1 40274656.1 Demystifying Blockchain for Life Insurance Alexander F. L. Sand, Eversheds Sutherland May 7, 2018 I. Agenda A. What is a Distributed Ledger? B. Building the Chain C. Powering Transactions D. Building Consensus E. Promises of Blockchain F. Risks of Blockchain G. Questions II. Bitcoin Basics A. Some Basics on Bitcoin 1. Where do you get Bitcoin? – There are companies that specialize in buying and selling bitcoin. They operate exchanges that offer exchange rates between USD/BTC and other digital currencies, similar to exchanging money at an airport. 2. What gives Bitcoin value? – Like many investments, Bitcoin’s value derives from people’s willingness to accept it as having value. The fact that there are liquid markets that are constantly willing to exchange money for Bitcoin means it has value. What gives gold value? 3. Where do you keep Bitcoin? – Bitcoin only exists as a balance on a shared ledger, so you can’t really hold Bitcoin in your hand like you can a dollar. What you can hold is the code that proves you own the balance of bitcoin associated with an address. Software and services that help you store this code and make it easy for you to transfer Bitcoin are called a bitcoin “wallet.”
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1 40274656.1
Demystifying Blockchain for Life Insurance
Alexander F. L. Sand, Eversheds Sutherland
May 7, 2018
I. Agenda
A. What is a Distributed Ledger?
B. Building the Chain
C. Powering Transactions
D. Building Consensus
E. Promises of Blockchain
F. Risks of Blockchain
G. Questions
II. Bitcoin Basics
A. Some Basics on Bitcoin
1. Where do you get Bitcoin? – There are companies that specialize in
buying and selling bitcoin. They operate exchanges that offer
exchange rates between USD/BTC and other digital currencies,
similar to exchanging money at an airport.
2. What gives Bitcoin value? – Like many investments, Bitcoin’s value
derives from people’s willingness to accept it as having value. The
fact that there are liquid markets that are constantly willing to
exchange money for Bitcoin means it has value. What gives gold
value?
3. Where do you keep Bitcoin? – Bitcoin only exists as a balance on a
shared ledger, so you can’t really hold Bitcoin in your hand like you
can a dollar. What you can hold is the code that proves you own the
balance of bitcoin associated with an address. Software and services
that help you store this code and make it easy for you to transfer
Bitcoin are called a bitcoin “wallet.”
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B. Bitcoin and Criminality
1. Bitcoin did prove popular on “dark markets” in its early days.
2. It enables users to provide instant payment anywhere in the world.
i. As it would be to any internet business, this is useful if for
selling illegal things on the internet, and has the added benefit
of not having to deal with banks.
3. It was often billed as being “anonymous” and so buyers and sellers
thought it would be safer to use Bitcoin than another form of
payment.
4. Turns out Bitcoin isn’t nearly as anonymous as people thought.
5. Law enforcement has been able to shut down multiple dark markets
and arrest their operators across jurisdictions.
6. In the most famous case, Ross Ulbricht, who had run the “silk road”
dark market, was arrested by the FBI in San Francisco. He received a
life sentence.
7. Cash will always be king for crime.
III. Bitcoin vs. Blockchain
A. What’s the difference?
1. Bitcoin
i. The first “cryptocurrency”
ii. A distributed electronic payment system that does not rely on
central banks or other counterparties
iii. Enables global peer to peer payment with no single central
depository or processor
iv. Powered by the first ever blockchain
2. Blockchain
i. The technology underlying bitcoin and many other projects
ii. A new system to arrange, process, store and share information
electronically
iii. Leverages existing and widely used cryptography
iv. Just one kind of “distributed ledger technology”
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IV. Blockchain
A. Capabilities
1. Blockchain is a digital ledger system for recording business
transactions and events.
i. Near immediate settlement – Enables the near immediate
settlement of recorded transactions, reduces risk and limits the
ability to cancel transactions.
ii. No intermediary – There is no need for a trusted third party.
because the technology is based on cryptographic proof.
iii. Distributed ledger – The distributed ledger is maintained
through the list of blocks providing a secure source of proof
that the transaction occurred.
iv. Resistant to manipulation – The distributed network and
distributed ledger mitigates the risk of double-spending, fraud,
abuse and manipulation of transactions.
There is nothing magical about the blockchain. It is a database or ledger.
B. Why are people excited about ledgers?
1. Ledgers are where ownership lives.
i. We don’t actually possess most things we own.
ii. United States total money supply is roughly $75 trillion.
(a) Only 6% ($4.5 trillion) is currency in circulation
(b) 94% ($70.5 trillion) is sitting on ledgers
iii. What else is on ledgers?
