Presented at Consob, Rome, November 22, 2016

1. About Bitcoin, Blockchain,
and the Distributed Ledger Technology Chimera
Ferdinando M. Ametrano
Politecnico di Milano, Milano Bicocca University
Consob, Rome, November 22, 2016
ferdinando@ametrano.net
@Ferdinando1970
http://www.slideshare.net/Ferdinando1970
https://it.linkedin.com/in/ferdinandoametrano

2. Investment Landscape
2/80

3. A Blockchain Transaction
https://blockchain.info/tx/8f1d3a8ef6b2d4a25d2f499279e01518b4770819ccbc39a765c4c326170c61b3
About $83M transacted with $0.04 fee
3/80

4. Bitcoin Economy
http://bitcoincharts.com/charts/bitstampUSD#tgWzm1g10zm2g25zv
• Total number of BTC is about 14M
• BTC Market Cap: about $3-14B (USD M0 is about $1,200B)
4/80

5. December 2013: China crackdown
• People’s Bank of China crackdown:
– prohibits financial institutions from trading, underwriting, or
offering insurance in bitcoins or any other digital currency
– Bitcoin is not to be considered a currency
– owning bitcoins is not outlawed or prohibited
• As of December 2013 BTC China was world's largest Bitcoin
exchange by volume
• Alibaba, China's top Internet retailer, stopped using bitcoins
as of January 19 2014
5/80

6. February 2014: Mt Gox bankruptcy
• As of January 2014 Mt Gox was world's largest Bitcoin
exchange by volume
• In February 2014 it filed for bankruptcy protection
from creditors
• It announced that around 850,000 bitcoins belonging
to customers and the company were missing and likely
stolen, an amount valued at more than $450 million at
the time
• Fraud or theft?
6/80

7. Silk Road
• Online market, operated as a Tor hidden service
• Online users were able to buy illicit goodies using bitcoins,
while browsing it anonymously and securely without
potential traffic monitoring
• Launched in February 2011, shut down in October 2013
• Ross William Ulbricht, alleged to be the owner of Silk Road,
arrested in San Francisco, sentenced to life in prison
• Other black markets have filled in as successors
7/80

8. Bitcoin resilience
• Is there anything else in financial world:
• Just 7 years old
• Without government or corporation backing
• That can lose its main (China) market
• With fraud/theft at its main reference exchange (Mt
Gox)
• With such a bad reputation (Silk Road)
• That could be still alive and kicking?
8/80

9. 1. About Bitcoin
2. Bitcoin as Digital Gold
3. Bitcoin in the History of Money
4. Blockchain Beyond Bitcoin
9/80

10. • Decentralized digital currency
• Not backed by any government or organization
• Instantaneous peer-to-peer transactions
• No need for trusted third party
• Cryptographic security
• Low-cost banking for everybody everywhere
https://bitcoin.org/en/faq
http://www.coindesk.com/information/
10/80

11. The bitcoin currency
• Not to be found anywhere, they only exist as public ledger documented
transactions
• A bitcoin wallet is a public address
• 1FEz167JCVgBvhJBahpzmrsTNewhiwgWVG
• the bitcoin public ledger (aka blockchain) certifies for everybody how
many bitcoins are associated to the wallet
http://blockexplorer.com/address/1FEz167JCVgBvhJBahpzmrsTNewhiwgWVG
It is mine; you are
REALLY
encouraged to tip
11/80

12. Bitcoins Are Scriptural Asset
• Bitcoins only exist as validated transactions
• Bitcoins are not liabilities
• Bearer instruments
12/80

13. Pseudonymity, Anonymity
• Bitcoin is really pseudonymous, not anonymous:
• The public key does not provide direct information about
the private key owner
• All transactions are transparent to everybody’s inspection.
• Perfect persistent public account history: the public ledger
is forever
https://blockchain.info/
http://blockexplorer.com/
13/80

14. Bitcoin’s public ledger: the block chain
• Transactions are bundled in blocks, sequentially
chained, about one block every 10 minutes
• The block chain is a history of transactions resilient to
network attackers
• The cryptographic link between blocks requires large
amount of computing power, so the block chain cannot
be altered without huge resources
• Computing power is measured in hash/s, hash being
the basic operation needed for validation
14/80

