2.5 Introducing the Tools (Short Overview) We Discussed the Field, the Positions in the Field and the Different Players That Are Active in the Game

2.5 Introducing the tools (short overview) We discussed the field, the positions in the field and the different players that are active in the game. Let’s now discuss the different tools they can use during the game. An entire overview of the hardware and software can be found here, but here is a quick overview of the most commonly used tools. 1. Keys 2. Wallets 3. Clients 4. Nodes 5. Mining tools 6. Github 7. Internet protocol & communication Side note: in level 3 will we do a deeper dive per tool!

1. Keys Nothing new here: we discussed the keys already so a short recap (details in level 3). We have, as you know, public/private key pairs. The private key is nothing more than a very, very, very (!!!!!!!!!!!!!!!!!!!!) big number (approx. between 1^77 = 2^256 in case of Bitcoin). For competition: current science states that there are between 1078 to 1082 atoms in the known, observable universe. The public key is nothing more than a hash of a hash of a hash, often using different hashing formulas, rendering is virtually impossible to calculate back to the original number. (“chances of succeeding are as big as being hit by a comet within 2 seconds”). But….what do we do with this key pair? Send (private) and receive (public) data transactions (often this data presents some form of value, like a bitcoin). So tool #1 is like the bat you need in baseball to move the ball. No keys = no bat = no game.

2. Wallets In short: the game of blockchain is played with as many keys as you like. Wallets offer the service of keeping your keys together and often ordened. A wallet is software that holds all your addresses. Use it to send bitcoins and manage your keys. Ownership is established through digital keys and digital signatures. These keys are generated locally on Bitcoin end-users’ computers using special software called a Bitcoin client. They can be stored in a file, in a database, or just printed on a piece of paper, but most commonly they are stored in a Bitcoin wallet. The keys within each user’s wallet allow the user to sign transactions, thereby providing cryptographic proof of the ownership of the bitcoins sourced by the transaction. Keep in mind that if you don’t know who generates your private keys, where they are stored, or if someone else has them (as when using a cryptocurrency exchange), they are not actually yours, as seen in the case of MtGox, which discontinued operations in February 2014. “Like email addresses, Bitcoin addresses can be shared with other Bitcoin users who can use them to send bitcoins directly to your wallet. Unlike email addresses, you can create new addresses as often as you like, all of which will direct funds to your wallet. A wallet is simply a collection of addresses and the keys that unlock the funds within. There is practically no limit to the number of addresses a user can create.” (from Antonopoulos, Mastering Bitcoin). Different wallets for different scenario’s, but most importantly: pick your wallet very carefully! In level 3 will we discuss and show you the different types, mainly categorized in hot wallets (created online) and cold wallets (created offline, stored away from internet).

3. Client In short: the client, also known as client software, is software that lets the wallet communicate with the network. In other words: it connects the wallet, that holds your keys, with the miners that records your transactions. Side note: this also enables to participate without becoming a full node (we rely on the client software of the wallet to connect to the SSOT). Check out the work Wikipedia did for us https://en.bitcoin.it/wiki/Clients 4. Nodes Catching up with the digital time (ledger) itself…downloading the bitcoin ledger (blockchain). Bitcoin “client” software - downloads the blockchain (transaction history). You know become a recordkeeper, just another copy of the distributed ledger among “client nodes” But…which blocks does the software pick? How does it (do I) reach consensus with other clients = BGP = longest chain principle Integrity check: do we have the same hash as others nodes?) A node is hardware (or an entity, just like a “miner”). It is quite easy to become a node (instructions), but it does require a lot of bandwidth and memory storage on your hardware device. (Bitcoin, n.d.)

5. Mining hardware The hardware we already discussed. Here is a comprehensive overview of the different kind of software. Students will explain in level 3 how to set up a rig in detail, will be an awesome session! (Beigel, 2019)

6. Github Developers Playground in the blockchain realm in short Github is a platform to co-work on projects together and to share data and code. Nowadays owned by Microsoft, www.github.com. More info on the platform can be found here, explained visually here. Get used to it, we will be working intensively with it in further levels. Here is your pick of tutorials (oooow what beautiful things did the internet for us teachers ). (Wikipedia, 2019) (GitHub, 2016)

7. Internet protocol & communication software Bitcoin uses a simple broadcast network to propagate transactions and blocks. All communications are done over TCP. Bitcoin is fully able to use ports other than 8333 via the -port parameter. IPv6 is supported with Bitcoind/Bitcoin-Qt v0.7. Using bitcoin over tor is also supported. (Bitcointalk, 2012) (Bitcoin, 2019)In general: Source (Bitcoin, 2018) The Transmission Control Protocol is one of the main protocols of the Internet protocol suite. It originated in the initial network implementation in which it complemented the Internet Protocol. Therefore, the entire suite is commonly referred to as TCP/IP. Always wanted to know how the internet works? Click here. Perhaps also interesting: here you can find how your phone communicates. (Engineering, 2019) (Learn Engineering , 2018)

Further readings - Overview tools: https://en.bitcoin.it/wiki/Main_Page - Clients explained: https://en.bitcoin.it/wiki/Clients - Instructions on how to become a node: https://bitcoin.org/en/full-node - A comprehensive overview of the different kind of mining software: https://99bitcoins.com/bitcoin-mining/software/ - Github explained https://en.wikipedia.org/wiki/GitHub - Github explained visually: https://www.youtube.com/watch?v=w3jLJU7DT5E - Github Tutorial: https://www.youtube.com/results?search_query=github+website+tut orial - Bitcoin communications: https://bitcointalk.org/index.php?topic=81378.0 - Tor explained: https://en.bitcoin.it/wiki/Tor - Bitcoin Network Tech: https://en.bitcoin.it/wiki/Network - How does the internet work (short?): https://www.youtube.com/watch?v=x3c1ih2NJEg - How does the internet work (Harvard, long): https://www.youtube.com/watch?v=U6hkOAnFJxM&feature=emb_logo - How does your mobile phone works: https://www.youtube.com/watch?v=1JZG9x_VOwA

2.6 I Transactions This session is all about the ball in the game, no ball = no game. With blockchains it is all about sending value from one to another, hard to do without transacting. We first start with a minor overview of transactions and the different accounting ways on how to record them (which we will do an entirely separate course about later, this is like in the crypto flower, an entire field on its own called accounting & auditing). After you have learned the very basic elements we will explain how transactions work on Bitcoin and on Ethereum. This way we have covered most of the different types of transactions being send around the world We of course invite you to dig out other variants as well on your own! So let’s start with the beginning, what were the transactions again?

In short. As you know we use transactions to send value from entity a to for example entity b. Value in the digital realm is represented by data (bits & bytes), and blockchain either fully transfers the data (= processed in totality) or nothing at all. If a transaction is deemed valid by the protocol the miners and minters record them as you know now, it they aren’t valid they are ignored (but you are always able to try to send invalid transactions, they just don’t record them). No recording = no transfer. An abbreviation a transactions = “tx”. Where the internet enabled us to transfer information, a blockchain additionally enables us to transfer value. By solving the BGP, we can create a global Single Source of Truth without Trusted Third Parties = creating a digital ledger we can use to send unique pieces of data representing value. It is unique, because we all agree about who owns that data (we will discuss “the how” of this later on).

This article explains why bitcoin is an accounting revolution. It portrays a good overview and history of accounting & audit, all the way leading up to lightning network. A must read for our students as you may have seen in the portfolio already ! In short: it explains the migration from single entry accounting to “triple entry accounting”.

2.6.1 Single Entry

Single entry accounting = profit & loss recording. Did not work optimally because you could not determine balance positions (needed for example for stock positions etc.). Single-entry accounting is a form of bookkeeping and accounting in which each financial transaction is a single entry in a journal or transaction log (system is called single- entry system, the approach single-entry bookkeeping). Easy approach, does not require training in accounting. A few (small!) businesses choose single-entry accounting instead of the more common double-entry system. With the single-entry approach, each financial event calls for just one accounting system transaction. This approach is similar to the way that individuals use a check register (see picture). Firms using single-entry approach are effectively limited to reporting on a cash based ledger system: you either have the asset or you don’t. Simple, but limited: It does NOT allow for recording debits (assets people own you) or credits (assets that you owe people). You also can’t periodically depreciate assets, you can’t record time aspects of assets. Benefit: you don’t need complicated accounting rules etc! Bitcoin combines computing with a cash based accounting system = you either own the data / bitcoin (= Unspent Transaction Output = “UTXO” = the number of spendable bitcoins) or you don’t.

