Author: Marcin Zduniak

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Blockchain Fintech: History of innovation

Innovations come to existence through different means and circumstances. Some of them start as meticulously planned inventions. Others – due to pure luck and uncontrollable external conditions. It’s never just one source that transforms promising innovation into a successful product or services. It’s usually mix of different factors. What about Fintech innovation, and blockchain Fintech challenges? Was it luck or the Invisible Hand of the Free Market? I’ll have to give you a bit of history first.

Let’s go back a decade…

We can’t talk about blockchain Fintech without mentioning Bitcoin. Bitcoin was the first successful decentralized cryptocurrency. It launched, at least as far as we can tell, before the financial crisis of 2008. In Bitcoin’s genesis block (the very first block created by Satoshi) there’s even a reference to a Times article mentioning a banks bailout program. There were several pre-crisis signs that could ignite Satoshi’s vision and spark Fintech innovation.

  • fractional-reserve banking
  • lack of transparency in government monetary decisions (inflation, printing new money)
  • greedy financial institutions creating financial products to benefit mainly themselves (subprime mortgage derivatives)

Satoshi worked towards creating a truly stateless currency that would be used directly between parties. The parties interested would trade (person to person or between businesses) without any third party who could stop, corrupt, ban or censor transactions.

Financial crisis

This ‘shock to the system’ amplified the focus on cryptocurrencies and its values in later years. We could see this during the Greek government debt crisis and later during the Cypriot financial crisis. Statistics gathered by Google Trends show how often people searched for the term “bitcoin” in Google. During these times of hardship, you could see a correlation between the economic climate and the Bitcoin price on major crypto exchanges. It shows that people were trying to partially escape from certain ‘difficult’ currencies. For instance, EUR deposits of some Cypriots were confiscated in 50% at that time. People considered moving to something that they saw as less susceptible to government oppression.

Blockchain FinTech technology stack

The above mentioned source of innovation helped cryptocurrencies to form their basic manifesto and define their initial properties. But to exist and work as advertised, cryptocurrencies needed a sophisticated technology stack. In its core, Bitcoin and other cryptocurrencies created later derive a lot from other technologies, created much earlier. This can be regarded as part of a ‘Watching others’ source of Fintech innovation. Starting with the Bitcoin White Paper that refers to such inventions as: hash functions (SHA256) for anonymizing data and summarizing digital signatures, Elliptic Curve Cryptography for signing transactions and Hashcash for its proof of work algorithm. All of these technologies have existed much earlier than Bitcoin (some even 50 years earlier). However, they created the product we now know only in combination.

Cryptocurrencies created after the publication of the Bitcoin protocol  derive a lot from Bitcoin itself, but also from other inventions and technologies. These include: quantum computing, Schnorr signatures, Scrypt algorithm, Ring signatures, zero-knowledge proofs, Turing-complete programming languages for smart contract development or many more. All of these inventions were and are mixed and matched together, forming remarkable combination of various cryptocurrencies with distinct features.

Suddenly, entrepreneurs had many options to choose from to build products on top of existing cryptocurrencies. This spurred the ‘Recombination’ source of Fintech innovation. Companies and individuals from various industries started to look how they could utilize blockchains and cryptocurrencies in their fields of expertise. Also, they considered how they can disrupt other industries with trustless principles.

The cloud

From cloud computing providers (experienced with delivering easy-to-use development experience) to software developers interested in particular technologies: various people started to offer blockchain-based technologies in the cloud. These were pre-configured and ready to use, for everybody who wanted to experiment. All without spending days or weeks on proper configuration of the servers and setting up nodes.

Things became easier then for blockchain Fintech innovators. Insurance companies started to work on top of blockchain technologies like R3 Corda. Small insurance startups now experiment with blockchain technologies to offer products that aren’t feasible for other technologies (Tontine Trust). Financial startups try to reposition funds and assets settlement markets. Internet of Things (IoT) firms are looking at blockchains to safeguard access to devices and to make sure data gathered by the IoT monitoring devices are not tampered with.

Risks and regulations

As the technological, social, financial and business revolution progresses, there are new risks emerging. We couldn’t anticipate them: lost of access to investors’ fund, complex fraud schemes, Ponzi schemes using cryptocurrencies, money laundering, breaches to capital controls or financing terrorism. No government would turn a blind eye on these problems. Hence, we are seeing various forms of regulations popping up in different parts of the world, trying to curb some of the risks observed. Some of these regulations try to ban a particular form of cryptocurrency activities. Others are trying to stop some of the business participants from using crypto. These blockchain regulations, constraints and additional external factors drive further innovations in cryptocurrencies. How? Creators try to make them regulatory compliant and still useful for the consumers.

