RSM2321

An Introduction to Blockchain Technology and Decentralized Finance for Business

Blockchain Technolgy in Finance

Instructor:           Andreas Park
Date:                       November 2, 2019, 10:15-11:45

 

 

 

 

 

2019 Rotman – Master in Finance

Financial Innovation

What is decentralized finance?

provision of financial services without the necessary involvement of a traditional financial intermediary 

(bank, broker-dealer, insurance corporation)

Why should you care?

\(\Rightarrow\) it's growing and it's coming

disclaimer: compared to existing markets this is still a tiny amount

Total Funds used in/dedicated to Defi

Why should you care?

Verbal Overview: Origins of Financial Institutions

  1. Money
     
  2. Safekeeping
     
  3. Deposit certificates and lending
     
  4. Trade facilitation & finance
     

Why should you care?

What's new with Financial Institutions?

old days: silos

today: cloud computing

cloud data centers are a worldwide affair

Source: Wendy Rotenberg's Payments lecture

Why should you care?

What questions arise from new tech?

  1. Do we need banks for safekeeping if AWS/Google/Microsoft hold the data = asset information?
     
  2. Why are transfers still hard and costly?

\(\Rightarrow\) Can we decentralize finance?

course content

questions we will address

  1. How does "decentralized" work?
    • not cloud compution, but blockchain
  2. ​How does centralized work?
    • What roles do intermediaries play?
    • Can intermediation be decentralized?
    • How do platforms work economically?
  3. What DeFi solutions are there?

quick comparison

FinTech vs. Defi

FinTech

DeFi

  • more user-friendly UX
  • more customer-oriented
  • less squeezing/rent-extraction
  • more competive services
  • more innovative services
  • currently: horribly user-unfriendly
  • "blowing up the banks"
  • fundamental re-thinking of financial services
  • lots of scams, cowboy-attitude towards laws

innovation vs. salesmanship

main focus

Meanwhile, in the traditional world of finance

Business as usual?

The World of Banking is Opening

Is this a distant future?

Will there be banks in the future?

Is this a distant future?

  • 900M WeChat Pay Users
  • 84% market penetration
  • >150K WeChat Pay users @GTA

Partnerships

Some Examples of (Past) Industry Leaders

Why worry about the distant future?

Nokia's market shares for devices:

  • 2007: 49.4%
  • 2012: 3%

What happened and can it happen to banks?

Examples: Blackberry and a generic bank

Paid-for vs. valued 

  • Keyboard
  • Security
  • Being businessy
  • Cool and cutting edge
  • Being Canadian
  • Independence from desk

What did they pay for?

What do people value?

  • Mobile email
  • Brand name
  • Easy access to branch
  • Great product range
  • Fair prices
  • Great advice
  • Latest tech
  • Friendly tellers
  • Safe-keeping of assets

If banks move all data into "the cloud," why do we need banks?

What took the place of Blackberry?

Major Lesson: Platforms provide value

What took the place of Blackberry? The App-Phone

Past, Present, and Future

Who will provide the next gen banking platform?

Siloed banks

Cloud computing and cloud storage

Open banking and open data

The past (and the present?)

The present and near future

3-5 years in the future

5-10 years in the future

Platforms?
Banks?
Tech firms?

  • Each bank has a separate data center
  • high costs
  • no scaling
  • little network externalities
  • AWS etc
  • Use specialized IT providers
  • Network with external providers (FinTechs)
  • Share data with external parties at customer request
  • Platforms will emerge
  • Customers can switch at the drop of a hat
  • How will basic banking work?
  • Who will run the platform and how will you survive on a platform?
  • What will a platform work in financial services look like?
  • What roles will current banks play?
  • How will a bank earn money in a platform world and with which services?