Read more about single entry here.

2.6.2 Double entry According to the historiography, the current bookkeeping method was conceived in 1491 Venice and allows us to prepare both a balance sheet in addition to the profit and loss account from single entry accounting (enabling debts and credits!). The important thing about accounting 2.0 is that every transaction in the accounting must be in balance (debit = credit!), so that the total financial balance is not disturbed. You can find a more detailed explanation here. The single-entry approach contrasts with double-entry accounting, in which every financial event brings at least two equal and offsetting entries (equal in amount!). One is a debit (DR) and the other a credit (CR), resulting in an accrual reporting system. Focus on Revenues, Expenses, Assets, Liabilities, and Equities. A double-entry system keeps the firm's entire "Chart of accounts" in view. This chart for a double-entry system has, in fact, five kinds of accounts in two categories:

Firstly, Income statement accounts: (1) Revenue accounts, and (2) expense accounts.

Secondly, Balance sheet accounts: (3) Asset accounts, (4) Liability accounts, and (5) Equity accounts. These “balance sheet accounts” are new in double entry accounting and is like a frozen moment in time (for example the 31st of December 2019) where the income statement is a flow of time (for example “2019”). In other words: the balance sheet is a snapshot of the income statement, enabling us the record additional assets (debits) and liabilities (credits).

All transactions in a double-entry system result in entries in at least two different accounts. When the company receives cash through a bank loan, the double-entry system records:

Firstly, a debit (DR) for an asset account, e.g., Cash on hand. For an asset account, a DR is an increase.

Secondly, a credit (CR) to a liability account, e.g., bank loans. A CR to a liability account increases its balance. With double entry accounting you can introduce time aspects in recording and for example record debt (money that somebody will pay you in the future). Like mentioned: A double-entry system keeps the firm's entire "Chart of accounts" in view, in other words: it presents “the state” of the income statement (just like Ethereum presents the world state of transactions per block).

The administration is almost always conducted in private accounting, in closed-off environments. It does not work optimally because these accounting ledgers can’t or won’t communicate with each other, creating walled silo’s. This system works on the basis of "trust", something that must be strengthened by, among other things, audits by external parties such as an accountant. The information age seems to be asking for a call for more transparency, and regulators are trying to meet this. Recently, in the Netherlands, regulators have decided that is time to act harsh towards the auditors of these ledgers, because the quality of audits are under a desired level(Dutch article). Question is: isn’t it about time to set up a new system with more integrated preventive transparency?

2.6.3 “Triple” Entry (new accounting revolution?) “Triple Entry” (or actually single or double entry, depends on the blockchain, but all with included Third Party Verification on every transaction). We will learn in a few minutes that Bitcoin uses transaction based accounting (entering transactions like single entry accounting) and that Ethereum looks more like double entry accounting (entering account based transactions). But before we dive in those, what’s new here?

1. The recording of transactions are cryptographically secured. History can’t be altered when recorded!! Also known as append- only systems. The advantage of append-only storage is that the database is “immutable”, it keeps an entire history of all the transactions that have been done. Read more about it here. 2. Near instant verification by multiple external parties, proving that the transaction actually happened 3. The transactions contain data that can automatically execute itself / change its own state (= no TTP or accountant needed, the so-called “smart contracts”)

Resulting in a global ledger, sometimes automatically updating its own state, without using a TTP. You already know the benefits: it reduces the three risks of TTP and removes thresholds (exclusion, dishonesty and loss of records). Blockchain & Accounting: record data, where data can take multiple forms like for example a regular bitcoin transaction, the representation of a real world asset, but also enabling a smart contract. How that data is used differs per blockchain.

Like the previous mentioned article about Bitcoin and accounting stated: Bitcoin is the first accounting system to ever provide absolute assurance over ledger data. Unlike double entry, Bitcoin accomplishes this by providing expedient third-party verification via its inflexible, highly redundant protocol + network. From an accounting perspective, the speed at which this verification from independent parties occurs is incredibly significant, as it reflects a paradigm shift from an overhead intensive and slow verification regime to one that is lightweight for users and only “a click away” at all times. To put more simply, it disintermediates the old and separate internal accounting + external audit functions by combining them into a single, inseparable product. To simplify: normally transactions within one closed-off ledger needed to be audited, by internal and external auditors, and the quality of data increases when different ledgers from different entities with different interests still state the same outcome (so my ledger says you owe me 10 euro, and you ledgers says you owe me 10 euro). The alignment of outstanding records with records of other parties are known as the “third party confirmation”. In an open ledger, like Ethereum’s or Bitcoin’s, you don’t need this confirmation, because every transaction is record in the exact same ledger (every valid transaction is audited by all the miners and nodes).

IMPORTANT DIFFERENCE: in your own ledger, you can be a king of the ledger. You can create stuff out of the blue and do whatever you want. If you are accountable, because for example you are a company, you will have a certain set of rules you need to abide by (which is checked by auditors). But still, either you or the can (deliberately) make mistakes and misrepresent the ledger, resulting in wrong data and information. This only happens in closed-off environments where people can alter the data. Bitcoin for example is a append-only ledger, you can only send or receive transactions. You can’t alter records, other than sending transactions. As you already understand, you can’t alter the past, but what you need to realise as well is that nobody can add or delete or alter accounts. If you want to alter something, like for example to raise the balance of an account from 1BTC to 2 BTC = you need to make a transaction. A transaction that will be checked and audited by the miners that record the transaction and the nodes that validate the blocks. All third parties.

In short: you can only pass value along. You can’t make copies of the data, you either keep it in your wallet, or your send it to another wallet. KEY NOTE: you have UNIQUE data, that only an owner (or owners) of the public key can alter by sending the data forth. Either by sending Bitcoin to somebody or by interacting with a smart contract, all will alter the data and create new unique data (where the old state is lost and can’t be reproduced).

Question remains here whether it actually qualifies as “triple entry accounting”, but more about that in the “all about accounting” course.

To summarize: we first had the single-Entry System, but a big down side was that it is limited in accounting records (only profit & loss) and equally important: Error Checking is not built in! If the single-entry bookkeeper mistakenly enters, say, a revenue inflow as $10,000 when the correct value is $1,000, the error may go unnoticed until the firm receives a bank statement with an unexpected low account balance. In a double-entry system, however, the $1,000 cash deposit entry (a debit to an asset account, cash on hand) will be accompanied by another entry recognizing the source, for example, a credit to a liability account (e.g., bank loan) or a credit to another asset account (accounts receivable). And, if the firm omits the second entry, the sums of credits and debits in the system would differ, immediately revealing the error.

Double Entry accounting to the rescue, integrated error checking. One “minor” problem remains, there is a trusted third party involved with the power to alter the ledger and create fictional entries (also brings the three main risk categories as we discussed in level 1!). As we will show next is how Bitcoin solves this problem: by continually referring to the entire past of a transaction and more importantly: fully send that transactions (and its past) as unique data to a new owner and not just a part of the transaction. Like the definition of computing transaction already stated in the very first source: a transaction is “a (1) single unit, (2) processed in totality or failed”! Verified by third parties (triple entry accounting).

2.6.4 Bitcoin Transactions – the mechanics of “transaction based” blockchain accounting

Here are some overviews that tells you nothing that we haven’t told you, but does a good recap to start with.

Source

In this overview you see that miners “verify”…But what? And how? What is happening here?

At “verifying” the miners check whether the send transaction (“tx”) is valid. The tx is valid when (among other things): 1. The sender of the public key proves he/she/it owns the private key (remember private – public key pairs?) 2. When history has shown that the public key actually (1) received the tx in the past and (2) hasn’t spent it.

When you receive a transaction, you receive a so-called unspent (u) transaction (tx) output (o) = UTXO. It is unspent, because you yourself still haven’t spent it. It will become a spent transaction for the previous owner. A UTXO is therefore the equivalent of (a part of) bitcoin, it merely states the amount of spendable bitcoin.

So every block new bitcoins are created (“born”): in the coinbase the miner is allowed to send a number of bitcoins to their account (based on the protocol, currently in August 2019 12,5 BTC per block). The protocol / rules also state that the miner needs to wait 100 blocks before they can spent the bitcoins. The first block, the genesis block, has therefore created the very first bitcoins. A “small” problem: approximately 1.000.000 bitcoins are mined the first 20.000 blocks and are most likely owned by Satoshi. They still haven’t moved since then, and are therefore still recorded as unspent transactions (UTXO’s a.k.a. bitcoins). Step-by-step approach of bitcoin transaction (simplified):

Step 1: a single unit transaction of 12,5 bitcoins are born in the Coinbase of a freshly new block (so not “12,5 units of 1” bitcoin, but “1 unit of 12,5 bitcoins”. Because the miner can’t spend this transaction for 100 blocks and therefore still hasn’t spent it, the transaction is recorded as an unspent transaction output of 12,5 bitcoins. Note: spending = sending the transaction to another address.