(a) Money
(b) Identity
(c) Voting
(d) Education and certification
(e) Land and buildings
(f) Intellectual property
C. A Distributed Ledger
1. What is a distributed ledger?
i. An asset database shared across a network on multiple sites or
geographies.
ii. All participants can have access to the ledger via a copy or
connection to other databases.
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iii. Any changes made on any one of the ledgers will be reflected
on all ledgers.
iv. It’s a technological means of keeping accurate, up-to-date
records in multiple locations.
D. Types of Networks
Centralized Decentralized Distributed
• One authority/failure • Several authorities • No central authorities
• Easy to maintain • More stable • Quicker evolution
• Can be unstable • Medium scalability • Infinite scalability
• Slow scalability/evolution • Quicker evolution • Difficult to maintain
• Most resilient
E. A Peer-to-Peer Distributed Network
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F. A Function of the Network
1. Validation
i. Anything that happens on a blockchain is a function of the
entire distributed network as a whole.
ii. Each node has a copy of the blockchain (all logged
transactions), and every copy must be consistent with all other
copies; otherwise the transaction will not be incorporated into
the blockchain.
G. What is it really?
1. Some ways to think about Blockchain?
i. The great chain of being sure about things
ii. Single source of truth with many copies
iii. A tool for organizing, tracking, and using large sets of ever-
changing data
H. What is a block?
1. If a blockchain is a ledger then a block is a page of that ledger.
2. A block contains:
i. A record of some or all recent transactions broadcast to the
network but not yet confirmed (at least one transaction, but
may contain thousands)
ii. A unique identifier (the “hash”) for the current block
iii. A reference to the unique identify (the hash) from the previous
block of transactions in the chain
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3. The ledger is kept through the long list of blocks, known as the
blockchain.
I. Building the Chain – If anyone can write a page in the ledger, how do we
make sure they all work together?
1. Hashes
i. When a block is created, the transactions listed in the block
are processed through a mathematical formula to transform the
information into a hash.
ii. The answer is hard to guess but easy to verify.
iii. Hashes can be used to verify that the information has not been
changed in any way.
iv. If a single character is changed in the block, it will completely
change the hash.
J. Hashing – A Cryptographic Fingerprint
1. A one-way function that is not reversible.
2. Each transaction has a unique fingerprint that cannot be changed.
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3. The hash of each block will be used in the next block. This is what
makes it a chain. If data is changed, all the hashes will fail. This
makes the ledger immutable.
4. Hashes
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K. Powering Transactions – If anyone can submit a transaction, how do we
know the person submitting the transaction has authority to initiate the
transaction?
1. Public-key cryptography powers transactions.
i. Blockchain relies on public-key cryptography: it is built on
pairs of public and private keys.
ii. Every account on the ledger has an “address” (public key or
account number).
iii. Only the owner of the account gets the corresponding private
key.
iv. The public and private keys are mathematically linked.
v. It is computationally easy to derive a public key from the
private key, but hard to derive a private key from the public
key.
vi. The public key is used as an account number that holds assets.
vii. The private key is used to prove ownership of the assets
associated with the public key.
viii. The owner of the account mathematically signs a transaction
with the private key to authorize the transaction in the account.
ix. The private key never needs to be shared or shown to anyone
else.
x. Everyone else on the chain can mathematically prove that
whoever authorized the transaction had the private key, and
therefore it is a valid transaction.
xi. Whoever holds the private key owns the account (like a bearer
bond).
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2. Remember this?
Let’s zoom in on a transaction…
3. Asymmetric Keys – Public and Private Keys
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4. Pseudonymous Transactions
i. Sending and receiving an asset is similar to writing under a
pseudonym.
ii. On blockchain, the owner of an asset is identified by their
address.
iii. If your address is linked to you, then every transaction
involving your address will also be linked to you.
iv. Your address is a version of your public key.
L. Building Consensus – If anyone can submit a new page to the ledger at
any time, how do all the parties agree which pages are valid?
1. Why consensus?
i. In a centralized network, no need for consensus; it is done by
the central authority.
ii. In a distributed or decentralized network, how do you agree on
what is true?
iii. Goal: The aim of the consensus approach is to secure the
network, predominantly through economic means: it should be
too expensive to attack the network, and more profitable to
help protect it.
2. Byzantine Fault Tolerance
i. Byzantine Fault Tolerance (BFT) is the ability to tolerate
byzantine failures in a system which is a crucial part of
blockchains’ ability to maintain reliable records of
transactions in a transparent, tamper-proof way.
ii. BFT is a solution to the Byzantine Generals’ Problem, a
logical dilemma that researchers Leslie Lamport, Robert
Shostak and Marshall Pease described in a paper in 1982.
