundation, standardization Smart contracts: language and verification Scalability, storage and fault tolerance Privacy, governance, regulation and law Stable coins and monetary policy What’s next?

26 27 Privacy:

To London’s Telegraph headline: bitcoin is not anonymous! Satoshi owns more than 1M bitcoins This is an equivalent of $6B USD He pays a large price his anonymity! zCash vs. Monero vs. : perfect privacy vs. obfuscation vs. semi‐trusted mixing masternodes … what is the best? Ethereum can simulate all the above BISQ: decentralized Tor‐like dark web network brokerage

28 Governance:

Past forks in bitcoin and ethereum came with controversy , Cardano, Algorand, : self‐governed chains through proof‐of‐stake, probabilistic protocols, or reputation Open questions: Is a self‐governed chain desirable? Is governance possible or is it an elusive idea?

29 Wildly different regulation in various jurisdictions Virtual currencies are legal tender in Japan They are outlawed in Bangladesh and Vietnam They are subject to capital gains in Australia, Brazil, Canada, USA and Israel They are treated as commodities or securities in the United States depending on the currency New York licenses businesses Nevada prohibits local governments from doing the same Ontario Securities Commission: Follows US lead of classifying ICOs as securities

30 Switzerland

The first major economy to issue guidance on launching ICOs FINMA guidelines: Three categories: asset / utility / payment tokens A single token can be in multiple categories The categories mostly determine whether or not a token is subject to securities regulation All pre‐launch tokens are securities Many companies with ICOs are nominally located in Switzerland, Zug under a foundation Tax benefits

31 ICOs have emerged as a fundraising mechanism Company distributes new cryptocurrency. It can be equity/debt/asset with rights and/or use of service 2017 landscape: > 200 ICOs raising > $3.7B USD Exceeds traditional venture capital for same time SEC: Howey test for security regulation (1946) Canada’s regulatory approach (OSC) is similar Yet Ethereum had relocate to Switzerland to run ICO in 2014 Canadian banks still close accounts to companies/individuals Money outflow to foreign jurisdictions with favorable regulation (Switzerland, Singapore, Cayman, etc) 32 Smart contracts also impact the field of law as ownership of traditional assets Delaware: blockchain‐based records of ownership are admissible as evidence Legal status of smart contracts Tennessee: legal contracts can reference smart contracts Arizona: digital signatures are legally binding records

33 Law Technology Today, January 31, 2017: The evolution of platforms such as blockchain will offer lawyers one of two choices: (1) disregard in an attempt to maintain the status quo, or (2) understand and adapt into the practices. I suggest (2) is the prudent course of action for those lawyers not planning to retire by 2020. From itsynergis.ru research via blackmooncrypto.com

35 From itsynergis.ru research via blackmooncrypto.com

Nov 12, 2018 on Jasper III BoC project:

“…there is promise in this technology” Scott Hendry, BoC

“…it’s less and less about the technology it’s more about the regulatory, the legal and the monetary policy” Andrew McCormack, Payments Canada

“The next wave of economic disclocations won’t come from overseas but from the relentless pace of automation that makes good, middle‐ class jobs obsolete. The inequality caused by automation is a main drive of political polarization” President Obama, Chicago, IL, Jan 12, 2016 Introduction Crypto economic foundation, standardization Smart contracts: language and verification Scalability, storage and fault tolerance Privacy, governance, regulation, law Stable coins and monetary policy What’s next?

37 Central Bank Sandboxes:

Bank of Canada: Jasper I, II and III Monetary Authority of Singapore: Ubin I and II European Central Bank and Bank of Japan: Stella Focus: domestic and cross‐border payment/settlement (with fiat collateral held by central bank) or securities settlements

Stable coins:

Maintain coin stability against some asset (usually USD or Ether) : Financial engineering with Ether collateral : (alleged) USD collateral, $2B valuation Saga: Fiat collateral (eventually fractional reserve) pegged to SDR 38 China: payment systems via Alibaba and Wechat (with collateral) Africa: mobile payments with Mpesa (with collateral) World Bank: Bond‐I Global Blockchain‐based Bond (August 2018) Smart Dubai, e‐Estonia, Vienna City of Blockchain: blockchain & AI Introduction Crypto economic foundation, standardization Smart contracts: language and verification Scalability, storage and fault tolerance Privacy, governance and regulation Stable coins and monetary policy What’s next?

40 A step toward Hayek’s multiple competing currencies vision? • Facebook‐coin, • Amazon‐coin, • My‐coin, • Your‐coin…

41 …Or the epitome of Charles Mackay’s “Popular Delusions” tulip‐mania?

42 Most like the first but currently, it is a crypto zoo Growth today driven by promise wild speculation money outflows Scalability, privacy and governance are major technology challenges Standardization necessary Regulation to embrace technology not be punitive to innovation/opportunity Market consolidation