The ICO as FinTech innovation

Cryptocurrencies show up more and more often in mass media. There’s a heightened awareness that there are more investments coming into  crypto projects, especially from non-professional investors in form of the ICO. These investments are driven mainly by sophisticated and innovative marketing campaigns. They target private investors with relatively small capitals, but open to invest in high-risk ventures. There are advertising agencies solely created to support the needs of this type of activity. This Fintech innovation is curbed to some extent. Regulatory requirements change towards investments in risky startups, spurring even more innovations on the verge of these two competing forces. These include blockchain-based KYC or blockchain identities project.

Academia!

I’ve been calling it Fintech innovation but to be honest, blockchain penetrates various disciplines. Finance, technology, governance or social needs. No wonder it receives academic attention. It’s pushing curious scientific communities to look into blockchain deeper and to conduct research projects on it and its potentials. Institutions like MIT Media Lab, Cornell University or University of Nicosia are investing substantial money and involving top researchers and lecturers to deepen our understanding of this innovation. What’s more, they spin-off further developments on top of their research outcomes. In addition to research institutions, there are also commercially-led research projects. A good example is Blockstream with their impressive list of Bitcoin Core developers involved. There’s also individual lead research (for example MimbleWimble).

Design-driven innovation

Some blockchain Fintech innovators try to create completely new values in this space. They start from a different angle. Rather than innovating on top of the existing technologies and amending them, they try more of a design-driven approach. They learn from other projects’ mistakes and build better initial concepts. Then, basing on those concepts, they build new technologies better suited to fulfill different users’ needs. An example might be EOS. It was designed from scratch for massive scale, built from earlier experiments with BitShares technology.

The frustrated user as a source of innovation

Yet another Fintech innovation comes from the needs of the end users. It’s designed and developed by the frustrated (but technically capable) users. Examples could be cryptocurrency mixers. These try to hide the source and destination of the funds transfers in public ledgers by mixing many transactions into one. Another example is Monero, which tries to hide transfer details by cryptographic techniques.

As technology matures, and less technical users can begin to use it, ‘User innovation’ begins. Smart contract platforms were initially very complex to use. Now, they’re becoming more and more approachable. As an example, I’ll mention the Ethereum Solidity programming language (btw, do check out our Solidity tutorial). It’s very similar to JavaScript, and it opened smart contract development – and blockchain Fintech opportunities – to Web Developers.

This is further simplified by WYSIWYG-type of innovative platforms that will allow users to create sophisticated contracts by only interacting with intuitive wizards. ICOs are also an example of user-inspired innovations. Capital or years of development expertise might no longer be needed to set up innovative companies. If the project has enough convincing factors, an enthusiastic team behind it, it might get the funding needed to start off the ground.

So what do you need to be an innovator?

Each innovation is different and each can come into life differently.  I hope that I’ve managed to explain how blockchain Fintech came to be . What I can tell you is that at the beginning, innovation definitely needs sufficient resources. These can be financial resources or a dedicated team focused on delivery (yes, one like ours). Those resources promote it to the stage where you can observe its value. Over time, as the snowball effect takes place, a different type of  participant enters. And by mixing and matching one type of innovation with other innovations these varied participants create products that nobody even thought of at the beginning. This is the way industry disruption works. This same cycle happens until a new and significantly superior invention appears and takes its place. Then, the cycle starts from the beginning….

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Blockchain Supply Chain Technology

How blockchain traceability can change your organization

Businesses, governments – various entities can benefit from decentralization. However, even criminals may derive some use from decentralized operation modes and various cryptographic primitives. The goals and objectives of those three categories of organizations are different, so the way blockchain traceability can be used also varies. I’ll look at predictive markets, DAOs …and crypto anonymity.

Businesses and blockchain traceability & transparency

Businesses (for-profit organizations) owned by  groups of shareholders often value the transparency of the way the organization is run. Those organizations aren’t led by a single person, but by an elected group of directors. The most fundamental feature of businesses governed by smart contracts is that all of the transactions and decisions are stored in a publicly verifiable ledger. This sort of businesses can be called a DAO (a decentralized organization). No director can refute the decisions they make, as their cryptographic signatures can’t be forged (direct accountability).

In DAOs, shareholders or members also have a direct and immediate impact on the direction of growth and future decisions. All costs or expenses in organizations like that are accountable, including employee remuneration. In an environment like that any gender, religious, political or other biases can’t exist.

Governments and prediction markets

Governments run in a decentralized mode are a form of a larger DAO. There are some thought experiments to organize governments in the form of a futarchy. In a futarchy, the legislative branch bases on the results of prediction markets. Prediction markets are sort of like betting or voting systems, and they proved to be an accurate way of extracting value from the wisdom of crowds. Any citizen participating in nation-wide prediction markets can have an immediate impact on the bills passed. What’s more, they can easily see the impact of those bills on their own welfare. That’s probably the best form of traceability that exists!

