Location:

QuantUniversity Meetup

November 14th 2017

Boston, MA

Blockchain Technology Workshop

2017 Copyright QuantUniversity LLC.

Presented By:

Duru Turkoglu, PhD

www.QuantUniversity.com

Blockchain TechnologyCryptocurrencies, Applications, Limitations

• Public

• Distributed

• Immutable

• Trustless

What is Blockchain?

Open to everybody

Audited by everybody

Append only

No central authority

Blockchain is an accounting system that is:

Briefly: Distributed Ledger

Introduced by: Bitcoin

• 1970s/80s --- Public key cryptography

• Guardtime --- Application of public key cryptography

• 1990 --- Digicash/ecash

• 1992/1997 --- Hashcash/Proof-of-work

• 1998 --- b-money, bitgold

History of Blockchain

• 2008 --- Satoshi Nakamoto, creator of the Bitcoin Network

Think: Store of value

• 2013 --- Vitalik Buterin, creator of the Ethereum Network

Think: Smart contracts and Worldwide computer

• 2017 --- ERC20 Tokens/ICOs using the Ethereum Platform

First ICO actually took place in 2013

Think: Stocks/assets (not fully clarified yet)

• Ongoing --- Private blockchains, State channels, etc.

History of Blockchain

Ownership

Easy to Verify and Hard to Fabricate

Ledger

Easy to Transact and Hard to Modify

Essential Qualities of a Functioning Ledger

CashHow do you make people believe that some cash out there is yours?

Verifying Ownership

Bearer’s Instrument

If you have it in your

wallet, then it is yours!

CashWhat if you have a LOT of cash? It would be very hard/risky to carry it.

Verifying Ownership

?

Bearer’s Instrument

If you have it in your

wallet, then it is yours!

CashWhat if you have a LOT of cash? It would be very hard/risky to carry it.

Verifying Ownership

Place it in a Trust

The bank has your funds,

but you can withdraw!

Car & HomeWhat about other kinds of physical assets, such as cars, real estate, etc?

Verifying Ownership

Government Record

Ownership is registered with

DMV and Recorder’s Office.

Verifying Ownership

Conventional Methods Rely on a Single Trusted Party

• Banks, government offices, etc.

• Problems arise when trust is broken:▫ Access may be restricted or denied

▫ Prone to mistakes in recordkeeping

▫ Bank runs result in loss of funds (due to fractional reserve)

• Transfer of ownership may require multiple parties involved

• High transaction fees to be paid to each party involved

Blockchain does not place trust in a single entity

Double Spending

Cash in WalletCan you double spend the cash in your wallet? NO!(Unless you are a magician)

Issues

Cannot transact with

large amounts. Actually,

you can but very risky.

Cash in Bank AccountCan you double spend the funds in your bank account.No, banks do not clear funds twice, but you can try!

Double Spending

Issues

Transaction fees are high.

Clearance of funds may

take several days.

Car & HomeCan you double sell a car?Or a house? No! (In general) Fraudulent sales exist!

Double Spending

Issues

Many parties are involved to

prevent such fraudulent sales.

Very high transaction fees.

Double Spending

Conventional Methods Are Prone to Such Frauds

• If the amount is too small there is no incentive (e.g., cash)

• There are prevention methods for larger amounts/real assets▫ Central parties managing the funds disallow double spend

▫ Third intermediary parties check validity of ownership

• Requires trust in central or intermediary parties

• Transfer of ownership may require multiple parties involved

• High transaction fees to be paid to each party involved

Blockchain prevents double spend via its ledger

Transactions and Ledger

Physical CashVery easy transactions.Very hard to modify ledger. Need physical exchange.

Issues

Theft is relatively easy.

Physical cash is not the

only source of money.

Fiat MoneyRelatively easy to transact within the same bank but not so easy with others. Hard to modify ledger from outside.

Transactions and Ledger

Issues

Transaction fees are high.

Money supply can be

diluted relatively easily.

Car & HomeNot very easy transactions.Relatively hard to modify ledger from outside.

Transactions and Ledger

Issues

Many parties are involved in

transactions leading to high

fees.

Transactions and Ledger

Conventional Methods

• I

Blockchain is not easy to modify

Transactions require some time

Cryptography

&

Distributed Systems

Blockchain Solution

Easy to Verify

Hard to Fabricate

Story:Alice would like to send a very important message to Bob.

