Cornerstone CEO Erika Karp discusses the current state of capitalism at Fluidity Summit, kicking off Blockchain week in NYC.

Recently, Small Cap Nation (SCN) interviewed Cornerstone Capital founder and CEO, Erika Karp, and Vince Molinari, CEO of Templum Markets LLC (and member of Cornerstone’s Global Advisory Council). The discussion centered on the prospects for use of blockchain in ways that will amplify positive social and environmental impact.

In the view of blockchain proponents, one of the technology’s major advantages is that it doesn’t require trust at the point of transaction, leading to a radical shift in the power of intermediaries. However, there is a question outstanding about how the need for trust can be changed and whether blockchain technology reduces the need for trust or shifts the burden of trust.  We recently published a piece exploring the issue of trust.

Following on from our report, Cornerstone’s Sebastian Vanderzeil hosted a conversation with Michael Oved, co-founder of AirSwap and former partner at Virtu Financial, who is “passionate about a future where people fearlessly trade digital value without third-party intervention.” The discussion and Q&A session touched on a range of topics including:

 

Electronics 360, December 6:  Blockchain: A Future Foundational Technology?

 

 

Trust:

• assured reliance on the character, ability, strength, or truth of someone or something
• dependence on something future or contingent: hope
• reliance on future payment for property (such as merchandise) delivered

A ‘trustless’ technology

In the view of blockchain proponents, one of the technology’s major advantages is that it doesn’t require trust to conduct transactions. In today’s world, transactions require trust or, in the place of trust, intermediaries, which exist to facilitate the transaction, record the details, and serve as guarantors that each party has sufficient assets. However, intermediaries cannot always be trusted, as illustrated by the “Byzantine Generals problem,” an oft-cited analogy used to explain blockchain . Proponents argue that blockchain removes the need for trust and thus also removes the need for intermediaries.

Bitcoin, the first cryptocurrency application of blockchain technology, aimed to resolve concerns about the trustworthiness of financial intermediaries by creating a “trustless” system . Two inherent components of trust are vulnerability and expectation: there is a possibility for disappointment, but both parties accept the risk because they believe in a positive outcome . Bitcoin developers suggest that it can reduce reliance on trust by reducing the risk of disappointment.
This may be true if one takes a narrow view of the transformative quality of the blockchain. Our analysis suggests that blockchain technology may not reduce the need for trust so much as shift the burden of trust.

How does blockchain shift trust?

The focus on blockchain has been on ensuring that parties complete their transactions and that transactions are immutably recorded. However, we argue that trust is still a factor outside of the immediate transaction environment. To illustrate, we’ll use the trading of renewable energy certificates, which currently requires multiple steps.

Traditionally, a certificate-creating regulator must verify the validity of the renewable energy generator, while brokers aggregate certificates from the generators and link buyers and sellers. A simplified diagram of this process is shown below in Figure 1.

Figure 1: Current renewable energy trading (stylized)

Source: Cornerstone Capital Group

Proponents of blockchain renewable energy trading argue that no “trust” or intermediary is necessary because the technology allows parties to trade directly, and only when both parties have their assets ready. As shown in Figure 2, the renewable energy generator links sensors to a blockchain-enabled ledger. As each MWh of renewable energy is generated, the ledger updates its records with a new certificate, recorded as a digital token. Buyers can source certificates by buying tokens, and the transaction history is recorded on the blockchain ledger.

However, this argument looks at the renewable energy trading system through the narrow lens of immediate transaction mechanics. The broader “transaction ecosystem” still requires trust:

Figure 2: Blockchain-enabled trading system

Source: Rocky Mountain Institute, Cornerstone Capital Group

The ecosystem, therefore, looks more like Figure 3. In this diagram, the proposed blockchain renewable energy trading shifts the “burden of trust” from transaction intermediaries to parties outside the enclosed system. This shift might transfer responsibility to entities that are not prepared, which could be particularly dangerous as the blockchain purposefully does not allow for arbitration or the undoing of transactions. For example, a buyer who spends financial resources on a certificate from a generator who is improperly audited may have no means of recourse. Once the transaction is executed, it is recorded and unable to be undone or negotiated.

