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Week 4 - DApps, Smart Contracts, and Decentralized Incentive Systems

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Week 4 - DApps, Smart Contracts, and Decentralized Incentive Systems

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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: 4 (of 7)

This class will shift will focus on the promise of smart contracts to provide cheap verification, reduce costs and automate many routine transactions. We will explain what a smart contract is (and what it is not), how it works and discuss where it can be implemented to the current economy. We will discuss the use of distributed applications built on the block chain and examine how Ethereum allows dApps to run. We will also look in depth at several dApps including Cryptokitties, Augur and Local Ethereum.

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

Week: 4 (of 7)

This class will shift will focus on the promise of smart contracts to provide cheap verification, reduce costs and automate many routine transactions. We will explain what a smart contract is (and what it is not), how it works and discuss where it can be implemented to the current economy. We will discuss the use of distributed applications built on the block chain and examine how Ethereum allows dApps to run. We will also look in depth at several dApps including Cryptokitties, Augur and Local Ethereum.

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Week 4 - DApps, Smart Contracts, and Decentralized Incentive Systems

  1. 1. Week 4. DApps, Smart Contracts, and Decentralized Incentive Systems Roger Royse rroyse@rroyselaw.com www.rroyselaw.com Research Assistant: Justin Sher Stanford Continuing Studies FALL 2018 BUS 35 The Business Basics of Blockchain, Crypto Currencies, and Tokens Week 4 July 15, 2019 Stanford Continuing Studies BUS 35: Business Basics of Blockchain, Crypto Currencies, and Tokens 1
  2. 2. Recap Week 3: Cryptocurrencies Stanford Continuing Studies BUS 35: Business Basics of Blockchain, Crypto Currencies, and Tokens 2 • 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
  3. 3. Early Alternative Applications • Eric Voorhees and Satoshi Dice • https://www.forbes.com/sites/michaeldelcastillo/2019/01/03/bitcoins-last-gunslinger/#200e89c240bb • Altcoin: After Bitcoin • Namecoin: Bitcoin fork for DNS • Colored coin: transform real assets into digital e.g. gold, equity • Mastercoin and the rise of the ICO • https://www.forbes.com/sites/laurashin/2017/09/21/heres-the-man-who-created-icos-and-this-is-the-new-token-hes- backing/#57919ba41183 • Many platforms tried and failed at being the Blockchain 2.0 platform • https://bitcointalk.org/index.php?topic=1153740.0 • Jed McCaleb: Ripple, Stellar • https://www.coindesk.com/coindesk-most-influential-blockchain-2018-jed-mccaleb • Mike Hearn and Smart Property • https://en.bitcoin.it/wiki/Smart_Property • Vitalik Buterin and Ethereum: Miami conference in 2014 • https://www.youtube.com/watch?v=l9dpjN3Mwps
  4. 4. Lack of Turing Completeness • Bitcoin is not “turing complete” • Turing complete: a program language is generally enough to emulate all others and equivalent in terms of computations • You can’t tell whether a program will halt or forever without running the code to check for yourself • Ethereum is turing complete Stanford Continuing Studies BUS 35: Business Basics of Blockchain, Crypto Currencies, and Tokens 4
  5. 5. What are smart contracts? • A smart contract is a program that, for a fee paid in the blockchain’s cryptocurrency, can be placed by anyone permanently on the blockchain. • Each smart contract is executed by every node in the network and has its data stored on every node in the network. • Anyone with the blockchain’s cryptocurrency may interact with the smart contract subject to its rules. • Smart contracts can transfer the blockchain’s cryptocurrency, store and retrieve data, and call other smart contracts based on the programs rules.
  6. 6. What are the limitations of Ethereum smart contracts? • Every data storage or computation operation in a smart contract costs cryptocurrency. Costs are astronomical compared to non-crypto computation processing and storage. No operations are free. • All data in the Ethereum blockchain is public. The Ethereum team has acknowledged that there is no practical way to hide information contained in a smart contract. • Because all data on the Ethereum blockchain is public, any secure credentials must be maintained in another system. This leads to a weak notion of identity inside of Ethereum. • Ethereum is relatively slow in its processing. Peak transaction volumes globally for the system as a whole max out at about 15 per second as opposed to 45,000 a second processed by Visa.
