Potential of Blockchain Technology as Protocol of Universal Virtual Reality.

Updated on September 12, 2018
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I did my Ph.D. at Stanford University following my masters from the University of Houston.

Potential of Blockchain Technology

Potential of Blockchain Technology as a protocol of universal virtual reality

This piece is geared at discussing the contents of the third chapter in Viternity, a book that explains argument for a perpetual digital existence. One of the key components of this existence is the new introduction of blockchain technology. As blockchain now forms the basis for a variety of tasks, such as cryptocurrencies, security, accounting and the decentralization of important data, it appears as if the technology is here to stay. Moreover, one would be premature in analysis if the current state of the technology was portrayed as the only form in which it can exist. This is due to the seemingly endless possibilities which blockchain represents.

Thus, this paper seeks to expound on the potential intrinsic to this technology and the ways in which it may be implemented in a digital environment. This paper seeks to explore that potential, examining exactly what blockchain is and the benefits it could bring; the areas within financial services in which it is most likely to be applied; the current state of play with blockchain implementation in the industry; the challenges that need to be overcome in order for it to fulfil its promise; the likely way in which the blockchain story will develop in the coming months and years; the implications of that development for existing market participants; and possible approaches for institutions to ensure they benefit positively from the blockchain phenomenon.

The first, and arguably most important aspect of the technology, is the use of cryptocurrency and the many benefits derived therefrom. For this reason, blockchain’s feasibility as a currency replacement will be analysed in detail. Thereafter, there will be a discussion of the use of cryptocurrencies in the form of a ledger, store of data and the decentralized features on offer. All of these encompass the possibilities of Bitcoin.

1. Methodology of Analysis

As alluded to, this paper will make use of qualitative data in the form of direct quotations from the Viternity book. These quotes will be used to present the rhetoric that is mentioned in the pages of the focal literature that has brought about this piece. Thus, the first step will be to present the findings of Virternity’s third chapter – a presentation which will make use of the qualitative data that is formed from direct quotations. Following this, there will be a mention of the current blockchain landscape and the scientific bridges that will need to be crossed before the current technology may be adopted in a virtual existential environment. Thereafter, there will be an assessment of the findings in light of trusted and present literature. This will include the scrutiny of statistical, mathematical and the current scientific data.

1.1. Source of Data

The literature will be derived from present science and that which has been proven trustworthy in nature so that any conclusions drawn may be inarguably accurate. This brings about the culmination of the piece: a well-conceived and fair conclusion that asserts itself on the authority of reason. The scientific research presented will be primarily qualitative in nature, however, if a statistical representation of facts is required, it shall be used in order to bring about better clarity. To solve all concerns, the sample size of literature will be triangulated so as to provide studies that are minimal in bias, for it would not prove beneficial to merely cite sources just because they are in agreement with the bias of the author. Therefore, only unbiased and professional work will be included in the analysis. Furthermore, studies that have not been exposed to sufficient experience, and whose outcome may be questioned due to malfunction of practice, will not be included. Discrepant data will be accounted for – not excluded. Thereafter, it will be subject to the same criticism from external literature as with all other literature.

1.2 Step-by-step Outline

This paper, for the sake of complete ease of understanding from the reader, will follow an orderly structure. Therefore, the following structure will be observed:

  1. The accurate representation of information that has been given in chapter three of Virternity. This will appear primarily in the form of direct quotations and the expounding thereof. However, this may require the paraphrasing of ideas so that a correct and easily understandable ideologue may be understood by the reader.
  2. Once sufficiently defined, the data that has been presented will be run through a proverbial sieve formed from the current literature. Each theme that is presented regarding blockchain technology will be weighed by positive and negative rebuttals.
  3. At this point, the discussion will turn to the present day, the nature of the current virtual currency technology (as seen in markets, trusted literature, and leading research) and the implications that are derived from this so that a forecast of the future might be created. Once the current trajectory of the field has been observed, there will be mention of how to obtain an outcome where blockchain technology may be used in a virtual existential eternity.
  4. After the data has been successfully strained through the scope of current literature, information will be obtained that will allow for a conclusive section to be created. Thus, the final step will see a broad conclusory comment on the results brought about by a thorough analysis.

Blockchain Defined

In times prior to the digital revolution which provided the internet, there was a noticeable shift towards the use of centralized systems. These systems were governed by those in power, such as governmental departments, large entities and organizations. As the internet dawned, the world saw a new type of media exchange in the form of interpersonal tools that stem from the use of the internet. As a result, exchanges of information started to become decentralized and the onus of control was now placed more on the individual instead of the monopolized entities.

A purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution. Digital signatures provide part of the solution, but the main benefits are lost if a trusted third party is still required to prevent double-spending. We propose a solution to the double-spending problem using a peer-to-peer network. The network timestamps transactions by hashing them into an ongoing chain of hash-based proof-of-work, forming a record that cannot be changed without redoing the proof-of-work. The longest chain not only serves as proof of the sequence of events witnessed, but proof that it came from the largest pool of CPU power. As long as a majority of CPU power is controlled by nodes that are not cooperating to attack the network, they'll generate the longest chain and outpace attackers. The network itself requires minimal structure. Messages are broadcast on a best effort basis, and nodes can leave and re-join the network at will, accepting the longest proof-of-work chain as proof of what happened while they were gone.