Figure 3: Cornerstone’s assessment of blockchain renewable energy tradingSource: Cornerstone Capital Group

Our assessment raises questions for investors in blockchain-enabled applications, as well as more mainstream investors assessing how to improve efficiency of trading. The ability of the technology to set the boundaries of the transaction environment may create as much complexity and risk as it resolves. At what point does it become prohibitively expensive to expand the scope of technological control to remove the need for trust? Is the need for trust such a significant drag on the economy or society?

These questions around how trust is shifted and at what cost apply beyond the current discussions of Bitcoin and blockchain bubbles. Investors across the market may benefit from assessing the relative cost versus efficiency of redistributing the responsibilities of trust outside the immediate transaction environment. A narrow view may position investors for unforeseen consequences, including negated efficiency gains or failure to deploy blockchain technology in the most valuable way.

Efficiency in shifting trust

Blockchain proponents speak of a future facilitated by trustless systems. Our assessment, currently, is that blockchain does not reduce the need for trust but rather shifts the burden of trust beyond the scope of the actual transaction. This may increase the efficiency of the immediate transaction, while moving intermediary roles to the edges of the transaction system. New responsibilities may be transferred to intermediaries who are unprepared or create bottlenecks. Investors purely focused on transaction-level trust may not be aware of the risks the might arise from such shifts.

Value in shifting trust

Investors interested in reducing the trust involved in transactions should determine whether the application is focused on the core vulnerability within the system. For renewable energy trading in particular, we view monitoring and auditing of the generators as a key vulnerability. At this point, blockchain-supported renewable energy does not address these concerns. The system still relies on trusting a third-party auditor or a set of sensors to ensure that the renewable energy is valid. Blockchain applications that address the critical issues in a trading system are likely to be more strongly positioned.

Click here to download the report and for important disclosures.

Emma Currier is a Research Associate at Cornerstone Capital Group. Emma graduated with a Bachelors of Arts degree in Economics from Brown University in May 2016. While at school, she worked with the Socially Responsible Investing Fund and as a teaching assistant for the Public Health and Economics departments. She spent her sophomore summer researching differences between American and Indian educational styles in Arunachal Pradesh, India, and completed a summer investment bank analyst position with Citi in the Media & Telecom group in 2015.

Sebastian Vanderzeil is Director, Global Thematic Research Analyst with Cornerstone Capital Group. He holds an MBA from New York University’s Stern School of Business. Previously, Sebastian was an economic consultant with global technical services group AECOM, where he advised on the development and finance of major infrastructure across Asia and Australia. Sebastian also worked with the Queensland State Government on water and climate issues prior to establishing Australia’s first government-owned carbon broker, Ecofund Queensland.

As the rapid evolution of the blockchain has captured the attention of the investment community, Cornerstone has begun to offer insight into the technology’s potential to foster positive social change and the evolving notions of governance in its application. (See our reports Governance and the Ungovernable: Implications of Blockchain Proliferation and Making Sense of Blockchain Opportunities, as well as our July webcast “Beyond Finance: Considering the Business and Social Potential of the Blockchain“.)

We’ve  had the pleasure of getting to know leaders in this fast-growing field,  thanks to Cornerstone Board members Ibrahim AlHusseini and Andrew Masanto. And I am particularly pleased to join the Advisory Board for AirSwap, a token exchange based on the Swap protocol, a peer-to-peer protocol for trading Ethereum tokens. AirSwap is designed “to harness the same power of blockchain as a globally accessible, friction-free value network, supporting private and secure exchange between peers.”

In conjunction with the launch of AirSwap Token on October 10, this video was created. Please feel free to share – most of us face a steep learning curve in this potentially disruptive force.

A panel discussion at “Blockchain and the New Global Economy” with Michael Oved of AirSwap, Sam Tabar, and Matthew Bishop.