As the decisions are transparent (and the assets/value allocation is transparent) the money allocation to projects/bills is unbiased, and the money is assigned to objectively the best contractors. We won’t see any shady connections between government representatives and their families or friends.

Criminal organizations – blockchain traceability vs. anonymity

Speaking of shady. There’s something we should be aware of. Criminals can also use the blockchain in creative ways, sadly. For example, let’s look at markets that trade in illicit goods or those offering nefarious services. The objective is to tangle up all the dealings and transactions conducted to hide both the nature and the parties to the transaction. Seems like something that just won’t work on the blockchain? Wrong. Distributed systems include, most importantly, the full anonymity of the transacting parties. These are paired with encryption algorithms of the data exchanged by the parties. This allows such organizations to reach their objectives.

Cryptocurrency systems where you can’t see the parties to the transaction or the actual amounts (but with full guarantee of the actual value transfer!) are perfect tools for organizations that value their… privacy. If those parties get caught, the deniability of the transaction is a vitally important feature. (Un)fortunately, that’s what some of the more complex cryptocurrency systems can offer. Those are the problems regulators should definitely research.

Blockchain for different needs

To conclude, various organizations have different needs. Distributed and blockchain technologies are not one-size-fits-all techniques. They can combine and match these technologies in different ways. Prediction markets won’t work for all, and neither will an anonymous crypto system. The goal is to end up with features that suit the needs of a given organization. As we can see, they can sometimes provide an answer to contradicting needs, such as both transparency and deniability.
Just so you know, I’m organizing a workshop on Stellar soon, check it out. Also, if you’re wondering how traceability (or any other feature I wrote about) can work in practice, say, in your company, write to me using the box below.

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Blockchain Entrepreneurship Public

How blockchain regulation should look

Despite what you might read online, not all blockchain regulation is bad. Regulations are, in general, necessary. They help businesses thrive on markets that suffer from information asymmetry. What’s more, they also make the industry landscape clearer and sanction the government’s approach towards it. Regulations also protect customers’ interests if access to information is limited or if there’s a constraint on competition between market actors. However, blockchain regulation can be done wrong, as we’ve seen in some cases. Let’s raise some questions and try to look for solutions: from green addresses to exemptions.

Thinking cross-nationally

Regulations are usually national. There are certain cross-national regulations, but they happen only to some extent. You don’t want people financing terrorism, for example. However, it can be futile to try and regulate companies that operate through using blockchain technologies only on the national level . That’s because companies can change the jurisdiction of their inc. to avoid unnecessarily harsh blockchain regulation. It would be very beneficial for the whole industry to create cross-national non-profit organizations and self-governing bodies that can address policy blind spots . Their members can range from industry representatives to government representatives. They could be tasked with suggesting and promoting good regulatory practices across the members and jurisdictions they represent.

Educating

As a technology, blockchain can’t be regulated or banned , as it’s only a concept/algorithm and a technical data structure. Entities (especially those non-formalized) operating purely on the blockchain that don’t interact with real-world companies can’t be regulated either. However, regulators should also be involved in education campaigns , spreading awareness of fully decentralized schemes or pointing to risks of suspicious schemes (example here).

Focusing on entities interacting with blockchain

Blockchain regulation should be focused on the entities that interact with blockchain technologies. They operate on the blockchain network, offering their services to other real-world consumers or companies. Regulation on this level shouldn’t be much different from what we have for similar non-blockchain services. This includes any financial operations, insurance, logistics, etc.

Allowing exemptions

As the technology is very innovative and can create positive change across many industries, there should be regulatory exemptions in place. Good examples include blockchain regulations in Switzerland or Gibraltar for small-scale operations. They’re measured, for example, by a maximum value of customers’ assets held by the operation without full license or by the exemption time. In these cases, the regulation is won’t limit innovation before it’s able to prove its positive value.

Self-regulation

Some fully decentralized schemes can and will impose self-regulation practices and extreme transparency . An entire industry built around providing analytical, monitoring and transparency services to existing fully decentralized schemes may emerge . This would increase the customers’ confidence in the schemes. So, regulators should also promote these practices – or companies offering them. Regulators and Central Banks can even go one step further and create national cryptocurrencies with self-regulating capabilities built right into their scheme. Decentralized services built on top of national cryptocurrencies can be considered safer by the end customers. Of course, if the scheme can self-enforce regulation best practices (proper KYC and AML).

Anonymous schemes

It’s possible that national governments and regulators may create their technical interfaces/APIs . For example, for proper tax calculation or for direct sales tax payment. So, those fully decentralized services offering their products to the citizens can become fully compliant with the local regulations even if they lack any real-world manifestation . Schemes like that can increase the customer’s safety. What’s more, they contribute to the view that customers can operate within the law even in the case of fully anonymous schemes . At the very minimum, regulators have to clarify their stance on the sales and VAT taxation applications to transactions conducted with blockchain .