15. Network hash rate
Specialized non-generic hardware, with hashing capacity thousands times
that of the combined 500 largest supercomputers
15/80

16. Mining
• Miners are the nodes of the network providing the computing
power for:
– processing and validating transactions (avoiding double spending)
– securing the network
– synchronizing the nodes
• Miners compete to process a new block of transactions. The winner
provides a proof-of-work and is rewarded with the issue of new
bitcoins.
• Seigniorage revenues subsidize the network, making transaction
almost free
16/80

17. Bitcoin Monetary Rule
• 2009: 50BTC every 10 minutes
– halving every 4Y
• This is the only way new bitcoins are released
• It is called mining because of its similarity with
the progressive scarcity of gold extraction
digital cash supply free of discretionary intervention
17/80

18. Inelastic Money Supply
Deterministic Decreasing Rate
2029: issued
96.88% of all BTC
2141: issued last
0.00000001 BTC
18/80

19. 1. About Bitcoin
2. Bitcoin as Digital Gold
3. Bitcoin in the History of Money
4. Blockchain Beyond Bitcoin
19/80

20. “Blockchain –
not bitcoin –
will prove
revolutionary
in banking”
http://www.economist.com/news/leaders/21677198-technology-behind-bitcoin-could-transform-how-economy-works-trust-machine
20/80

21. Bitcoin in 2014 Is Like Internet in 1994: Weird and Scary
Marc Andreessen: American entrepreneur, investor, and software engineer.
Coauthor of Mosaic, cofounder of Netscape
https://twitter.com/pmarca/status/677658844504436737
3 4 521
21/80

22. The Walled Garden Model
• Controlled access to web content and services
• Offered in the late ‘90s and early ‘00s by
Compuserve, AOL (and to some extent MSN)
• Corporates wanted to go online, but not in the
wild unregulated internet, populated by
anonymous agents
• They eventually realized that perceived risks,
which are real, are outweighed by benefits
22/80

23. Understanding Lags Well Behind The Hype
Understanding of the technology however lags well
behind the hype, amongst practitioners, policy makers
and industry commentators alike. ‘Blockchain’
technology seems to promise major change for capital
markets and other financial services – some say it may
ultimately prove to be as important an innovation as
the internet itself – but few can say exactly how or why.
Michael Mainelli, Alistair Milne (2016)
The Impact and Potential of Blockchain on the Securities Transaction Lifecycle
http://ssrn.com/abstract=2777404
23/80

24. Why Bitcoin Is Hard To Understand
At the crossroads of:
1. Game theory
2. Cryptography
3. Computer networking and data transmission
4. Economic and monetary theory
Mainly not a technology,
a cultural paradigm shift instead
24/80

25. What is The Blockchain?
[A hash pointer linked list of blocks]
• An append-only sequential data structure
• New blocks can only be appended at the end of
the chain
• To change a block in the middle of the chain, all
subsequent blocks need to be changed
• Very inefficient compared to a relational database
25/80

26. Blockchain:
A Distributed Transaction Ledger
• Every block contains multiple transactions
• Massively duplicated across network nodes
• Shared with a P2P file transfer protocol
• Updated by peculiar nodes, known as miners,
appending new blocks of transactions
26/80

27. A Distributed Back-office
• All network nodes perform transaction validation and
clearing.
• Miners perform the additional work required for
settlement. How do they reach consensus on the
transaction history?
• Consensus in a distributed network with faulty (or
malicious) nodes is a very hard problem known as
Byzantine General Problem
27/80

28. Distributed Consensus
• Nakamoto reaches consensus using (game
theory) economic incentive for the mining
nodes to be honest
• Miners are compensated for their proof-of-
work using seigniorage revenues, i.e. with
issuance of new bitcoins
28/80

29. Blockchain Without Bitcoin
Does it make sense?
No bitcoin
No asset available to reward miners
Appointed validator officials required
Why should validators use a blockchain,
i.e. a subpar data structure, instead of a database?
29/80

30. What is Bitcoin?
bitcoin is the native digital asset,
tracked by the first (and most relevant so far)
blockchain
• It exists only as scriptural asset, i.e. validated
transaction recorded on the blockchain
• It is a bearer instrument: the (private key) holder
is the actual effective owner
30/80