Executive Summary:

A blockchain taxonomy for investors. Blockchain technology is being used in a growing diversity of applications, offering a complex array of investment opportunities. While the technology is so new that any investment in it is speculative, patterns of use are emerging. In this report, we propose a taxonomy to enable investors to more quickly and effectively understand individual blockchain applications’ key attributes and to assess how blockchain technology will be used in the near and medium term. To illustrate use of the taxonomy, we apply the indicators to several blockchain applications that range in investment, purpose, and launch date, including Bitcoin, EOS, Tezos, Ethereum and Provenance.

Figure 1: Blockchain taxonomySource: Cornerstone Capital Group

What does the taxonomy tell us?

Our view. We remain skeptical about the ability for blockchain to replace existing non-digital transaction processes without clearer demonstrations of benefits to a wide range of users. However, blockchain is gaining traction within communities and marketplaces focused on the technology-enabled.

Download the full report here.

 

Sebastian Vanderzeil is a Global Thematic Research Analyst with Cornerstone Capital Group. He holds an MBA from New York University’s Stern School of Business. Previously, Sebastian was an economic consultant with global technical services group AECOM, where he advised on the development and finance of major infrastructure across Asia and Australia. Sebastian also worked with the Queensland State Government on water and climate issues prior to establishing Australia’s first government-owned carbon broker, Ecofund Queensland.

Emma Currier is a Research Associate at Cornerstone Capital Group. Emma graduated with a Bachelors of Arts degree in Economics from Brown University in May 2016. While at school, she worked with the Socially Responsible Investing Fund and as a teaching assistant for the Public Health and Economics departments. She spent her sophomore summer researching differences between American and Indian educational styles in Arunachal Pradesh, India, and completed a summer investment bank analyst position with Citi in the Media & Telecom group in 2015.

Cornerstone Capital CEO Erika Karp will take part in a panel discussion with noted blockchain experts on Thursday, August 3, 5-8 pm. The event will be hosted by SWAP, a team of financial technology, product, blockchain, and security experts who are developing a protocol for trading tokens on the Ethereum blockchain. Swap is uniquely built around the idea that peer-to-peer is the best design for trading on a decentralized computing platform like Ethereum. The panel will be held at 101 Warren Street, 5th floor, NYC.

On June 23 Cornerstone hosted Jalak Jobanputra for a discussion on the blockchain’s transformative potential. Jalak is the Founding Partner of Future\Perfect Ventures, an early-stage venture capital fund focused on next-generation technology such as blockchain and machine learning. She was an early investor in the space, and is widely considered to be an expert.

Cornerstone’s Sebastian Vanderzeil, Director and Thematic Analyst at Cornerstone, led the session. In addition to recent developments in the space, Jalak and Sebastian discussed  a number of ways emergent applications for blockchain technology could address social challenges, particularly in less developed regions. The two also addressed issues of governance and accountability, following on from Sebastian’s recent report Governance and the Ungovernable: Implications of Blockchain Proliferation.

 

Overview

Theory and politics. The blockchain and related innovations represent a new and relatively complex set of potential investment opportunities. The technology has received significant attention from a range of individuals and institutions, from computer scientists to corporations to private equity groups. We outline the theory of the technology as well as the governance implications to guide investors.

Disruptive opportunity. Advocates of the blockchain believe it has tremendous potential to enable novel ways of creating, managing, and maintaining systems of fundamental rights. It is already being used to facilitate transparency and combat corruption — for example, Kenya is piloting its use to record land ownership and transfer, historically a poorly managed and easily manipulated process1. The blockchain operates, by design, independently of traditional arbitrators and regulators. Its widespread adoption could remove courts, central banks, and government policy makers from financial and sociopolitical transactions, which in turn has governance implications for the economic, legal, and institutional relationships as we know them today.

Governance implications. Innovation spurred by blockchain technology could result in more efficient and transparent business models. For this reason, investors should be actively assessing emerging blockchain-specific opportunities. However, in addition to understanding the basics of the technology, we believe it’s important to understand the governance implications of the blockchain ecosystem. This report undertakes an assessment of the current pillars of blockchain governance and compares these pillars to current norms of corporate governance as laid out in Cornerstone Capital’s proprietary framework. We see two scenarios: “A Blockchain World” and “Our World with Blockchain,” each offering distinct advantages and disadvantages.

