An Introduction to Blockchains

1
An Introduction
to Blockhains
By Nikolaus Lipusch
Workshop - Understanding the
Challenges and Opportunities of the
Blockchain

2
Impulsvortrag 1
Blockchain - Agenda:
1. What is blockchain technology
2. How does blockchain technology work?
3. What are thinkable applications of blockchain technology?
4. What are pros & cons?
5. Why should we care about blockchain?
6. Excurse: Initial Coin Offerings

3
What is blockchain technology and how does it work?
 The concept of blockchain was originally described by someone
using the pseudonym “Satoshi Nakamoto” in 2008
 The database consists of a chain of data structure blocks and
grows linear chronologically by adding new blocks
 Each block holds timestamped batches of valid transactions and
a specific link (hash) to one previous block
 A 1:1 duplicate of the complete blockchain resides on each
computer of a blockchain network
 New transactions have to be repeatedly authenticated across
this distributed network, before they are included as a new block
on the chain
Distributed database that maintains a continuously growing list of
data records secured from tampering and revision

4
 The cryptocurrency bitcoin (BTC) was initiated based on
blockchain technology in 2009
 The BTC blockchain is a digital, decentralized, and public ledger
that records every bitcoin transaction that has ever occurred 
no intermediary needed
 Everyone can view the source code and can participate in the
further development of the bitcoin software  open source
 Every user is allowed to connect to the network, send new
transactions to it, verify transactions, and create new blocks 
open access
 The generation of blocks is called “mining”, which is rewarded
with a certain amount of BTCs (defined by the system) for the
miner  bitcoin mining
 Nowadays, mining is a computational-intensive process
The case of Bitcoin

5
Volatile development of the market price (in USD) http://www.finanzen.net/devisen/bitcoin-dollar/chart
Volatile development of the BTC market price
Statistics Jannuary
2018
Size of the BTC
blockchain
154 GB
Total number of BTC 16,7 million
Market price of 1 BTC 10,947 USD
Market capitalization 188 bn USD

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Block 1 Block 2 Block 3 Block 4
…
Block 3
Header Checksum of block 2
Hash tree of transactions
Appendix Transactions
Genesis-block
Structure of a Blockchain (simplified)

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Example: Tom wants to buy Dana’s car with bitcoins
Tom & Dana both
have a digital
bitcoin wallet and
open their Bitcoin
clients (e.g. a
smartphone app).
Tom needs Dana’s
public key (payment
address) and his
private key (personal,
digital signature to
access the bitcoins in
the wallet).
Tom scans Dana’s public key
via QR code (or she e-mails
her payment address). And
Tom initiates the transaction
(Internet access necessary).
1F1tAaz5x1
HUXrCNLbt
MDqcw6o5
GNn4xqX
1F1tAaz5x1HUXrCN
LbtMDqcw6o5GNn4x
1F1tAaz5x1HUXrCN
LbtMDqcw6o5GNn4x
1F1tAaz5x1HUXrCN
LbtMDqcw6o5GNn4x
1F1tAaz5x1HUXrCN
LbtMDqcw6o5GNn4x
The bitcoin app forwards
the impending transaction
to the ‘miners’ of the bitcoin
network. All miners own an
1:1 copy of the complete
bitcoin ledger and verify the
transaction autonomous.
In order to process and verify
the transaction, impending
transactions must be packed
into blocks and added to the
blockchain. The creation of
blocks is a competitive
process and accomplished by
completing cryptographic
processing power intense
computations (proof-of-work).
Solving the cryptographic
problem comprises
calculation of hash values
that meet a strict criterion.
The hash values are based
on a combination of the
previous hash value, the
new block and a nonce.
When a miner solves the problem,
a new block is generated and
propagated to the network for
verification. The block is added to
the blockchain and the winning
miner receives new bitcoins as a
compensation for his work.
The transaction is processed
and the blockchain and Tom’s
and Dana’s wallets have been
updated throughout the entire
network.
How does blockchain technology work?

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Smart Contracts:
 facilitate, verify, or enforce the negotiation or performance of a
contract
 make a contractual clause unnecessary
 aim to provide security superior to traditional contract law
 reduce other transaction costs associated with contracting
 Smart Contracts represent the actual disruptive potential of
blockchain technology
Smart Contracts are short computer programs, based on blockchain technology
that execute their pre-defined instructions once certain criteria have been met
Blockchain technology enables the creation of Smart
Contracts

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Revokes the contract
contract mortal {
/* Define variable owner of the type address */
address owner;
/* This function is executed at initialization and sets the owner of the contract */
function mortal() { owner = msg.sender; }
/* Function to recover the funds on the contract */
function kill() { if (msg.sender == owner) selfdestruct(owner); }
}
contract greeter is mortal {
/* Define variable greeting of the type string */
string greeting;
/* This runs when the contract is executed */
function greeter(string _greeting) public {
greeting = _greeting;
}
/* Main function */
function greet() constant returns (string) {
return greeting;
}
}
Smart Contract example for Ethereum

