Module 2

MODULE 2

BLOCKCHAINS, BITCOINS AND SMART CONTRACTS

2.1. INTRODUCTION

A blockchain is a tamper-evident, shared digital ledger that records
transactions in a public or private peer-to-peer network. Distributed to all
member nodes in the network, the ledger permanently records, in a
sequential chain of cryptographic hash-linked blocks, the history of asset
exchanges that take place between the peers in the network.1

The term “BLOCKCHAIN” has been from its working and also from the
manner in which it stores data, namely that the information is packaged
into blocks, which link to form a chain with other blocks of similar
information.

The act of linking blocks into a chain makes the information stored on a
blockchain trustworthy, unlike commodity based money. All the confirmed
and validated transaction blocks are linked and chained from the beginning
of the chain to the most current block. It acts as a single source of truth, and
members in a network can view only those transactions that are relevant to
them.

1Sloane Brakeville,, Bhargav Perepa (Published on March 18, 2018) , Retrieved from
https://developer.ibm.com/tutorials/cl-blockchain-basics-intro-bluemix-trs/, Last visited on
20/11/2018 at 6:10 pm

Instead of relying on a third party, such as a financial institution, to mediate
transactions, member nodes in a blockchain network use a Consensus
Protocol2 to agree on ledger content, and cryptographic hashes and digital
signatures to ensure the integrity of transactions.3

The decentralized peer-to-peer blockchain network prevents any single
participant or group of participants from controlling the underlying
infrastructure or undermining the entire system. Participants in the network
are all equal, adhering to the same protocols. They can be individuals, state
actors, organizations, or a combination of all these types of participants.

At its core, the system records the chronological order of transactions with
all nodes agreeing to the validity of transactions using the chosen consensus
model. The result is transactions that cannot be altered or reversed, unless
the change is agreed to by all members in the network in a subsequent
transaction.

The key features of cryptographic security, decentralized consensus, and a
shared public ledger (with its properly controlled and permissioned
visibility), blockchain technologies represents a new way to transact
business which can ardently change the way our economic, social, political,
and scientific activities are organized.

2 ‘Consensus’ in the context of Blockchain means that the nodes on the network agree on the same
state of a blockchain, in a sense making it a self-auditing ecosystem, Retrieved from
https://lisk.io/academy/blockchain-basics/how-does-blockchain-work/consensus-protocols, Last
visited on 20/11/2018 at 4:04 pm
3 Sloane Brakeville,, Bhargav Perepa (Published on March 18, 2018) , Retrieved from
https://developer.ibm.com/tutorials/cl-blockchain-basics-intro-bluemix-trs/, Last visited on
20/11/2018 at 6:15 pm

2.2. CHARACTERISTICS OF BLOCKCHAIN

The words of William Mougayar -“The blockchain cannot be described just
as a revolution. It is a tsunami-like phenomenon, slowly advancing and
gradually enveloping everything along its way by the force of its
progression.”will be befitting in order to understand the importance and
scope of Blockchain technology.

2.2.1. Increased capacity

The first and an important feature of Blockchain is that it increases the
capacity of the whole network because of the reason that there are a lot of
computers working together which in total offers a great power then few of
the devices where the things are centralized. A perfect example of increased
capacity is a project started by Stanford University which created a
supercomputer that simulates protein folding for medical research.4

2.2.2. Better security

Blockchain technology has a better security because there is not even a
single chance of shutting down of the system. Even the highest level of the
financial system are subject to get hacked. Bitcoin in the second hand had
never been hacked. the reason is that the blockchain network is secured by
a number of computers called nodes and these nodes confirm the transaction
on this network.5

4 Retrieved from https://data-flair.training/blogs/features-of-blockchain/, (Published on 1/06/2018),
Last visited on 20/11/2018 at 4:11 pm
5 Ibid.