Step 2: after 100 blocks the miner can send the transactions to another public key = “spending” the bitcoins. For example to the public key of the energy supplier to pay for used energy in the real world.

Step 3 - Scenario 1: costs of energy are 12,5 bitcoin. The wallet takes the 1 single unit (12,5 bitcoins) and sends it to one address: 12,5 to the public key of the supplier. The UTXO is recorded as “spent” for the public key of the miner and as “unspent” for the key of the enerhy supplier. The fee is ignored in this example. Fee is currently +/- 20 satoshi per byte, median tx is 226 bytes, so 4,520 satoshi (1 bitcoin = 100.000.000 satoshi’s). Note: the fee changes fast, based on demand. A nice overview (in dollars), can be found here. Normally the sender needs to pay for this fee, so the miner needed to send the 12,5 btc + a bit of fee.

Step 3 - Scenario 2: cost of energy are 10 bitcoins. Here comes the trick: The miner still sends the full transaction of 12,5 BTC (remember the single unit in the computing definition?!). The wallet software sends it times to two addresses, (a return address is added!). Which means that the single transaction of 12,5 BTC goes: (1) for 10 BTC to the PK of the supplier, (2) 2,5 BTC back to (often a new) PK of the miner (= “change” received back). So now the miner has 12,5 spent, but also a new unspent transaction of 2,5 recorded at its public key. The supplier has now a new unspent transactions unit of 10.

Step 4 the energy supplier: can spend the 10 UTXO. So let’s say they spend 8 UTXO to pay the manager, the wallet sends 10 UTXO to 8 PK of manager and 2 PK back to own wallet. What remains is a new UTXO of 2, waiting to be spend.

Step 4 the miner: can spend the 2,5 UTXO, let’s say 1 UTXO to the PK of the grocery store. The wallet sends 2,5 UTXO to 1 UTXO in the PK of the grocery store and 1,5 UTXO to a return address.

So how does this all work?

Because you need to wait for your change, you can only send one transaction output per block. After the block you received your change back and can spend the change.

Your wallet can also combine multiple unspent transactions into one new transaction, creating a new unspent transaction for the receiving party. So let’s say the miner has paid the energy supplier 12 times, and every time receives 2,5 UTXO unit back. The wallet can combine these 2,5 UTXO and send them to one public key as 25 btc (if you need to pay somebody 25 btc for example). If you needed to pas somebody 4 BTC, the wallet would take 2 x 2,5 UTXO and send 4 to one public key and the remaining 1 back as 1 UTXO to the own account.

A miner checks the history of the transaction, by using “hash pointers” as we will learn later. Every block the miners update the state of the ledger: which public keys hold which UTXO’s. The ledger only records these transactions and their entire history. The miners therefore follow the transaction outputs, and not the accounts (public keys)!! This is why bitcoin is called a transaction based ledger system.

What’s happening here? – recap

• Nodes keep track of the UTXO’s - a reference to a transaction received and not yet send forward yourself. In that case you have a transaction that has not yet been spent, an unspent transaction. Everyone on the network agrees that you (your public key) have received the transaction and that you have not yet spent it and they are all in agreement about that (the SSOT).

As soon as you spend this, = send the UTXO = the single unit of data, to another public key, the transaction is recorded as 'spent’ for your public key and “unspent” for the next public key.

So, after creating a bitcoin in a block, you get a whole series of referrals, a sort of decentralized consensus of different nodes that agree on the history of the current unspent transactions.

So the Bitcoin blockchain is currently nothing more than a decentralised distributed ledger with 10.000 nodes all in consensus on what public keys hold what unspent transactions outputs. “And that’s all”

To summarize previous parts: keeping the blockchain is mainly keeping track of transactions that have not yet been issued (unspent transaction outputs = UTXOs). A Bitcoin is therefore actually a reference to a transaction received and if you do not yet issue it yourself, in that case you have a transaction that has not yet been issued = a bitcoin is nothing more than a reference to the past where you received a transaction input from somebody else! Everyone on the network agrees that you (your public key) have received the transaction and that you have not yet issued it. As soon as you spend this, so connect another public key to the UTXO, the transaction is for your 'spent' and for the next public key 'unspent'. So, after creating a bitcoin in a block, you get a whole series of referrals, a sort of decentralized consensus of different nodes that agree on the trajectory of the

Why do these UTXO’s have value? The only thing the book currently does is watching: where are all of the UTXO’s now. Why does this has value?! 1. An UTXO is a intangible asset, just like the other examples of intangible assets we encounter (derivates, money in the bank ledger accounts). 2. This time the underlying value is not the promise of a bank paying you back (credit based fiat money, 98% of current fiat), a government paying you back (government fiat, 2% of fiat) or a stock or a derivative of that stock of a company promising you returned cash flows. Or a derivative of derivative of a derivate (housing bubble in 2008, still haven’t watched the big short ?!) 3. So this time the value it is not based on “trusting a TTP”, but still isn’t neither based on a physical commodity like gold, jewels etc. (which are only worth something because we deem that worthy, because they are hard to acquire for example). Value = subjective over time and changes. 4. So bitcoins, UTXO’s, are intangible commodities. We already did a comparison with gold, but the same goes for other commodities with limited real life use-cases. But this time this intangible commodity harbours some neat properties because: - no TTP’s and no intervention is possible. You own the UTXO and you alone - a decentralised ledger is not significantly more secure, but also censorship resistant, open network, borderless, etc. etc. - It is scarce, supply is limited, it is a collectible, a rarity. - An UTXO harbours enormous amounts of energy, has a lot of similarities with the “energy dollar”. Data representing energy = data representing one of universe most valuable resource! As we seen economies often align with energy consumption in the past. This time though represented / registered in worlds most secure ledger and secured by enormous power (digital walls). - Currently important for example as international value transfer (remittances), protect purchasing power (Venezuela) or as a store of value and hedge instrument (non-correlation with other markets). - It removes TTP’s thresholds, increasing transaction cost efficiency and create a more levelled playing field for the commons. - I think we have covered the value of an interconnected borderless already in part 1 !

2.6.5 Additional part: bitcoin mechanics 2.0 There is a small part in the Coursera video where they talk about the mechanics: https://youtu.be/t3hJsFpPmXs?t=908. To ease your mental pain a bit, here a short additional explanation: EXPLANATION / VISUALISATION 1 I as a sender stop $ 10 with unique transaction ID 123456789 in your public safe / key. Before I check the deposit in your safe miners the $ 10. I do not know the private code / key of your vault, so once in your public vault, I will never be able to access the money without your code. Only you as owner / receiver knows the combination safe & code and therefore can also be the only one with the money and passing on / issuing.

99.9% of the transactions concern the above scenario and are followed 1-on-1 by script. Two people are also involved in the script. Part 1 is for the recipient: 1. Take your private key (code safe) = 2. and open your public address (open the safe) =

Part 2 of the script has been given by me as a sender (security conditions): 3. I uniquely send $ 10 ID123456789 to your secure public safe so that only you can get it = OP_DUP OP_HASH160 = . 4. As soon as you claim the money, I check whether you are in front of the good vault = does the vault number you now represent () Match the vault number where I put the money (OP_EQUALVERIFY) 5. Enter the correct code = OP_CHECKSIG

How does the script know if you have entered the correct code? Only with the private code you can transfer the $ 10 bill and send it (see step 3). To be able to forward these you can only send $ 10 ID 123456789, in other words: to be sent through, the money must be removed from the vault (= be stripped of the old public key / safe / lock). You cannot leave the safe closed and with lock and all forward to the next person with the statement "there is $ 10 123456789 in" because that does not allow the miners.

Another explanation from the Nicosia Introduction MOOC (highly recommended MOOC!):

EXPLANATION / VISUALISATION 2 The blockchain is a chain of registered transactions in various blocks (database), where both the individual transactions (Tx) and the block (block header) are linked to previous blocks with hash pointers. The owner of a token refers to previous blocks where they refer to the unspent transactions output (UTXO) towards their public address. When they forward the transaction, the transaction is "spent" for their public address and therefore unspent for the next public address. Decentralized miners provide consensus on both the validity of these transactions, where the order is essential to prevent double spending. Upon approval, they present the new block to all nodes in the world.