Download the full report here.

Sebastian Vanderzeil is Director, Global Thematic Analyst with Cornerstone Capital Group. He holds an MBA from New York University’s Stern School of Business. Previously, Sebastian was an economic consultant with global technical services group AECOM, where he advised on the development and finance of major infrastructure across Asia and Australia. Sebastian also worked with the Queensland State Government on water and climate issues prior to establishing Australia’s first government-owned carbon broker, Ecofund Queensland.

Emma Currier is a Research Associate at Cornerstone Capital Group. Emma graduated with a Bachelors of Arts degree in Economics from Brown University in May 2016. While at school, she worked with the Socially Responsible Investing Fund and as a teaching assistant for the Public Health and Economics departments. She spent her sophomore summer researching differences between American and Indian educational styles in Arunachal Pradesh, India, and completed a summer investment bank analyst position with Citi in the Media & Telecom group in 2015.

This article assumes a basic understanding of blockchain technology. For background information please see this overview from the founder of Bitcoin.

Blockchain-based smart contracts have generated ample buzz recently as they could eventually build entirely autonomous organizations, enable self-regulated peer-to-peer insurance models, and facilitate the renting of all internet-connected things. This article explores how smart contracts work. It provides a brief primer on smart contracts, then compares the coding, storage and execution of smart contracts on Bitcoin and Ethereum, the two permissionless blockchain protocols that have achieved scale thus far. While plenty of healthy skepticism still exists around smart contracts, ARK Invest believes Bitcoin and Ethereum will be instrumental in validating the potential of this budding innovation.

Primer on Smart Contracts

A smart contract refers to coded logic that moves digital assets when triggered by necessary events. It is akin to a series of “IF, THEN” statements, where the “ifs” are preconditions that must be met in order to trigger the “thens.” The idea fits well within blockchain technology because blockchains offer a guarantee of future execution, in a decentralized manner,[1] once the smart contract logic is stamped within a block.

The term “smart contracts” often puts mental imagery of complex documents in peoples’ minds, which ARK believes is misleading.  This misconception explains why Mike Hearn, an early pioneer within the Bitcoin space, called smart contracts a misnomer in a November 2013 conversation on the matter. While he preferred the term conditional payments, ARK prefers broadening the term to conditional transactions to capture the idea that this technology can facilitate more than the transfer of money for goods and services.

Conditional transactions executed via a blockchain are computationally expensive because every computer that is part of the network needs to execute the same logic and update the state of the blockchain. In other words, each time a smart contract is triggered every computer has to perform the same task, consuming considerable resources and making the process inefficient when compared to parallel processing architectures. Therefore, not every conditional transaction will be appropriate for execution via a blockchain, but rather only those use cases that demand the distributed and secure nature of a shared ledger. Once more sophisticated solutions are implemented — like sharding, which can help to better parallelize computing tasks and storage — conditional transactions may prove less computationally expensive to the network, further widening the scope of applications.

Coding of Smart Contracts

While Nick Szabo conceived the concept in the 1990s, Ethereum popularized the idea of smart contracts. It remains a common misconception that Bitcoin can’t facilitate the same range of functionality. Even though Ethereum currently has more flexibility in the programming languages that can be used — because it was designed with developers keenly in mind — the two blockchain platforms can accommodate the same smart contract functionality.

With its source code written in C++, coding for Bitcoin applications often occurs at a more granular layer, making it a less desirable sandbox for many new-age web and application developers. The high-level languages readily available within Ethereum, however, make smart contracts accessible to most developers.
For example, Geth is available to Ethereum developers; it is implemented in Go, the easy-to-learn open source programming language that Google released in 2009. Go was created in part because the founders hated the complexity of C++.  ARK believes people confuse “difficult” and “impossible” with regard to encoding complex smart contracts in Bitcoin. While it may currently be more difficult to encode complex smart contracts in Bitcoin, that does not mean it is impossible.

Storage and Execution of Smart Contracts

Bitcoin and Ethereum differ in the storage and execution of smart contracts, which became clear to us during conversations with relevant parties at Coala’s NYU Blockchain Workshops in April this year. We will start with Ethereum because it was designed specifically with smart contracts in mind and therefore easier to understand, whereas while smart contracts are cleverly layered into Bitcoin transactions.

