Blockchain Technology

Blockchain technology Brief explanation, potential effects and use cases for a modern world

Sverrir Eðvald Jónsson University Of Iceland

The Icelandic Student Innovation Fund September, 2016

“Once a new technology rolls over you, if you’re not part of the steamroller, you’re part of the road.”

- Steward Brand

2

Index Definitions Executive Summary Introduction 1 Technology 1.1 Blockchain 1.1.1 Cryptographic Hash function 1.1.2 Proof-Of-Work 1.2 Public Blockchains (consensus process) 1.3 Private Blockchains (consortium process) 1.4 Trade-offs 1.5 Smart Contract Blockchains 2 Disruptive Potential 2.1 Financial instruments 2.2 Records and certification 2.3 Digital Assets 2.4 Low Level Legal Operations 2.5 Identity Management 2.6 Supply chain records and product-centric data 3 Use Cases 3.1 Case: Bitnation 3.2 Everledger – Diamond certification 3.3 Ujo Music – A decentralized music platform 4 Economic Impact 4.1 Adaptation in commerce & organizations 4.2 International remittance 5 Online Survey Final words

3

Definitions Blockchain A blockchain is a type of distributed ledger, comprised of unchangeable, digitally recorded data in packages called blocks (rather like collating them on to a single sheet of paper). Each block is then ‘chained’ to the next block, using a cryptographic signature. This allows block chains to be used like a ledger, which can be shared and accessed by anyone with the appropriate permissions.

Consensus Process The process a group of peers responsible for maintaining a distributed ledger use to reach consensus on the ledger’s contents.

Consortium Process The process of a pre-selected group of peers that are responsible for maintaining a ledger’s integrity and functionality.

Cryptocurrency A form of digital currency based on mathematics, where encryption techniques are used to regulate the generation of units of currency and verify the transfer of funds. Furthermore, cryptocurrencies operate independently of a central bank.

Cryptography Cryptography is the practice and study of techniques for secure communication of data.

Distributed Ledger Distributed ledgers are a type of database that are spread across multiple sites, countries or institutions. Records are stored one after the other in a continuous ledger.

Hash An output of a hash function that represents some kind of data.

Proof-of-Work A system that ties mining capability to computational power. Blocks must be hashed, which is in itself an easy computational process, but an additional variable is added to the hashing process to make it more difficult. When a block is successfully hashed, the hashing must have taken some time and computational effort. Thus, a hashed block is considered proof of work.

Smart Contracts Smart contracts are contracts whose terms are recorded in a computer language instead of legal language. Smart contracts can be automatically executed by a computing system, such as a suitable distributed ledger system.

4

Executive Summary The blockchain, mostly known for being the main technological building block of the cryptocurrency Bitcoin has generated a lot of interest since it was first introduced in 2008.

Following the creation of Bitcoin, other cryptocurrencies were made, by using the same fundamental blockchain technology. In recent years the perception of what blockchains can accomplish has changed from supplying the underpinnings for cryptocurrencies to being a vehicle for fundamental changes in numerous industries. The possibilities for blockchain technology are extensive and its implementation could lead to a dynamic progression of multiples systems that we interact with in our daily lives.

5Â

Introduction The blockchain technology was first introduced to the world in 2008 in a white paper titled “Bitcoin: A Peer-to-Peer Electronic Cash System”. It is the system which came forth alongside Bitcoin and made the peer-to-peer transactions of Bitcoins possible. The computer code is open-source and anyone can make their own blockchain and cryptocurrency using the same basic principles. In the years to follow numerous cryptocurrencies came forth with various tweaks that made them differ from Bitcoin. A couple of well known examples are: Auroracoin, Dash, Dogecoin, Ethereum, Litecoin, and Ripple. These are but a part of a growing ecosystem of blockchain-based cryptocurrencies.

Today there are 710 currencies that are available to trade in the online markets1 . However the underlying blockchain technology can be implemented in numerous ways other than to make cryptocurrencies. This paper will explain the basic principles behind the blockchain and explore some of the ways it could be implemented.

