01_Decentralized Finance - Basics of Blockchain 2024 - updated.pdf

Decentralized Finance Basics of Blockchain Technology Dr. Stephan Romeike Munich, April 18, 2024 Agenda 1 Organizational Topics 2 Blockchain 1.0: Fundamentals 3 Blockchain 2.0: Smart Contracts 4 Use Cases in Finance Decentralized Finance | Basics of Bl...

Decentralized Finance Basics of Blockchain Technology Dr. Stephan Romeike Munich, April 18, 2024 Agenda 1 Organizational Topics 2 Blockchain 1.0: Fundamentals 3 Blockchain 2.0: Smart Contracts 4 Use Cases in Finance Decentralized Finance | Basics of Blockchain Technology | April 18, 2024 2 Agenda 1 Organizational Topics 2 Blockchain 1.0: Fundamentals 3 Blockchain 2.0: Smart Contracts 4 Use Cases in Finance Decentralized Finance | Basics of Blockchain Technology | April 18, 2024 3 The Beginning... Source: https://bitcoin.org/bitcoin.pdf Decentralized Finance | Basics of Blockchain Technology | April 18, 2024 4... of a New Era? History of the Web Web 1.0 Web 2.0 Web 3.0 Information Economy Platform Economy Token Economy Read Read Read Write Write Own Source: Adapted from Voshmgir (2019) Decentralized Finance | Basics of Blockchain Technology | April 18, 2024 5 Blockchain adoption takes off Source: Deutsche Bank, Imagine 2030 Decentralized Finance | Basics of Blockchain Technology | April 18, 2024 6 Blockchain paves way for a new economy Blockchain as an economy: the multiplier is changing! Metcalfe’s Law: The value of a network is proportional to the square of the number of Price connected users of the system (n2). The token economy is a shift from a people- based to a people- and device-based market potential: Traditional: Web 2 Web 3 Price x People = market potential Token economy: Price x (People + connected devices) = market potential User base (human + devices) The token economy offers new revenue models, smaller niches with very low prices and yet a large number of transactions. Decentralized Finance | Basics of Blockchain Technology | April 18, 2024 7 Plenary Discussion What do you know about blockchain technology? Decentralized Finance | Basics of Blockchain Technology | April 18, 2024 8 What is Blockchain? “A blockchain is a distributed, immutable ledger that facilitates the process of recording transactions and tracking assets in a network.” Decentralized Finance | Basics of Blockchain Technology | April 18, 2024 Source: academy.binance.com 9 Terminology Source: charteredaccountantsanz.com/futureinc Decentralized Finance | Basics of Blockchain Technology | April 18, 2024 10 Attributes of a Blockchain Central Decentral Distributed Immutability Source: Datarella Decentralized Finance | Basics of Blockchain Technology | April 18, 2024 11 Block & Chain Block #1 “Genesis Block #2 Block #3 Block” Data: „...“ Data: „I love TUM“ Data: „...“ Hash: 8aef0032c Hash: 39f20e22b Hash: 3476acb3f Prev. Hash: - Prev. Hash: 8aef0032c Prev. Hash: 39f20e22b Source: SuperDataScience Decentralized Finance | Basics of Blockchain Technology | April 18, 2024 12 Hashing SHA256 6ae47876fe977e1adc 2446c82f0f2f6a2a249 3292e63d5643f15276 58d716f9e Developed by U.S. National Security Agency (NSA) SHA = “Secure Hash Algorithm“ 256 = number of bits 64 characters long Hexadecimal string: 0, 1, 2, 3, 4, 5, 6, 7, 8, 9, a, b, c, d, e, f 2256 possible combinations Source: SuperDataScience Decentralized Finance | Basics of Blockchain Technology | April 18, 2024 13 Requirements of Hash Algorithms 1 One Way ✓ 0ae1896bb7ee2731fad...  „I love TUM“ 39f20e22b2e8e3254f3b... 2 Deterministic „I love TUM“ 39f20e22b2e8e3254f3b... „I love TUM“ 39f20e22b2e8e3254f3b... 3 Avalanche Effect „I 1ove TUM“ bd9995c811bd9e426ea... 0ae1896bb7... 4 Collusion Resistance ✓ Decentralized Finance | Basics of Blockchain Technology | April 18, 2024  Source: SuperDataScience 14 Immutability through Hashing Data Data Data Data Data Data Data Hash Hash Hash Hash  Hash  Hash  Hash Prev. Hash Prev. Hash Prev. Hash Prev. Hash Prev. Hash Prev. Hash Prev. Hash Source: SuperDataScience Decentralized Finance | Basics of Blockchain Technology | April 18, 2024 15 Immutability through Distribution & Transparency ✓ ✓  ✓ ✓ Source: SuperDataScience Decentralized Finance | Basics of Blockchain Technology | April 18, 2024 16 Consensus Options How do network participants reach consensus in absence of a central authority? Proof-of-Work (PoW) Proof-of-Stake (PoS) Others Miners perform hash Network Proof-of-Activity function calculations (pseudo)randomly Proof-of-Liquidity using trial and error selects an individual to Proof of Personhood (“Mining”) approve new transactions Proof-of-History Trial-and-error- Selection is based on the Proof-of-Authority approach is time- proportional share of Proof-of-Elapsed Time consuming and token ownership Proof-of-Burn required a lot of Reward vs. penalty: Practical Byzantine computer memory Deposited amount of Fault Tolerance Miners are rewarded money gets transferred if Proof-of-Identity for their work with invalid block is detected … tokens of the blockchain Examples: Ethereum, Example: Bitcoin Solana Decentralized Finance | Basics of Blockchain Technology | April 18, 2024 17 Excursus: Mining (PoW) Block All possible Hashes High Hashes Block #479 274ad5c4e1... 1 Nonce: 9328 500 16e99317ff... Not Data: Accepted 014adce4ef... Previous Hash: Target Hash: 16e99317ff... 014adce4ef... 000004ec96... Accepted 000004ec96... ✓ 0000000000... Low Hashes Source: SuperDataScience Decentralized Finance | Basics of Blockchain Technology | April 18, 2024 18 Architecture Options Source: https://blog.fingo.pl/when-should-i-use-blockchain/ Decentralized Finance | Basics of Blockchain Technology | April 18, 2024 19 Blockchain Trilemma Fast processing of high transaction volumes on-chain Scalability Blockchain Protecting data integrity on Trilemma Prevents control of the network the blockchain by a small number of participants Security Decentralization Decentralized Finance | Basics of Blockchain Technology | April 18, 2024 20 Blockchain Layers Layer Example Properties/application Layer 3 ▪ Application level with corresponding UI for the user ▪ Use L1s and L2s to execute smart contracts and store data dApplications immutably on the corresponding blockchains Layer 2 ▪ Building on the infrastructure of L1 blockchains ▪ Aiming to increase scalability and transactions per second Rollups ▪ L2s often have transaction costs of less than one cent ▪ Networks such as Bitcoin or Ethereum that process and confirm Layer 1 transactions on their own blockchain ▪ All subject to the blockchain trilemma Blockchains ▪ Relatively high transaction costs and transaction times Layer 0 ▪ Platforms, software development kits and basic architectures (e.g. communication) on which blockchains can be built Architecture ▪ Enable blockchains to interact with each other Decentralized Finance | Basics of Blockchain Technology | April 18, 2024 21 Transactions per Second → For comparison: Visa executes up to 24,000 TPS Source: https://chainspect.app/dashboard Decentralized Finance | Basics of Blockchain Technology | April 18, 2024 22 Blockchains become less energy intensive Source: https://blog.ethereum.org/2021/05/18/country-power-no-more/ Decentralized Finance | Basics of Blockchain Technology | April 18, 2024 23 Agenda 1 Organizational Topics 2 Blockchain 1.0: Fundamentals 3 Blockchain 2.0: Smart Contracts 4 Use Cases in Finance Decentralized Finance | Basics of Blockchain Technology | April 18, 2024 24 Smart Contracts Definition Simple Example Smart contracts are written code stored on the blockchain Code and conditions are publicly available on the ledger Event (e.g., date, transaction, price) in the contract triggers code execution „Smart contracts are neither > if money received == €3.00 > smart, nor contracts.“ && the button pressed is "Coke Zero"> then release Coke__Zero Decentralized Finance | Basics of Blockchain Technology | April 18, 2024 25 Legal Challenges Legal Contract “[A contract is a] voluntary, deliberate, and legally binding agreement between two or more competent parties.” businessdictionary.com vs. Smart Contract “A smart contract is a computerized transaction protocol that executes the terms of a contract.” Nick Szabo, 1994 Decentralized Finance | Basics of Blockchain Technology | April 18, 2024 26 Terminology Decentralized Finance | Basics of Blockchain Technology | April 18, 2024 27 Example: Minimum Viable Token Decentralized Finance | Basics of Blockchain Technology | April 18, 2024 Source: blockgeeks.com 28 Smart Contracts are the Basis for Token Economy Cryptos using own blockchain 9% 9706 Crypto Assets are currently trading, of which 879 are coins, i.e., they are native to their own blockchain, and 8827 are tokens, i.e., they are utilizing an existing blockchain. Cryptos using 91% existing blockchain Decentralized Finance | Basics of Blockchain Technology | April 18, 2024 Source: coinmarketcap.com 29