  7. 7. What can you do with Ethereum Smart Contracts? • Start your own cryptocurrency. • Easy to do. Thousands have been created. • Sell digital assets that may be traded anonymously. • Cryptokitties – Unique virtual kittens that breed with each other to produce new virtual kittens. Cryptokitties can be transferred and thus bought and sold. • Start a anonymous decentralized crypto exchange. • Local Ethereum – Meet people and trade Etherum with them in person for cash. • Start a decentralized prediction market • Augur – Bet with people around the world about the outcome to various questions.
  8. 8. So what makes Ethereum a good fit for your application? • Your application prefers participants to be anonymous. • You want to make all your money in cryptocurrency. • You have very small amounts of data to store. • Your program logic is simple. • You trust no one you’re dealing with. • You are fine with your application data and smart contract code being public. • You don’t need to process more than 15 transactions per second. • If any of these limitations are a dealbreaker, you probably want to consider using a private blockchain instead.
  9. 9. ERC-20 Tokens: DIY Cryptocurrency • https://en.wikipedia.org/wiki/ERC-20 • ERC-20 Tokens are a Smart Contract Program with 5 operations • What is the total supply of tokens? • How many tokens does an account own? • Distribute tokens from the creator’s account to another account. • Over $3 million dollars lost from mistakenly sending tokens to smart contracts instead of wallets! (https://www.investinblockchain.com/what-are-ethereum-tokens/) • Transfer tokens from one account to another. • Allow a spender to withdraw from your account as many times as needed up to a specified value limit. • Check the spender’s remaining balance. • Who creates the money? You do! Just specify a total number of tokens in the smart contract and send it to the blockchain. Given them out to anyone till they’re all gone. In order to create the contract and give out the tokens you’ll have to pay some Ethereum cryptocurrency. • You can make your own cryptocurrency in under a half an hour. • https://medium.com/bitfwd/how-to-issue-your-own-token-on-ethereum-in-less-than-20-minutes- ac1f8f022793 • Get it right the first time because you will never be able to change it.
  10. 10. Traditional SAAS Business Architecture SAAS Company Administrators Cloud Database Web Application Developers Deploy Code Administrative Actions Payment System Bank API Secure Wire Service ACH/FedWire Customers
  11. 11. Traditional SAAS Business + Crypto Payments Architecture SAAS Company Administrators Cloud Database Web Application Developers Deploy Code Administrative Actions Customers Any Blockchain SAAS Crypto Account Customer Crypto Account
  12. 12. Basic Attention Token: SAAS + Native App That Makes Crypto Payments with ERC-20 tokens • https://basicattentiontoken.org/BasicAttentionTokenWhitePaper-4.pdf • Advertisers pay for targeted ads with BAT ERC-20 Token. • Publishers show ads. • Users browse web sites with Brave browser. • The user’s browser automatically reports anonymized ad viewing statistics to Brave’s servers and are paid ERC-20 tokens. • Tokens are shared with publishers after visits to publisher’s site. • Brave does not endorse trading of ERC-20 tokens for regulatory reasons, but they are sold on many exchanges anyway. No smart contracts are used.
  13. 13. Ethereum Blockchain Smart Contracts Company Crypto Account Customer Crypto Account Crytpo Fees for each call Distributed Blockchain dApp Architecture Company Administrators Developers Deploy Code (Rarely and Carefully!) Administrative Actions Customers
  14. 14. ERC-20 Example: Gemini Dollar Stablecoin • https://gemini.com/wp-content/themes/gemini/assets/img/dollar/gemini- dollar-whitepaper.pdf • Aims to mirror fiat currency 1 to 1. • Backed by audited reserves which mirror the supply of tokens. • Token supply will be decreased or increased as reserves are redeemed or deposited. • Contract is updateable to • Resolve vulnerabilities • Extend the system • Improve the system • Pause, block or reverse token transfers in response to security incident or if legally obligated or compelled to do so by a court of law or other government body.
  15. 15. Gemini Dollar Stablecoin Architecture Impl contract can be switched out for updates of how the contract functions. Certain high risk operations, like transferring large amounts of tokens or issuing new tokens, must consult a custodian contract which requires approval from a user with access to offline cryptographic keys.
  16. 16. ERC-223 Tokens: Bug fix for ERC-20 Token • Mainly fixes issues in ERC-20 • Allows for transfer of tokens to smart contracts instead of causing their permanent loss. • Uses less Ethereum to transfer tokens. • Backwards compatible. • Limited adoption due to wallets not supporting it yet.
  17. 17. Cryptokitties are examples of ERC-721 tokens. Each one is unique. They are even viewable inside of Ethereum blockchain debugging tools. ERC-721 tokens can be used to represent the ownership of other unique assets like rare works of art or antiques. https://etherscan.io/token/0x06012c8cf97bead5deae237070f9587f8e7a266d?a=1611461#inventory ERC-721 Tokens: Non-fungible assets