But what does the transaction chain (blockchain) look like? The transaction: https://www.youtube.com/watch?v=sKnsDjtXPsU The Blockchain: https://www.youtube.com/watch?v=FrfY6xj0GFg Visualisation:

Also interesting is Matt Thomas blockchain sessions on YouTube: https://www.youtube.com/channel/UCbXiy1W_1HSMawmBDfo_TOA

EXPLANATION / VISUALISATION 3 the real deal and meta-data So far still no zeroes and ones (bits), and we mainly saw a human readable front in Matt Thomas his example. Between the Matrix styled bits & bytes and the human readable user friendly front end is another phase of visualising transactions. Readable for the techies, but not for the “noobs”. This phase contains the input and outputs (which we explained) and a sort of “household / clean-up” data called the meta- data. The meta-data is used by the software to compose transactions and give the some properties, like for example the lock time that states how many blocks we need to wait before we can spend the transaction. Take a quick peek to these slides from the Princeton MOOC (if you can’t follow but you want to, just watch the Princeton MOOC):

Okay, okay, this last one isn´t fair. We will dive in those later on, because remember: this is just the introduction to blockchain technology . More about this type of content in level 3 where we dive in the nitty gritty parts of mechanics. Can’t wait? Once again: watch the Princeton Cryptocurrency course!

2.6.6 Ethereum Transactions – the mechanics of “account based” blockchain accounting

You may have noticed a change in title here. Where we were talking in Bitcoin about transaction based accounting, we switched in Ethereum towards account based accounting. The transaction-based system = each transaction is followed separately by independent individual parties, all of whom follow the same agreed consensus rules. If desired, the transactions can be collected per user. The transaction is therefore followed by the administration and is leading, not the “account” holding it. This has a lot of similarities with single entry accounting, only this with a triple entry accounting sauce (third party verification in a transparent ledger). The accounts based system = administration per account number ("account"). This can be, for example, a bank account number or a general ledger account. The transactions are registered per account and the new balance is calculated by a central party (in this case a bank or the company accountant). This is similar to the double entry accounting system. Only this time, in Ethereum’s case there is less dependency on TTP’s and every transaction is still verified by third parties.

In short: (1) Ethereum = account based accounting, where the miners track the accounts and keep up the state of the accounts.

(2) Bitcoin = transaction based accounting, where the miners track the transactions and keep up the state of the transactions (where are they currently residing).

(!!!) This seemingly small tweak in accounting, from transaction based in Bitcoin to account based in Ethereum, makes a huge difference! In Ethereum we record the state of accounts (= how does the data looks like per public key) instead of the state of transactions (= where are the unspent transaction outputs). This enables Ethereum Virtual Machine to calculate and compose transactions that change in state WITHIN the account as well, so not only between accounts. So where Bitcoin miners record changes BETWEEN accounts, Ethereum record changes BETWEEN and WITHIN accounts. Within accounts = the data (value) is changed in the account (public key) without transferring data (value) to another account (public key). So the data only transfers / changes within the public key, made possible by the code that lets the data run a certain course (sounds familiar?). Once again: the state of the ledger changes, while no data is exchanged between accounts but within accounts. A dummied down example would be:

Person A owns $10. Person B owns $10. In Bitcoin you can only send the $’s between the persons. In Ethereum you also have an automated code (“smart contract”) which you, as person A or person B, can give input to move the $10 from your left pocket to your right pocket. Person A still has $10, person B still has $10, but person A moved the 10$ from left pocket to the right pocket.

Why is this important? As mentioned: this might seem like a minor change in accounting, but enables an entirely new world of automated smart contracts 😊! A smart contract can change the state of a public key, for example move data from spot 1 (left pocket) to spot 2 (right pocket). In Ethereum not only huge private numbers become public keys, but also a set of code / a written smart contract can be hashed into a public key on its own. This way you can update the state of the ledger when a smart contract runs but doesn’t send value (move money between pockets).

Small nuance: Bitcoin can do smart contracts as well, but in smaller fashion. More about this in later courses.

Reread red sentences above until you understand it……

……And once more please, just to be sure

Because we assume we have extended, and most likely went beyond your limitations at the moment, we leave this part optional for you as a student in this phase. If you want to learn more about the mechanics of Ethereum, start with this article and you will come a long way: https://www.preethikasireddy.com/post/how-does-ethereum-work-anyway. Later on, in level 3, will we discuss way more details where we discuss this article and the second book of Antonopoulos: Mastering Ethereum!

2.6.7 Component approach (finishing recap)

So instead of just a random number hashed (public key Bitcoin), Ethereum adds (in addition!) also the possibility to hash written software code. The outcome of the hashed data, is still the same. As shown in section 1: it doesn’t matter what data you hash, the length of the hash is still the same. This is because, where we read text, a computer still reads a number (so it still hashes a huge random number).

So now we can add more data in a public key and program that data (= write code in it / create a digital decision tree). Important is that you realise that you can’t alter the code later on, because then the data is altered which leads to a different hash / public key. So when you aim to automate the recording of transactions you need to take into account all the components in advance. Not only the different variables and entities, but also the different scenario’s / possible outcomes need to be accounted for.

Further readings

• Definition transaction: http://www.businessdictionary.com/definition/transaction.html • Why bitcoin is an accounting revolution: https://medium.com/@permabullnino/bitcoin-an-accounting- revolution-40efcb903d7b • Explanation cash based ledger / single entry accounting https://www.business-case-analysis.com/cash-basis-accounting.html • Explanation Unspent Transaction Output (UTXO): https://www.investopedia.com/terms/u/utxo.asp • Read more about single entry accounting: https://www.business- case-analysis.com/single-entry-accounting.html • Short clip explaining double entry accounting: https://www.youtube.com/watch?v=ijPDIy6gXxc • Double entry explained: https://www.business-case- analysis.com/double-entry-system.html • Accrual reporting system: https://www.business-case- analysis.com/accrual-accounting.html • Chart of accounts: https://www.business-case- analysis.com/account.html • Quality of audits under desired level (Dutch): https://www.accountant.nl/nieuws/2020/1/nba-cta-rapport-is- scherpe-analyse-van-de-sector/ • Append only ledger explained: https://redislabs.com/ebook/part-2- core-concepts/chapter-4-keeping-data-safe-and-ensuring- performance/4-1-persistence-options/4-1-2-append-only-file- persistence/ • Visualisation of how a bitcoin transaction works: https://www.zerohedge.com/news/2013-05-12/visualizing-how- bitcoin-transaction-works • Visualisation of the bitcoin transaction life cycle: https://www.weusecoins.com/images/bitcoin-transaction-life-cycle- high-resolution.png • Overview bitcoin transaction fee in $: https://billfodl.com/pages/bitcoinfees • Explanation of bitcoin change: https://www.youtube.com/watch?time_continue=4&v=BuUPKC6rFlE&featu re=emb_logo • Princeton Cryptocurrency MOOC: https://www.youtube.com/watch?v=t3hJsFpPmXs • Bitcoin mechanics explained (Princeton course): https://youtu.be/t3hJsFpPmXs?t=908 • Free Nicosia Master MOOC: https://www.unic.ac.cy/blockchain/free- mooc/ • Example visualised bitcoin transaction (Matt Thomas): https://www.youtube.com/watch?v=sKnsDjtXPsU • Recording of the transaction on the Bitcoin Blockchain (Matt Thomas): https://www.youtube.com/watch?v=FrfY6xj0GFg • Visualization of the transaction via www.blockchain.info • Matt Thomas Blockchain course: https://www.youtube.com/channel/UCbXiy1W_1HSMawmBDfo_TOA • How does Ethereum work anyway? https://www.preethikasireddy.com/post/how-does-ethereum-work- anyway Recap Single entry Single-entry accounting is a form of bookkeeping and accounting in which each financial transaction is a single entry in a journal or transaction log (system is called single-entry system, the approach single-entry bookkeeping With the single-entry approach, each financial event calls for just one accounting system transaction Firms using single-entry approach are effectively limited to reporting on a cash based ledger system: you either have the asset or you don’t. Simple, but limited: It does NOT allow for recording debits (assets people own you) or credits (assets that you owe people). Bitcoin combines computing with a cash based accounting system = you either own the data / bitcoin (= Unspent Transaction Output = “UTXO” = the number of spendable bitcoins) or you don’t.