Blockchain is a mere by-product of this phenomenon, as the technology is a decentralized database that allows for the exchange of information between private parties, thereafter storing it within different virtual blocks that are chained together and accessible only by the users of the data. As a result, blockchain is the realization of many different possibilities and it could play a key factor in the feasibility of a virtual existence. Blockchain has the ability to provide a global record of any transaction, such that any person who exchanges information or currency will alter the system. It makes use of advanced cryptography to achieve this feat and the possibilities, due to near endless records, are monumental. This can be seen in the work of Mclean (2017):

"Blockchain – the shared ledger technology which allows any participant in a business network to see the system of record – will have a transformative impact on a number of industries, including financial services, in the future. Blockchain is still in its relative infancy, but a number of initiatives underway are already driving its progression to an industrial solution which will yield several important benefits in the context of the transfer of assets within business networks.”

1.2 Presentation of Data as Presented by Chapter Three of Virternity

This section will present the findings of the third chapter, as seen in Virternity. This relates to blockchain technology and its feasibility as an actual system of the future. These concepts will be presented thematically herein, divided by commonalities and a solidarity in concept.

1.2.1 Foundation for Use of blockchain

The first premise asserted within the chapter speaks to the need of virtual existence for blockchain technology. This would, theoretically, be necessary for interpersonal transactional exchanges, allowing the view of life as we know it to continue in a digital environment. Bailey (2016) mentions this through the following diction: “It is self-evident that any kind of virtual existence which involves the potential transaction of business personal or otherwise will require a method of exchange.” This attempts to explain the need for the use of currency after a virtual existence of being.

Further dialogue presents the options as a two-fold scenario. On the one hand, software could be introduced in order to use the current banking system – on the other, there could be an adoption of worldwide, decentralized currency system allowing for the eradication of the former. To this end, Bailey (2016) states,

“…continue the use of the existing banking fraternity and their systems by linking into these with appropriate and proprietary software and interfaces. …be to create an independent virtual currency system that does not conform to the conventional fiscal models and is not central bank regulated”.

These pose the two alternative options, each one with a specific opportunity cost that is forgone with the adoption of the other. Furthermore, Bailey expounds on the use of a digital adaptation of the current banking system, shown by the following excerpt:

“It could be considered that the use of the current banking system may not be entirely desirable since one is buying into a heavily regulated institutionalized arena which in itself may exert undue influences on the virtual environment beyond those that are purely financial. If autonomy is sought, then control of financial systems by external institutions and governments is very likely to compromise this aim. One of the key points outlined by the proponents of Virternity is the wish to maintain control by democratic means that is not vested in the hands of one or more individuals, governments or corporations.” (Bailey, 2016)

According to Bailey, the use of the current banking system defeats the purpose of a digital existence, as one of its chief aims is libertarian in nature. This translates into a society (virtual or otherwise) that is free from governmental sovereignty. Rather than a central governing institution, Virternity seeks the rule of the people through populism means. By making use of the current banking system, those encapsulated within the virtual realm would not be able to obtain this utopian ideologue, as the dependence leaves one vulnerable to the authority of the institution. Thus, any true virtual existence must include a virtual currency lest it lose its benefits. However, as Bailey argues, there may be potential problems that arise with the complete move away from the traditional banking system. The foundation remains a move to cryptocurrency because of the libertarian ideology that defines Virternity.

1.2.2 The Evolution of blockchain into cryptocurrencies

Blockchain technology is the foundation for cryptocurrencies, which in themselves are needed for a sustainable digital existence (Bailey, 2016). Thus, arguably, the most important part of the technology is its ability to provide an alternative to fiat currencies. The following sections will, therefore expound in greater detail on this topic.

Virtual currencies have seen a rise in their complexity and their nature of late. Bitcoin may have the honour of being the father of this genre of transaction with the likes of Ethereum and others following. The blockchain transactional systems have seen a rapid adaption to the needs of those seeking an alternative transactional system. To illustrate this, Bailey quotes the following from IBF:

“New technologies—supported by advances in encryption and network computing—are driving transformational change in the global economy, including in how goods, services and assets are exchanged. An important development in this process has been the emergence of virtual currencies (VCs). VC schemes are private sector systems that, in many cases, facilitate peer-to-peer exchange bypassing traditional central clearinghouses. VCs and their associated technologies (notably distributed ledgers based on blockchains) are rapidly evolving, and the future landscape is difficult to predict. VCs offer many potential benefits, including greater speed and efficiency in making payments and transfers—particularly across borders––and ultimately promoting financial inclusion. The distributed ledger technology underlying some VC schemes—an innovative decentralized means of keeping track of transactions in a large network– –offers potential benefits that go far beyond VCs themselves. At the same time, VCs pose considerable risks as potential vehicles for money laundering, terrorist financing, tax evasion and fraud. While risks to the conduct of monetary policy seem less likely to arise at this stage given the very small scale of VCs, risks to financial stability may eventually emerge as the new technologies become more widely used.” (IBF et al., 2016, p. 5).

This shows the evolution of the decentralized transaction system, as to lead to a point of a greater utility of individuals. For example, there is no foreign exchange risk, monetary value may be transferred anywhere around the world on a whim and the costs of this are reduced. Furthermore, a properly developed cryptocurrency will act in superiority to fiat currencies (currencies backed by a central bank). However, as seen by the explanation from IBF, there are dangers that the technology may produce. Due to the nature of blockchain technology, there is an opening that could be crafted for fraud, money laundering, and in extreme cases, terrorism. Thus, along with the evolution of virtual currencies, comes certain negative consequences according to IBF and Bailey.