  18. 18. ERC-721 Tokens: New Business Models • Cryptokitties • Sell 50,000 cats for Ethereum. 1 every 15 minutes in a descending clock auction. • Sellers choose high opening bid, a minimum closing bid, and a timeframe for which they’d like their auction to run. • First buyer wins • Auctions are done this way because otherwise buyers would have to pay Ethereum transaction costs for every bid. • Let users breed cats • There is a similar process for breeding cats. Owners who want to breed and sire new cats place their maximum and minimum closing bid and timeframe. • Receive 3.75% of each trade of a cat. • All this is processed automatically on the Ethereum block chain. The developers don’t have to do anything except promote the collectibles and make art depicting them.
  19. 19. ERC-721: Digital Collectible Benefits • No central issuing authority • There is no way for the issuer to make more of a popular collectible. • No provider dependency • Unlike other digital collectibles, the existence of the collectible is not dependent on the existence of the provider • Functional • Smart contracts can have unique functions unavailable in most collectibles. For example, Cryptokitties can reproduce and make completely new Cryptokitties.
  20. 20. Cryptokitties Fans and Skeptics • Blockchain has unlocked the magic of digital scarcity, and combining that with the power of making the digital goods persistent gives them a potential value that is only limited by how much prestige a wealthy person might place on ownership of the item. • -- Justin Poirier • Nobody wants to pay $300 for a hexadecimal string. That's LITERALLY all you’re buying. All the website does is display a picture of a cat. You're paying hundreds of dollars for a picture of a cat. Let that sink in. • This was a modern tulip bubble. You were buying hex strings that tied to the picture of a cat. People were paying 10-20-30 ETH for a cat picture. 10 ETH was around $4000? For a cat picture. Yeah... • -- CryptoKitties • “By now everyone has heard of CryptoKitties, a cute game that went viral to the point of overloading the whole Ethereum network. This is the inside story behind how we made $107K investing in CryptoKitties and briefly set the record for the largest sale ever (currently second-largest). Later, we made ~$8K running an automated arbitrage bot. While playing the speculation game at the height of the mania was exciting, the bot was fairly technically involved and will be interesting to people who want to learn blockchain engineering in general.” • https://hackernoon.com/how-we-made-100k-trading-cryptokitties-2d69aebe715b • https://kittysales.herokuapp.com/ • Total Sales: 577,446 • Total Unique Kittens Sold: 465,071 • Total USD Sold: $27,458,376.84 Average Sale Price: $47.55 Median Sale Price: $12.26
  21. 21. Augur – a decentralized prediction market • https://github.com/AugurProject/whitepaper/blob/master/english/whitepaper.pdf • Allows anyone to bet on a future outcome. • Different outcomes are matched with each other so that losers pay winners. • Outcome reporters and successful disputers are also compensated for their service. • There are bonds posted to provide for penalties in the case of a default by any party and automatic contingency procedures to provide for smooth operation of the market in case of any party defaulting. • Robustly designed outcome reporting and dispute resolution • The outcome is reported by a designated reporter but can be disputed by those posting a bond in REP, the reputation currency of Augur. If they successfully overturn the result, they make a fixed 50% return. • Any reported results that are overturned result in the loss of all REP staked by any person staking their REP to the overturned result. • If 2.5% or greater of the REP currency is involved in a outcome dispute, a condition known as a “Fork” is created and users may choose a side and be compensated for joining the winning side. Those who choose the losing side will lose all their REP. • Is it legal? Isn’t this essentially gambling? • https://www.technologyreview.com/s/611757/this-new-ethereum-based-assassination-market-platform-could-cause- napster-size-legal/
  22. 22. Augur Example: Sports Betting • https://cloudflare-ipfs.com/ipfs/QmZ6kwTnc3G6mx5Jxuu8fRZZvrzwhq3yPXndnmwxqkQyrj/?ethereum_node_http=https%3a%2f%2feth- mainnet.alchemyapi.io%2fjsonrpc%2f7sE1TzCIRIQA3NJPD5wg7YRiVjhxuWAE&augur_node=wss%3a%2f%2faugur-node.augur.casino#!/market?id=0x2a3d2ec16158c99ccfe55f9440d723387afc9ddb