M. Byzantine Generals’ Problem
1. The Problem
i. Each division of the Byzantine army is commanded by its own
general, and the general communicate with each other via
messenger. Some of the generals are traitors who can attempt
to sabotage the army’s strategy by submitting bad messages to
the network of generals.
2. Solution Requirements
i. All loyal generals decide on the same plan of action.
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ii. A small number of traitors cannot cause the loyal generals to
adopt a bad plan.
iii. The loyal generals will all do what the plan (algorithm) says
they should do, but the traitors may do anything they wish.
iv. The plan (algorithm) must guarantee that the plan executes
successfully even with a small number of traitors trying to
subvert the plan.
v. The traitors cannot convince the rest of the group to adopt a
bad plan.
N. Byzantine Fault Tolerance and Blockchain
1. BFT is essential on a blockchain.
i. Most traditional distributed computing environments have
central configuration databases or authorities that can fix
things in the event of a Byzantine failure.
ii. On a blockchain, because there is no central authority,
transactions are confirmed based on community consensus
alone, which is what makes it so powerful.
iii. Most blockchain technology, including Bitcoin, has relied on a
concept called proof of work (PoW).
iv. Under this model, anyone who wants to add to the blockchain
must perform a work-intensive task using information from
the existing blockchain in order to add new information.
v. In the case of Bitcoin, PoW is produced using a hashing
algorithm that, by its nature, takes a fair amount of time to
execute.
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O. BFT vs. Bitcoin
P. Consensus in Bitcoin
1. Proof of Work
i. In a PoW system, data can’t be added to the blockchain
without a significant time investment on the part of the party
adding the data.
ii. This provides a practical protection against manipulation of
the blockchain because, in order to undermine group
consensus, a malicious party would need to invest a great deal
of time producing sufficient PoW to exert a meaningful
influence on the blockchain.
iii. On a blockchain that is sufficiently large, the PoW
requirement effectively provides BFT.
iv. This approach also has a limitation. It requires the expenditure
of a large amount of computational effort for no purpose other
than fault tolerance.
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Q. Mining for Bitcoins
1. Computers compete to find a hash with specific properties.
2. The computer that finds the answer first—the proof that it has done
the necessary work—is allowed to add a new block of transactions to
the blockchain.
3. It is rewarded with a tranche of newly minted bitcoins (currently 12.5
BTC per block, or roughly every 10 minutes), plus all of the small
transaction fees users have paid to send coins.
4. In addition to building consensus, this also serves to incentivize
participation, which makes the blockchain bigger, and which makes
the blockchain more secure.
R. Building Consensus
1. Consensus Concepts
i. Proof of Work
ii. Proof of Stake
iii. Leased Proof of Stake
iv. Delegated Proof of Stake
v. Proof of Importance
S. Recap of What Makes It Work
1. Key Elements of Blockchain
i. Many participants always agree on what a single version of
what is valid and true (distributed peer to peer network).
ii. Every transaction is securely and permanently linked together
(a chain of hashes).
iii. All participants can verify transactions, but only authorized
parties can initiate transactions (powered by public key
cryptography).
iv. The ledger is trustworthy, even if a few bad actors are actively
trying to deceive it (fault tolerant consensus).
V. Promises of Blockchain
A. Potential Benefits of Blockchain
1. Reduce choke-points – Ability to verify and process transactions
without third-party involvement.
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2. Data reconciliation – The information is transparent and the data is
complete, accurate and consistent across all locations and databases.
3. Data Access – Data from many sources can be instantly available
across the network.
4. Automated transactions – Transaction processing can be nearly
instantaneous and can leverage automation.
5. Cost reduction – Costs associated with third-party intermediaries,
governance and audits can be greatly reduced.
B. A Tool for Business
1. Public vs. Private
i. Public blockchain – Anyone can join and see transaction
records.
ii. Private blockchain – Only those who are authorized may join
or see certain information.
(a) In many cases, businesses will set up a private
blockchain for increased privacy and security.
VI. Many Different Flavors
A. There are many different blockchain and distributed ledger products.
1. Cryptocurrencies
i. Bitcoin
ii. Litecoin
iii. Monero
2. Something else
i. Ethereum (Ether)
ii. Ripple (XRP)
iii. Hyperledger
iv. Corda
VII. Promises of Blockchain Beyond Payment
A. Smart contracts – A “smart contract” has the potential to automate value
transfer based on defined conditions through the blockchain.
B. Clearing and settlement – The use of blockchain technology could enable