31. What Makes Bitcoin Special?
• It is scarce in digital realm, as nothing else before
• It can be transferred but not duplicated
• (i.e. it can be spent, but not double-spent)
Bitcoin is digital gold: this is the brilliant
groundbreaking achievement by Satoshi Nakamoto
31/80

32. Bitcoin as (Digital) Gold
in the History of (Crypto)Money
gold
• Its adoption was not centrally
planned
• For centuries it has been the
most successful form of money
• It has bootstrapped all monetary
systems we know of
• It has been surpassed by other
kind of money without becoming
obsolete
bitcoin
• Its adoption has not been centrally
planned
• It is the most successful form of
cryptocurrency
• It will bootstrap new monetary
systems
• It might be surpassed by more
advanced type of cryptocurrencies
without becoming obsolete
32

33. 1. About Bitcoin
2. Bitcoin as Digital Gold
3. Bitcoin in the History of Money
4. Blockchain Beyond Bitcoin
33/80

34. Explain Money To An Alien
fiat money
• No intrinsic value (legal
tender, social contract)
• Currency based on
paper/ink security
• Discretionary governance
• Wicksellian interest-rate
approach
bitcoin
• No intrinsic value (digital
gold)
• Currency based on
math/cryptographic security
• Algorithmic governance
• Deterministic supply
34

35. Money As A Social Relation Instrument
1. Human beings are born into a gift economy
2. Enlarged relationship circle requires exchange
economy
3. Barter economy: coincidence of wants
4. Trade economy: money as medium of exchange
5. Global information economy: supranational
digital money
35/80

36. The Information Economy
• Data is transferred with zero marginal cost
• Why pay a fee to move bytes representing wealth?
• Why only 9-5, Monday-Friday?
• Who (and when) will gift humanity with a global
instantaneous free p2p payment network?
BANK
36/80

37. Bitcoin:
Money For The Information Economy
• Decentralized: no authority
• Permissionless: no regulator
• Censorship resistant: no frozen funds
• Open-access: no discrimination, no amount limits, 24/7, 365 days
• Free: negligible transaction costs
• Borderless: no geographic limits
• Transnational: no specific jurisdiction applies
• Secure: non falsifiable, non repudiable transactions
• Resilient: nothing has been able to stop it or break it
37/80

38. Trade Economy
From gold standard to fiat money
• Gold: the commodity money standard
– resistance to corrosion and oxidation
– high malleability
– relative easiness of purity assessment
– Pleasant color
• Gold purity certification
• Representative money
• Fractional receipt money
• Fiat money and legal tender
38/80

39. Friedrich August von Hayek -
Denationalisation of Money
• history of coinage is an almost uninterrupted story of debasements; history is
largely a history of inflation engineered by governments for their gain
• why government monopoly of the provision of money is regarded as
indispensable? It deprived public of the opportunity to discover and use a better
reliable money
Blessed will be the day when it will no longer be from the benevolence of the
government that we expect good money but from the regard of the banks for their
own interest
A Free-Market Monetary System, Gold and Monetary Conference, New Orleans, Nov. 1977, https://mises.org/daily/3204
Hayek, F. A., Denationalisation of Money, The Institute of Economic Affairs,http://www.mises.org/books/denationalisation.pdf
39/80

40. Permissionless Innovation
Fast and Effective
• No centralized security mechanism, no barrier to
enter, no editorial control
– Email has not been designed by a consortium of postal
agencies
– Internet has not been developed by a consortium of telcos
• Will a decentralized transactional economy be
shaped by a consortium of banks?
40/80

41. Statement of the bitcoin problem
• successful at getting
rid of a centralized
monetary authority, it
has given up the
flexibility of an elastic
supply of money
• no salaries, no
mortgages, no stable
purchasing power
41/80

42. Money Comparison
Medium of Exchange Store of Constant Value Unit of Account
Live cattle
Diamonds
Gold
Fiat coins and notes
Bitcoin
• swappable
• fungible
• portable
• divisible
• recognizable
• resistant to
counterfeiting
• reliably saved, stored,
and retrieved
• retain usefulness over
time
• Maintain its storage
properties
• non-perishable or
with low preservation
cost
• relative worth unit of
measure
• stable value for
stable price
comparison
• supply must be
controlled in some
way
42/80