Illustration of Infrastructure Frictions: money transfers

Version 1: They use the same bank

Change ledger entry locally

Version 2: They use different banks but the banks have a direct relationship

Sue's bank transfers from Sue's account to Bob's bank's account

Bob's bank transfers from its account to Bob's account

Version 3: They use different banks that have no direct relationship

Sue's bank transfers from Sue's account to its own account

Bob's bank transfers from its account to Bob's account

Central Bank

Central bank transfers from Sue's bank's account to Bob's bank's account

International transfers

Sue's bank transfers from Sue's account to its own account

Bob's bank transfers from its account to Bob's account

use the Swift network of correspondent banks

Five key problems in finance

Defi vs Legacy finance

interoperability

inefficiency

centralized control

limited access

opacity

interchange (=VISA) fees, settlement times, microtransactions, physical infrastructure

between-institution or transfers, reconciliation process, international remittances, various securities custody and trading systems

information for users, health of deposit taker, what-happens-behind-the-scenes, counterparty risk

local monopolies/switching costs, central banking, deposit concentration, control vs. competition

1.7B unbanked in the world, 24M in the US, many services or products not available based on location etc, lack of SME support, inability to collateralize

Source: Wendy Rotenberg's Payments lecture

Bottom Line

very complex

many parties

lots of frictions and points of failure

very expensive

Crazy thought: Wouldn't it be nice if there was a single ledger/common resource?

Existing solutions

Problem:
power concentration/Monopoly

Distributed Ledger/Blockchain Technology

  • "joint, single system" "shared resource" "common infrastructure"
  • Features:
    • secure storage of information and transfer of value
    • guaranteed execution of code
  • Promise
    • open platform
    • global reach
    • frictionless finance

How can we reach consensus? The Byzantine Generals' problem

How can we reach consensus? The Byzantine Generals' problem

Blockchain proof of work establishes consensus

Byzantine Generals' Problem

\(t\)

\(t\)

\(t\)

\(t\)

\(t\)

\(t\)

\(t\)

\(t\)

\(t\)

\(t\)

\(t\)

\(x\)

\(t\)

\(t\)

\(t\)

\(t\)

\(t\)

\(x\)

\(t,t,x\)

\(t,t,x\)

\(t,t,t\)

consensus is reached!

Byzantine Generals' Problem

\(x\)

\(y\)

\(z\)

\(y\)

\(x\)

\(z\)

\(y\)

\(x\)

\(z\)

\(x,y.z\)

\(x,y,z\)

\(x,y,z\)

consensus is reached (no attack)

Byzantine Generals' Problem

Equilibrium

  • generals pick majority message
  • successful consensus as long as no more than 1/3 cheats

Blockchain requirement

  • reach Byzantine Fault Tolerant consensus
  • trick: messages are hard to forge

Byzantine Generals' Problem

Proof of Work Protocol

A Byzantine Fault Tolerant Algorithm

This Hash starts with a pre-specified number of zeros!

Blockchain BFT

= 00000xd4we...

= 00000xd4we...

= 00000xd4we...

consensus is reached if hash starts with right number of leading zeros

PoW does two things

- selects a leader

- makes messages hard to forge

Blockchain BFT

B3

B1

B2

B4

B5

Contains transaction from Bob to Alice

Question: Can Bob rewrite history?

Drilling down part 2b: immutability

No! Bcause: Economics!

Importance of Economics, Step 1: Incentive to support longest Chain

B3

B1

B2

B4

B5

B6

Where to add a new block B7?

  • Add to B3?
    • => people after still more likely to add to B6
    • lose "coinbase" reward

Importance of Economics, Step 2: Altering the past?

B3

B1

B2

B4

B5

  • needs to be faster than anyone after who adds to B5 and build a longer chain
  • or needs to be able to mine repeatedly

B8

B7

B9

B10

B6

Contains transaction from Bob to Alice

Bob wants to undo the transaction by rewriting history with B6

Bob's objective

  • Wants to undo this trade and cheat Alice by building alternative chain from B6

What does it take?

  1. needs to be predictably able to add several blocks to the chain without interference, or
  2. needs to be faster than anyone after who adds to B5 and build a longer chain, or
  3. needs to ability to reject new blocks that are added to B5 .

How does Proof of Work prevent this?

  • mining success is random subject to resources spend:
    • computers/GPUs
    • electricity
  • you need faster/more computers than 51% of the network
    • current network power: 25million tera-hashes per second (blockchain.info)

Back of the envelope calculation

  • hashrate: 25,000,000 TH/s
  • best GPUs have 2.5GH/s per card=0.0025 TH/s
  • => need 25,000,000 x 400 x 0.5 = 5,000,000,000 GPUs
  • 1 GPU costs around $200
  • =>Cost = $1,000,000,000,000

Economic Analysis, Part II

Double spend attack prevention

  • Validation rewards are taken as given, but they are crucial in
    • determining incentives to participate,
    • to support the chain, and
    • to expense electricity and computing power

Basic idea of competitive equilibrium

aggregate mining cost = aggregate reward

Double spending attack

  • expense resources but:
  • win N block rewards until "confirmation" block
  • ability to double-spend

condition that prevents it

(Chiu & Koeppl RFS 2018)

 

 

\text{mining reward} \times (N+1)N > \text{double spend amount}

How do we establish trust in commerce?

trustworthy People

long-term Relationships

reputation

contract law

institutions

How do we get trust in an open system with anonymity?