Double entry The single-entry approach contrasts with double-entry accounting, in which every financial event brings at least two equal and offsetting entries (equal in amount!). One is a debit (DR) and the other a credit (CR), resulting in an accrual reporting system. Focus on Revenues, Expenses, Assets, Liabilities, and Equities. A double-entry system keeps the firm's entire "Chart of accounts" in view, in other words: it presents “the state” of the income statement (just like Ethereum presents the world state of transactions per block). The administration is almost always conducted in private accounting, in closed-off environments. It does not work optimally because these accounting ledgers can’t or won’t communicate with each other, creating walled silo’s. This system works on the basis of "trust", something that must be strengthened by, among other things, audits by external parties such as an accountant. The information age seems to be asking for a call for more transparency, and regulators are trying to meet this.

“Triple” Entry (new accounting revolution?)

“Triple Entry” (or actually single or double entry, depends on the blockchain, but all with included Third Party Verification on every transaction). We will learn in a few minutes that Bitcoin uses transaction based accounting (entering transactions like single entry accounting) and that Ethereum looks more like double entry accounting (entering account based transactions). But before we dive in those, what’s new here?

4. The recording of transactions are cryptographically secured. History can’t be altered when recorded!! Also known as append- only systems. The advantage of append-only storage is that the database is “immutable”, it keeps an entire history of all the transactions that have been done. Read more about it here. 5. Near instant verification by multiple external parties, proving that the transaction actually happened 6. The transactions contain data that can automatically execute itself / change its own state (= no TTP or accountant needed, the so-called “smart contracts”)

Like the previous mentioned article about Bitcoin and accounting stated: Bitcoin is the first accounting system to ever provide absolute assurance over ledger data

So we first had the single-Entry System, but a big down side was that it is limited in accounting records (only profit & loss) and equally important: Error Checking is not built in! If the single-entry bookkeeper mistakenly enters, say, a revenue inflow as $10,000 when the correct value is $1,000, the error may go unnoticed until the firm receives a bank statement with an unexpected low account balance. In a double-entry system, however, the $1,000 cash deposit entry (a debit to an asset account, cash on hand) will be accompanied by another entry recognizing the source, for example, a credit to a liability account (e.g., bank loan) or a credit to another asset account (accounts receivable). And, if the firm omits the second entry, the sums of credits and debits in the system would differ, immediately revealing the error.

Step-by-step approach of bitcoin transaction (simplified):

Step 4 the miner: can spend the 2,5 UTXO, let’s say 1 UTXO to the PK of the grocery store. The wallet sends 2,5 UTXO to 1 UTXO in the PK of the grocery store and 1,5 UTXO to a return address.

This is all very well described and explained in this course from Princeton. We highly recommend watching the entire course, but we can imagine that you might be drowning in information already. If you truly want to excel, do yourself a favour and reserve a day or two to watch the course. To summarize previous parts: keeping the blockchain is mainly keeping track of transactions that have not yet been issued (unspent transaction outputs = UTXOs). A Bitcoin is therefore actually a reference to a transaction received and if you do not yet issue it yourself, in that case you have a transaction that has not yet been issued = a bitcoin is nothing more than a reference to the past where you received a transaction input from somebody else! Everyone on the network agrees that you (your public key) have received the transaction and that you have not yet issued it. As soon as you spend this, so connect another public key to the UTXO, the transaction is for your 'spent' and for the next public key 'unspent'. So, after creating a bitcoin in a block, you get a whole series of referrals, a sort of decentralized consensus of different nodes that agree on the trajectory of the

Ethereum Transactions – the mechanics of “account based” blockchain accounting

You may have noticed a change in title here. Where we were talking in Bitcoin about transaction based accounting, we switched in Ethereum towards account based accounting

Small nuance: Bitcoin can do smart contracts as well, but in smaller fashion. More about this in later courses. 2.7 Ecosystems & Commons

You now understand the field (crypto-flower example), the rules and referee (protocol), the players and their tools and even the ball (transactions). But…for whom are we playing this game? Well other than inherent in its design of open public blockchains is the fact individually every player plays for its own benefits, but all together they play for the Commons. So let’s introduce in this section the big question: “why are we doing all this?!”

2.7.1 Introducing the commons So who, or better said, what are the commons?

The commons is the cultural and natural resources accessible to all members of a society, including natural materials such as air, water, and a habitable earth. These resources are held in common, not owned privately.

Commons can be also defined as a social practice of governing a resource not by state or market but by a community of users that self-governs the resource through institutions that it creates.

Each stakeholder has an equal interest.

Examples of commons:

Environmental resource (air example)

Cultural and intellectual commons

Digital commons (Wikipedia & FOSS) Urban commons

Knowledge commons These resources may be part of the natural world (e.g. forests, climate systems, or the oceans) or they may be created (e.g. infrastructures such as irrigation systems, the internet or (scientific) knowledge, for example of the sort that is published in open-access journals). For detailed examples per category, see previous Wikipedia source. Another interesting example of a digital common is Linux. Or in the blockchain realm the DAO, the decentralised autonomous organisation. The DAO as a common: self-sovereign entities generating “value”. Could be generating clean air, but also actual “money”. Example: a DAO Forest “Terra0”.

As you might experience yourself already, it is not always clear when something is a common. We need to better understand this institutions and for that many initiatives, like the commons journal, exist. The IASC is the international Association for the Study of the Commons. We still have a very long way to experience and understand the things we share beyond the enclosed spaces of private and public property A good place to start to understand if something is a common or a public good is to ask: Does this particular resource require management as a social mandate (= public good) or is it an expression of social mutuality and collaboration (= common)? In other words, is this property best maintained by government (= public good) or the public (= common)? Note: a public good is therefore not a fully public good owned by the public. Often some form of centralised governance is in control and remember the three main risk categories of centralised power…? This is a useful starting place, yet it raises further questions.

If you want to do a deep dive, which is recommended, go check out this article! An example: who is responsible for the internet or clean air? Is it all of us? Is the G20? Are it the corporations? Or is it us the public? So far we opt in for the more centralised versions, but how is that working out? “Over the past few decades, the intergovernmental system has proclaimed its capacity to meet the needs of the world’s population and environment through global public goods. This concept – a hybrid of Keynesian internationalism and corporate/financial neoliberalism – illustrates the lack of understanding and vision in the present management of the global commons.” In more simple terms, just ask yourself this: are we heading in to the right or wrong direction regarding our commons (natural like water & air or for example the digital commons like the internet)? Or what about the Quantitative Easings and unlimited printing and devaluation of Fiat in this world? Why are they sliding down hill? Current (centralised) infrastructures and institutions don’t seem to work. And for that we need to take a look at something called the tragedy of the commons.

2.7.2 The tragedy of the commons This short clip + this short clip explains the tragedy of the commons very well. Tragedy of the commons in short is the tendency of any resource that is unowned, and hence nonexcludable, to be overused and undermaintained. This is not a current day problem and existed long before our generations. As Aristotle already mentioned 2400 years ago (!): “what is common to the greatest number, gets the least amount of care”. The problem of our generations though is that our world is getting increasingly smaller and better interconnected because of new technologies. Hence, this amplifies and rapidly increases the speed in which we now need to solve this tragedy. So aren’t there any solutions to avoid the tragedy of the commons? Yes, but there is no single universal cure that will work in all conditions. There are currently three general groups: 1. Command and control / Regulation (Hardin) 2. Creating property rights (Hardin) 3. Cultural norms / bottom-up institutions (Elstrom)

Problem in current systems, where centralised parties still hold control, is something we previously encountered and called the “Coase Theorem”: the more parties required to make an agreement, the more transaction costs, the less likely an agreement is to actually happen.

If only we had a technique that incorporates transparent rules (1), that designed from bottom up norms in an open environments by peers (3) creating individual property rights of assets (2)… See here the end game of blockchain technology: a tool to create a better infrastructure to enable solutions suited for the Tragedy of the Commons. Because of properties like increased transaction cost efficiency, transparency, immutability, decentralised ownership and incorporated compliance including third party audits on each transaction it offers a solution for the Caose Theorem (because transaction costs are low and property rights are clearly defined: “if transaction costs are low and property rights are clearly defined, private bargains will ensure that the market equilibrium is efficient even if there are externalities. Markets can be used to control externality problems”).

