Blockchain - key concepts and its importance for the Financial Services innovation, lecture at ESCP Europe's Business School as part of certified FinTech diploma

1. §
Blockchain:
Key concepts and its
importance for the Financial
Services innovation

2. Name an event that has reshaped
finance in recent years?

3. The collapse of
Lehman Brothers.

4. Bitcoin!

5. Blockchain!

6. the way we interact with
that database
is different!
What is Blockchain? YES, but…

7. A blockchain, at its
simplest, is a shared
transaction database
on which all
participants agree that
something is true
without the need
for a central authority!

8. Blockchains are built on a series of innovations:
DISTRIBUTED DATABASE
• Data is stored in more than one place: no single
point of failure
• Each entry is chained to the previous: time stamp
• Data is kept in sync
• Transfer of digital value: any asset can be digitally
represented
CONSENSUS
VALUE TRANSFER
• Public/private key encryption
• Cryptographic currencies/units
CRYPTOGRAPHY
SMART CONTRACTS
• Code that is stored, verified and executed on
a blockchain

9. Key benefits:
DISTRIBUTED VALIDATION WITH
CRYPTOGRAPHIC GUARANTEE OF
SETTLEMENT
INCREASED SETTLEMENT SPEED AND
REDUCED SETTLEMENT RISK
IMMUTABILITY AND
AUDITABILITY OF TRANSACTIONS

10. DIGITAL CURRENCIES
SMART CONTRACTS
DIGITAL IDENTITY
SMART PROPERTY
Blockchain technology enables the creation of:

11. Digital currency is
both an internet based
currency and a payment
system.

12. The most popular
digital currencies:
Market Cap
Bitcoin (BTC)
Ether (ETH)
Ripple (XRP)
$14b
$850m
$300m
Total = 21m BTC in 2140
72m pre-mined + 18m ETH p/y
100% pre-mined = 100b XRP
The main purpose:
1. Block validation incentives
2. Transaction spam prevention

13. The cool thing is that you can
transfer other things over the
bitcoin blockchain…
…other financial
assets, e.g. shares or
collateralised debt!

14. Use Case
• BITT Inc., A CARIBBEAN BASED
DIGITAL CURRENCY EXCHANGE,
HAS CREATED THE BARBADOS
DIGITAL DOLLAR - 1:1 RATE TO
THE COUNTRY’S GOVERNMENT
BACKED CURRENCY.
• NASDAQ’S PRIVATE MARKET FOR
TRADING OF PRE-IPO SHARES IN
PRIVATE COMPANIES HAS
STARTED TRADING SHARES THAT
ARE RECORDED AND DELIVERED
IN THE FORM OF COLORED COINS.
• EVERLEDGER USES COLORED
COINS TO TRACK DIAMOND
OWNERSHIP.
The smallest measurable fraction of a
bitcoin (‘satoshi’) can be ‘colored’ in
order to represent real world assets,
such as, for instance, a share in a
company or collateralised debt
portfolio.
Colored Coins

15. If you can’t beat them,
join them!
Central Banks have already started exploring
blockchain to create digital currencies.

16. • GDP COULD RISE BY 3% AS A
RESULT OF REDUCED INTEREST
RATES AND LOWER TRANSACTION
COSTS.
• THE FINANCIAL SYSTEM COULD
BECOME SAFER.
• COMPETITION AND INNOVATION IN
THE PAYMENT SYSTEMS WOULD
BE ENCOURAGED.
• FINANCIAL INCLUSION WOULD BE
IMPROVED.
What could happen
if the BoE
introduced its own
digital currency?
Source: [to come]

17. The most famous use
case of blockchain is Bitcoin!

18. C
Bitcoin is the first Blockchain App
APPLICATION
LAYER
APPLICATION PROTOCOL
LAYER
GENERAL PROTOCOL
LAYER
Bitcoin
Blockchain
Bitcoin
protocol
Bitcoin Gmail
SMTP
TCP/IP
Blockchain is to Bitcoin what Internet is to email:
the underlying tech!

