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Week 3 - Cryptocurrencies

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Week 3 - Cryptocurrencies

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Instructor: Roger Royse, Founder of Royse Law Firm
Course Title: The Business Basics of Blockchain, Cryptocurrencies, and Tokens
Location: Stanford Continuing Studies

Week: 3 (of 7)

The third session focuses specifically on cryptocurrencies. We will discuss the history of digital currencies from Bitcoin to Ether and others. We will review core concepts and terms and more highlight the major events in cryptocurrency space, new opportunities and existing problems that remain to be solved.

Instructor: Roger Royse, Founder of Royse Law Firm
Course Title: The Business Basics of Blockchain, Cryptocurrencies, and Tokens
Location: Stanford Continuing Studies

Week: 3 (of 7)

The third session focuses specifically on cryptocurrencies. We will discuss the history of digital currencies from Bitcoin to Ether and others. We will review core concepts and terms and more highlight the major events in cryptocurrency space, new opportunities and existing problems that remain to be solved.

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Week 3 - Cryptocurrencies

  1. 1. Royse Law Blockchain Initiative Cryptocurrency Roger Royse rroyse@rroyselaw.com www.rroyselaw.com Research Assistant: Justin Sher 1 Stanford Continuing Studies FALL 2018 BUS 35 The Business Basics of Blockchain, Crypto Currencies, and Tokens Week 3 July 8, 2019
  2. 2. Recap : Technology review 2 The double spend problem: Preventing someone making a purchase with digital cash from reusing the same token to purchase again
  3. 3. Crypto Currency defined 3 A cryptocurrency (or crypto currency ) is a digital asset designed to work as a medium of exchange that uses strong cryptography to secure financial transactions, control the creation of additional units, and verify the transfer of assets. (Wikipedia)
  4. 4. Cryptocurrency I. Financial Crisis and a New Trusted Protocol II. Problems with Cryptocurrency III. Cryptocurrency Forks IV. Legal Frameworks V. Privacy Coins and Zero Knowledge Proofs VI. Cryptocurrency Market Overview VII. Future Authoritarian Government Cryptocurrencies 4
  5. 5. I. Financial Crisis and New Trusted Protocol 5 • Financial Crisis of 2008 affected trust in intermediary Source: Medium where they describe what happens after a financial crisis 5
  6. 6. Current Banking System 6 • Bank transfers; Slow, Expensive • Western Union slow and 7% charge • Paypal: Expensive and not universally available Source: Medium where they describe transferring money mechanism before bitcoin
  7. 7. Launch of Bitcoin 7 Source: Reddit where they describe transferring money mechanism after bitcoin
  8. 8. ABRA: P2P remittance network via smartphone 8 Source: Abra website
  9. 9. Altcoins (Bitcoin alternatives): • Bitcoin: P2P, PoW, limited supply, 10 minutes per block • Ether: P2P, PoW (new consensus algorithm under development, called Casper), 18 million per year, 15 seconds per block, need Ether to run on Ethereum • LiteCoin: P2P, an early bitcoin spinoff or altcoin, started in October 2011. Technically nearly identical to Bitcoin. • Chia: Farmers instead of miners, Based on storage capacity (not computing power), Rewards for verification of transactions. 9
  10. 10. Ripple 10 Source: Abra website • Ripple is built upon a distributed open source internet protocol, consensus ledger and the decentralized native cryptocurrency known as XRP (the 3rd largest coin as of June 2018) • Banks can exchange funds in different currencies quickly and at low cost • Ripple supports tokens representing fiat currency, cryptocurrency, commodity or any other unit of value such as frequent flier miles or mobile minutes • Used by MIT, UniCredit, UBS, and Santander (Source: NY Times)
  11. 11. • From chain.com, as compared to centralized systems • Slow • Expensive • Less scalable • Worse user experience • Volatile and uncertain governance • Volatile • Fixed money supply? • Smart contract bugs can be devastating • Not used as medium of exchange • Many users rely on wallets • Mt. Gox Hack • Coinbase Subpoena • Cryptocurrency Forks 11 Source: Coindesk Problems with Cryptocurrencies
  12. 12. Cryptocurrency Volatility 12 Source: Coinmarketcap.com