43. Unit of Account: Money as numeraire
• Money is the unit of account against which the
value of every other good is measured
• The price system measures the value of goods
relative to the value of money
Good money should provide stable prices to best
perform its role as unit of account
43/80

44. The Holy Grail of Stable Prices
• Gold standard, bimetallism, symmetallism
• Fixed value of bullion (Aneurin Williams 1892)
• Compensated dollar (1911-20 Irving Fisher)
• Commodity Reserve Currency (1932 J. Goudriaan, 1937-44
B. Graham, 1942 F. Graham, 1951 M. Friedman)
• ANCAP basket (1982 Robert Hall)
• Futures contracts (1984 Miles, 1989-95 Sumner)
• Quasi-futures contract (1994 Kevin Dowd)
• Price index option (2000 Kevin Dowd)
44/80

45. Hayek Money
• The cryptocurrency monetary standard of
elastic non-discretionary supply
• Price stability paradigm with respect to a
reference basket
• Concurrent cryptocurrencies will compete in
monetary policy definition and reference
basket choices
45/80

46. Fixed USD Exchange Rate
• USD/BTC: 15-Apr-11 1.0, 29-Mar-14 500.0
• x500 increase for BTC demand relative to USD
• 29-March-14: 12.5M bitcoins in circulation
• Inflate their number 500 times to 6250M
• On 29-Mar-14 it would have been equivalent
– to own BTC1 worth $500
– or (rebased) RBTC500 each worth $1
46/80

47. USD-Parity Rebased Bitcoin
Daily rebasing
47/80

48. Brent-Wheat Commodity Price Index
48/80

49. Brent-Wheat Commodity Price Index
Rebased Bitcoin
49/80

50. Brent-Wheat Commodity Price Index
50/80

51. Rebasing Bitcoin?
No, not really!
• Use bitcoin for the sake of discussion, basically
to leverage its historic price series
• Bitcoin is good as it is: more of a
cryptocommodity than a cryptocurrency,
bitcoin is digital cryptogold
51/80

52. Observation of Commodity Prices
Without A Central Authority
• Miners are the agents of the transaction history
consensus algorithm
• Miners can also be the agents of the reference
price consensus algorithm
• Shelling points: unbiased market prices are focal
prices for the average consensus process
• Miners as (black market) brokers
52/80

53. Commodity Price Index Maintenance
• Commodities’ importance changes, traded volume, relative
price stability and sensitivity, and competitive markets
might suggest Commodity Price Index alterations
• The Commodity Price Index is composed of technically
unconstrained numbers
• Nothing could stop the majority of miners from changing
the Commodity Price Index definition
• Proof-of-stake is crucial: the prerogative to change the Price
Index is not oligopolistic power abuse, but the proper right
of the majority to rule about its own money
53/80

54. Hayek Money
This First Simplistic Implementation
• Results:
– Price stability
– Salaries, mortgages, forward payments are now possible
• Problems:
– Number of coins in a wallet changes without direct in/out flows
– Purchasing power of a given wallet is not stable
– Miners are in charge of reference basket maintenance
– Coins still have speculative investment appeal and so enjoy
limited transaction usage
54/80

55. Hayek Money
Further Research
• Split transactional and speculative money demand
with two non-fungible assets: coins and shares
– see Sams (2014) A Note on Cryptocurrency
Stabilisation: Seigniorage Shares
https://github.com/rmsams/stablecoins/blob/master/paper.pdf
• Leverage bitcoin as reserve asset
– see Ametrano (2016) Price Stability Using Bitcoin as
Reserve Asset
http://ssrn.com/abstract=2508296
55/80

56. 1. About Bitcoin
2. Bitcoin as Digital Gold
3. Bitcoin in the History of Money
4. Blockchain Beyond Bitcoin
56/80

57. Blockchain Transactional Economy
• Bitcoin is the only blockchain asset
• Everything else tracked with blockchain technology is
somebody’s liability
A healthy digital transactional economy requires
a native digital asset
to be used for payment and collateral;
it makes no sense to only have liabilities!
the same is true for other native
digital assets (ethereum, litecoin,
etc.) of less secure blockchains
57/80

58. Blockchain Needs A Native Digital Asset
https://www.finextra.com/videoarticle/1241/blockchain-needs-a-native-digital-asset
Ferdinando Ametrano, Head of
Blockchain and Virtual
Currencies, Intesa Sanpaolo,
discusses the relationship
between bitcoin and
blockchain, and outlines how
banks can stay ahead of this
evolving landscape.
58