19. Just what is it
that makes Bitcoin
blockchain tick?

20. A blend of cryptography,
and game theory!
m
a
t
h
s

21. Bitcoin Blockchain: Under the hood
DISTRIBUTED
CONSENSUS
DISTRIBUTED
LEDGER
THE INTERNET OF MONEY
PUBLIC KEY
CRYPTOGRAPHY

22. PUBLIC KEY CRYPTOGRAPHY
Alice
Tx
Alice Bob 2 BTC
Alice’s private key Alice’s public key
Signature
Bob
CREATE VERIFY
Signature = f(private key, message)

23. DISTRIBUTED CONSENSUS
BLOCK 4001
BLOCK 4002
BLOCK 4003
TX
TXTXTX
TX
TX
TX
TX TX
TX
New/Pending
Transactions
Existing
Blockchain
random number (guess)

24. DISTRIBUTED LEDGER
LEDGER
LEDGER
LEDGER
LEDGER

25. Why are banks SO excited
about blockchain?

26. ‘It could cut $20bn
in bank costs for
cross-border payments,
securities trading and
regulatory compliance
by 2022.’
(Santander InnoVentures)

27. DECENTRALISED
SECURE
PAYMENT = SETTLEMENT
REAL TIME ASSET MOVEMENT
IMMUTABLE HISTORY = AUDIT TRAIL
TRANSPARENT
EFFICIENT
Atributes that make blockchain SO attractive:

28. But, what should a distributed ledger
for financial institutions look like?

29. PRIVACY
COST REDUCTION
SCALABILITY
GOVERNANCE
Motivation for building private distributed ledgers:

30. Blockchain vs. Distributed Ledger

31. Blockchain
• No single owner
• Permissionless
• No restriction on ability to
join and transact
• Users are pseudo-
anonymous: access
gained through
downloading software
• Secured by
cryptoeconomics
• Owned
• Permissioned
• Participants identified and
meet regulatory standards
(KYC and AML)
• Read/write permissions
are normally restricted
• Consensus is controlled
by preselected nodes
Distributed Ledger

32. TRANSACTION COST
OPENESS
DECENTRALISED TRUST
CENSORSHIP RESISTANCE
SPEED/SCALABILITY
DISTRIBUTED LEDGER
BLOCKCHAIN
Blockchain vs. Distributed Ledger

33. BLOCKCHAIN
+
PROGRAMMING LANGUAGE
=
THE INTERNET OF VALUE

34. I’ve built a blockchain
from scratch, put a fully
functional computer on it… and
called it Ethereum!

35. It can execute ANY smart
contract!

36. Why did I do it?

37. Because,
traditional contracts
are not geared up for
the digital age!

38. Problem with traditional contracts:
• Inefficient
• Settlement delays
• Fraud
• Concentration of risk

39. ENHANCED EFFICIENCES
RISK REDUCTION
COST SAVINGS
Potential benefits
for financial
institutions and
their clients:

40. IMMUTABILITY
CORRUPTION & TAMPER
PROOF
SECURE
ZERO DOWNTIME
PROGRAMABILITY
ESCROW CAPABILITY
ORACLE INPUTS
Advantages of
blockchain-based
smart contracts:

41. How do Smart Contracts on a distributed
ledger work in practice?
A smart contract between transacting parties is written as
code on a distributed ledger shared between all
participants. It gets validated by validators.
The smart contract connects with banks’ internal systems or
external world (e.g. account balances, share prices, etc.) as
programmed.
The contract waits for external triggers to evaluate pre-
defined conditions. It also provides data for compliance and
reporting.
When the triggering event like an expiration date or strike
price is hit, the smart contract executes itself according to
the coded terms built into it. It also provides data for
compliance and reporting.

42. Use Case
Flight delay insurance policy that
pays out conditionally based on
the delayed time.
The smart contract waits until
the predetermined time.
The Oracle pushes the time
report to the blockchain.
The smart contract retrieves
the time report and self-
executes.

43. Use Case
• INTERBANK CROSS-BORDER
PAYMENTS WITH R3 AND 12 OF
ITS CONSORTIUM MEMBER
BANKS.
Smart Bond - automated
coupons payments • The smart contract code
automatically initiates the
payments at the appropriate
times.
• It avoids all manual processes
and guarantees that the issuer
cannot default.

44. • THE LAGGING LEGAL AND
REGULATORY
ENVIRONMENT
• THE COMPLEXITY OF THE
BUSINESS ECOSYSTEM
Key adoption
challenges:

45. By combining digital currencies,
smart contracts and other new tech,
blockchain will empower completely
new business models!

46. What can you do
and where to look for
opportunities?

47. dean.demellweek@me.com
@deandemellweek