Ethereum users load smart contracts into its blockchain via a transaction to the network that has a payload containing the logic of the contract. The transaction is not sent to a particular address.  Instead, the nodes processing the transaction on the network recognize the “smart contract payload,” and create a smart contract address. The underlying logic and interactions for smart contracts can be seen on blockchain explorer sites like Ether.Camp. Once uploaded to the blockchain, the logic underlying a smart contract can be activated by sending to its address a transaction with the preconditions necessary to trigger it. Triggering a smart contract can lead to the sending of another transaction, triggering another contract, theoretically ad infinitum.

With Bitcoin smart contracts, it’s important to understand that each transaction exists as a data structure composed of inputs and outputs, as can be seen in a Bitcoin block explorer. In order to send bitcoin, users must provide certain inputs meeting pre-determined requirements that prove they own, and therefore have the authority to send, the bitcoin they claim to own. Users can also create contract transactions that require a more complex set of inputs in order to trigger the release of bitcoin. A simple example of more complex inputs is a multi-signature transaction, which requires more than one entity to sign off on the release of bitcoin, proving useful in escrow situations where perhaps two of three parties must vouch for a transfer.

Often surprising is the complexity of operations that can be created from the combination of simple operators. With the introduction of Segregated Witness (SegWit), the flexibility of Bitcoin’s scripting system will increase. Since the scripting system is responsible for creating the logic embedded within Bitcoin transactions, making the scripting system more dynamic will allow transaction types to be more dynamic as well. Additionally, Rootstock is working on building an easy-to-use smart contracts platform atop Bitcoin. Given the many ways to construct and execute a smart contract using the Bitcoin network, we recommend those further interested to read BitFury’s white paper, “Smart Contracts on the Bitcoin Blockchain.”

Summation

The promise of smart contracts is that once the logic is live, the underlying blockchain guarantees future execution as long as the necessary conditions are met. For example, a company employing smart contracts within Ethereum is Slock.it, which ties the unlocking of real world devices with blockchain technology. Imagine a world where you rent a house via Airbnb and all of the internet-connected-devices within the house are updated with information about your digital wallet and date of arrival. Then, whenever you want to release a service within that house, whether unlocking the fridge to get a beer, the WiFi to sip megabytes of data, or the autonomous car for a trip, you send a transaction to the house with a request for that service. The funds are deducted automatically from your account and the device is unlocked with no credit card intermediaries and perfect record keeping via the decentralized ledger of the underlying blockchain. If the house were connected to the bank which services its loan, you can imagine homes that pay off their own mortgages with the funds they accrue from renters.

One of the more abstract implementations of smart contracts is The DAO, with “DAO” standing for decentralized autonomous organization. Such an organization has no concrete leader, but is instead composed of a series of logic and rules embedded in an interconnected web of smart contracts. While it may seem like science fiction, in May 2016 The DAO raised $160 million in the world’s largest crowdfunding to date. It was promptly hacked in June 2016 as an attacker drained $50+ million in funds, only for that breach to be reverted in July by a hard fork of the network. The space remains young, and now security is rightly top of mind for smart contracts and DAOs

Smart contracts could increase capacity utilization of houses and other assets, decrease legal disputes thanks to flawless ledgers, and cut intermediary costs across the board. Given the efficiency, transparency and economic value that smart contracts will provide to a multitude of sectors and services, they could enable a productivity boost from currently stranded assets. ARK Invest believes Bitcoin likely will be the environment of choice for mission critical contracts requiring utmost security, while Ethereum will continue to push consensus past what previously was thought possible.

Chris Burniske is an analyst with Ark Invest, specializing in big data, cloud computing, cybersecurity, bitcoin, and blockchain technology. He can be reached via his Twitter handle @ARKBlockchain if you have any questions, concerns, or would like to discuss further.

[1] If the blockchain is permissionless— providing open access to participants that would like to join it— ARK believes it will maintain greater decentralization than if it is a permissioned blockchain.