1

https://en.wikipedia.org/wiki/List_of_cryptocurrencies

6

1 Technology

1.1 Blockchain A blockchain is a record of digital events that have been verified by a majority of nodes in the network and executed. Each event or transaction is verified by the majority of participants in the blockchain. The transactions are placed into so-called blocks that are then linked together in a linear chronological order to form a chain of blocks. Each block contains the hash of the previous block. To prevent nodes from broadcasting an unconfirmed block to the chain it will only be accepted provided it contains the answer to a very specific mathematical problem. In order for the block to be put into the blockchain the node has to prove that it has put in enough computational resources to solve the puzzle. This procedure is also known as “proof of work”. The end result is string of text that represents the data that has been processed. Blockchains can be either public or private and both options have their benefits depending on what purpose they are going to be used for.

Blockchain is a technology that introduces a new way to store and record data. It is in some ways like a traditional database, but differs in the way in which information is verified and stored. Blocks of data are linked together using cryptographic hash functions and timestamped at the exact time of execution. The purpose of using these cryptographic hash functions is to avoid manipulation and fraud. Each block that is generated by the function contains some form of information in the form of computer code. Below we have an example of a proof-of-transaction hash between two wallets using the Bitcoin blockchain:

Be3b58c2450235c2a36636496b21be84d932e71c013649cb56ce6f306f70cbc8

In the case of Bitcoin the information is a proof of transaction. (The Bitcoin blockchain which contains the list of transactions is publicly available, even though the identity of the parties involved is kept anonymous). Although the hash of the Bitcoin blockchain is a proof 7

of transaction, the hash could be practically anything. The cryptographic hash function which makes the hash could be written to represent almost anything that we can come up with. It could be a contract between parties, a certificate of ownership or a statement of authenticity for an example.

1.1.1 Cryptographic Hash function A cryptographic hash function is an algorithm that produces a string of characters as its output (also called hash or hash value). When an original piece of information goes through the cryptographic hash function the output is a hash with string values that seem completely unrelated to the original information. The cryptographic properties of a hash make it so that it is infeasible to invert the hash value to the original messages and a small change in the message produces a hash value that is significantly different from the original. This makes decoding the original messages and finding correlation between similar bits of information extremely hard. There are various types common standards of hash functions. The standard that the Bitcoin protocol uses it called SHA-256 and produces a 256-bit hash output. The outcome of the hash does not seem to be related at all to the input and that is excactly why it is so effective. For an example the simple string “hello” which we can easily see and interpret would change to the following when the cryptographic hash function with a SHA-256 standard is used 2 : cf24dba5fb0a30e26e83b2ac5b9e29e1b161e5c1fa7425e73043362938b98249595c9df90075148eb06 860365df33584b75bff782a510c6cd4883a419833d50

2

https://en.bitcoin.it/wiki/Protocol_documentation

8

1.1.2 Proof-Of-Work One of the most popular verification protocols that blackchain databases use is called proof-of-work and is the protocol that the Bitcoin blockchain uses for verification. In the Bitcoin blockchain it is carried out by so-called miners who in-turn for their efforts receive Bitcoin. It is a protocol by which someone can effectively prove that they have engaged in a significant amount of computational effort. In the case of the Bitcoin blockchain it is implemented to verify a block in the blockchain. The reason for the protocol is to make fraudulent behavior on the blockchain unfeasible. The verification process takes time and money to do but when the correct answer has been found it can be easily verified in far less time than it took to conduct that effort in the first place. The way it often works is that for a given string the prover (or miner in the Bitcoin blockchain) must come up with an answer string that is constructed so that when both of these strings are put into the cryptographic hash function the output is the desired string with a very specific property. The difficulty can be adjusted by changing that specific property but traditionally the prover has to try a lot of different random answer strings to find the output.The prover must randomly try answers and hash them in order to try to get the right one. The established property could be for an example that all the first 40 bits of the hash are zero. In that example the prover could have to guess 2Â 40 times to find the desired output. The number of tries it takes to guess correctly in that example would be approximately one trillion. The Blockchain can be kept alive forever (in theory) as long as all peers keep a copy of the Blockchain and keep verifying each transaction or event that takes place.

