Blockchain correct logo port by michael constantine

Cracking the Code â&#x20AC;&#x201C; Blockchain Technology 101

FO R EWO R D M I K K EL L A R SE N, MANAG ING DIR E CTO R DB S - F INA NC E

As a Managing Director in Finance I am not the “usual suspect” to get involved with or get excited over new technology like blockchain. Yet, I find myself just like my colleagues leading the bank’s discovery within this space. Why? I first got interested in blockchain technologies by seeing how companies help real people in emerging markets. One example is coins.ph a digital wallet that helps domestic workers living in Singapore transfer money to their families offshore at a lower cost. I think it is important to understand what type of problems a blockchain based solution is useful for. Many see blockchain as the solution for every issue that involves some public ledger when in reality there is a “distributed trust”. Whilst there is no clear “best case” emerging there are many opportunities in the financial space and these go far beyond just payments and wire transfer and could cut to the heart of banking industry. Whilst some are disruptive, many more will fail and as a bank, we (DBS) must be careful not to ‘drink from the cool aid’. I do think that with the possible emergence of the Internet of Things and blockchain 2.0 (smart contracts), the opportunities for these types of technology increases. Who finds the winning solution is unclear but the technology cannot be disregarded without analysis. With that in mind it is great to work @ DBS, where we not only proactively investigate potentially disruptive new technologies but we also have a larger

purpose and we consider how technologies such as blockchain can help the Emerging Market and financial inclusion – something we are exploring with our inaugural hackathon on blockchain. We use the same hackathon to mentor and build lasting relationships with entrepreneurs in Singapore by helping them enhance both their technical “coding” knowledge and their business acumen.

1. What is Block Chain? The term “Blockchain” is generally understood to be the public ledger used to support the specific cryptocurrency Bitcoin. At its core a blockchain generically is public ledger protected by cryptography to capture all approved transactions taking place. A blockchain is potentially useful when no single counterparty is trusted to keep the same information within a centrally kept database. When such issue of centralized trust does not exist the introduction of a blockchain often is an expensive solution to a problem. It is helpful to distinguish between “Simple Blockchain Technologies” (“SBT”) and “Smart Contracts” (“SC”) also deemed “Blockchain 2.0”. The former is in fact solutions based on a decentralized ledger and the value arises from a mix of faster and cheaper solutions for settlement. SC adds an additional feature that contracts build on SC technology can be self executing based on pre-programmed rules. This significantly increases the scope of opportunities and can reduce cost of applications. Importantly the technical features of SC technology has largely emerged already and will be further relevant with the Internet of Things.

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The Fundamentals of Blockchain Technology

The basics of the blockchain is well explained in the book “Bitcoin – A Primer for Policy Makers” from which the below extract is taken and altered. Bitcoin is an open-source, peer-to-peer digital currency. What makes Bitcoin unique is that it is the world’s first completely decentralized digital-payments system. Until Bitcoin, online transactions always required a trusted third-party intermediary. For example, if Alice wanted to send $100 to Bob over the Internet, she would have had to rely on a third-party service like PayPal or MasterCard. Intermediaries like PayPal keep a ledger of account holders’ balances. EX AM P LE: When Alice sends Bob $100, PayPal deducts the amount from her account and adds it to Bob’s account. Without such intermediaries, digital money could be spent twice. Imagine there are no intermediaries with ledgers, and digital cash is simply a computer file, just as digital documents are computer files. Alice could send $100 to Bob by attaching a money file to a message. But just as with email, sending an attachment does not remove it from one’s computer. Alice would retain a copy of the money file after she had sent it. She could then easily send the same $100 to Charlie. In computer science, this is known as the “doublespending” problem and until bitcoin it could only be solved by employing a ledger-keeping trusted third party. FACT: Bitcoin’s invention is revolutionary because for the first time the double-spending problem can be solved without the need for a third party. Bitcoin does this by