In addition, as you might have caught yourself already as well during the clips, individual incentives are extremely important. Incentivizing individuals by transferring value between them (through cryptocurrencies) is one of the main design elements of blockchain technology as well. Problems like tragedy of the commons arise when the interest of the individual are not aligned with the general interests. This is something you can steer with token-design, as Satoshi has proven with proof-of-work mining where the interests of the individual miner (mining bitcoin) is in the interest of the ecosystem as well (validating transactions and adding security to the blockchain). More about this in the “ecosystem” & “game theory” part of this chapter !

One of the fundamental questions here is whether we as a species can come to a solution together or if we are just like parasites or viruses: expanding and killing our host, killing our source of food and therefore killing ourselves? Should we keep doing what we are doing and slowly kill our host? Or shall we change course and look for solutions? What is needed? That we will see in next paragraph.

2.7.3 The rules for successful commons While the original work on the tragedy of the commons concept suggested that all commons were doomed to failure, they remain important in the modern world. Work by later economists has found many examples of successful commons, and Elinor Ostrom won the Nobel prize for analyzing situations where they operate successfully. For example, Ostrom found that grazing commons in the Swiss Alps have been run successfully for many hundreds of years by the farmers there. Allied to this is the "comedy of the commons" concept, where users of the commons are able to develop mechanisms to police their use to maintain, and possibly improve, the state of the commons. Other related concepts are the inverse commons,. It is argued that some types of commons, such as open-source software, work better in the cornucopia of the commons; proponents say that, in those cases, "the grass grows taller when it is grazed on". Other examples of successful open source projects (other than Linux): Further reading: 20 examples Further reading: 8 other examples

According to Elstrom her research the following 8 principles need to be held uphold. Check critically (always critically!) for yourself if the fundamental properties of blockchain sufficiently act according to all these principles.

1. rules are clear 2. rules are shared by community 3. decision-making is democratic 4. conflict resolution is local and public 5. sanctions are graduated 6. cheap & accessible conflict resolution 7. users themselves check compliance to rules 8. rules don't conflict with higher laws

Once more but a bit better formulated by our friends from Wikipedia 1) Clearly defined (clear definition of the contents of the common pool resource and effective exclusion of external un-entitled parties); 2) The appropriation and provision of common resources that are adapted to local conditions; 3) Collective-choice arrangements that allow most resource appropriators to participate in the decision-making process; 4) Effective monitoring by monitors who are part of or accountable to the appropriators; 5) A scale of graduated sanctions for resource appropriators who violate community rules; 6) Mechanisms of conflict resolution that are cheap and of easy access; 7) Self-determination of the community recognized by higher-level authorities; and 8) In the case of larger common-pool resources, organization in the form of multiple layers of nested enterprises, with small local CPRs at the base level.

Do open public blockchains fully match with these properties? Just think about bitcoin not being accepted in every region (#8) or the centralized decision making in open public blockchains as seen with Bitcoin developers pushing through upgrades or Ethereum Forks(#3). Not yet a perfect match. Yet ! Luckily this is something we can all work on. Comparing current society and current open public blockchains opens up room for debate and with it many new routes for improvement. It is a two-edged sword if you are the current form of governance (Government of a country for example). If you don’t move forward to a better Common Infrastructure we don’t seem to be able to tackle these global challenges. Global challenges ask for a global infrastructure. But will you as a government install new legislation as long as open public blockchain still harbor centralized components? I can only imagine that current centralized institutions like governments won’t be all that happy to transfer their power by new laws to new centralized entities. Ignoring the question if you can even stop this decentralized new global decentralized infrastructure with local laws (take Venezuela & Bitcoin for example). You compared the 8 rules for commons with an open public blockchain, and although it wasn’t a perfect score, it is a more than decent score (it suffices on many of the criteria). Another question / food for thought: how well does the current centralized infrastructure of governments and companies score in this rules-set for the Commons? Do you know understand the “usecase” of open public blockchains? It is to build a new infrastructure for the commons. Whether that is global money (bitcoin) or global governance (Ethereum), the aim is to become a globally adopted digital common. Build by everybody, governed by everybody, for everybody. Just remember though: we are a very far way from that ideal situation and we always need to remain very critical, but with an open mind!

2.7.4. Fat Protocols So the goal here is to transform from the Tragedy of the Commons to the Wealth of the Commons. The question stated in this Medium post is a legit one: how can crypto-powered businesses create new types of abundance? Of course there are often initial investments needed to build these commons, but why build a new protocol other than from the good of your heart? Joel Monegro’s fat protocol thesis is a very important idea in that regard and we highly recommended this short read. To summarize: the value transfers from the “fat” (= valuable) application layer, to the thin protocol layer. With current protocols like the Internet we have a thin protocol layer (the internet itself doesn’t catch much value, but applications like Google, Facebook and Uber do). With blockchains it is the other way around: the more people that uses the blockchain, the more valuable the protocol layer will become. Because of the open source character and transparency in open public blockchains, applications can’t catch much value (because they are easily copied and improved by others). To give a comparison: on the internet you can build big companies in closed off environments, like Google and Apple, that are getting increasingly bigger and bigger because they can harvest data and hide their algorithms. In open blockchain environments not only the data is accessible by everyone, but so is your code. The value is therefore not be caught by one party that builds the application, but by the protocol. Caught by the tokens, the currency, active in that specific protocol. In short:

Because some of you might not read the article: “…the main point remains: by replicating and storing user data across an open and decentralized network rather than individual applications controlling access to disparate silos of information, we reduce the barriers to entry for new players and create a more vibrant and competitive ecosystem of products and services on top. As a concrete example, consider how easy it is to switch from Poloniex to GDAX, or to any of the dozens of cryptocurrency exchanges out there, and vice-versa in large part because they all have equal and free access to the underlying data, blockchain transactions. Here you have several competing, non-cooperating services which are interoperable with each other by virtue of building their services on top of the same open protocols. This forces the market to find ways to reduce costs, build better products, and invent radical new ones to succeed…….. ….This is a big shift. The combination of shared open data with an incentive system that prevents “winner-take-all” markets changes the game at the application layer and creates an entire new category of companies with fundamentally different business models at the protocol layer. Many of the established rules about building businesses and investing in innovation don’t apply to this new model and today we probably have more questions than answers. But we’re quickly learning the ins and outs of this market through our blockchain portfolio and in typical USV fashion we’re going to share that knowledge as we go along.” A second post that dives a bit further, and interesting as well: click here.

2.7.5 So now what? Well…in short: the blockchain community will keep on building for obvious reasons. Not only because they can, or they aim to improve failing structures, but as you know now also because they are incentivised in multiple ways to do so (financially as well by holding parts of the cryptocurrencies of the protocol that they are building). But how does the rest of society adapts? The blockchain applications are already finding their way to the users, so this seems to be a “from the bottom-up” movement, reforming societies institutes. Hard to stop by current institutes. Not only because of a lack of knowledge, but also because of limitations in jurisdictions and perhaps most important: different incentives and belief systems. Different groups need to share similar (digital) commons, explained shortly here in the end of this video.

The world seems to be on the tipping point, heading to create a new global social contract. Could be protocol based like Bitcoin or Ethereum, but also based on the application layer with open public smart contracts. New social contracts, with global reach. For legitimate forms of commons democracy to be rooted in and distributed across all political communities, a major reconfiguration of socio- economic relations, rules and institutions is needed. This takes time, not only for users to adjust to new applications but also for institutions to adjust. They may even remain a use case for the former institution or infrastructure, horses are still (rarely) visible on the road sometimes (hopefully not on the highway though 😊). To this end, common goods offer the possibility of a legal and constitutional basis for democratic global governance. In bringing this platform forward, truly to the next phase of worlds next infrastructure, the world’s people must organize their local commons, declare their sovereignty as global citizens, and call upon governments to acknowledge the natural rights belonging to all human beings and life-forms across the planet. We in the Netherlands are lucky so far, and we are currently exploring multiple ways to create so-called self- sovereign identities (SSI’s) where citizens privacy increase. Neither the government nor we Universities don’t know the exact routes, so if you want to help in this quest visit www.koios.online/ssi To take up a notch (from previous source as you might have recognized): The people’s contract for global citizenship will empower resource communities and civil society organizations to create trusteeships, which include but transcend parliamentary forms of governance, giving them a democratic means for voicing local claims to self-determination outside the state system. By this means, national sovereign authority may be renegotiated in terms of commons resource areas and bioregions. Resource users and producers/providers would then make direct decisions on all common properties of significance, holding and managing them for future and existing generations and species. Since every resource domain is unique and so many commons overlap, commons management would be deliberated through local, state, interstate, regional, and global stakeholder discussions. In this way, democratic commons institutions would operate at every level of governance independently while overlapping at the same time.