What's needed for trust in  anonymous deals?

Authority

Execution

Continuity

Authority

Do you have the item?

Do you have power over it?

Tool: "key" cryptography

Execution

Can we agree that it happened?

Tool:
consensus algorithm

Security and Continuity

Are the records immutable?

restricted permissions

really difficult to hack

premise of blockchain

no trusted parties needed

everything
in code

open to
anyone

platform or network

commerce thrives

How?

Cryptography: only Sue can spend her money

Authority

Execution

Problem: double-spending

How can we trust that

  1. sale happened and
  2. $$ only spent once?

Execution

Security

One more application:
a stock trade

Sue wants to sell ABX

Bob wants to buy ABX

sell order

buy order

Clearing House

Stock Exchange

Broker

Broker

3rd party tech

custodian

custodian

record beneficial ownership

central bank for payment

With Blockchain: single ledger for money and securities

0xA69958C146C18C1A015FDFdC85DF20Ee1BB312Bc

0x91C44E74EbF75bAA81A45dC589443194d2EBa84B

0xA65D00Eda4eEB020754C18e021b1bF4E66C9Ed90

  • blockchain 1.0
  • first solution to double spending
  • clunky, slow, expensive
  • huge following and computing power

vs

  • blockchain 2.0
  • smart contract platform
  • highly flexible
  • foundation for many private initiatives
     

"Let me just say how impressed I am with Ethereum...If Bitcoin is email ––a one-trick pony, so to speak, but obviously revolutionary–– Ethereum goes far beyond that; it's more like the Internet...The whole idea of DeFi really is, number one, it’s obviously revolutionary, and I think at the end of the day could lead to a massive disintermediation of the financial system and the traditional players."

Heath P. Tarbert, CFTC Chairman, October 2020

Private vs. public

some key questions

Who gets to update?

Can a higher body prevent
transactions?

Can the past be altered?

consensus

immutability

censorship resistence

Public Blockchains provide

Main private blockchain systems

Features of Private vs. public blockchains

open to anyone

no one can be excluded

past cannot be changed

Public Blockchains

private Blockchains

high visibility of transactions

open-access eco-system

slow governance

privacy only at a cost

joint control and governance

straightforward KYC and AML

tech support

transaction secrecy simpler

rely on corporate development

compliance with law (reversion)

can keep competition out

Cryptocurrency = money?

Can bitcoin or ether replace "fiat" MONEY?

store of value?

unit of account?

method of exchange?

A short history of Money

A short history of Money

A short history of Money

A short history of Money

A short history of Money

Cryptocurrencies vs USD

Cryptocurrency = money

Can bitcoin or ether replace "fiat" MONEY?

store of value?

unit of account?

method of exchange?

Cryptocurrencies are (currently) useless as money

cryptocurrencies' volatility?

Cryptocurrencies are (currently) useless as
money

fiat money cannot be used in smart contracts on the blockchain

solutions:

 stablecoins
 

central bank digital currency

BTC, ETH

fiat: USD, EUR

asset (gold)

fee-backed

Seigniorage

Crypto

Traditional

Algorithmic

Collateral-Backed

Taxonomy of Stablecoins

$174M

$33M

$144M

funding figures from Nov 2018; source: blockchain.com

The One the world is talking about

What is Libra and how does it work? 

issued by a consortium of firms (e.g., Facebook, Mastercard) and not for profits (Creative Destruction Lab)

each coin will be backed by a basket of SIX fiat currencies

idea is conceptually similar to IMF Special Drawing Rights (pegged to USD, EUR, YEN, GBP, YUAN)

Survey Info on Libra

Would you use Libra/Money issue by Tech Firm?

If we ask explicitly for Facebook vs Tech Firm

Scaled to yes/maybe/no. About 20% say: "Need more info"

unified unit of account: dai

Money

Idea:

  • create fiat money on chain
  • mechanism
    • a collateralized loan with ETH in escrow
    • DAO-managed monetary policy (=creation or destruction of tokens)

Sidebar: what is a DAO?

