Money & Payments III – Blockchain & Smart Contracts

Nitin Yadav

Brain, Mind and Markets Lab

The University of Melbourne

Semester 2, 2019
Quiz 2

● 5 multiple choice questions

● 10 minutes to complete
● Worth 2% of your final mark
○ All multiple choice questions are weighted equally
● Please enter your name and student number correctly
○ Your marks will be recorded against your student number
● Please use your Unimelb student account to login to Google
● Complete on your own!

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Announcement for tutorials

● Please shutdown your jupyter notebooks when you are not using the system
○ Some students still have multiple week-1 notebooks running on their accounts
● In tutorial 2, please don’t request more than 10,000 Wei (in total)
○ You cannot exchange these coins for fiat currency!
○ Please don’t abuse the system
■ Try as much as you wish, but please return excess coins back to the Faucet
■ Otherwise, we will do it ourselves (Proof-of-Authority!)

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Today’s lecture

1. Smart contracts
a. Revisiting the idea of blockchain
b. Self-executing contracts
2. Applications
a. E-estonia
b. Trade finance
3. Assignments 1 & 2
4. Guest lecture

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1. Smart contracts

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Blockchain

● Last week we saw how a blockchain can be used to create

a public distributed ledger
○ The blockchain stored cryptocurrency transactions
● Blockchains not limited to storing payment transactions only
○ Cryptocurrency blockchains are only one specific use case of a blockchain
○ We can use blockchains to store (any) structured data
○ Where will this be beneficial? Think about the properties of blockchains:
■ Immutability of past blocks
■ Robustness {
● Stored on a network 'to': '0x479aA362A6c7522554A59C1d8903eFDBb23329c8',
'from': '0x46390b352Be56d796B005966b8EADaa58f220e7D',
■ No central authority 'value': 500,
● Multiple entities need access 'nonce': 12,
...}
■ Security
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Blockchain

(Let us revisit the blockchain slide from last week)

In this lecture we extend the definition of
transactions to include any structured data.
Common components of a public blockchain:

1. A peer-to-peer network that transmits and stores transactions

2. A set of rules defining what is a valid transaction
3. Secured blocks that provide a ledger of all past transactions
4. A consensus algorithm for decentralised control
5. A sound incentives scheme for maintenance and security
Q: But then how to validate a transaction?
A: Via pre-defined rules in (smart) contracts

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Blockchain

Why store data on a blockchain? Data in Hash of

traditional data Blockchain
storage
● What does blockchain provide: Any change in data will require a change in its hash in
○ Tamper-proof timestamped data the blockchain. Authorised updates in the data can be
recorded as new hashes in subsequent blocks.
○ Decentralised consensus
○ Transparency
● What about privacy?
○ Stored data can be encrypted so that only authorised users can access it
● What if data is large?
○ One does not have to store all the data on the blockchain
■ Storing only hashes can establish tamper-proof property (see figure)
● Is stored data always correct?
○ This may not be the case, one has to trust the external entity recording the data
○ This is a different issue from the tamper-proof property 8
Blockchain

Two important things to consider:

1. How to manage the custom data in a blockchain (i.e., inside the system)?
○ Rules for verifying currency transactions in Bitcoin and Ethereum are pre-specified
○ If one owns custom data, how can one define rules for valid transactions?
i. Smart contracts
2. Who provides and checks the correctness of the data (i.e., outside the system)?
○ There was no need for external verification in Bitcoin/Ethereum as there was minimal
interaction with the external world
i. New currency generated within the system
ii. Exchanges involving fiat currency or goods are outside the system
○ What if the custom data requires verification (e.g., trade records, vehicle details, etc)?
i. “Oracles”: You can ask external entity to verify data correctness

Note: Smart contracts provide a richer set of functionality that we will discuss next. 9
Smart contracts

● Technically, it is a program that may update blockchain data

● Automatic execution when conditions are met
○ Think of it as “digital promises”
● Rule based agreement between one or more parties
○ Transactions are executed only when the specified conditions are met
● They live on the blockchain!
○ Immutable
○ Decentralised with multiple copies
● Smart contracts allow for more powerful systems to be built on blockchains
○ We will see examples below

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Smart contract example from tutorial
If the conditions are met:
● Requested amount less than the limit
● Faucet still has funds
Faucet Then the Faucet promises to transfer the requested
amount of funds.
withdraw(uint amount)
:condition -> amount < limit

Request Ether
transaction
(signed)

Transfer Ether
transaction

User
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Smart contracts

● What kind of programs can one write with smart contracts?