  13. 13. Fixed money supply • Bitcoin’s Money Supply Regulation • Programmed into the underlying software and fixed • To avoid devaluation • Prevent creation of unauthorized funds • Avoid “double spend” • Economic Perspectives on Fixed Money Supply (Optional Material) • Deflation and Cryptocurrencies • https://medium.com/peercoin/deflation-and-cryptocurrencies-the-long-term-ramifications-of-fixed- supply-currencies-c192f44dddc1 • However, higher inflation systems such as Dogecoin have been proposed and implemented, but have not gained anywhere near the popularity of Bitcoin • https://arstechnica.com/information-technology/2014/02/dogecoin-to-allow-annual-inflation-of-5- billion-coins-each-year-forever/ • Bitcoin’s has a far lower inflation rate vs. fiat currency • https://www.cryptovibes.com/analysis/bitcoin-inflation-rate/ Stanford Continuing Studies BUS 35: Business Basics of Blockchain, Crypto Currencies, and Tokens 13
  14. 14. Total Bitcoins over time Stanford Continuing Studies BUS 35: Business Basics of Blockchain, Crypto Currencies, and Tokens 14 Source: https://commons.wikimedia.org/wiki/File:Total_bitcoins_over_time.png
  15. 15. Total USD (M2) over time Stanford Continuing Studies BUS 35: Business Basics of Blockchain, Crypto Currencies, and Tokens 15 Source:https://fred.stlouisfed.org/series/M2
  16. 16. Stablecoins • A stablecoin is a cryptocurrency that has price stable characteristics • Fiat collateralized, • central entity holds money as collateral and issue a token that represents the money held by the entity • Tether • Facebook’s Libra • Crypto collateralized • A user is required to deposit crypto assets into a smart contract upon which he receives a certain number of stablecoins • if the cryptoassets in collateral do go through significant value depreciation, the loans taken out by users are automatically liquidated • Non-collateralized • Basecoin and Carbon • the supply of the coin will be dictated by the price of the stable coin 16
  17. 17. Facebook’s Libra Coin • Stablecoin – Backed by a basket of currencies. Control of supply is centrally managed by a small consortium of companies and based on the reserves held by the consortium. Reserves are invested and earn interest for the consortium, but not token holders. Promises to control conversion to fiat and comply with government regulation. • Targeted to launch in the first half of 2020 • Governance model will allow removal of nodes and other governance actions, recorded on the blockchain, if 75% of nodes agree. • Smart contract language similar to Ethereum called “Move” with built in libraries. • Overview • https://libra.org/en-US/white-paper/ • Technical Paper • https://developers.libra.org/docs/assets/papers/the-libra-blockchain.pdf Stanford Continuing Studies BUS 35: Business Basics of Blockchain, Crypto Currencies, and Tokens 17
  18. 18. Speed and Scalability Problem • When the number of transactions approaches Bitcoin’s fixed maximum, transaction fees increase rapidly. • The Lightning Network is a workaround now in use to help increase these transaction limits by performing transactions off-chain. Stanford Continuing Studies BUS 35: Business Basics of Blockchain, Crypto Currencies, and Tokens 18 Source: Bitcoinfees.info
  19. 19. Crypto security • Strong passwords – password managers • 2FA, with OTP like google Authenticator or Authy • Exchanges • Never store tokens on an exchange • Wallets • Store of private keys • Hardware wallet – Ledger Nano, Trezor Keepkey 19
  20. 20. Coinbase Subpoena 20 Source: https://arstechnica.com • In November 2016, a federal judge granted an IRS application to serve a John Doe summons on Coinbase • Two taxpayers admitted that they disguised the amounts they spent purchasing bitcoins as deductible technology expenses • The summonses asked Coinbase to identify all United States customers who transferred convertible virtual currency from 2013 to 2015 • The John Doe warrants are just the beginning of this enforcement process for the IRS.
  21. 21. 21
  22. 22. Exchange Transparency • Digital currency associated with criminal activity can be traced • Frozen accounts • Mt Gox • Linode hack 22
  23. 23. Decreased Financial Privacy • Pseudonymous • Transparent • Identities can be reverse engineered on transaction graph analysis 23