1.2.3 The Benefits of Virtual Currency

The next theme that is presented within this chapter sees some of the benefits of a virtual currency expounded. If blockchain based currencies are to be of use in the future, one must have a clear indication of the benefits that they possess. Therefore, Virternity showcases these benefits and later pins them against its negative points (however, this will be discussed further in the 1.2.4). This allows for the clear understanding of a correct prescription of what technology to adopt, and also what needs to be improved. For example, the hackability rate of Bitcoin in the past would be of great concern if it became a dependant for a worldwide movement such as a digital state of being. Thus, an alternate source may need to be found (maybe a new, more secure virtual currency like Quarkchain (see ICO, 2018).

Chapter two presents the concept of virtual currency as a prospect for replacing fiat currency. As Bailey explains (2016), “This points out that the VC system is self-fulfilling in the respect that value derives from those who use it. It is thus not based on the traditional benchmarks of creditworthiness and other current mechanisms in place to determine measures of confidence in matters of currency value and its inherent credibility as a reliable exchange medium.” To paraphrase, Bailey is stating that a cryptocurrency is more viable than a centrally backed legal tender due to the fact that it has intrinsic value based on the people who use it. Thus, there is no legal binding required for such a currency to exist – instead, the same invisible hand that is famous for managing markets into an equilibrium of supply and demand is found at play. Again, one can see how this plays into a positive libertarian rhetoric, as it poses the advantages that are found when loosed from excess government intervention.

As seen by the writings of Anderson, Bitcoin further poses the possibility to act as any form of legal tender. This can be observed by any day trader, as most cryptocurrencies present themselves as any foreign currency – available for trading against another commodity. As Anderson explains, this is due to the high volume of trade that occurs with virtual currencies, therefore, it is possible to get a fair-market related value due to purchasing power parity. To this end, the following excerpt from the works of Anderson is quoted below

“Bitcoin’s volatility as a means of storing value has also drawn a lot of attention. Again, this has tainted many people’s views of digital currencies in general. Actually, Bitcoin can be bought and sold like a foreign currency and has a market exchange rate against numerous currencies. There are dozens of active markets and exchanges within which Bitcoin (and other digital currencies) can be liquidated and/or converted. The exchange rate of Bitcoin fluctuates in just the same way that exchange rates for sovereign currencies fluctuate.” (Anderson, 2016, p. 26).

Moreover, Cryptocurrencies are only perceived as anonymous. The truth resembles an exchange tool that may rather be more accurately described as pseudonymous, as it merely masks your identity through the vail of other online users. Thus, the government has been able to track Bitcoin-related crimes such as dealings on the infamous Silk Road, money laundering, and fraud through advanced tracking systems that are able to locate individuals through the veil that is created through a decentralized currency. Although this may seem like an intrusion into the privacy of individual transactions, such a backdoor accountability loophole may just be what is needed in order to discourage negative and unwanted activity. This is backed up by the Acuity Magazine (2016):

“Bitcoin ownership and use is widely thought of as anonymous, which made it popular on ‘dark net’ websites such as Silk Road (infamous for facilitating drug dealing and other illegal activity). Unfortunately, the perception of anonymity tarnished the image of digital currencies as they appeared to facilitate criminal activity. However, as criminal offenders have found at the cost of their liberty, bitcoin ownership and provenance can be established from the blockchain. Even the UK Treasury acknowledges that Bitcoin is only perceived to be anonymous. More correctly, it can be said to be pseudonymous; ownership is masked to some extent.” (Anderson, 2016, p. 26).”

According to Bailey, the assumptions that surround cryptocurrencies (assertions which state that it inevitably leads to illegal transactions and the like) are unfounded. Due to the nature of the technology and the rate at which it is evolving (as a result of the constant updates and research), there is little worry of it being used for illegal means. To this end, Anderson continues:

“We have not reached the sweet intersection of consumer acceptance and technological capability for digital currency, but we can’t be far from it. The digital wallet technology exists today. Consumer acceptance of digital currencies is growing and will continue to grow. Digital currencies are steadily gaining legitimacy in commerce, courtrooms, and legislatures around the world.” (Anderson, 2016, p. 27)

This clearly shows that there is a growing trust and popularity of virtual currencies, as the public starts to see the utility of the idea. Although it does not seem as revolutionary, some have argued that the advent of cryptocurrencies is as important an event as the introduction of the internet. More specifically, it is described as a blockchain revolution of which virtual currencies are the first major tangible expression. Despite this, some cryptocurrencies have moved away from the blockchain foundation, showing that it is not just on ‘one trick pony’ – it is a unique concept of great potential that is a possibility, due to the benefits described in this segment, to form one of the foundations of a virtual eternity. This positive outlook is further held by governments, as the news breaks, at the time this paper is being penned, of the American government investing billions of dollars (US) into the research of cryptocurrencies.