○ Depends on the platform
○ Bitcoin
■ Transactions have a script language that can be used to define conditions on spending BTC
● Bitcoin scripting is not a complete programming language (e.g., loops are not allowed)
○ Ethereum
■ Has the concept of a “virtual machine”
■ Provides a complete programming language (loops are allowed)
■ How to prevent someone from triggering an infinite loop?
● Each transaction provides a limit on gas
○ Hyperledger Fabric
■ Backed by the Linux foundation and IBM
■ Does not have a cryptocurrency component

Note: List of platforms is not exhaustive. 12

Smart contracts (Ethereum)

How do they work?

● One writes a smart contract in a programming language (e.g., solidity)

○ One can define variables to store custom data along with rules to update them
● The contract owner deploys the smart contract on the system
○ Upon deployment the contract gets its own public address
● Users trigger contract’s functionality by sending transactions to its address
○ The contract will execute the required functionality on valid transactions
○ The contract can interact with other contracts
○ Execution of a functionality costs gas
○ Contract executions may update the contracts internal data
● A contract can be deleted
○ In this case, a gas refund is issued to the contract owner
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Smart contract example from tutorial
A transaction that updates the blockchain A “read-only” transaction

Faucet Car

0xe09639Bd8DEfd6A8868F84e6010DB9c6cC49Ac74 0xe09123da4….
withdraw(uint amount) getColor()
:condition -> amount < limit

Request Ether Request car

transaction color
(signed)

Transfer Ether
transaction Car’s color

Private Key: 3828a2f90c796…..

Public address: 0xdCB5920d8b7…. Public address: 0xdCB5920d8b7….
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Tokens

● Tokens are smart contracts

● One can define properties of tokens
○ Fungible vs non-fungible (see lecture 1)
○ Mintable
○ Transferrable
○ Burnable
● Different types of tokens (see lecture 2)
○ Utility tokens (see assignment 1 & 2)
■ Fungible tokens that are used to access a particular service
○ Asset tokens (e.g. the car tokens from tutorial 2)
■ Non-fungible tokens that are used to establish ownership of an asset
■ Asset could be a physical or virtual entity, equity, voting right, etc.
○ Currencies
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Trust in smart contracts

One has to trust the code (i.e., the programmer)

● Software may have bugs

● Reentrancy bug (Ethereum)
○ Reported in a DAO smart contract that had two lines of code in wrong order
■ DAO stands for “Decentralised Autonomous Organisation”
○ An attacker could repeatedly withdraw tokens (re-enter the line that executes the withdrawal)
■ An (anonymous) attacker did withdraw 3.6 M Ether out of a DAO
■ A community group called the “Robin Hood” group used the same strategy to secure the
remaining funds
● No implemented checks for unsupported tokens
○ A smart contract should either implement a refund function or reject transactions with
unsupported tokens
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2. Applications

Note: We do not endorse or promote any of the mentioned applications. Our purpose is to show potential use cases of the
technologies discussed in lecture 2.
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E-estonia

“I should have called the Estonians when we were setting up our health care website.”
- Barack Obama in 2014.

● Estonia
○ A northern European country with a population of around 1.3 M
○ Most digitally advanced society (according to “Wired”)
■ 98% of government interactions are online
■ https://www.wired.co.uk/article/digital-estonia
○ First country to hold elections over of the internet
○ First country to provide e-residency
■ Allows non-estonians to access Estonia’s digital services
● Start a company, access banks, lodge tax returns, etc.

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E-estonia
● Each citizen has a card that contains their private key
○ This establishes a secure digital identity (recall the cryptography slides from week 2)
○ Works across government and private systems
○ Digital signatures saved ~20 minutes per transaction (according to a World Bank report)
○ Used for:
■ Online banking
■ Taxation
■ Health records and drug prescriptions
■ Voting

Sources: http://documents.worldbank.org/curated/en/896971468194972881/pdf/102725-PUB-Replacement-PUBLIC.pdf 19
E-estonia