59. Blockchain Without Bitcoin: No
Blockchain Beyond Bitcoin: Yes
• 1992: email was the killer Internet app
• Impossible to imagine Google, Facebook, Amazon
• 2016: bitcoin is the killer Blockchain app
• More ambitious apps will be built on blockchain, but
they have not been really imagined yet, and they will
need a native digital asset
59/80

60. Time-stamping and Notarization
• A generic data file can be hashed to producing a short unique
identifier, equivalent to its digital fingerprint.
• Such a fingerprint can be associated to a bitcoin transaction
(irrelevant amount) and hence registered on the blockchain
• Blockchain immutability provides non-repudiable time-stamp,
proving the existence of the data file in that specific status at
that moment in time
• This generic process is even undergoing some standardization
to achieve third party auditable verification: broker-dealers
could use it to satisfy regulatory prescriptions
60/80

61. Anchoring: A New Security Paradigm
• Bitcoin blockchain network security is preserved
by a computation power unparalleled in human
history
• Other transactional networks can tap into this
security via anchoring (i.e. periodic time-
stamping of the network status)
• Bitcoin miners as global outsourced decentralized
security of the future
61/80

62. Other Blockchain Use Cases
OK: applications based on cryptographic proofs and digital IDs [not
really blockchain]
As for the rest, it is basically hype. Questions always to be answered:
• Can be achieved with a database?
• What consensus is required? (distributed, bilateral, centralized)
• What kind of security is required: preventive, detective, or
corrective? (ok / yes today, probably not in the future/ no)
• Blockchain is absolutely not suited for storing large amount of data
62/80

63. The Shifting Narrative
2014 bitcoin
2015 blockchain technology (Economist)
2016 distributed ledgers
2017 Databases on crypto-steroids
2018 bitcoin, again!
63/80

64. Insecure Snake-Oil Sold To Bank
Andreas Antonopoulos: technologist, serial entrepreneur, one of the most
well-known and well-respected figures in the bitcoin ecosystem
https://twitter.com/aantonop/status/702307516739428353
64/80

65. R3 Corda
http://r3cev.com/blog/2016/4/4/introducing-r3-corda-a-distributed-ledger-designed-for-financial-services
• R3 was originally touted as “a project intended to bring
blockchains to finance”
• Its Distributed Ledger Group is developing a
proprietary platform, named Corda: “Corda is a
distributed ledger platform […] we are not building a
blockchain”
• A revamped SWIFT secure messaging protocol on
cryptographic proof & bilateral ledger steroids?
• Goldman Sachs and Santander just left the consortium
65/80

66. Why is finance fascinated with blockchain?
Blockchain transactions are immediately validated
and cleared, then settled shortly thereafter,
automatically without a central authority
• In the financial world, cash transactions only are
cleared and settled automatically without a
central authority
66/80

67. Consensus by reconciliation
• Financial transactions that take milliseconds to
execute, clear and settle in days
• Not a technological problem
• Consensus by reconciliation of multiple
independent ledgers: a checks and balances
system that allows for prescriptions,
corrections, and restrictions
67/80

68. Instant Settlement
• Instant settlement would reduce liquidity
making leverage, short selling and netting
almost impossible
• Instant settlement (e.g. for payments) has
costs: who should pay for them?
• It costs: who should pay for it?
68/80

69. Cash On The Ledger
• Cash-on-the-ledger is imperative for Delivery
vs Payment
• absent from the agenda of prominent players
promising DLT solutions
69/80

70. Cash on the Ledger
• Central bank digital currency is problematic: [… it] is appealing
[…] it would mean people have direct access to the ultimate
risk-free asset [...] it could exacerbate liquidity risk by lowering
the frictions involved in running to central bank money [...] it
could fundamentally and perhaps abruptly re-shape banking.
Mark Carney, Governor of the Bank of England, June 2016
http://www.bankofengland.co.uk/publications/Documents/speeches/2016/speech914.pdf
• IMF sponsored blockchain tokens might replace Special
Drawing Rights: unrealistic as it would severely undermine US
dollar predominance
• A free instantaneous P2P payment network is a great
opportunity for retail banks (probably worth a consortium)
70/80