“… agency, which received more than $7b in funding from Congress for Fiscal Year 2015, has funded other efforts aimed at exploring cryptocurrencies, including one initiative at Princeton University and another at the University of California-Irvine.” (Higgins, 2015)

It has captured great excitement from the public, but government adoption is a huge leap for the credibility and viability of virtual currencies. This proves that it represents economic and practical benefit on a macro level, as virtual currencies have often been seen as a short-term scam that only a few benefit from. However, the last few years have shown the opposite – the statements within this section are a testament to this as well, for cryptocurrencies have a potential to be a viable medium of transactional exchange in a virtual eternity.

Despite doubts about Bitcoin, a number of observers continue to believe the potential for blockchain in payments is high, and companies like Ripple have garnered a lot of attention in the payments space. As Fulmer says, the theory here is potentially strong. “Blockchain allows everybody involved in a transaction to see the entire transaction lifecycle and everyone else’s involvement in it. That’s very good. We have been trying to achieve that in payment systems with messages – but if you have a complex chain, that’s difficult to do.” While messages are a reasonable way to offer clarity on each step in the payments process, blockchain could add to this by providing provenance and auditability for these messages. Smart contracts could then be used to make payment terms and positions more visible, reducing risk.

1.2.4 Negative Aspects of Blockchain-based Cryptocurrency

Virtual currencies have been viewed with scepticism by most since they arrived on the scene in the form of the blockchain based Bitcoin. There are plenty of good reasons for this, as the introductory phases of the technology were largely associated with drugs, terrorism, and fraud. This is partly due to the anonymity that the currency provided, as unlike fiat currencies, virtual ones are more difficult to trace. As a criminal, there would be less concern with money trails and the like. However, some of these points have been sufficiently dealt with in 1.2.3, but there are still other concerns that would threaten a virtual eternity.

Consider the following excerpt provided from Finance Professor Luigi Zingales, which notes the inherent general distrust in finance:

“throughout history, finance has been perceived as a rent-seeking activity. Prohibitions against finance date as far back as the Old Testament. The aftermath of the 2007 to 2008 financial crisis has only worsened this view. From Libor fixing to exchange rate manipulation, from gold price rigging to outright financial fraud in subprime mortgages, not a day passes without news of a fresh financial scandal.” (Zingales, 2015, pp. 1327-1328).

In his book Virternity, Bailey paints the use of finance as a negative transactional system that is only used to extort the borrower out of any fair financial growth. However, empirical evidence has proven such a stance wrong, as finance has provided the means for entities to externally grow at a quicker financial pace than through organic growth. Thus, economies are larger, faster in growth and the access to markets with high barriers of entry is improved. For example, space exploration is impossible without the backing of multiple financiers (whether government or otherwise). A good example of this is Elon Musk and his SpaceX company, who leverage on high access to finance and exorbitant government subsidies in order to achieve what would be impossible without finance.

With virtual currencies, there is a greater risk of default on the behalf of borrowers, as it requires greater trust from lenders who usually rely on a staunchly regulated sector. The central bank and the laws that it produces are an integral part of making sure that both sources of capital and those who make use of it are protected from each other. Moreover, without such a system, there is potential for an economy that contains fewer financiers due to the level of risk that they have to live with. Investors are often the heartbeat of an economy. They are the entities that every country seeks to attract through policy and fiscal reformations. For this reason, external rating agencies exist to provide reliable data so that investors may act with sophisticated measures. Increased risk, which an exclusive cryptocurrency reality ensures, is not a great move economically speaking. This is a problem that needs to be solved, as it prohibits the growth of financial markets.

With the advent of cryptocurrencies, security risks must also be considered. In a virtual state of being, one would rely heavily on these virtual currencies which are the reason for ensuring that they are not complicit in illegal acts. There is no denying that the evolution of cryptocurrencies has shaped a more secure end product. However, risks still remain, as seen by the following (Investopedia, 2016):

“Malware created specifically to steal Bitcoin and any of the 200 other cryptocurrencies currently in circulation has emerged, fuelled by a rapid increase in the value of Bitcoins recently. Attacks are commonly aimed at Bitcoin wallets and the compromise of private keys. But one thing is perfectly clear; criminals have already adapted their attacks to include these platforms wherever and whenever the opportunity arises. Financial institutions need to remain vigilant and be agile to stay ahead of nefarious actors and ensure they remain relevant in an increasingly virtual, mobile and hyper-connected world.”

The virtual currency world is currently open to new adaptions of software that have been designed to steal and launder according to an illegal agenda. Such risks are not as prevalent with fiat currencies due to the traceable nature. If, however, someone was to raid a virtual wallet, that money is gone and largely untraceable.

However, in aid of this, Bailey provides the following insight:

“However, what if instead one could build a virtual world with effective open borders, in a consensual and cooperative way? Perhaps the element of ‘conspiracy’ inherent in these types of predictions may be mitigated. The Virternity project proposes a more benign and positive outlook to the future of humanity’s adventure into the virtual realm and the increasing emergence with the digital world. There is perhaps a sense of inevitability about the move towards a future where humans span both the physical and digital world. I also speculated about this same topic in my Master’s thesis Hyperreality: The merging of the physical and digital worlds (Bailey, 2014). The thesis explored the burgeoning relationship between these two worlds and whether humanity is indeed moving closer to this merged reality until it becomes inextricably part of it. The conclusion that I came to at the end of the dissertation was that we do appear to be moving in that direction of unity with the digital world but that it is our responsibility to ensure that we all become arbiters of our new future. We cannot leave it to corporations and governments to ultimately take charge of the direction which this digital emergence takes. (Bailey, 2014). One entrant into this new digital arena is the Virternity project. The project bills itself as the builder of a new virtual world where those within it can indeed, as I suggested, be the arbiters of their own virtual fate and retain some control over its destiny. The creation of the Virternity world involves the idea of openness where ultimate control is not vested in any one organisation, individual or even group of individuals. This chapter introduces and discusses the overriding vision of the Virternity project, discrete parts of the project itself are discussed in more detail in further chapters.” (Bailey, 2016)

In this excerpt, the author cites the implementation of a virtual environment as the solution to the dilemma of the problem of illegal activity, as it provides transparency. More of this will be discussed in the latter sections of this paper, as this fits more in line with the feasibility of adoption instead of an actual problem.