Using green addresses

In some jurisdictions (like China), capital controls, especially the flow of capital abroad, are an important part of regulatory responsibilities. It’s hard to curb Bitcoin transactions as they’re naturally borderless. However, it’s possible to control all the participants that take part in converting fiat money to Bitcoin – and vice versa. There’s also the concept of Green Addresses. These are Bitcoin addresses that belong to a known and trusted financial institution which also manages the users’ bitcoin wallets. Whenever a user wants to make a transaction from a wallet to an external party, they can send it via its Green Address provider. Then, the outgoing transactions will look as if they’re coming from a trusted address of the Green Addresses provider. Regulators can require all transactions into and out of exchanges in a given jurisdiction to go via Green Addresses.

Fixing information asymmetry

The concept of information asymmetry exists in the general economy. For example, in used cars trading. Let’s say the buyer can’t really tell if a car is good or bad. The seller can easily hide some defects, which leads to increased distrust between two parties. Blockchain technologies can help, as they can provide irrefutable provenance proves. Every object can be traced back to its producer and all the previous owners. Additionally, you have trackable quality assessments and can see all the amendments and repairs ordered in the meantime. This information can’t be removed or hidden from the blockchain. Regulators could structure market transactions so that proper provenance collection is required for every newly built product from a certain market. This way, it gradually introduces complete reliability to this market and lowers information asymmetry.

Blockchain regulation catches up

These are only some of the issues that national regulators have to face. Some advancements were impossible to predict when regulators passed resolutions. It’s a difficult game of catching up. And if you feel you need to catch up with what’s currently allowed and what’s not, go for blockchain training.

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Blockchain Financial Services

Blockchain legal issues with DAOs

In my first article, I covered the benefits and possible problems that come with joining a decentralized organization. Today I’ll focus on some blockchain legal issues concerning DAOs.

Keeping things safe

  1. At its core, DAO was designed as an informal group of parties which operates entirely within the algorithm of its code . Theoretically, they can stay anonymous. However, it’s impossible that this code would cover every possible future case. There’s the obligations and interaction mechanisms between different DAOs and between different members and participants of the DAO. Moreover, if there’s no formalized legal structure in place for this entity, courts will impose one. A DAO most resembles a general partnership in which members/partners jointly represent DAO and are liable for its actions and obligations. The DAO may not have assets from which to indemnify third parties. So, it lacks assets or legal form. Therefore, the court could see the entity as fiction and could allow a lawsuit to proceed against individual members .
  2. A safe approach for DAO members would be to create a standard legal entity to which the DAO belongs. Every change in the DAO membership will have to be reflected in the entity membership/shareholding structure.
  3. A DAO can control cryptoassets. They can represent almost anything, including real-world assets, fiat money, valuable objects like cars, houses or precious metals. Those assets should be put under control of multisignature wallets (escrow) which DAO members have control over. Of course, proportionally to their DAO membership shares.
  4. There are initiatives in development that plan to setup “virtual jurisdiction” within which DAOs could operate. They could then cooperate with each other safely and with clearly defined rules. What’s more, they could have dedicated arbitration procedures in case of an unresolvable dispute.
  5. A DAO smart contract could also include a clause referring to a private court which specializes in smart contract disputes. It’s far better to determine preferred jurisdiction beforehand, than let a plaintiff or a government choose it afterwards.

Blockchain legal issues – DAO

  1. In the real world a ‘principal’ is liable for its agent’s actions . Check out agency theory for more. An individual developer or software company that created a DAO can be considered as principal in some scenarios. That principal can be held liable for the actions of the DAO (and its members) without having any control over them.
  2. Legal language is very different from procedural computer language. Usually, a software developer isn’t able to express all legal details accurately. Development of specialized smart contract law programming languages is still in its very early stages.
  3. There’s no common way, yet, to represent fiat money on the blockchain. Here’s an attempt. However, most of the traditional contracts still need to represent value using fiat money or precious metals . Possibly, Central Banks can also digitize fiat money on the blockchain. Until that happens, most of the DAOs operations will be very limited in scope.
  4. If we treat a DAO as a for-profit company, there is whole set of unanswered questions. For example:
    1. Can DAO members or DAO itself claim expenses against profits?
    2. If the DAO needs to buy a physical asset, whose name goes on the paperwork?
    3. If the DAO creates and patents intellectual property, who’s the registered owner?
    4. How a DAO can own an internet domain when domains still need to be registered to a person or company?
    5. How should taxes be paid if the DAO (or its members) make a profit?

Final remarks

Naturally, my article doesn’t constitute any blockchain legal advice. But these are certainly blockchain legal issues to consider. A DAO is definitely an interesting initiative that can fix real problems. Just make sure you’re prepared for every contingency. If you’re not sure you are – consider our blockchain training sessions. We’ll work through your problems.