2.2.3. Immutability

One of the main values of Blockchain is creating immutable ledgers. Any
database that is centralized is subjected to get hacked and they require trust
in the third party to keep the database secure. Blockchain on the other hand
keeps its ledgers in a never-ending state of forwarding momentum.6

2.2.4. Faster settlement

Traditional banking systems can be slow, as they require a lot of settlement
time which usually takes days to proceed. This is one of the main reason
why the banking institutes need to upgrade their banking systems.
Blockchain Technology tends to solve this prblem as it can settle money
transfer at really fast speeds. This ultimately saves a lot of time and money
from these institutions and provide convenience to the consumer also.7

2.2.5. Decentralized system

Decentralized technology gives the power to store your assets in a network
which further access by the means of the internet, an asset can be anything
like a contract, a document etc. Through this owner has a direct control over
his account by the means of a key that is linked to his account which gives
the owner a power to transfer his assets to anyone he wants. The Blockchain
technology proves to be a really effective tool for decentralizing the web. It
does possess the power to bring massive changes in the industries.8

6 Ibid.
7 Retrieved from https://data-flair.training/blogs/features-of-blockchain/, (Published on 1/06/2018),
Last visited on 20/11/2018 at 4:11 pm
8 Ibid.

2.2.6. Distributed ledger

Blockchain technology comprises of a public ledger that provides
information of all the participants and all digital transactions that have ever
been executed. A block is the “prevailing” part of a blockchain which keeps
the record of the recent transactions, and once they are completed, it goes
into the blockchain. Blocks are added in sequential manner with the next
block containing hash of the previous block. A new block is generated as
soon as the previous block gets entered in the blockchain database.

This technology helps in recording of each transaction and shares it across
the network. Every user in the network can validate transactions and has an
identical copy of the ledger, to which the encrypted transactions can be
added. Any changes to the ledger are reflected in all copies in minutes, or in
some cases, seconds. Through the use of ‘keys’ and signatures the security
and accuracy of assets is maintained cryptographically and are controlled
by the participant.9 The shared information can easily be verified and its
available to anyone on the network to access it. This ensures that no data is
lost and it syncs with other files. Most importantly, since the central point
is eliminated, the data cannot be corrupted or hacked.10The end result is a
highly efficient and secure method of performing transactions and it serves
as an online ledger keeping record of transactions that can’t be changed.

9Retrieved from https://www.techracers.com/blogs/blockchain-key-features/, (Published on
03/09/2017) Last visited on 20/11/2018 at 4:26pm
10 Aviv Lichtigstein, (Published on 24/05/2018), Retrieved from
https://101blockchains.com/introduction-to-bloackchain-features/, Last visited on 26/11/2018 at
4:34 pm

2.2.7. Corruption free

Blockchain checks itself automatically after every 10 minutes. The
continuous checking of itself is similar to self-auditing and after every 10
minutes, it reconciles with the prior information stored. Each information
stored after self-auditing is referred to as a block. Every data within the same
network is shared with all the computers within the same network. This
promotes transparency. Also, this information cannot be corrupted because
if the information is changed on one computer, cannot be changed in other
computers. In other words, it will require changing the information in all the
computers connected to the same network. It is impossible to corrupt or hack
information stored using blockchain.11

There are three main characteristics of a blockchain: decentralized;
distributed and public ledger. It has become a potentially transformative
force in multiple aspects of government and private sectors, also been
recognized globally with a variety of international organizations and
technology companies highlighting the benefits of its application in
reducing costs of operation and compliance, as well as in improving
efficiencies. Even though the technology is still in a nascent stage of its
development and adoption as it continues to evolve, it is important for
stakeholders such as policy-makers, regulators, industry, and citizens to
understand the functional definition of the entire suite of Blockchain or

11 Retrieved from https://www.techracers.com/blogs/blockchain-key-features/, (Published on
03/09/2017) Last visited on 20/11/2018 at 4:30 pm

distributed ledger technologies along with legal and regulatory issues and
other implementation prerequisites.12

The term ‘Decentralization’ is a process of distributing and dispersing
power away from a central authority i.e. the underlying technology, the
Blockchain, offers every single user an opportunity to become one of the
network's many payment processors. 13

2.3. BENEFITS OF DECENTRALIZED SYSTEM

1. There is less censorship

2. There is less likely to be a single point of failure

3. Users don’t have to put trust in a central authority

4. Decentralized networks are more likely to be open development
platforms

5. There is potential for network ownership alignment

6. Decentralized networks can be more meritocratic14

12 https://niti.gov.in/sites/defa, ult/files/2020-01/Blockchain_The_India_Strategy_Part_I.pdf. AM),
13 Decentralization News (May 19, 2020, 12:15 AM), https://cointelegraph.com/tags/decentralization.
14 Doug Petkanics, The Benefits of Decentralization (May 19, 2020, 12:36
https://medium.com/@petkanics/the-benefits-of-decentralization-88a0b5d0fd39.