  • DAO=decentralized autonomous organization
  • \(\to\) entity without management
  • governance decided by token holders essentially by vote

user perspective

Maker DAO

4 ETH
(1 ETH = $375)
(Oct 15, 2020)
\(\approx\) $1,500

\(\vdots\)

1,500 DAI
(1 DAI = $1)

formally: this smart contract is a collateralized debt position (CDP)

user perspective

Maker DAO

fractional collateral \(\to\) collateralization factor \(=\) 150%

\begin{array}{rcl} &&\textsf{maximal amount of DAI in \$}\\\\ &=&\frac{\textsf{\$ equivalent of ETH in escrow}}{\textsf{collateralization factor}}\\\\ &=&\frac{1,500}{150\%}=\$1,000 \end{array}

total collateral = $1,500

maximum loan = $1000

overcollateralization = $500

actual loan (example) = $500

buffer = $500

user perspective: what happens if the price of ETH rises?

Maker DAO

ETH \(\nearrow\) $500

value of ETH collateral = $2,000

maximum loan = $2,000/150%=$1,333

total collateral = $2,000

maximum loan = $1,333

overcollateralization = $667

actual loan (example) = $500

buffer = $500

overcollateralization = $667

new loan capacity= $333

user perspective: what happens if the price of ETH falls?

Maker DAO

ETH \(\searrow\) $187.5

value of ETH collateral = $750

maximum loan = $750/150%=$500

total collateral = $750

maximum loan = $500

overcollateralization = $250

actual loan (example) = $500

buffer = $0

for reference: former value of collateral

user perspective: what happens if the price falls & max loan is exceeded?

Maker DAO

ETH \(\searrow\) $150

value of ETH collateral = $600

maximum loan = $600/150%=$400

total collateral = $600

maximum loan = $400

required overcollateralization = $200

actual loan (example) = $500

buffer = -$100

for reference: former value of collateral

\(\Rightarrow\) liquidation possible by "keeper"

sell 3.33 ETH=$500=500 DAI

repay $500=500 DAI loan

retain incentive

return ETH remainder to pool

Maintaining the Peg: monetary policy

Maker DAO

  • Why works:
    • over-collateralization:
      • ETH expensive relative to DAI \(\to\) issue more DAI
      • supply (DAI) \(\nearrow\)
      • price (DAI) \(\searrow\)
    • market: if ETH \(\searrow\) then:
      • ​ETH cheap relative to DAI
      • demand (DAI) \(\nearrow\)
      • price (DAI) \(\nearrow\)

\(\Rightarrow\) all relies on behavioral assumptions

\(\Rightarrow\) But: there are also real incentives & mechanisms

Maintaining the Peg: monetary policy

Maker DAO

  1. stability fee
     
  2. DAI savings rate (DSR)
     
  3. debt ceiling

borrowers of DAI need to pay interest \(\to\) stability fee

  • if too much minting (=too much DAI) then
  • \(\to\) interest \(\nearrow\) \(\to\) cost of DAI \(\nearrow\)
  • \(\to\) minting \(\searrow\) \(\to\) supply DAI \(\searrow\)

DSR paid on "locked" DAI

  • DAI deposited to specific contract (demand \(\nearrow\))
  • funded by stability fees
  • \(\to\) SF>DSR

total amount of debt (or DAI) outstanding is limited

Sidebar: how is this decided?
\(\to\) special "governance" token MKR

decentralized exchange

Key Components

Idea:

  • create a way to exchange items on-chain
  • fully decentralized
  • \(\to\) no single controlling entity, or location, everything runs with smart contracts

How do you organize DEX trading?

Atomic swaps

How do you organize DEX trading?

Liquidity?