9Â

1.2 Public Blockchains (consensus process) A public blockchain is a distributed ledger that follows the so-called consensus process. It is a blockchain that anyone can read and partake in the confirming events via the consensus process. The security of the blockchain is maintained by verification using cryptography.

Anyone can act as a node in the network and thereby decide along with others what block gets added to the chain and what the current state of chain is. The incentives for partaking in the process is usually an economic reward such as Bitcoins in the Bitcoin blockchain. These types of public blockchains that adhere to the consensus process are regarded to be decentralized and distributed. All verified events that take place on the chain are time-stamped and no singular entity can control the set time.

Instead, all peers have to agree that the event has taken place at a certain time.

1.3 Private Blockchains (consortium process)

A private blockchain follows the consortium process and its nodes have been pre-selected.

These nodes have the job of validating each event that goes through the network. This type of blockchain can be useful when total secrecy is desired.

However it makes fraudulent behaviour more likely as there are fewer nodes that confirm events. An outside party cannot partake in the process of confirming the validity of the chain and cannot see the events on the blockchain. This type of blockchain provides less transparency than public blockchains but may be necessary in certain applications.

10Â

1.4 Trade-offs

All data on a public blockchain is public by default, although the common practice is to hide the identity of participants. The benefit of an open blockchain is its transparency and that every participant can see all account balances and the movement of transactions. However public blockchains tend to get bigger and bigger, therefore the size of the blockchain grows and it becomes harder to scale. This means that transactions take longer and more energy has to be spent. Private blockchains on the other hand can be faster and more energy efficient. But a small number of nodes in a private blockchain could also mean more risk of fraudulent behaviour.

A private blockchain is also prone to more censorship than the public blockchain.

1.5 Smart Contract Blockchains

Instead of the blockchain being dependant upon outside parties acting or transferring data, smart contracts can act on their own. They do so by executing pre-written code that has certain conditions built in. These types of blockchains are referred to as smart contract blockchains. One of the most well known today is called Ethereum. Smart contract blockchains work in a similar manner as the private and public chains but with the fundamental difference that they can trigger actions on the blockchain given fulfillment of certain criteria. They act completely autonomously if conditions are met. These types of contracts open up all types of new opportunities.

11Â

A simple visual representation of how smart contracts work can be seen above. These types of blockchain contracts can be very useful for simple execution of contracts. Whether the blockchain is public, private or based on smart contracts there are a lot of applications that could better existing solutions.

12Â

2 Disruptive Potential Blockchain was originally invented to create a digital currency. It was a public blockchain that relied on a consensus process for verification. However in recent times people are starting to see that the blockchain can be used for other purposes than cryptocurrency.

The disruptive potential of blockchain technology is huge. The technology has introduced a secure way to verify digital data without being dependent on trusting a single person or entity for verification purposes. This could have huge implications as many professions and companies whole existence is based on being a trusted intermediary. The technology could streamline and lower costs of actions that require a third-party to facilitate trust between parties. The potential list of application is ever-growing.

2.1 Financial instruments The world of finance is dominated by big entities upon which its existence is based on facilitating trust between individuals. Credit card companies, banks, brokerage firms and so forth. Examples of fields where blockchain technology is applicable are bonds trading, derivatives trading, commodities trading, spending records, trading records, mortgage loan records, crowdfunding and microfinance.