2.4. DIFFERENCE BETWEEN CENTRALIZED BLOCKCHAIN
AND DECENTRALIZED BLOCKCHAIN15

Centralized Decentralized

Only known and identified parties Anyone can transact on the ledger.
can transact on the ledger.

The transaction can be audited. No auditing.

Example: Hyper Ledger Fabric Example: Bitcoin
from IBM

Different sectors such as financial sectors, healthcare sectors, etc. are all
crucial for an emerging economy like India—can see tremendous benefits
from the application of Blockchain technology. However, Blockchain
without cryptocurrency tokens are just data networks, not value networks.
Cryptographic money tokens perform three key capacities—keeping up
decentralization by giving the essential monetary motivation to organize
hubs to approve exchanges, empowering engineers to assemble
decentralized applications on Blockchain arranges, and permitting

15 Emily Rutland, Blockchain Byte, R3Research (May 19, 2020, 1:00 AM),
,https://www.finra.org/sites/default/files/2017_BC_Byte.pdf.

beginning time extends another approach to publicly support capital and
clients.

Blockchain is presently the quickest developing range of abilities requested
on places of work, with work development rates at 2,000-6,000% and pay
rates for blockchain engineers 50-100% higher than normal designer
occupations. The decentralized idea of ventures with circulated groups can
convert into lakhs of lucrative occupations from everywhere throughout the
world being accessible to Indian engineers.

Decentralized applications on open blockchains can take care of bunch
Indian issues, for example, dispensing with go-betweens, giving
information security, decreasing debasement and altering of budgetary
records, and improving the speed of administration conveyance by
governments and enterprises.

The present discussion in India has, lamentably, centered too vigorously
around exchanging and hypothesis, taking a gander at digital forms of
money as a venture apparatus, instead of understanding the capability of
center blockchain innovation and the essential job of cryptographic forms
of money as a motivating force instrument to make sure about decentralized
exchanges. To track or control money laundering, tax evasion, investor
protection, and capital flight, regulation is required by the government. But
it is sensitive to form regulation as any action on cryptocurrencies that
misses the nuance of separating speculative activity from core software
development inadvertently shuts down core development as well.

However, Indian developers do not have the ability to develop open
Blockchain solutions at scale, but some professionals are migrating rapidly
to countries with more friendly regulations. As a result, India’s ability to
benefit from jobs, capital, local innovation, and positioning is all curtailed
without the talent ecosystem in place.16

In the important judgment delivered by SC in the case of “Internet and
Mobile Association of India v. Reserve Bank of India”17, which has changed
the future and has a revolutionary impact on the crypto industry in India.
The Supreme Court held that there were less invasive means of achieving
the same objective that was not considered by RBI at the time of issuing the
circular, and it failed to provide data showing any resemblance of damage
suffered by the financial entities regulated by it. Further, as per the proposals
made by the European Parliament, and Crypto-Regulation Bill 2018,
blanket ban on Virtual Currency was not advocated.18

On March 21, 2020, the Indian Government asked the RBI (Reserve Bank
of India), Central Bank and SEBI (Securities and Exchange Board of India)
to discuss the regulatory framework for crypto-currencies and also they are
waiting for the SC to make its final decision on crypto regulation. It has also
said that “whether the virtual currencies can be regulated by the Reserve
Bank of India … A framework for the regulation will be decided upon after
deliberations with the central bank”. As, the central bank is worried that the