She wants him to know that it is indeed her who sent the message.

How can Alice accomplish this?

Answer:One way functions and public key cryptography!

Private and public keys to encrypt and to decrypt.

Applications:Communications of any kind: internet, military, etc. Developments in cryptography created the field of computer science back in the 1940s.

Public Key Cryptography

Illustration:• Alice produces private and public keys.• She publishes her public key to everyone.• Private key encrypts, public key decrypts.• Nobody can produce the same encryption

without knowing the private key of Alice.

Alice sends a message M to Bob:She encrypts M using her own private key: M⟶ MA

Bob decrypts the message from Alice:He decrypts message using Alice’s public key: MA⟶M

Public Key Cryptography

Guarantees:Using Alice’s private key ensures that message is sent by Alice.

Nobody else could have written it!

Digital signatures:Encryption using a private key is called a “digital signature”.

Digital signatures are enforceable in a court of law!

Alice cannot claim that she did not send the message.

Application in blockchain:Digital signatures are used to authenticate ownership.

Payment addresses are generated by public keys.

Public Key Cryptography

Verifying Ownership in Blockchain

Public Key Cryptography to Prove Ownership

• User creates a pair of public and private keys

• Public key to generate and publish payment addresses

• Private key to digitally sign for the funds in those addresses

Verifying Ownership in BlockchainSecurity of Public Key Cryptography• Brute force is a possible attack, but infeasible in general• One-way functions for encrypting, cannot invert the function• Best to avoid spending from the same address many times• It is extremely hard to forge a signature even with observation• If your private key is exposed, your address is compromised

. . .

Verifying Ownership in Blockchain

Anybody Can Verify Ownership in a Transaction

• Address of the funds being spent unlocks the transaction

• Verification similar to the process between Alice and Bob

• Nobody else but the owner of the address must have signed

• Owning an address is equivalent to owning its private key

• If your private key is exposed, ownership is lost forever

As long as the private keys are secured

It is practically impossible for someone to steal

Easy to Transact

Hard to Modify

Consists of several

computers called nodes

Each node has its

own private memory

Nodes communicate with

each other by messages

Network structure isnot known in advance

Distributed Systems

Nodes in the network

may fail or may exhibit

malicious behavior

Client-server: Designated servers accept clients

Three-tier/n-tier: More

organized structure

Peer-to-peer: Every node

can be a server or a client

Distributed Systems

Computation by a master node or by using a shared database

Blockchain itself is the shared database

Consensus required:

• Who holds correct data

• Who can make changes

• How are these rules

enforced between nodes

Let's not forget, there may

be malicious nodes

Distributed Systems

Blockchain approach: Publicly verifiable data requires (hard) proof Tampering with data becomes exponentially harder as time passes

Advantages:• No need to trust any particular (central) node• Collective computation effort more powerful

than what can be done by one central entity• Rules to be agreed on collectively• More resilient to certain forms of attacks

Challenges:• Scalability in the number of transactions• Providing incentives for honest behavior

and/or penalties for malicious behavior

Distributed Systems

• Block number (height)

• Latest transactions

• Resulting changes to data

• Pointer to previous block

• Proof of validity

Structure of the Blockchain

…

• Each block stores a list of transactions

• Similar to chain of title in real estate trxs, if we assume one trx per block.

• For correctness, the entire chain must be valid

Structure of the Blockchain

• Transactions require digital signatures

• How to verify the entire history of transactions in the blockchain?

• Any message can be digested into a short string using a hash function

• One-way functions

Cryptographic Hash Functions

• Cryptocurrency

Bitcoin, Ethereum, Litecoin, etc.

There are over 1000 different altcoins

• Smart contracts

Legal contracts which are enforced automatically

• Asset management

• Identity verification, notary, voting

• Decentralized exchanges

• Many more…

Applications of Blockchain Technology

Cryptography

&

Distributed Systems

Main Components of Blockchain

Story:Alice would like to send a very important message to Bob.

She wants him to know that it is indeed her who sent the message.

How can Alice accomplish this?

Answer:One way functions and public key cryptography!

Private and public keys to encrypt and to decrypt.

Applications:Communications of any kind: internet, military, etc. Developments in cryptography created the field of computer science back in the 1940s.