2.2 Records and certification Blockchain technology could be hugely beneficial for keeping track of records and providing certification. Examples are land titles, vehicle registries, criminal records, passports, birth certificates, death certificates, voter registration, voting, building permits and court records. By implementing the technology in these fields it is possible to lower costs, increase efficiency and transparency for all entities involved. A good candidate for this kind of overhaul would be government organizations. Record databases can be costly and time-consuming. The existing databases can also be easy to infiltrate and vulnerable to

13Â

attacks. By using the blockchain there are multiple sources of verifications through the distributed ledger, increased transparency, traceability and cost-effectiveness. “The only thing that saves us from the bureaucracy is its inefficiency.�

-Eugene McCarthy

2.3 Digital Assets Digital assets can be hard to protect in the modern world. By allowing digital assets to be stolen we can be undermining the existence of whole fields. We have easy access to many digital assets that were not accessible before the time of the internet. By allowing assets to be shared and stolen companies and individuals lose a vast amount of money and we normalize the act of stealing.

Blockchain could help keep track of every asset and therefore distinguish which assets are real and which are stolen.

2.4 Low Level Legal Operations Low level legal operations require manpower and funding. However many of these operations do not need human involvement. If the act is simple enough it could be programmed into the blockchain and made to happen instantaneously if the requirements are met. Some examples could be notarizations, proof of identity, proof of ownership and contracts between organizations and individuals. Instead of paying for, waiting for and relying on the integrity of a single entity you could relay on laws that are built into a blockchain code and execute on demand. With fewer intermediators, the risk of fraud and mistakes decreases significantly.

2.5 Identity Management Blockchain technology could make digital identities more ubiquitous and trustworthy in that they can be freely integrated to any service where the identity holder and the counterparty together wish to do so. This could make online reputation much more pervasive and meaningful, potentially leading to a digital environment where complete strangers trust each other to a higher degree than what is common today.

14Â

2.6 Supply chain records and product-centric data When customers are looking to buy products today, they are currently very limited in their ability to evaluate the origins of the materials used or the ethical aspects of how products have been manufactured. Even companies that manufacture the product can have a hard time tracking the legitimacy of their complex supplier networks. Blockchain technology has the potential to bring massive improvements to this by providing both companies and consumers with access into detailed and immutable supply chain records, on the level of individual products.

15Â

3 Use Cases 3.1 Case: Bitnation Bitnation is an organization that is powered by the blockchain technology. It wants to make available the same services that traditional governments offer in a more efficient and easy way. It uses the blockchain so all verifications are done in a globally distributed manner. They offer the validation of identities, notarization, dispute settlement, and other related services. The first nation to use the service is the Estonian government through their e-Residents service. By signing with their online IDs, Estonian e-Residents can now notarize official documents such as birth certificates, land titles and other documents.

3.2 Everledger – Diamond certification Everledger uses the blockchain technology to track diamonds. It inscribes serial numbers in the diamonds with lasers that are then recorded in a distributed blockchain database along with details of the diamond fx. its origin and attributes. A buyer can therefore know where the diamond comes from, what intermediaries it has gone through and if it has been involved in any unethical activity.

3.3 Ujo Music – A decentralized music platform Ujo Music uses smart contracts with the Ethereum platform to allow music licensing to be recorded and rewarded. The service allow artist to record their work on the blockchain as a smart contract and specify how much each contributor gets of the total revenue. Once someone pays for and downloads a song the payment is distributed to all the contributors in the same instant.

16Â

4 Economic Impact The economic impact of blockchain-based technology could be very significant but is is hard to estimate exactly how much of a difference it would make. New applications of the technology could require fewer staff members, streamline processes and reduce costs.

4.1 Adaptation in commerce & organizations An adaption of blockchain technology in an organization could reduce the number of employees of an organization, thereby lowering prices and meaning that the customers could have more money in their wallets at the end of each month, or to spend in goods. If governments would try to automate their organizations as much as they can the effects could be significant savings in expenditure which could eventually pave the way for lower taxes. In Iceland the domestic credit card turnover in 2015 was approximately $2.5 billion3 . Payment remittance companies traditionally charge merchants 1-3% of each transaction. These sums add up and any cost reduction will benefit both the customer and merchant.