2. Blockchain used as a currency replacement

In order for there to be a true assessment of the present state of virtual currencies, one must understand the nature of all its faculties. Therefore, this section will make use of various excerpts in order to explain mining, the various types of virtual currencies and the market capitalization thereof (amongst others). Thereafter, it will be stated as to how a bridge to the level of technology needed for a virtual existence that contains a cryptocurrency underwriting could be created. This will be done using relevant literature and excerpts thereof (Popper, Nathan, 21 May 2016).

2.1 Different Brands of Blockchain-based Virtual Currencies

The following is a list of the most popular cryptocurrencies. This is to provide a bit more context and allow for insight as to what the current use of virtual currencies. These are what is spoken about in the second chapter of Virternity and the future of the concept would need an adaptation of one of the following in order to see success.

“As of April 2017, the following cryptocurrencies are the largest after bitcoin in terms of market capitalization:

DASH Privacy-focused cryptocurrency launched in early 2014 that has recently experienced a significant increase in market value since the beginning of 2017. In contrast to most other cryptocurrencies, block rewards are being equally shared between miners and ‘master nodes’, with 10% of revenues going to the ‘treasury’ to fund development, community projects, and marketing.

MONERO (XMR) Cryptocurrency system that aims to provide anonymous digital cash using ring signatures, confidential transactions and stealth addresses to obfuscate the origin, transaction amount and destination of transacted coins. Launched in 2014, it saw a substantial increase in market value in 2016.

RIPPLE (XRP) Only cryptocurrency in this list that does not have a blockchain but instead uses a ‘global consensus ledger’. The Ripple protocol is used by institutional actors such as large banks and money service businesses. A function of the native token XRP is to serve as a bridge currency between national currency pairs that are rarely traded and to prevent spam attacks.

LITECOIN (LTC) Litecoin was launched in 2011 and is considered to be the ‘silver’ to bitcoin’s ‘gold’ due to its more plentiful total supply of 84 million LTC. It borrows the main concepts from bitcoin but has altered some key parameters (e.g., the mining algorithm is based on Script instead of bitcoin’s SHA-265).”

All information has been derived from (Hileman and Rauchs, 2017)

Introduction To Blockchain in A Capital Market

Storing and agreeing datasets of financial obligations and ownership forms the basic core of capital markets operations. The current methods are highly complex, utilise fragmented IT and data architectures and suffer from a lack of common standards. This creates the continual need to reconcile data with massive systems and process duplication, leading to high costs and protracted time to execute task.

1. Securities transaction

Client A and Client B are matched on an execution venue, and automatically verify that the other has the means to complete the transaction. (For example, Client A demonstrably owns the security on the asset ledger, and Client B demonstrably owns cash on the cash ledger). Client A and Client B jointly ‘sign’ the transaction by applying their private keys to unlock their asset or cash, and then by transferring ownership to the recipient via their public key. The signed transaction is broadcast to the distributed ledger to be validated and recorded in the next update, along with a simultaneous update to a cash ledger.

2. Asset servicing

For new issues, assets are issued directly onto the asset ledger. In fact, securities themselves could be unbundled so that the individual cash flows, and the rights they encapsulate, could be transferred separately.

Mandatory events and distributions can be managed via smart contracts embedded within the securities. Complex events can be structured as simple Delivery Versus Payment (DVP) transactions between issuers and investors. Fund managers will have perfect visibility of their pools of investments in securities (the asset side of their balance sheet), and will be able to manage investors’ holdings in their funds via units created as tokens on a fund ledger.

With flat accounting, the multiple custody layers are shrunk to a single function. Currently, a single security may be held in as many as five or six layers of custody (stockbroker, sell-side bank, local custodian, global custodian, CSD, etc.) each with their own accounting views. Here the asset is held by a form of wallet provider recording the final beneficial owner.

3. Derivative transaction

The utopian setup for derivatives represents the biggest change. In the first instance, unbundled securities could enable new approaches to financial engineering, enabling specialists to construct bespoke instruments consisting of individual cash flows that meet precise needs in terms of timing and credit risk. These instruments could be financed by issuers selling their own instruments that match the cash flows they expect to achieve, in essence creating swaps without the need for balance sheet intermediation.

Moreover, derivatives will be created as pre-programmed smart contracts, capturing the obligations of the two counterparties (such as margin agreements or swap conditions).