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Banking
 Concepts to facilitate the exchange of money, e.g. digital currencies
 Shared databases for KYC and AML compliance
Insurance
 Streamline payments of premiums and claims via smart contracts
Public Sector
 Replacing traditional approaches for registering properties and assets
Media Industry
 New form of (direct) digital music distribution via smart contracts
(management of copyright, payment of royalties)
Internet of Things
 Managing the support of smart home devices across the entire life-
cycle
Supply Chain
 Traceability of the whole lifecycle of products—from production to
consumption
Applications for blockchain technology

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Picture: https://aqurus.ca/wp-content/uploads/2018/01/blockchain-example.png
Block-
chainSmart
Contracts
How the blockchain transforms supply chains

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Security
 No need for trusted third parties (banks, financial intermediaries)
as transactions are transparent to anyone within the network
 Security for data against tampering and revision via
cryptography and collective intelligence
Transparency
 Decentralization paves the way for aggregate and analysis of
large pools of data across institutions
 Easy, traceable, and reliable user & use verification
Efficiency
 Radical reduction of transaction costs and costs for financial
reporting & administration and central IT infrastructure
 Automation of the detection of weaknesses in transactions,
supply chains, and other business processes
Advantages of blockchain technology

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Technology
 Limits of scalability, due to throughput capacity (network bandwidth, storage limits,
processing power)
 Speed and performance of a distributed database is slower than a centralized one
(less appropriate for high-speed, high-volume applications)
 High and increasing demand for energy (for executing the computations)
Governance
 Unclear responsibilities (admitting new users, regulation of access permissions)
 Bypassing regulation (digital identities, cross border standards, system integrity)
 Rising questions regarding privacy and security (pseudonymity vs. real identity)
Commercialization
 Challenges of integration with corporate legacy and record systems
 Total shift in the culture of doing things
 Standards needed to gain widespread adoption and to ensure interoperation
between multiple, specialized blockchains
Hurdles of blockchain technology

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In famous blockchains, like bitcoin or Ethereum, the single account
identifier is the key ID. No more information is provided.
→ Meets the criteria for anonymity and pseudonymity of the
EU Data Protection Regulation
But:
 Blockchains are intended to be public, so everyone can retrace every
single transaction on the blockchain
→ This allows to track the owner of an account, e.g. by tracing back to
his/her IP address, even though he or she is anonymous.
→ Additional adoptions would be required to prevent back-tracking
 Additional information that may be required to store title deeds, music
licenses or environmental certificates on a blockchain, e.g. name and
address of the owning person or company, are publicly accessible
Privacy

15
Updates and changes of a blockchain system are hard to realize
Example for bitcoin:
 Original, the bitcoin blockchain was limited to 7
transactions per second
 To allow more transactions per second, a fork of bitcoin
was required
that was executed in August 2017
Blockchain updates and changes

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Transactions are persistent
→ Mistaken transactions can not be rolled back
If the private key gets lost, the account can't be accessed
anymore, thus the money, contracts or what ever was put on
the blockchain is lost forever
Damages caused by programming errors on Ethereum:
 2016: The DAO exploit
 A programming error in a contract caused damage of 150,000,000 USD
 Ethereum was forked to make it unhappened → this was a big and
unique act of the Ethereum community
 2017: Bugs in the Parity wallet contract
 Bug #1 allowed to steal 30,000,000 USD
 Bug #2 has frozen 160,000,000 USD that can't be accessed anymore
Risk of persistent transactions

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Blockchain technology has the potential to:
 disintermediate the middleman
 disrupt economies, markets, and existing participants
 drive cost savings by reducing labor-intensive processes and eliminating
duplicate effort (disruption of the labor market)
 create new markets by exposing previously untapped sources of supply
 facilitate secure, de-centralized transactions among many parties in the Internet
of Things
 increase transparency and efficiency in multi-party transactions
 reduce fraud and increasing trust with increased security
Blockchain technology is in its infancy and has the potential to
change … everything!
Conclusion – Why should we care?