  24. 24. Pseudonymous: Bitcoin • Contrary to popular belief, bitcoin is not, strictly speaking, anonymous. In fact, it’s pseudonymous • Why not anonymous? • Bitcoin provides less anonymity than cash transactions in that all of your transactions are publicly available to the entire bitcoin network. • Because the transaction block chain acts as a “public ledger”, anyone can readily see the records of all of the transactions that have ever involved your bitcoin address. • Even though bitcoin possession and transactions aren’t tied to your real name, your email, or your physical address, it is tied to only your randomly-generated bitcoin address • However, your anonymity isn’t compromised unless someone can connect your bitcoin address to your real-world identity. 24
  25. 25. Bad Actors: Fraudulent Exchange 25 Source: CNN Money • New York: A man running unregistered securities exchange and converting user’s bitcoin to his personal use was pled guilty to securities fraud (July 24, 2018) • Korea's Biggest Crypto Exchange Raided Over Suspected Fraud (May 12, 2018) • Ukraine: Four Arrested for Running Fake Crypto Exchanges (June 22, 2018) • India: Multiple criminal investigations were sparked by the death of the owner of the QuadrigaCX Crypto exchange. His death, which some believed to have been faked, lead to $190 million in cryptocurrency being lost. (Jun 4, 2019)
  26. 26. Bad Actors: Silk Road Stanford Continuing Studies BUS 35: Business Basics of Blockchain, Crypto Currencies, and Tokens 26 Source: CNN Money
  27. 27. Smart Contract Bugs Can Be Devastating • Curious user exploring the parity wallet smart contract accidently permanently froze $150 million dollars in cryptocurrency due to a bug in its implementation. • https://blog.springrole.com/parity-multi-sig-wallets-funds-frozen- explained-768ac072763c Stanford Continuing Studies BUS 35: Business Basics of Blockchain, Crypto Currencies, and Tokens 27
  28. 28. III. Forks: Soft and Hard Fork • Forks: a developer makes a copy of a project’s source code and begins independent development • Soft Fork vs. Hard Fork • Soft Fork: new version compatible with older versions • Hard Fork: new version no longer compatible with older versions • Cryptocurrency fork • Most altcoins are technically hard forks of Bitcoin since they are based on the Bitcoin codebase but are not compatible with the Bitcoin network. • When a hard fork has been created as the result of a split within the community, sometimes the fork adopts the existing blockchain history of the cryptocurrency they split from and multiple cryptocurrencies will share a blockchain history. Owners of cryptocurrency on the pre-existing blockchain will now own cryptocurrency on both blockchains (e.g., Bitcoin and Bitcoin Cash). • Taxation? 28
  29. 29. Case: Ethereum Forks • Ethereum split in July 2016: high-profile hack of The DAO, roughly $50 million in ether (Ethereum’s native currency) was stolen • Ethereum holders voted on whether to institute a hard fork to return all ether taken from the DAO. • Two blockchains with a nearly-identical history were created by split • Majority voters agreed with the hard fork: Ethereum • A sizeable minority protested to the hard fork: Ethereum Classic • Ethereum Classic have operated independently of the main Ethereum network ever since. 29
  30. 30. 30 IV. Legal Frameworks • The scale of money laundering is increasing rapidly with illegal activities in crypto world • In 2009 money laundering was estimated at 2.7% of the world’s GDP (US$1.6 trillion) • What to do avoid supporting illegal activities? • Anti-money Laundering (“AML”) • Know Your Client or Customer (“KYC”) • Bank Secrecy Act (“BSA”)
  31. 31. AML & KYC in Crypto Practice 31 • Identify the client and their beneficial owner: identify high risk countries and clients • Keep pace with new ways in which money laundering is carried out • Maintain an adequate AML program in place and ensure AML compliance in domestic and foreign business • Report suspicious transactions: report to finance intelligence unit
  32. 32. Outsourced AML/KYC services 32
  33. 33. Bank Secrecy Act in Crypto • The Bank Secrecy Act (“BSA”): financial institutions share customer information with the Financial Crimes Enforcement Network (“FinCEN”) • In 2013, FinCEN published a guidance on the “Application of FinCEN’s Regulations to Persons Administering, Exchanging, or Using Virtual Currencies” (the “Guidance”). • The Guidance invented a new term called “Virtual Currency” • The Ripple XRP Example: Settlement Agreement in 2015, fining Ripple for violating BSA requirements • “Acting as a money services business (MSB) and selling its virtual currency, known as XRP, without registering with FinCEN, and by failing to implement and maintain an adequate anti-money laundering (AML) program designed to protect its products from use by money launderers or terrorist financiers.” 33