  • Laissez-faire: Etherdelta or Kyber
    • people submit contracts (limit orders) on-chain
    • system collects info
    • system offers "tools" to trade against standing contracts
  • Hybrid: 0x
    • "dark liquidity"
    • off-chain/sidechain purchase/sale agreements
    • system matches compatible orders and posts on-chain
  • Automated market maker (AMM) (Uniswap)
    • AMM holds assets on both sides
    • offers two-sided quotes (\(\to\) always liquid)
    • prices adjust continuously to demand/supply shifts

How do you organize DEX trading?

automated market maker

Price mechanism:

  • risk-neutral "invariance" pricing
  • at price, contract (AMM) is indifferent between buying and selling
  • \(X=\) contract balance of asset \(A\)
  • \(Y=\) contract balance of asset \(B\)
  • \(k=\) invariance factor
  • key relation \(k=X\times\ Y\)

Prices

  • when you want to sell \(x\le X\) you receive \(y\) that maintains invariance. 
  • implied exchange rate: \(e=\frac{x}{y}\)

How do you organize DEX trading? EXAMPLE

automated market maker

invariant \(k=4\times4=16\) 

Instantaneous exchange rate:

1             =   1

Contract deposit:

How do you organize DEX trading? EXAMPLE

automated market maker

sell 4 DAI for USDC

what price will therefore be quoted?

\begin{array}{rcl} k&=&\#\text{DAI}\times\#\text{USDC}\\ 16&=&(4+4)\times(4-y)\\ x&=&2 \end{array}

how many USDC?

e=x/y~~\to~~e=2

How do you organize DEX trading? EXAMPLE

automated market maker

Problem: large "slippage" (or price impact)

  • imagine: deposit is 100 DAI & USDC:
    • \(k=100\times100=10,000~\to\) for \(x=4\) need \(y=100-10000/104=3.85\)
       
  • imagine: deposit is 10,000 DAI & USDC:
    • \(k=10,000\times10,000=100,000,000~\to\) for \(x=4\) need \(y=10,000-100,000,000/10,004=3.998\)
       
  • ​\(\to\) the more money is in the contracts, the lower the price impact

How do you organize DEX trading? other mechanisms

automated market maker

  • anyone can become a liquidity provider when supplying both sides of a pair
     
  • trades carry a fee of 30bps \(\to\) paid to liquidity providers (pooled)
     
  • LPs still face opportunity costs relative to all other assets \(\to\) income must be sufficient

supercool feature

automated market maker

  • establish and sell a new token
     

    • create token
    • deposit token and counterasset (e.g., DAI)
    • \(\to\) opening price
    • \(\to\) new purchases will increase price

  •  

superannoying feature

automated market maker

  • front-running

    • transactions enter mem-pool

    • \(\to\) all visible there

    • arbitrageur make instant-swap trade at higher gas price

      • \(\to\) trade instead of original trade

      • \(to\) reverse to gain slippage from earlier trader

Convenient feature for arbitrage: Flash loans (Flash swaps)

automated market maker

  • take three pairs (ignore that BTC is not directly on Ethereum)

    • BTC-DAI

    • ETH-BTC

    • ETH-DAI

  • three pairs must satisfy non-arbitrage condition
  • e.g. if ETH:DAI =1:100 and BTC:DAI=1:10000 then BTC:ETH=1:100
  • say BTC:ETH=1:200 then
    • borrow (say) 10,000 DAI
    • use DAI to buy  1 BTC
    • sell 1 BTC for 200 ETH and
    • sell 200 ETH for 20000 DAI
    • of which you use 10,000 DAI to repay loan and pocket 10,000
  • Normally, this is hard!
  • But on blockchain you can do all operations in one go
  • \(\to\) no risk of leg of transaction not going through or non-delivery
  • flash (single-block) loans enable this

How does it look?

automated market maker

\(\to\) simply connect with MetaMask (or similar wallet)

How does compound finance work?

Lending

Fundamentally, what does a bank do?

  • size intermediation
  • term intermediation
  • risk intermediation

And how is this done?

  • pooling deposits
  • issuing loans based on deposits
  • loan rates based on collateral or credit rating

on blockchain

  • short-term loans
  • pseudo-anonymous

collateral

compound Finance

  • Collateral ratio \(\in[0,90]\)
  • =0 \(\to\) not usable
  • =90 \(\to\) stablecoin
  • post 100 DAI 
  • factor 90
  • \(\to\) for each $1 borrow, deposit $100/90=$1.11
  • can borrow up to $90
  • post 1 ETH=$300 
  • factor 60
  • \(\to\) for each $1 borrowed, deposit $100/60=$1.67
  • can borrow up to $180