distributing the necessary ledger among all the users of the system via a peer-to-peer network. New transactions are checked against the blockchain to ensure that the same bitcoins haven’t been previously spent, thus eliminating the double-spending problem. The global peer-to-peer network, composed of thousands of users, takes the place of an intermediary; Alice and Bob can transact without PayPal. Transactions are verified, and double-spending is prevented, through the use of public-key cryptography. WH AT I S P U B LI C- K EY CRY P TO G R A P H Y? Public-key cryptography requires that each user be assigned two “keys” one private key that is kept secret like a password, and one public key that can be shared with the world. EX AM P LE: When Alice decides to transfer Bitcoins to Bob, she creates a message, called a “transaction,” which contains Bob’s public key, and she “signs” it with her private key. By looking at Alice’s public key, anyone can verify that the transaction was indeed signed with her private key, that it is an authentic exchange, and that Bob is the new owner of the funds. The transaction—and thus the transfer of ownership of the bitcoins—is recorded, time-stamped, and displayed in one “block” of the blockchain. Public-key cryptography ensures that all computers in the network have a constantly updated and verified record of all transactions within the bitcoin network, which prevents doublespending and fraud.

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FACT: Because Bitcoin is a peer-to-peer network, there is no central authority charged with either creating currency units or verifying transactions. This network depends on users who provide their computing power to do the logging and reconciling of transactions. These users are called “miners” because they are rewarded for their work with newly created bitcoins. Bitcoins are created, or “mined,” as thousands of dispersed computers compete against one another to solve a complex math problem that verify the transactions in the blockchain. This problem can only be solved by guessing. As more systems compete, the algorithm adjusts and the difficulty of solving this problem increases or decreases. While the public keys for all transactions—also known as “Bitcoin addresses”—are recorded in the blockchain, those public keys are not tied to anyone’s identity. Yet if a person’s identity were linked to a public key, one could look through the recorded transactions in the blockchain and easily see all transactions associated with that key. So, while bitcoin is very similar to cash in that parties can transact without disclosing their identities to a third party or to each other, it is unlike cash in that all the transactions to and from a particular bitcoin address can be traced. In this way Bitcoin is not anonymous, but pseudonymous.

$11.8 BILLION! The annual cost of consumer charge backs

Sometimes itâ&#x20AC;&#x2122;s misreported that Bitcoin is totally free. But the bitcoin network does require a fee in certain circumstances. Itâ&#x20AC;&#x2122;s a small, variable amount. The technical details of each transaction determine the sum, which is based on the amount of data being sent, not the transaction value. And, yes, in some cases, there is no fee at all. Bitcoin merchant software provider Coinbase estimates the cost of this fee at between .0001 and .0005 BTC. (This is $0.02 to $0.15 based on current bitcoin exchange values). Importantly this is due to the implicit subsidy existing through mining. Bitcoin transactions are non-repudiable. There is no such thing as a chargeback. There are no overdrawn accounts and bounced checks. Consumer chargebacks cost retailers up to $11.8b annually.

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Is blockchain technology truly disruptive?

Blockchain has been offered as truly “disruptive” as a disintermediation to today’s banking institutions. Nearly all banks now have dedicated projects on the technology, some of size (e.g. UBS, Baclays, CCBA). DBS’ goal is to distinguish the few real potential winners from the many more ideas that will fail and be aware of the more disruptive broader trend. Below is an outline of the potential impact of simple and smart blockchain technologies.

3.1 Simple blockchain technologies Payment and transfer. Because of the low transaction fees without need for banks SBT has been widely used for micro transactions (e.g. cross border transfer). Ripple is another platform that utilizes a different blockchain technology to compete with SWIFT by providing direct peer to peer settlement without central SWIFT clearing. Security exchanges and crowd funding. We have seen the first issuance of “tokens” directly to investors using SBT as an alternative to the use of established security exchanges. Crowd Funding is another obvious use case already being used. Loyalty programs. SBT could be used to create a liquid market out of different loyalty programs. Many of the opportunities highlighted under section 3.2 are also partly interesting with SBT.

3.2 Smart Contracts Collateralized lending. Mortgages and e.g. car loans may be pre-programmed to execute (lock down collateral) in case of lack of payment under contract.

Trade finance / Letter of credit. LC contains multi party complex legal contracts that may be pre-defined and programmed. The key requirement is that all parties sign up and this has proven difficult in practice.