Public Key Cryptography

Illustration:• Alice produces private and public keys.• She publishes her public key to everyone.• Private key encrypts, public key decrypts.• Nobody can produce the same encryption

without knowing the private key of Alice.

Alice sends a message M to Bob:She encrypts M using her own private key: M⟶ MA

Bob decrypts the message from Alice:He decrypts message using Alice’s public key: MA⟶M

Public Key Cryptography

Guarantees:Using Alice’s private key ensures that message is sent by Alice.

Nobody else could have written it!

Digital signatures:Encryption using a private key is called a “digital signature”.

Digital signatures are enforceable in a court of law!

Alice cannot claim that she did not send the message.

Application in blockchain:Digital signatures are used to authenticate ownership.

Payment addresses are generated by public keys.

Public Key Cryptography

Verifying Ownership in Blockchain

Public Key Cryptography to Prove Ownership

• User creates a pair of public and private keys

• Public key to generate and publish payment addresses

• Private key to digitally sign for the funds in those addresses

Verifying Ownership in BlockchainSecurity of Public Key Cryptography• Brute force is a possible attack, but infeasible in general• One-way functions for encrypting, cannot invert the function• Best to avoid spending from the same address many times• It is extremely hard to forge a signature even with observation• If your private key is exposed, your address is compromised

. . .

Verifying Ownership in Blockchain

Anybody Can Verify Ownership in a Transaction

• Address of the funds being spent unlocks the transaction

• Verification similar to the process between Alice and Bob

• Nobody else but the owner of the address must have signed

• Owning an address is equivalent to owning its private key

• If your private key is exposed, ownership is lost forever

As long as the private keys are secured

It is practically impossible for someone to steal

• Transactions require digital signatures

• How to verify the entire history of transactions in the blockchain?

• Any message can be digested into a short string using a hash function

• One-way functions

Cryptographic Hash Functions

Cryptography:

• Validity of transactions can be verified quickly

• Ownership is tied to the private keys

• Each block can be digested into a string

which proves the validity of the entire history

Distributed Systems:

• Trustless distributed public ledger

• Creating a block is hard, so it is much harder

to modify earlier blocks in the blockchain• Constantly audited by peers

Main Components of Blockchain

Smart Homes, Smart Cars:

• Ownership information can be recorded on the blockchain

• Exchange of the ownership, money, keys (authority to use),

can be transferred in the same single transaction

• Crucial information related to the asset can also be recorded

on the blockchain: past insurance claims, previous owners

• Very reliable: any crucial information recorded on the

blockchain cannot be modified later

Applications of Blockchain Technology

Identity, Notary, Voting:

• Self identifying information is required in any business

transaction: photo ID, passport, etc

• This information can be stored on the blockchain and the proof

of identity can be produced without any government backing

• One can prove identity by just simply using the private key

• Claims about the identify of Satoshi Nakamoto was made

based on the use of one of his/their private keys

Applications of Blockchain Technology

Decentralized Exchanges:

• Exchange of two assets is generally carried out by a trusted

third party that acts as escrow

• Central entity controlling the exchange can be the subject of

an attack resulting in the loss of deposits

• Such incidents can be eliminated via exchanging the assets by

using an escrow for the transaction on the blockchain itself

• Swap will be carried out when both parties sign the transaction

Applications of Blockchain Technology

Private Blockchain:

• Even though the main motivation to introduce the blockchain

technology was to remove trust, settings where there is a

trusted entity can still enjoy the benefits of using a blockchain

• Automated maintenance and auditing of records

• No need for consensus. The blockchain is truly an append

only ledger. Once written, the past is indeed set in stone

• Requires full trust in the centralized node(s) issuing the blocks

Applications of Blockchain Technology

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• Coming in 2018 to Boston, NYC, Chicago, San Francisco and online!

• Sign up at www.analyticscertificate.com/Blockchain-ML for updates!

Blockchain workshop

51

Q&A

Thank you members and CIC!Checkout our programs at:

www.analyticscertificate.com

Sri Krishnamurthy, CFA, CAPFounder and CEO

QuantUniversity LLC.

srikrishnamurthy

www.QuantUniversity.comInformation, data and drawings embodied in this presentation are strictly a property of QuantUniversity LLC. and shall not be

distributed or used in any other publication without the prior written consent of QuantUniversity LLC.

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