  23. 23. Augur Architecture • Pre-Reporting • Question registered on blockchain and bond posted by registrant to ensure question validity and that the designated reporter will post an outcome promptly after the prediction deadline. The bids of those supporting different question outcomes are matched to each other so the winner will take the loser’s bid. • Designated Reporting • After the prediction deadline passes the designated reporter has 3 days to post the outcome. The reporter must stake his REP cryptocurrency to an outcome and will lose it all if the prediction is overturned. • Open Reporting • If the designated reporter fails to show, the first person to post an outcome receives the no-show bond. • Waiting for Next Fee Window to Begin • The market is on hold until the fee window begins. This is usually every seven days • Dispute Round • If a dispute bond is posted, the funds are held in escrow and a chance for someone else to post a bigger dispute bond ensues. If the bond reaches 2.5% of all REP then a Fork ensues. If not then the disputer wins the crypto of the person he disputed. • Fork • All trading is shut down and all users can optionally stake to an answer. The answer with the most staked REP wins and those who staked to the other answer lose all their REP. Users cannot reverse their stake once committed. • Finalized • The answer is finalized and rewards are paid out to winning bidders.
  24. 24. Hybrid SAAS/Blockchain Business SAAS Company Administrators Cloud Database Web Application Developers Deploy Code Administrative Actions Customers Ethereum Blockchain Smart Contracts Company Crypto Account Customer Crypto Account Crytpo Fees for each call
  25. 25. Local Ethereum: Hybrid Decentralized Cash to Crypto • https://whitepaper.localethereum.com/ • Lets people buy and sell crypto online or offline. • Users of the system never give up their private keys to Local Ethereum or transfer Ethereum to Local Ethereum • Escrow of funds occurs on the blockchain. The company never gets custody of the cryptocurrency. • In case of a dispute, either buyer or seller ask Local Ethereum to arbitrate their dispute. Local Ethereum can only release it to the buyer or seller and can’t transfer it to itself. • Hybrid Architecture • Deals are arranged on a centralized server. • Encryption keys are maintained on users browsers. • Because users are completely identified by their cryptographic ids, there is no way to recover passwords or recover from account takeovers.
  26. 26. Alternative Public Smart Contract Blockchains • Ethereum’s transaction throughput and transaction fees are its main weakness. • EOS • High scalability: 4,000 transactions per second, delegated proof of stake consensus • Highly centralized: Only 21 Main Nodes, Low Transaction Fees • Regularly freezes accounts: https://www.coindesk.com/eos-blockchain-arbitrator- orders-freeze-of-27-accounts • Tron • High Scalability: 2,000 transactions per second, delegated proof of stake, lower transaction fees. Compatible with Ethereum smart contracts. • Aims to be decentralized but there are allegations of high centralization. • https://cointelegraph.com/news/tron-co-founder-and-cto-leaves-project-alleging- excessive-centralization Stanford Continuing Studies BUS 35: Business Basics of Blockchain, Crypto Currencies, and Tokens 26
  27. 27. Looking at alternative public blockchains • Evaluate the requirements of your application in light of the capabilities of the blockchain (e.g., high transaction throughput, irreversibility of transactions) • Evaluate the governance model of the blockchain • Evaluate the community’s confidence in the blockchain’s cryptocurrency • Evaluate the fee structure of the blockchain • Evaluate the maturity of the blockchain’s development ecosystem. Stanford Continuing Studies BUS 35: Business Basics of Blockchain, Crypto Currencies, and Tokens 27
  28. 28. Key Points • Technology review: limitation of bitcoin • Four Types of dApps (Though there are more) • Stable Coins • Escrow Exchanges • Collectibles • Prediction Markets • Ad Exchanges • Three architectures • Crypto Payments Only • Fully distributed • Hybrid • Biggest differences between blockchain and traditional apps • Smart contracts are very simple due to the high cost of computation and storage. • Smart contracts use largely anonymous identities. • Little server infrastructure to maintain for a fully decentralized apps • Development is tricky because bugs can cause huge loses and are difficult to fix. • Alternative public blockchains
  29. 29. Week 5. Blockchain Economics: Strategic Value in Private Blockchain • Questions to be addressed • How blockchain technology will shape innovation in different industries • How can companies determine if there is strategic value in blockchain? • How can we evaluate blockchain’s value in short-term and long-term perspective? • How do companies take a structured approach in developing blockchain strategies. Stanford Continuing Studies BUS 35: Business Basics of Blockchain, Crypto Currencies, and Tokens 29
  30. 30. 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 Research Assistant: Natalie Ryang nryang@rroyselaw.com Stanford Continuing Studies BUS 35: Business Basics of Blockchain, Crypto Currencies, and Tokens 30

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