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“Beyond its technological capabilities a blockchain can be considered as an
economic system”
Hence a blockchain can be used to build and enact…
 Digital currencies
 Payment methods
 Financing models (token sales, ICOs)
 And a variety of other business logics e.g. smart contracts
Excurse – Initial Coin Offerings

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“Initial Coin Offerings also known as ‘token-sales’ or ‘crowd-sales’ denote
a method of start-up fundraising via the sale of digital tokens over a
blockchain”
Features of an ICO What an ICO is not
Token -
Issuer
Token -
Buyers
Start-up Investors
Generate Tokens Issue Tokens
Send CryptocurrencyGenerate Protocol
• Tokens are a promise to future rewards or
services of a company
• Tokens can be bought in exchange for
other cryptocurrencies and act as
transaction mechanism on the blockchain
• Tokens are freely tradable on
crytocurrency exchanges (i.e. they have
high liquidity)
• Tokens are not a legal claim on debt or
equity
• Funds are not raised through an
intermediary (but directly by the
entrepreneur)
• ICOs are not regulated
What is an ICO?

20
ICOs constitute a very fast and easy way to collect funds. Also they can be conducted at a
fraction of the cost of more traditional fundraising methods (e.g. Venture Capital, IPOs)
Steps ICO
1. Initiate • Write a white paper (i.e. a business plan) and a yellow paper (i.e. a technical
paper)
• Announce your endeavour to the crypto-community to gauge interest
2. Marketing • Create a website
• Establish various channels to communicate with your community (e.g. slack,
reddit and/or telegram)
3. Token
Creation
• Create your tokens
- build your token on top of existing standard (e.g. ERC20 on Ethereum)
- or build your own standard (i.e. creating your own blockchain).
4. Sales • Determine the conditions of your token sale:
- Quantity/ Price
• Consider a pre-sale at favourable conditions (e.g. discount) to draw in early
users/investors
5. Diffusion • Get your token listed on various cryptocurrency exchanges (e.g. Kraken,
Bitfinex)
• Consider mechanisms to stabilize the price of your currency (e.g. gas)
6. Development • Shift all your resources to the development of your technology
How to conduct an ICO?

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Since ICOs seem to be particularly confined to a particular type of start-up
(i.e. blockchain-type start-ups) it is difficult to compare them to other
fundraising methods
However if we want to make a comparison, the following general characteristics are
observable:
Characteristics ICOs Crowdfunding Venture Capital
Equity - +/- +
Ease of Access ++ + --
Transaction
Volume
++ - +
Liquidity ++ -- -
Community
Help/Interaction
++ + -
Risk -- - -
*
* Depending on the type of crowdfunding (equity vs. reward-based cf)
How ICOs compare to other Fundraising Methods

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To prevent to come under scrutiny of financial authorities and regularties…
• Consider KYC (Know Your Customer) and AML (Anti Money Laundering) regulations
• Refrain from advertising your token as a financial security (i.e., focus on the utility of
your token and not the financial gain obtained from it)
• Make sure that you token is sufficiently decentralized if you do not want it to be
classified as a security.
• However, if you want your token listed as a financial security follow common security
law as well as the recently established guidelines of Coinbase:
• https://www.gdax.com/static/digital-asset-framework-2017-11.pdf
“Although ICOs are not regulated yet financial authorities are closely
monitoring this new phenomenon”.
Beware of the following mistakes!

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 Bitcoin, company website
https://bitcoin.org/
 Deloitte, «Blockchain, Enigma. Paradox. Opportunity», 2016
http://www2.deloitte.com/content/dam/Deloitte/ch/Documents/innovation/ch-en-deloitte-innovation-blockchain-full-
report.pdf
 Ethereum, « A Next-Generation Smart Contract and Decentralized Application Platform», 2018
https://github.com/ethereum/wiki/wiki/White-Paper
 Goldman Sachs Group, «Profiles in Innovation: Blockchain – Putting Theory into Practice», 2016
http://www.the-blockchain.com/docs/Goldman-Sachs-report-Blockchain-Putting-Theory-into-Practice.pdf
 Harvard Business Review, «The Impact of the Blockchain Goes Beyond Financial Services», 2016
https://hbr.org/2016/05/the-impact-of-the-blockchain-goes-beyond-financial-services
 Morgan Stanley Research, «Global Insight: Blockchain in Banking: Disruptive Threat or Tool?», 2016
http://www.the-blockchain.com/docs/Morgan-Stanley-blockchain-report.pdf
 Medium, «Understanding the SEC’s Guidance on Digital Tokens: The Hinman Token Standard», 2019
https://medium.com/@BlockchainAssoc/understanding-the-secs-guidance-on-digital-tokens-the-hinman-token-
standard-dd51c6105e2a
 Nakamoto Satoshi, «Bitcoin: A Peer-to-Peer Electronic Cash System», 2008
https://bitcoin.org/bitcoin.pdf
 Medium, «How to Determine if a Cryptocurrency is a Security or Not Using the Howey Test», 2018
https://medium.com/altcoin-magazine/how-to-tell-if-cryptocurrencies-are-securities-using-the-howey-test-da18cffc0791
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