  34. 34. V. Privacy Coins and Zero Knowledge Proofs • First proposed in 1985 by MIT researchers • A zero-knowledge protocol is a method by which one party (the prover) can prove to another party (the verifier) that they know a secret, without revealing any information apart from the fact that they know this secret. • Zero knowledge proof in blockchain • In regular blockchain transactions, when an asset is sent from one party to another, the details of that transaction (3 aspects) are visible to every other party in the network • A cryptocurrency transaction has 1) the sender’s address, 2)the receiver’s address, and 3)the amount being sent. • By contrast, in a zero knowledge transaction, the others only know that a valid transaction has taken place, but nothing about the sender, recipient, asset class and quantity. • The identity and amount being spent can remain hidden, and problems such as “front- running” can be avoided • Why and How zk-SNARK Works: Definitive Explanation • https://arxiv.org/pdf/1906.07221.pdf 34
  35. 35. Zcash, Monero, and Zero Knowledge Proofs • Zcash (ZEC) • Started in October 2016, the most prominent blockchain-based system using zero-knowledge proof • Considered the most bleeding edge cryptography available: special zero- knowledge proofs called zk-SNARKs. • Monero (XMR) • Started in 2014, based on the CryptoNote protocol • Monero’s PoW utilizes a hashing algorithm called CryptoNight • Other blockchain-based systems have incorporate zero-knowledge proofs into their solutions • Ethereum : implemented zk-SNARKS as part of the Byzantium upgrade 35
  36. 36. • US/Israeli Cryptographers • Israel is known as a nation having the best cryptography researchers and developers • Most of the top cryptography researchers are Israeli • Anonymous • Untraceable • Others • Zcoin – users mint new coins with no history • Dash – obscures transaction flow 36 Zcash, Monero, and Zero Knowledge Proofs
  37. 37. VI. Cryptocurrency Market Overview: Top Cryptocurrencies 37Source: CoinGEcko where they describe top 20 cryptocurrencies
  38. 38. Market Caps: Cryptocurrencies (Jun 2019) 38Source: Coin 360 where they describe top 10 cryptocurrencies market cap
  39. 39. Top Cryptocurrency Exchanges 39 Source: As of June 6, 2019; Currency in US$ 24 hour trading volume; coinmarketcap.com
  40. 40. Where is Bitcoin legal and illegal? 40 Source: https://coin.dance/poli where they describe Legality of bitcoin by country or territory
  41. 41. Cryptocurrency market: Recent Volatilities 41
  42. 42. VII. Future Authoritarian Government Crypto Currencies • Centrally controlled crypto to compete with bitcoin • Ecuador’s failed experiment with electronic money • The ‘Petro’, Venezuela’s attempt to circumvent US sanctions with an oil backed cryptocurrency • Russian and China crypto currencies being developed, also Sweden and Canada 42
  43. 43. Take-away 43 • Financial Crisis: A rise of bitcoin • Problems with Cryptocurrency: Bad actors • Legal Frameworks: KYC, AML, and BSA • Zero Knowledge Proof • Top 10 cryptocurrencies, exchanges, and market share • Future Authoritarian government crypto currencies?
  44. 44. Week 4: Smart Contracts • We will shift our focus to smart contracts • Smart contracts provide cheap verification, reduce costs and automate many routine transactions. • We will explain: • What is a smart contract? • How does it work? • Where can it be implemented in different business? 44
  45. 45. ROYSE LAW FIRM, PC For questions , Contact PALO ALTO 1717 Embarcadero Road Palo Alto, CA 94303 LOS ANGELES 11150 Santa Monica Blvd. Suite 1200 Los Angeles, CA 90025 SAN FRANCISCO 135 Main Street 12th Floor San Francisco, CA 94105 Palo Alto Office: 650-813-9700 CONTACT US www.rroyselaw.co m @RoyseLaw MENLO PARK 149 Commonwealth Drive, Suite 1001 Menlo Park, CA 94025 SANTA MONICA 520 Broadway Suite 200 Santa Monica, CA 90401 SAN FRANCISCO 135 Main Street 12th Floor San Francisco, CA 94105 Menlo Park Office: 650-813-9700 CONTACT US www.rroyselaw.com @RoyseLaw ORANGE COUNTY 135 S. State College Blvd Suite 200 Brea, CA 92821 rroyse@rroyselaw.com 45 Royse Law Blockchain Initiative

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