Derivatives. Non CCP derivatives may also be pre-programmed to execute upon meeting conditions.

CDO is effectively a highly structured derivative contracts where waterfall structures can be pre-defined to execute upon receipt of relevant payments.

As mentioned the Internet of things (IoT) may greatly expand the use of SC. When devises communicate and interact directly the use of a digital currency and self executing contracts that two devises can execute become palatable. IBM and Samsung under the banner of â&#x20AC;&#x153;Adeptâ&#x20AC;? is contemplating this (e.g. a washing machine that automatically negotiate and buy washing

3.3 Disruptive changes at society level A new currency. This would introduce all the services relevant to a new foreign currency such as hedging products, currency accounts, safe wallets, brokerages etc. Countries like the Philippines and Ecuador have been in early implementation considerations but many others are rumoured to be the same.

Tripple ledger account. This involves the registration of both the payment and the item purchased. Effectively a complete ledger of all sales transactions. Requires the potential need for “authorized parties” to unveil the identity behind the wallets.

Property and other asset rights. Today billions of dollars of valid collateral (especially in emerging markets) are not utilized for lending due to the lack of an authorized legal register. A blockchain may be a solution, but “political issues” exist.

Other uses. The blockchain is considered for holding multiple other sources of data such as medical records, DNA etc. Most importantly the blockchain can be used to “time stamp” transactions unequivocally making it a reliable source of documentation. Factom is one company leading the exploration here. Multiple companies are today involved with experimenting with the above solutions and we (DBS) are in contact with many or most of the well know parties.

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CONCLUSION

Blockchain solutions are potentially valuable when a need for “distributed trust” exists and no single counterparty should hold all the single authoritative ledger. Potentially solutions for banking (“simple” format) include payment systems (Ripple), exchange services, escrow services. More disruptive solutions include new currencies with implications on all foreign exchange related services (brokerage, derivatives etc.) or even more the introduction of a “triple ledger”. With “smart contracts” solutions may cover programmable and self-executing derivative and lending contracts (most notably collateralised obligations including mortgages), trade finance and CDOs.

5. Banking on the blockchain technology We, at DBS Bank have a curious mind and an appetite for innovation. Blockchain technology ignites possibilities, it is a new frontier for financial technology with limitless potential for improving our customers’ lives and presents opportunities for our own “DBS Intrapreneurs”. The DBS Blockchain Hack Meet-up on April 16 2015 was the first step that brought together over 60 blockchain enthusiasts, coders, entrepreneurs and industry experts who shared ideas, networked and fuelled sparks of innovation. Through our conversations at this session, we learnt that the blockchain community in the region is dynamic, curious and hungry for innovative ways to use the technology. The DBS Blockchain Hack is about creating new frontiers and a journey that we are co-creating.

JUDGES Neal Cross, DBS

Dr David Lee, SMU

Markus Gnirck, Startupbootcamp

Tan Kah Seng, IBM

Ron Hose, Coins.ph

Dusan Stojanovic, True Global Ventures

MEETUP SPEAKERS Paul Cobban, DBS

Markus Gnirck, Startupbootcamp

Dan Elitzer, MIT

Andras Kristof, Tembusu Systems

Rob Findlay, DBS

Antony Lewis, itBit

Adam Giles, Neuroware.IO

Stephan Wissel, IBM

Mentors: Kevin Beauregard, GoCoin

Rotem Lev, COLU

Ben Chan, BitGo

Antony Lewis, itBit

Chris DeRose, Derose Technologies

David Moskowitz, Coin Republic

Marco Faasse, Ripple

Timothy Stranex, Bitx

Marcelo Garcia Casil, DXMarkets

Marcus Swanepoel, BitX

Charley Hine, Chain.com

Jupe Tan, Plug & Play

Mikkel Larsen, DBS

Special thanks to: David Moskowitz, Coin Republic

SESSIONS DB S B l oc kc h a i n m eet u p (A pri l 16) I B M B l u e m i x w orksh op (A pri l 23 ) DB S B l oc kc h a i n pre- h ack (A pri l 29) DB S B l o c kc h a i n w orksh ops (May 4-5) DB S B l o c kc h a i n Hack (M ay 8- 9)