Novating the trade via a Central Counterparty Clearing House (CCP) would continue to allow dealers to net their exposures. Posting collateral to the CCP in the form of initial and variation margin can be done either by escrowing cash on a cash ledger, or by allocating assets held on other asset ledgers to a collateral ledger. In the future, if a central bank issues freely available electronic currency on demand, it would allow dealers to pledge the eligible portion of their inventory to the central bank and use central bank cash collateral when trading.

The smart contract can automatically recompute exposures by referencing agreed external data sources that recalculate variation margin. Interoperable derivative and collateral ledgers would automatically allow the contract to call additional collateral units on asset ledgers to support these needs. At maturity, a final net obligation is computed by the smart contract, and a payment instruction automatically generated in the cash ledger, closing out the deal.

Mathematical Proof of Blockchain

We consider the scenario of an attacker trying to generate an alternate chain faster than the honest chain. Even if this is accomplished, it does not throw the system open to arbitrary changes, such as creating value out of thin air or taking money that never belonged to the attacker. Nodes are not going to accept an invalid transaction as payment, and honest nodes will never accept a block containing them. An attacker can only try to change one of his own transactions to take back money he recently spent. The race between the honest chain and an attacker chain can be characterized as a Binomial Random Walk. The success event is the honest chain being extended by one block, increasing its lead by +1, and the failure event is the attacker's chain being extended by one block, reducing the gap by -1. The probability of an attacker catching up from a given deficit is analogous to a Gambler's Ruin problem. Suppose a gambler with unlimited credit starts at a deficit and plays potentially an infinite number of trials to try to reach breakeven. We can calculate the probability he ever reaches breakeven, or that an attacker ever catches up with the honest chain, as follows:

p = probability an honest node finds the next block q = probability the attacker finds the next block qz = probability the attacker will ever catch up from z blocks behind qz={ 1 if p≤q q/ pz if pq}

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Identities Transactions Trusted Third Party Counterparty Public

Identities Transactions Public

New Privacy Model

Traditional Privacy Model

Given our assumption that p > q, the probability drops exponentially as the number of blocks the attacker has to catch up with increases. With the odds against him, if he doesn't make a lucky lunge forward early on, his chances become vanishingly small as he falls further behind. We now consider how long the recipient of a new transaction needs to wait before being sufficiently certain the sender can't change the transaction. We assume the sender is an attacker who wants to make the recipient believe he paid him for a while, then switch it to pay back to himself after some time has passed. The receiver will be alerted when that happens, but the sender hopes it will be too late. The receiver generates a new key pair and gives the public key to the sender shortly before signing. This prevents the sender from preparing a chain of blocks ahead of time by working on it continuously until he is lucky enough to get far enough ahead, then executing the transaction at that moment. Once the transaction is sent, the dishonest sender starts working in secret on a parallel chain containing an alternate version of his transaction. The recipient waits until the transaction has been added to a block and z blocks have been linked after it. He doesn't know the exact amount of progress the attacker has made, but assuming the honest blocks took the average expected time per block, the attacker's potential progress will be a Poisson distribution with expected value: =z q p

To get the probability the attacker could still catch up now, we multiply the Poisson density for each amount of progress he could have made by the probability he could catch up from that point:

∑ k=0 ∞ ke− k! ⋅{q/ pz−k if k≤z 1 if kz} Rearranging to avoid summing the infinite tail of the distribution...

1−∑ k=0 z k e−k! 1−q/ pz−k

Converting to C code... #include <math.h> double AttackerSuccessProbability(double q, int z) { double p = 1.0 - q; double lambda = z * (q / p); double sum = 1.0; int i, k; for (k = 0; k <= z; k++) { double poisson = exp(-lambda); for (i = 1; i<= k; i++) poisson *= lambda / i; sum -= poisson * (1 - pow(q / p, z - k)); } return sum; }

7

Running some results, we can see the probability drop off exponentially with z. q=0.1 z=0 P=1.0000000 z=1 P=0.2045873 z=2 P=0.0509779 z=3 P=0.0131722 z=4 P=0.0034552 z=5 P=0.0009137 z=6 P=0.0002428 z=7 P=0.0000647 z=8 P=0.0000173 z=9 P=0.0000046 z=10 P=0.0000012 q=0.3 z=0 P=1.0000000 z=5 P=0.1773523 z=10 P=0.0416605 z=15 P=0.0101008 z=20 P=0.0024804 z=25 P=0.0006132 z=30 P=0.0001522 z=35 P=0.0000379 z=40 P=0.0000095 z=45 P=0.0000024 z=50 P=0.0000006 Solving for P less than 0.1%... P < 0.001 q=0.10 z=5 q=0.15 z=8 q=0.20 z=11 q=0.25 z=15 q=0.30 z=24 q=0.35 z=41 q=0.40 z=89 q=0.45 z=340

Blockchain as an Accounting Ledger

Blockchain was created as a method of storing decentralized data within a system of chains. The dta is, thus, safe and secure from the intervention of an authority. The only consideration, in this regard would be the likes of internet attackers and hackers. However, this is almost impossible due to the security of the technology. Therefore, most attacks have occurred from physical leaks from places such as cryptocurrency exchanges or other physical locations where the data. The security of the information and the fact that it is not subject to alterations once uploaded has left many with the belief that blockchain is the future of accounting (Williams, Ann, 2016).