Example 1

Example 2

Example 3

  • post 1 ETH=$300 and 100 DAI \(\to\) $400
  • factor 60 and 90
  • \(\to\) for each $1 borrowed, deposit
    $100/(.75\(\cdot\)60+.25\(\cdot\) 90)=$1.48
  • can borrow up to $270

borrowing and lending rates compounded per block

how are the rates determined? - a function

compound Finance

100%

fraction of supplied that's been borrowed

base rate

borrow rate

\textsf{borrow rate}=\textsf{base rate}+\textsf{slope coefficient}\times\textsf{\% borrowed}
\textsf{supply rate}=\textsf{borrow rate}\times\textsf{\% (borrowed}-\textsf{reserve)}

compound Finance

  • Compound escrows tokens
  • must account for % ownership
  • \(\to\) tokenized user share
  • \(\to\) use the c-token
    • cDAI
    • cETH
  • minted/burned based on funds added/removed from underlying
  • seamless movement of these shares (reduced transactions costs!)

Tracking ownership

common theme in DeFi: jumping between dApps

  • Assume 
    • 1 ETH = 200 DAI
    • supplied 100 ETH in Compound
    • borrowed 10,000 DAI to lever up and purchase an additional 50 ETH
    • \(\to\) also supplied to Compound
    • Borrow interest rate in DAI
      • Compound: 15%
      • Aave: 5%.
  • ​Can you refinance your borrowing?

dapp-linking

Defi is like real "high" finance

Source: Harvey, Ramachandran, and Santoro (2020)

Usage of blockchain in financial industry

Areas of applications

moving value (remittances)

digital money: real-time settlement, reduced reserves

tokenization of assets

automization of contract payments

securitization

systems and infrastructure reorganization

digital identity

new forms of financial contracts, assets, and forms of financing

Cumulative Token sales since Jan 2016

Data: coinschedule

$25B total

$21B in 2018

for comparison: total size of

  • Toronto Stock Exchange: $2,200B

  • Toronto Venture Exchange: $41B

Some spectacular returns

Source: Tokendata

The Ugly Truth: Scams

Source: Satis Group LLC

The Ugly Truth: Failure Rate

Source: Morgan Stanley (Nov 2018) “Update: Bitcoin, Cryptocurrencies and Blockchain”

Source: Tokendata

Also: a real horrow show

Key: you cannot collect money from just anybody!

The Ugly Truth: Many tokens are securities

Blockchain Tokens and Coins as Payments: a New Financing Tool?

  • Since Jan 2016: $31 billion for 1,700+ early start-ups
  • TMX Venture (successful, since 1999, for junior firms)
    • $42 billion market cap (since 1999!)
    • In 2018: 52 IPOs, $2.2 billion
  • Private markets in Ontario: raised $70 billion in 2017 

Lessons?

  • Significant interest in FinTech
  • Appetite by retail investors for risk/early-stage firms
  • Possible to raise funds directly from investors
  • VCs and intermediaries do provide a service
    • money does not substitute for business plan/advice
    • "wisdom of the crowd" is non-existent (?)

Tokens as Payments: a New Financing Tool?

Preliminary (academic) Research insights: What can (utility) tokens finance that traditional securities cannot? 

can finance projects that otherwise would find no debt or equity funding

enable network effects and new business opportunities

allows entrepreneurs to extract more surplus

can finance projects that otherwise would find no debt or equity funding

Blockchain Tech Stack: Tokens vs Cryptocurrencies


Infrastructure
 

reward
and
internal currency

usage fee
or
incentive


usage fee
 


Service
 


Application
 

Tech Stack Layer

Role of Token

cryptocurrency

Token

Token

The Ugly Truth: token trading and token markets are different from securities trading and markets

Investor

Broker

Venue

Settlement

Exchange

Traditional

Wholeseller

Darkpool

Internalizer

Venue

Settlement

Investor

On chain

Crypto

What Changes in Business Models can Blockchain Technology bring?

What does blockchain do?

peer to peer value transfers

self-powered platforms

contract execution

disintermediation

Who do you dis-intermediate, and then who is your customer?

issuer

investor

broker-dealer

The Business challenge of dis-intermediation

investment advisor

economics of Platforms are tricky

  • is it worth it for me to engage at all?

  • is the desired action of the platform the best for me?

Not everything that can be measured matters and not everything that matters can be measured

  • must be aligned with long-run goal of platform

  • must be under the control of platform participant

What does the platform need people to do?

Is there a suitable performance metric?

Utility tokens fail \(\Rightarrow\) not good platform tokens

Equity tokens fail too!

Observation: many Decentralized Apps = platform for  two-sided, dis-intermediated market

Question 3: Do you need to incentivize the establishment of trust?