71. DLT for Derivatives Clearing
• collateral amount calculation is computationally
intensive: not clear which agent would perform it, its
economic incentive, which models it should use
• variation margin automated payments: programmatic
access to payment funds entails huge operational risks
• the default of counterparty would leave the other
party exposed to the market risks usually covered by
initial margin: i.e. initial margin are still required
71/80

72. Single Shared Data Set
• Single data source, avoiding reconciliation
• Without a central governing node how to manage
priorities between conflicting updates? Which
consensus model?
• Bilateral consensus? Really?!?!?
• Central governance: back to DB admin
• What if the single authoritative data source is
hacked? Which reference can be used to fix it?
72/80

73. Improved Automation: Smart Contracts
• The DAO (decentralized autonomous org): the main Ethereum
project, it raised >$160m as leaderless Venture Capital
• The terms of The DAO are set forth in the smart contract code
[…] Nothing […] may modify or add any additional obligations
or guarantees beyond those set forth in The DAO’s code
• Based on its self-executing nature an agent diverted about
$50m from The DAO to its own child-DAO start-up
• If code is law, then this is not a theft: it is a feature
• Beware of extreme automation
73/80

74. The Mirage of Low Operational Costs
• If one takes into account the seigniorage revenues invested,
each transaction on the bitcoin blockchain has a cost of about
5-10USD
• Cheaper forms of consensus have not been proven yet
• Even in the case of basic bilateral consensus through digital
signatures (something hardly innovative or disruptive...) the
integration cost in the existing infrastructure is not going to be
irrelevant
74/80

75. Time-stamping and Notarization
• A generic data file can be hashed to producing a short unique
identifier, equivalent to its digital fingerprint.
• Such a fingerprint can be associated to a bitcoin transaction
(irrelevant amount) and hence registered on the blockchain
• Blockchain immutability provides non-repudiable time-stamp,
proving the existence of the data file in that specific status at
that moment in time.
• This process is undergoing standardization: third party
auditability makes it suitable for regulatory prescriptions
75/80

76. Anchoring: A New Security Paradigm
• Bitcoin blockchain network security is preserved
by a computation power unparalleled in human
history
• Other transactional networks can tap into this
security via anchoring (i.e. periodic time-
stamping of the network status)
• Bitcoin miners as global outsourced decentralized
security of the future
76/80

77. Data Storage, Consensus, Security
Questions always to be answered:
• Can be achieved with a database?
• What consensus is required? (distributed, bilateral,
centralized)
• What kind of security is required:
– Preventive (ok)
– Detective (ok today, probably not in the future)
– Corrective? (no)
77/80

78. New Regulatory Framework?
• Public permissionless blockchains are not aiming for regulation
• Private permissioned DLTs are supposedly being built from the
ground up according to regulatory compliance guidelines
• Regulators should examine DLT under the light of the existing
regulatory framework
• To regulate in advance on the basis of vague ephemeral discussions
about DLT would be problematic and might stifle innovation.
• The necessity for ad-hoc regulation is not evident yet, and there has
not been a motivated explicit request for it.
78/80

79. About Bitcoin, Blockchain
and the DLT chimera
• The slides of my recent presentation to Bank of Italy
(Rome) and the European Banking Federation (Bruxelles):
https://speakerdeck.com/nando1970/about-bitcoin-and-blockchain-1
• Joint answer with Barucci, Marazzina, and Zanero to the
ESMA consultation on DLT for securities markets:
https://drive.google.com/drive/folders/0B8tGDTaBY4-Nb3ZuRmgzRXJXOUk
• My recent article for the Swift Institute newsletter
https://www.linkedin.com/pulse/bitcoin-blockchain-dlt-chimera-ferdinando-maria-ametrano
79/80

80. Conclusions
• Bitcoin is resilient
• Blockchain needs a native digital asset such as bitcoin;
• Bitcoin is digital gold and can be as relevant as physical gold for the history
of civilization, money, and finance
• Unrealistic expectations arise from distributed ledger hype: no reference
implementation has emerged yet
• Instant settlement, cash on the ledger, shared data set, and improved
automation are not easy to obtain
• Time-stamping and anchoring are promising applications
• Hardly disruptive, DLT might be evolutionary DB tech
80/80