Challenges Faced for Implementation

Accounting is a standardized practice, as the reports are done in accordance with either international or domestic legal requirements. As a result, the first hurdle in the implementation of blockchain is legal in nature. As the technology requires specific formats and quantities pertaining to security are still unknown – not to mention the fact that accounting departments will have to work in conjunction with blockchain and IT experts – blockchain remains on the fringes of implementation. The most common system, the IFRS, is commonly used throughout most of the world. Certain exemptions are the United States of America and Russia. The EU, however, is a major adopter of the standard and more countries have followed since. To move away from a global standard would require both time and justification, something blockchain is yet to provide.

Benefits of Blockchain in Accounting

As opposed to the internet, blockchain is not a store of technology; ownership of information may be transferred between parties. Single ownership is also not possible, as the information is distributed amongst all stakeholders. In the accounting sphere, this provides an additional layer of security and the means by which to safely transfer reliable information between the desired entities. It is more secure, as the technology makes use of advanced cryptography to secure the link between chains and the market will soon use it as a standard. Thus, any accounting practice of the future will require an accounting that is based on blockchain technology.

Banking on Blockchain

The banking industry is an integral point of any economy. Commercial banks generally derive economic benefit through two measures. This may be categorized as charges and finance respectively. For example, anyone who seeks to store their money in a bank will be charged a monthly fee or any fee upon any pre-agreed transaction. Alternatively, an entity may take out a loan in order to finance a variety of endeavours or purchases, provided that entity pay interest on the loan. The interest gained by the bank will equal the profit.

If a bank cannot attract a sufficient level of core deposits, that bank can turn to wholesale sources of funds. In many respects these wholesale funds are much like interbank CDs. There is nothing necessarily wrong with wholesale funds, but investors should consider what it says about a bank when it relies on this funding source. While some banks de-emphasize the branch-based deposit-gathering model, in favour of wholesale funding, heavy reliance on this source of capital can be a warning that a bank is not as competitive as its peers.

Investors should also note that the higher cost of wholesale funding means that a bank either has to settle for a narrower interest spread, and lower profits, or pursue higher yields from its lending and investing, which usually means taking on greater risk.

Blockchain, however, is primed to revolutionize the industry. The sector is marked by multiple transaction types that flow consistently between banks. On the way, these may cross borders and be subject to a variety of external stimuli. Often, this makes things difficult for two reasons:

  1. Crossing borders initiates an exchange rate transfer
  2. Every transaction carries hefty fees due to high administration and red tape procedures

The result is often a messy scenario that takes days to complete. For example, wire transfers to third world countries take as long as a week to process. Moreover, they will carry substantial charges and be costly to both the institution and the parties involved. Blockchain provides a sufficiently secure peer-to-peer transaction system, which allows for a more efficient transfer of funds between parties.

Hurdles to Adoption

The path to adoption for block chains in capital markets requires clearing a number of hurdles. The technology requires further development to be truly scalable, as well as common standards to be agreed. Sufficient investment is needed to develop applications and run implementation programmes. An industry unaccustomed to cooperation will need to reach agreement on a wide range of challenging issues regarding implementation.

Scalability of the technology Blockchain technology remains nascent, even if it is developing quickly. Questions over the scalability and throughput capacity of block chains are starting to be successfully answered, with order of magnitude improvements over the original Bitcoin platform, although the current standard of technology remains some way behind the levels required to support adoption in capital markets. Much larger datasets will need to be handled if any core part of the capital markets system is to be replaced.

Moreover, there will be very high standards set for the security, robustness and performance of block chains used for major industrial purposes. Integration with existing non-blockchain systems (such as risk management platforms) will also be a requirement for the foreseeable future.

Regulation and legislation: Fitness for purpose Disrupters in other industries (such as Airbnb and Uber) have adopted an ‘act first, seek forgiveness later’ approach to regulation. Innovations in financial markets, however, require the explicit blessing of regulators well ahead of time. New regulatory principles may be needed where blockchain technologies become an integral part of the market infrastructure, and where consensus protocols are run through an international network of nodes. For example, the responsible parties for system integrity would need to be decided.

A considerable number of aspects of law will also need to be reinterpreted or changed through primary legislation. These issues include the legal definition of the finality of settlement which presupposes existing market processes and central data sources held at the CSD. Similarly, there currently exist geographic territorial requirements concerning where data is physically maintained as golden source, a concept that does not fit with copies of the ledger being distributed to nodes on a global basis.

Finally, as the mechanisms currently stand, records are irrevocable once entered into a blockchain, and amendments require changes to all subsequent blocks. This is one of the inherent security features of the blockchain concept. However, this has implications for judicial interventions in the event of disputes or outcomes of other legal proceedings. Regulators will not accept a mechanism that prevents their lawful intervention.

Therefore, the design of the system needs to incorporate features (at least for assets) that allow for a change in ownership to be enforced in the absence of compliance with the existing owner. This could be achieved by a multiple skeleton key approach (perhaps with the combination of keys held by the CSD and the issuer, or regulator), or by enabling a process to cancel assets in an issue and introduce replacements when mandated by a legal authority.

So far, several regulatory bodies have expressed interest in blockchain technologies. Because they see the potential to reduce inefficiency and costs, they are ostensibly keen to work with the industry The need for a robust cash ledger Short of fiat currency being recorded on a blockchain (as the Bank of England has already imagined in a research white paper)*, an interoperable cash ledger will require some intermediary step. The inability of existing cryptocurrencies to be perceived as stable sources of value will need to be tackled.