Question 2: What kind of incentives can you provide?

Question 1: What role does the intermediary play, what service does it provide?
 

  • Trust

  • Matchmaking

  • Time/size intermediation

  • marketing
     

Key Challenges for the blockchain Community for 2019

Technology

Legal/Regulation

Economic functions

What is the right governance structure for systems?

How should we design tokens as contracts?

How do platform payment means interact with outside world

How much do we have to pay operators to maintain the chain?

Key Economic Questions for Blockchain Design

Key Technology Questions for  Blockchain Design

interoperability

cybersecurity and privacy

functionality

scalability

smart contract features and verification

space constraints

Solution projects to Key Technology Questions

interoperability

scalability

space constraints:

Does the law have to change to accommodate new tech? If so, how? What's dated, what's not?

Key Legal Questions for  Blockchain Design

Legal setup of a platform: what rules can, should, and must a platform establish? What regulations are necessary?

How can token design and the law be married?

Questions for the future

What is the economic impact of "tokenizing everything"?

How will it affect investments and investment banking?

Which business opportunities will it enable?

What do tokens and "alternative money" mean for payments?

Newest Developments: CBDC

CBDC = Central Bank issued Digital Currency

not a cryptocurrency \(\to\) just a "normal" liability on central banks balance sheets

  • BIS Jan 2019: "Proceed with caution"

  • BIS Jan 2020: "Impeding Arrival"

Is it coming?

players (inter alia) 

  • China: in test mode; provinces prep own initiatives, coming next year

  • U.S.: has bigger problems and is always a last mover

  • UK: preparing

  • Canada: contingency planning (it'll happen within two years)

players (inter alia) 

What's the problem and what should a CBDC look like?

current problems

future concerns

crib sheet

too slow

too expensive

not flexible

lack of competition

disintermediation
by new players (Libra)

data harvesting
with no way out

ineffectiveness
of monetary policy

demise of the Loonie

two-tiered world in Canada

fast

cheap

flexible/programmable

universally accessible

 

Possible CBDC architectures

Source: BIS Quarterly Review, March 2020

What is "disintermediation"?

two types of money

government:

  • reserves

  • cash

commercial

  • each commercial loan \(\to\) deposit

cash withdrawl

convert commercial money into government money

lowers bank's balance sheet

disintermediation \(=\)

Would a CBDC destabilize the banks?

BoC analysis (August 2020):

  • [banks] are well-positioned to absorb potential temporary negative effects on profitability and liquidity
  • Banks[can] absorb the shock under plausible adoption scenarios.
  • [No] threat to the stability of the financial system or to banks’ competitiveness in terms of ROE.
  • banks will maintain healthy liquidity levels, and liquidity could become a concern only in the most extreme scenario.

Key question: what business opportunities will arise?

The most controversial entrant of them all ...

Partnerships

"new financial infrastructure"

My prediction: Libra Network will go live in the Spring of 2021

Will people use Libra?

Source: Will Libra Succeed? Results of a Global Randomized Survey Experiment; by Danielle Goldfarb and yours truly

     

 

Why does BigTech enter the finance game?

They have ZERO interest in becoming a financial institution/bank

\(\rightarrow\) no expertise

\(\rightarrow\) competitive market

\(\rightarrow\) one of the most regulated business environments

My take

They are trying to deal with frictions that impede their business

They aim to collect data which will vastly improve their business

Conclusion and final thoughts

blockchain is a transformative technology, but won't be used in practice overnight

many conceptual and technological challenges remain, but there are already various areas of application

legal, regulatory, and competitive changes are needed and then the opportunities are endless ...

it will open up the banking world further, foster international competition, and change how we pay and exchange value

My view: business development will happen in private/semi-public space; strong increase in recent activity; no more testing but re-engineering of processes.

@financeUTM

andreas.park@rotman.utoronto.ca

slides.com/ap248

sites.google.com/site/parkandreas/

youtube.com/user/andreaspark2812/

Intro to Blockchain and Decentralized Finance

By Andreas Park

Intro to Blockchain and Decentralized Finance

This is the slide deck that I use for a quick introduction in John Hull's course RSM2321 (Financial Innovation). I have created a set of instructional videos based on this ser of slides (but for a different course), available here: https://www.youtube.com/playlist?list=PLTmzBTSqnXdvF-T6FGXqJCsQBgVpZ-hzq

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