Obviously, the development of global governance is an enormous challenge. The basis of the sovereign state must be entirely reformulated. By agreeing to a new foundation for common goods in social and economic laws and institutions, the state will have to reduce the dominant role of private goods and recognize the moral and political legitimacy of people’s rights to preserve, access, produce, manage and use their own resources. This means developing a new epistemology of resource sovereignty, shared responsibility and legal accountability that recognizes the rights of world citizens to their commons. When the self-organized and participatory systems of common property, social charters and commons trusts are infused into global constitutional governance, the checks and balances that already exist within many nations will find a more perfect expression in the representative decision-making and political equality of democratic commons institutions. The new global economic system and its social contract will be grounded, not in corporate claims or state sovereignty, but in the sovereign rights of citizens to their common goods.

This might happen sooner than you think. Just remember: “sci-fi today is reality tomorrow” (with a bit of optimistic thinging ). People and communities are experimenting with decentralised nations like Bitnation Pangea and many many more. You can build your own decentralised nation. Of course a long way before we are there, but……

Imagine there's no countries It isn't hard to do Nothing to kill or die for And no religion, too Imagine all the people Living life in peace... You...

2.7.6 From ego- to ecosystems Hence the challenge of our generation to move from ego-orientated systems, resulting in a select group of entities getting more and more powerfull and accelerated by new technologies, to eco-system orientated systems. First signs already slightly visible, from the masses to the more theoretical parts of society. This is why we from KOIOS.online offer free education, simply because we don’t know the answers nor the routes and aim to co-create curriculum together = the power of the masses.

Okay….but wait a sec? What is an ecosystem?! In short: we have multiple forms of ecosystems, in general natural ecosystems and digital ecosystems. Since we are talking about digital realms here, let’s refrain from diving into natural ecosystems. These natural ecosystems are the very basics of digital ecosystems though: “A digital ecosystem is a distributed, adaptive, open socio-technical system with properties of self-organisation, scalability and sustainability inspired from natural ecosystems. Digital ecosystem models are informed by knowledge of natural ecosystems, especially for aspects related to competition and collaboration among diverse entities.”

In short, this seems to be the challenge of this century:

The topics of ecosystems and how to create and manage them is of course on of the most essential questions to ask when we talk about solving common related problems. In next level will we zoom in on these ecosystem related topics. Do note: studies in these field are still very young and our aim is to explore (and expand!) the boundaries of what we know so far. A great start is this research, that offers a “theory of ecosystems” that can explain what they are, when they emerge and why alignment occurs. It also outlines the critical factors affecting ecosystem emergence, evolution, and success ‐‐ or failure”. Applied the picture above to a blockchain based ecosystem, you might get a visual like this (high level overview): Source

2.7.7 Game theory & Token design Incentives, incentives, incentives, we humans seem to be all about incentives Key question: “How do we motivate an entity to behave a certain desired way”. Not only do you need to (1) determine what is “desired / not desired” and not only do you (2) need to know who all the entities are…you also (3) need to influence their behaviour a certain way. The first two question mainly relate to the ecosystem challenge and how to create insight in this ecosystem. “Game Theory” is all about the third question: (dis)stimulate entities.

Luckily for you, this was done before there were blockchains and computers There is a lot of information on this topic and I, as an economic, am very interested in this field. Economics can be seen as social behavioural, and is therefore a (big) part from this Game Theory field (another big component is psychology). Let’s start with the very basics in this basics course, later in further levels will we dive way and way deeper in these materials: what is game theory? And a bit more elaborated one, applied on economic theories. Also recommended: an interesting one about finite and infinite games (like war).

How does this apply on blockchain technology though? Just as game theory is about interaction between entities, we use blockchains to transfer value, which is also an interaction between entities. As you might have noticed in the above video’s, in game theory you often (1) use “value” as incentive, which can be monetary or time like a prison sentence or other values, or (2) you would need a proven history and transparency to base your actions on. A blockchain based infrastructure therefore offers a very good foundation for game theory, since it can send (micro)values and is a transparent and immutable ledger. In short: we use cryptocurrencies and tokens and badges and stuff to incentivise entities. Just think about the Bitcoin protocol rewarding miners to validate transaction in the networks native currency (bitcoin).

The “token design” is therefore an essential element to reach your final goal. If you want to offer secure borderless decentralised money, the design of the protocol and its inherent token, should be fully focussed on how to reach that goal. Bitcoin is therefore well equipped in aspects of acquiring security (hashing power), but less so in creating new forms of governance. Ethereum for example is the other way around, because their end goal seems to be different. They don’t want to offer a secure value transfer layer, Bitcoin is covering that market, they focus on creating decentralised application harbouring and facilitating new forms of governance like decentralised finance, web 3.0 or other centralised infrastructures that would improve in decentralised fashion. As you might have guessed already: if you make changes in the token design, you might end up changing the end goal of your blockchain network.

Because this field of game theory is so large, many different games (Common-payoff games, Zero-sum games, Evolutionary game) and dilemma’s (like for example the prisoner’s dilemma) we will devote an entire section about this topic in next level. This once, we stuck to the basics in this level

2.7.8 Network effects To create a well-working ecosystem of different independent entities, co-working to a shared goal, but also fulfilling their individual goals is not an easy task. Important in this design is that you design it in such a way that you incorporate the effects of the “network effects”. Network effects are essential for the adoption and survival of a new technology. An example would be the telephone. If nobody has a telephone, the value of the phone and the phone network drop significantly. But the more people have a phone, the more valuable the phone itself and the phone network become. But how do we measure network effects and with what criteria? Source: I’ll paraphrase, revise and summarize the various criteria as follows: • Size: Must be large and have scale (relative to the problem set or target community). • Inter-connectivity: Must exist between groups or systems inside the network (a basic requirement). • Engaged users: A good percentage of overall active users (about 30%) comes back often to use the service, at least daily, if not weekly. • User experience: Must be unique, original, and enable some new value creation while users are on the service. • Network effects: The value of the service increases for each user, as others use it or join it, and that value is propagated on the very network that was created. • Defensibility: Barriers to entry are gradually erected and strengthened by virtue of growing the service while it gets more valuable with each new user, also resulting in high switching costs. • Monetization: As the network matures, one or several atomic value units emerge and become the basis for sustainable economic activity.

One of the goals of a token is to capture this network effect: how to move up from one phone to a billion phones versus how to move up from one bitcoin user to a billion users. It might be too early to draw decent conclusions, but it isn’t that farfetched that the capability of tokenising value will have an enormous effect on how we catch this network effect (digital and digital representative of offline values). The combination of reduced costs, higher value capture by participants, and the powerful growth incentives that well-designed tokenized networks provide create the conditions necessary to supplant some of today’s most powerful companies. An interesting read in that regard: The Future Of Network Effects: Tokenization and the End of Extraction. Want to join that debate? Check this Twitter feed.

As you can might imagine, the world of game theory, network effects and tokenisation is an entire new world on its own. We would love to invite you to explore this realm with us in the next Economic Level. If you are more interested in the Tech part and how to build dApps, we are waiting for you in the next Technical Level. Before we see you all there, a final high level recap where we put level 1 and 2 together and create your new level of understanding how blockchains work. We will wait for you in the next level, see you there