There are a number of ways to innovate in this area, but fundamentally, cash would be just another asset class on a ledger. Commercial enterprises could create specific cryptocurrencies for interbank use (with a permanent par value and underpinned by near risk-free or escrowed cash holding). Another, simpler way, is to use existing accounts at banks where participants deposit liquidity for trading in segregated accounts, with changes to the cash ledger reflected on the balance in their trading account.

Common standards and governance Industry alignment will be required on certain design points, such as: whether systems are completely open (as with Bitcoin) or use permission-base access requirements; the principles for suitability in interacting with the ledger; and the interoperability between different networks, which may potentially run different consensus protocols and safeguards against coding errors, creating unforeseen knock-on effects (particularly with smart contracts). These will all be important to agree and enshrine in the initial scoping of new systems and standards for interoperability. There will need to be clear agreement on how blockchains will be managed and improved once they are life. This would involve governance processes, update approvals, roles and responsibilities, and so on.

Operational risks of transition Operational risks come into play through the adoption of new technologies, either by running parallel infrastructures whilst disruptive solutions grow, or from more substantive ‘lift and shift’ migrations. A significant amount of work will need to go into ensuring that these operational risks are minimised. The risk of technical failure during implementation will require participants to be able to recover quickly, or be able to revert to the traditional ecosystem as a fall back.

Managing anonymity is a critical requirement for many processes in capital markets. Cryptography could go a long way in protecting anonymity in a blockchain. However, it will require meticulous key management records, maintained separately from the blockchain for each participant, to decrypt and reference back the entries they hold an interest in. Furthermore, the ability to reveal selective information to counterparties for credit assurance, for instance, makes it extremely difficult to prevent errors that result in major data breaches. And overarching all these considerations is the question of how to link cryptographic identities to real-world identities. Some people envisage Know Your Customer (KYC) assessment to be a responsibility of the validation nodes in a permission network (Amy; Castor, 27 March 2017). Others imagine a more far-reaching change, where identity management is a service offered independently of data validation.

In addition, there is a degree to which regulators are likely to require perfect views of anonymised data in the ledger in order to perform adequate market surveillance and maintain anti-money laundering and anti-terrorist financing processes.

Conclusion and Further Steps for Adoption within a Virtual existence

1. Work on concrete proofs of concept

Innovators need to clearly define their use case, show why distributed ledger technology is necessary, and articulate why this will bring benefits to the industry and value for clients. The greatest innovations anticipate needs that customers did not even know they had (no one ‘needed’ an iPhone in 2006).

2. Challenge service providers to innovate

Where economics are not necessarily attractive for developers, or worse, where a better solution actually cannibalises service providers’ revenues (and reduces customer costs), customers need to challenge participants to invest in the innovation to bring about a better ecosystem.

3. Understand current quantification of operational costs, isolating savings from block chains

To drive the ultimate decision whether to develop and/or adopt new blockchain solutions, participants need to compile an accurate picture of specific challenges and operational costs, and isolate the areas where new solutions will be impactful.

4. Continue industry-wide engagement, turning hype into collective endeavour

There is a risk that the hype peters out, investment dries up, and what was once considered promising technology innovation falls on to the industry scrap heap. A persistent failure to overcome initial barriers is likely to sap momentum in the industry, and participants excited by what may lie ahead need to continue driving the industry forward by means of their engagement and collaboration.

5. Participate in prototypes and embrace

‘Learn by doing” Initial solutions are likely to be imperfect, and further solutions will benefit from the lessons learned by others. Participants need to embrace nascent technology solutions so that areas requiring refinement are exposed, and that successes breed further innovations and better solutions.

6. Bring the business mind to technological start-ups

There is no substitute for the deep collective knowledge held by the major participants in capital markets. Everything from significant industry

Final Comments

The application of the Blockchain concept and technology has grown beyond its use for Bitcoin generation and transactions. The properties of its security, privacy, traceability, inherent data provenance and time-stamping has seen its adoption beyond its initial application areas. The Blockchain itself and its variants are now used to secure any type of transactions, whether it be human-to-human communications or machine-to-machine (Brito, Jerry; Castillo, Andrea (2013). Its adoption appears to be secure especially with the global emergence of the Internet-of-Things. Its decentralized application across the already established global Internet is also very appealing in terms of ensuring data redundancy and hence survivability. The Blockchain has been especially identified to be suitable in developing nations where ensuring trust is of a major concern. Thus, the invention of the Blockchain can be seen to be a vital and much needed additional component of the Internet that was lacking in security and trust before. BC technology still has not reached its maturity with a prediction of five years as novel applications continue to be implemented globally.

According to the Gartner Hype Cycle for Emerging Technologies 2017, Blockchain still remains in the region of “Peak of Inflated Expectation” with forecast to reach plateau in “five to ten years”. However, this technology is shown going downhill into the region of the “Trough of Disillusionment”. Because of the wide adoption of the Blockchain in a wide range of applications beyond cryptocurrency, the authors of this paper are forecasting a shift in classification from “five to ten years” to “two to five years” to reach maturation. Blockchain possesses a great potential in empowering the citizens of the developing countries if widely adopted by e-governance applications for identity management, asset ownership transfer of precious commodities such as gold, silver and diamond, healthcare and other commercial uses as well as in financial inclusion. However, this will strongly depend on national political decisions.

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