● X-Road
○ Internet based decentralised system to allow for information sharing
■ Participating entities retain ownership of data
○ Around 900 (as of 2013) participating entities, 70% government and 30% private
○ Around 67% (as of 2013) of queries were automated exchanges between systems
○ Backed by policy: Requesting information already stored via X-Road is prohibited

https://www.pwc.com/gx/en/services/legal/tech/assets/estonia-the-digital-republic-secured-by-blockchain.pdf 20
E-estonia
● Blockchain
○ First country to have a nation-wide blockchain system
○ Hashes are stored in the blockchain
■ Provides scalability and speed
■ Data resides on respective systems
○ Data breaches are detected instantly
○ Provides a consistent view of the data
■ E-health records case notes, doctor visits, test results, drug prescriptions and access log
■ Public safety
● Driving license information recorded against digital id
● Time to access information reduced from 15-20 minutes (using radio) to ~2s (using
blockchain)
■ Many others → https://e-estonia.com/solutions/

Sources: http://documents.worldbank.org/curated/en/896971468194972881/pdf/102725-PUB-Replacement-PUBLIC.pdf, 21
https://www.pwc.com/gx/en/services/legal/tech/assets/estonia-the-digital-republic-secured-by-blockchain.pdf
Trade finance
● Incorporates use of financial products to facilitate international trade
● WTO estimates that around 80 to 90% of world trade depends on trade
finance
● Suppose an Australian importer wants to import an exotic fruit from an
exporter in San Marcos
○ The importer does not trust the exporter, hence, does not want to pre-pay
○ The exporter will not ship the fruit unless she is guaranteed payment
○ The shipping involves multiple ports
● Solution
○ The importer can get a letter of credit from its bank
■ Guarantees release of payment conditional on
shipment
○ The exporter provides bills of lading as proof of
shipment Australian Imports. Source: https://oec.world/en/profile/country/aus/
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Source: https://www.wto.org/english/thewto_e/coher_e/tr_finance_e.htm
Trade finance

● Traditional methods are tedious, inefficient, and susceptible to fraud

○ Documents are generally checked manually
○ Information is scattered across different systems
○ No central authority In practice: https://we-trade.com/

● Blockchain-based solution
○ Generation of letters of credit
■ Time can be reduced from 7 to 10 days to under 4 hours!
○ Automatic verification of shipping information
■ Tracking of goods recorded on blockchain
○ Automatic release of payments
■ Using smart contracts
○ Possible drawback is that all components need to be on blockchain
○ Major Australian banks are trialing blockchain-based solutions

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Source: https://cib.db.com/insights-and-initiatives/flow/trade_finance_and_the_blockchain_three_essential_case_studies.htm
3. Assignments 1 & 2

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Assignments 1 & 2
● A second-hand car market on blockchain
○ Underlying problem is information asymmetry
■ Buyer does not know the quality of the car but seller knows if her car is “good” or “bad”
■ Buyer knows the overall proportion of good and bad cars in the economy
○ How can a blockchain help?
■ Stores vehicle’s attributes on blockchain
■ Reduces (aggregate) information asymmetry
■ Allows for smart contracts (conditional offer price)
○ Buyers have incentives to trade in the “blockchain market”
■ Need a BMM Coin (token) to place an offer in the blockchain market
● Why not buy in a traditional market?
○ Think about information asymmetries!

Assignment 1: In a ICO of BMM Coins, how much should a buyer be willing to pay to get access to the
blockchain market? More details in next week’s tutorial...
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4. Guest lecture

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Volt Bank

● Digital-only bank with full banking

license (granted earlier this year)
○ It is the first new bank to get a full
banking license in Australia since early
2000s

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Dominic Ng

● Senior business and service designer and strategy

implementation specialist at Volt Bank
● He uses his understanding of how organisations work
to help design and transform the way they operate to
better serve their clients, across their organisational
lifecycle from start-up, through growth, and into
maturity
● Dominic is also a fervent champion of human–centred
design, and the way it helps us innovate to transform
the way we interact, learn and conduct business

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Next week

● Lecture
○ Quiz 3
○ Financial advice
● Tutorials
○ Preparing for the assignment
● Mandatory readings:
○ “IBM's Blockchain Consortium With The Seam Deploys 'Hyperledger' For Cotton Trading” by
Roger Aitken on Forbes.com
https://www.forbes.com/sites/rogeraitken/2017/01/07/ibms-blockchain-consortium-with-the-seam-deploys-hyperledge
r-for-cotton-trading/#481e77797e8a
○ “Trade finance and the blockchain -e fin three essential case studies” by Deutsche Bank
https://cib.db.com/insights-and-initiatives/flow/trade_finance_and_the_blockchain_three_essential_case_studies.htm

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