Further Readings

- Who or What are the Commons? https://en.m.wikipedia.org/wiki/Commons#cite_note-ReferenceA-1 - Interview with the mind behind Linux - Linus Torvalds https://www.youtube.com/watch?v=o8NPllzkFhE&feature=youtu.be - DAO Forest project https://www.terra0.org/ - The commons journal: http://www.thecommonsjournal.org - IASC Commons: https://iasc-commons.org/ - Why distinguish between common and public goods? http://wealthofthecommons.org/essay/why-distinguish-common-goods- public-goods - Tragedy of the commons explained 1: https://www.youtube.com/watch?v=CxC161GvMPc - Tragedy of the commons explained 2: https://www.youtube.com/watch?v=bs2P0wRod8U - Globalisation and the commons (very short): https://www.youtube.com/watch?v=-reuq1wlwio - Coase Theorem explained: https://www.youtube.com/watch?v=00HPak2RLlQ&t=382s - Who was Elinor Olstrom? https://en.m.wikipedia.org/wiki/Elinor_Ostrom - What is open-source software? https://en.m.wikipedia.org/wiki/Open-source_software - 20 examples successful open-source software? https://www.tripwiremagazine.com/20-most-popular-open-source- software-ever-2/ - Another 8 examples (overkill, just for the fun of it): https://royal.pingdom.com/the-8-most-successful-open-source- products-ever/ - Crypto-businesses & new types of common abundances: https://blog.usejournal.com/crypto-commons-da602fb98138 - Initial investment in commons: https://econweb.ucsd.edu/~carsonvs/papers/201(299).doc - Fat Protocol Thesis: https://www.usv.com/writing/2016/08/fat- protocols/ - Fat Protocol Thesis, bit more elaborated: https://hackernoon.com/will-cryptocurrency-protocols-be-fat-or- thin-36584863b0f8 - Awesome link to most awesome platform ever: www.koios.online/ssi - Examples decentralised nations: https://steemit.com/governance/@cc-billboard/decentralized- nations-are-they-the-future - Example 1 of decentralised nation: https://tse.bitnation.co/ - John Lennon with Imagine: https://www.youtube.com/watch?v=VOgFZfRVaww - Occupy movement: https://en.wikipedia.org/wiki/Occupy_movement - Thomas Piketty capital in 21st century: https://en.wikipedia.org/wiki/Capital_in_the_Twenty-First_Century - Natural ecosystems explained: https://en.wikipedia.org/wiki/Ecosystem - Digital ecosystems explained: https://en.wikipedia.org/wiki/Digital_ecosystem - From egosystems to ecosystems: https://medium.com/presencing- institute-blog/ecosystem-leadership-4227fd214f2 - The Theory of Ecosystems: https://www.researchgate.net/publication/323916602_Towards_a_Theo ry_of_Ecosystems - Very high level overview of entities in blockchain ecosystem: https://vanrijmenam.nl/five-blockchain-trends-consider-this-year/ - Explanation game theory: https://www.youtube.com/watch?v=MHS- htjGgSY - Explanation game theory 2: https://www.youtube.com/watch?v=PCcVODWm-oY - Deeper dive game theory 3: https://www.youtube.com/watch?v=0bFs6ZiynSU - Explanation Network effects: https://en.wikipedia.org/wiki/Network_effect - Article network effects blockchain & Bitcoin: http://startupmanagement.org/2015/01/04/its-too-early-to-judge- network-effects-in-bitcoin-and-the-blockchain/ - Tokenisation and Network effects https://medium.com/public- market/the-future-of-network-effects-tokenization-and-the-end-of- extraction-a0f895639ffb - Twitter battle network effects: https://twitter.com/nlw/status/1020099428777160704

Summary

So who, or better said, what are the commons?

Commons can also be understood as natural resources that groups of people (communities, user groups) manage for individual and collective benefit. Characteristically, this involves a variety of informal norms and values (social practice) employed for a governance mechanism. Commons can be also defined as a social practice of governing a resource not by state or market but by a community of users that self-governs the resource through institutions that it creates.

Each stakeholder has an equal interest.

Examples of commons:

Environmental resource (air example)

Cultural and intellectual commons Digital commons (Wikipedia & FOSS)

Urban commons

Knowledge commons

This short clip + this short clip explains the tragedy of the commons very well. So aren’t there any solutions to avoid the tragedy of the commons? Yes, but there is no single universal cure that will work in all conditions. There are currently three general groups: 4. Command and control / Regulation (Hardin) 5. Creating property rights (Hardin) 6. Cultural norms / bottom-up institutions (Elstrom)

In addition, as you might have caught yourself already as well during the clips, individual incentives are extremely important.

9. rules are clear 10. rules are shared by community 11. decision-making is democratic 12. conflict resolution is local and public 13. sanctions are graduated 14. cheap & accessible conflict resolution 15. users themselves check compliance to rules 16. rules don't conflict with higher laws

So the goal here is to transform from the Tragedy of the Commons to the Wealth of the Commons Joel Monegro’s fat protocol thesis is a very important idea in that regard and we highly recommended this short read. To summarize: the value transfers from the “fat” (= valuable) application layer, to the thin protocol layer. With current protocols like the Internet we have a thin protocol layer (the internet itself doesn’t catch much value, but applications like Google, Facebook and Uber do). With blockchains it is the other way around: the more people that uses the blockchain, the more valuable the protocol layer will become. “…the main point remains: by replicating and storing user data across an open and decentralized network rather than individual applications controlling access to disparate silos of information, we reduce the barriers to entry for new players and create a more vibrant and competitive ecosystem of products and services on top.

Different groups need to share similar (digital) commons, explained shortly here in the end of this video.

Hence the challenge of our generation to move from ego-orientated systems, resulting in a select group of entities getting more and more powerfull and accelerated by new technologies, to eco-system orientated systems. First signs already slightly visible, from the masses to the more theoretical parts of society. This is why we from KOIOS.online offer free education, simply because we don’t know the answers nor the routes and aim to co-create curriculum together = the power of the masses.

Incentives, incentives, incentives, we humans seem to be all about incentives Key question: “How do we motivate an entity to behave a certain desired way”. Not only do you need to (1) determine what is “desired / not desired” and not only do you (2) need to know who all the entities are…you also (3) need to influence their behaviour a certain way. The first two question mainly relate to the ecosystem challenge and how to create insight in this ecosystem. “Game Theory” is all about the third question: (dis)stimulate entities.

2.8 Putting it all together: how do blockchains work? 1. Step 0: So what do we already know (version 4) 2. Step 1: The entity is represented by a public key, this can be a human, department, organisation, but for the first time in human history value can now also be send by a piece of code called a contract enabling for example machines owning public keys (you can create an automated organisation without human interfering). The entity constructs a transaction (for example collecting UTXO’s and bundle them in one transaction) and adds the public key of the recipient as well as their own private key, called the digital signature. 3. Step 2: the constructed transaction is now cryptographically secured (remember the colour blending?), and is offered to the network by the clientsoftware that talks to wallet containing the keys as well as to the network where the miners are waiting for transactions. 4. All the transactions world wide are gathered (in the “mempool” = als “unconfirmed”), and each individual miner picks the transactions and collects them until the block is “full” (full is determined by the consensus rules). The miner checks the transactions, are these transactions valid. 5. Miner solves PoW puzzel or is for example randomly selected by an algortihm (PoS) and presents the valid block to the entire network (all the nodes). Each node validate the presented block and if valid (= check if the miner abides by the protocol rules?) adds the block to their blockchain and compare the hash with other nodes. If everybody has the exact same data, every node should have the exact same hash and therefore everyone has the exact same “single source of truth” 6. We now not only have (1) a decentralised ledger, but it also enables (2) automated transactions. A new form of ledger respectively a new form of data recording, most likely resulting in new forms of society.

A decentralized peer-to-peer network (enabled by the Bitcoin protocol)

A public transaction ledger (the blockchain)

A decentralized transaction verification system (transaction script)

The Internet protocol Asymmetric Cryptography, The Hash Function & The Proof of Work concept

Open source development “Bitcoin is a collection of concepts and technologies that form the basis of a digital money ecosystem, including:

A decentralized peer-to-peer network (enabled by the Bitcoin protocol)

A public transaction ledger (the blockchain) A decentralized mathematical and deterministic currency issuance mechanism (distributed mining and the “Proof-of-Work” concept)

A decentralized transaction verification system (transaction script)” - Mastering Bitcoin

A shared global truth with no trusted third party, entering a new era of ledger technology. Leading technologists believe that the implications of this technical breakthrough will be far-reaching, extending far beyond digital currency. Imagine a public and immutable ledger that is spread across the globe, open to all and lets you record digital data. Blockchain harbors a possible promise to distribute power from central entities to the commons and cut out the middleman. Think trustless, think privacy, think self – sovereignty and owning your own data in a data-driven world. Multi-leveled explanation https://www.wired.com/video/watch/expert-explains-one-concept-in- 5-levels-of-difficulty-blockchain Why is it hard to get Bitcoin? https://www.unchained-capital.com/blog/blockchain-spectrum/

Morpheus: This your last chance. After this there is no turning back. You take the blue pill, the story ends. You wake up in your bed and believe whatever you want to. You take the red pill, you stay in Wonderland, and I show you how deep the rabbit hole goes. Remember, all I'm offering is the truth. Nothing more.

Further readings - Multi-leveled explanation https://www.wired.com/video/watch/expert-explains-one-concept- in-5-levels-of-difficulty-blockchain - Why is it hard to get Bitcoin? https://www.unchained-capital.com/blog/blockchain-spectrum/

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