4.2 International remittance International remittances market is a $514 billion industry and transaction fees are on average 7.6 %4 of the amount which is transferred. Additionally, the waiting time for completion of blockchain-based assets is far less than the time transactions take with traditional fiat currencies using SWIFT BIC codes. Transitions that use SWIFT codes take from 1-4 business days to be transferred. The average time of settlement for the most widely used blockchain-based digital asset (Bitcoin) currently ranges from 6-14 minutes5.

3

http://px.hagstofa.is/pxis/pxweb/is/Efnahagur/Efnahagur__thjodhagsreikningar__efnahagslegar_skammtima tolur/THJ00113.px/ 4 https://remittanceprices.worldbank.org/sites/default/files/rpw_report_june_2016.pdf 5 https://blockchain.info/charts/median­confirmation­time

17

5 Online Survey An online survey was made for the purpose of this paper to explore the views of regular people in Iceland on a topic that may seem complex for many. The majority of the participants were in the age group 19-25 and round 30% were over 26 years old. The results were interesting and reflect the views of the younger generation Over 80% of the participants knew what Bitcoin was. 70.83% knew Auroracoin, a blockchain based cryptocurrency that was meant to replace the Icelandic krĂłna. Only 16.67% knew Ethereum, a programmable blockchain technology.

18Â

Although an overwhelming majority had heard of Bitcoin, only 41.67% knew blockchain, the fundamental technology behind it.

When asked about trust towards cryptocurrencies the answers were not convincing. 54.17% trusted them and 45.83% did not. The reason for this can very well be negative coverage in the media surrounding the usage of Bitcoin.

However when asked if they would use a cryptocurrency that was backed up by a government 50% said yes, 41.67% said maybe and only 8.33% said no. When asked if government organizations should use blockchain-based technology if it were to lower costs an overwhelming 95.83% said yes.

19Â

Final words Although blockchain has been around for more than eight years, we are seeing a voracious interest in the technology and its cross industry potential use cases. The financial service sector is beginning to respond to the threat and opportunities made possible by blockchain technology but other industries should also keep a close eye on all things that could be improved by the use of blockchain technology. The next generation of blockchain applications is likely to affect a whole host of industries. Sometimes change is needed in order to improve and move forward. If we have the courage to use this technology to our benefit we have a huge potential to improve current practices in numerous fields.

“We can only see a short distance ahead, but we can see plenty there that needs to be done.” ― ​Alan Turing​, ​Computing machinery and intelligence

20

Bibliography Bitcoin Wiki (21.10.2015). Blockchain. Retrieved from ​https://en.bitcoin.it/wiki/Block_chain Blockchain Technologies. Blockchain. Retrieved from http://www.blockchaintechnologies.com/blockchain-definition Coindesk (04.06.2016). Making sense of blockchain smart contracts. Retrieved from http://www.coindesk.com/making-sense-smart-contracts/ Deloitte (2015). Blockchain. Disrupting the financial services industry? [pdf]. Retrieved from https://www2.deloitte.com/content/dam/Deloitte/ie/Documents/FinancialServices/IE_Cons_Block chain_1015.pdf Intelligent HQ (14.06.2016). 12 Bitcoin and Blockchain thoughts and quotes you need to read.

Retrieved from http://www.intelligenthq.com/finance/12-bitcoin-and-blockchain-thoughts-and-quotes-you-nee d-to-read/ Oliver Wyman and Euroclear. (2016). Blockchain in capital markets. ​The prize and the journey.

03-23.

UK Government Chief Scientific Adviser (16.01.2016). Distributed Ledger Technology: beyond blockchain [pdf]. Retrieved from https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/492972/gs-16-1-di stributed-ledger-technology.pdf Satoshi Nakamoto (2008). Bitcoin: A Peer-to-Peer Electronic Cash System [pdf]. Retrieved from https://bitcoin.org/bitcoin.pdf

21