16 Tanvi Ratna, Nitin Sharma, Opinion | The importance of blockchain for India, Live mint (May 19, 2020, 1:45
AM), https://www.livemint.com/Opinion/wNYS0WfLeUIDPcFddJL84K/The-importance-of-blockchain-for-
India.html.
17 Writ Petition (Civil) No. 528 of 2018.
18 Diva Rai, Analysis of the Cryptocurrency judgment and way forward, iPleaders (May 19, 2020, 3:00 AM),
https://blog.ipleaders.in/analysis-cryptocurrency-judgment-way-forward/.

anonymous nature of cryptocurrencies could pose a threat to India’s banking
system.19

The decision is still pending whether to ban or to regulate the Crypto-
currency or to approve the “Banning of Cryptocurrency and Regulation of
Official Digital Currency Bill 2019”, which was drafted by IMC
(interministerial committee). However, an official has said that a complete
ban on cryptocurrency would not only be difficult to implement but also
lead to underground cryptocurrency trading.

2.5. BITCOIN

In the words of Eric Schmidt, CEO of Google- "Bitcoin is a remarkable
cryptographic achievement, and the ability to create something that is not
duplicable in the digital world has enormous value"

Bitcoin is a digital currency (also called crypto-currency) that is not backed
by any country's central bank or government. Bitcoins can be traded for
goods or services with vendors who accept Bitcoins as payment. Bitcoin-to-
Bitcoin transactions are made by digitally exchanging anonymous, heavily
encrypted hash codes across a peer-to-peer (P2P) network. The P2P network
monitors and verifies the transfer of Bitcoins between users. Each user's
Bitcoins are stored in a program called a digital wallet, which also holds
each address the user sends and receives Bitcoins from, as well as a private

19 Kevin Helmes, Indian Government Engages RBI to Discuss Cryptocurrency Regulation (May 19, 2020, 4:45
AM), https://news.bitcoin.com/indian-cryptocurrency-regulation/.

key known only to the user. The Bitcoin network is designed to
mathematically generate no more than 21 million.

Bitcoins and the network is set up to regulate itself to deal with
inflation. Bitcoins can be spent by initiating a transfer request from a Bitcoin
address in the customer's wallet to a Bitcoin address in the vendor's wallet.
As of this writing, one Bitcoin (also called a BTC) is worth $104 but just as
with stocks, the value of Bitcoins fluctuate quickly. 20

In distributed systems a particular form of client-server architecture exists,
where the secondary party only has a weak copy and is called a master-slave
architecture. In a system of debt, one of the two parties is always the slave.
We are the client. We are not the server. The server doesn’t really serve us
; they serve themselves because they’re the master. That is the architecture
of money we live in. That is the architecture of money we use in our
civilization: an architecture of money where you have no control; an
architecture of money where every interaction is mediated by a third party
that has absolute control over that money. Today, if we go to an ATM
machine and put in our card, the bank may decide to give us our money.
One day—as the people of Cyprus, Greece, Venezuela, Argentina, Bolivia,
Brazil, and a list of hundreds of countries over the last several decades and
even centuries have discovered—one day, we go to the bank and the bank
may not want to give us the money, because they don’t have to. That’s the
essence of a master-slave relationship. Bitcoin is fundamentally different
because in bitcoin, you don’t owe anyone anything and no one owes you
anything. It’s not a system based on debt. It’s a system based on ownership

20 Margaret Rouse, (Updated in June 2013), Retrieved from

https://whatis.techtarget.com/definition/Bitcoin, Last visited on 23/11/2018.

of this abstract token. Absolute ownership. An expression in the United
States, which is “possession is nine-tenths of the law.” In bitcoin, possession
is ten-tenths of the law. If you control the bitcoin keys, it’s your bitcoin. If
you don’t control the bitcoin keys, it’s not your bitcoin.21 There are almost
200 currencies of the world, but there’s only one international currency.
There are almost 200 currencies controlled by central banks and
governments, but there is only one mathematical currency today, and that is
bitcoin. "Cryptographic currencies are going to be a mainstay of our
financial future. You cannot uninvent this technology. You cannot turn this
omelette back into eggs." Cryptographic currencies are going to be a
mainstay of our financial future. We already have over 100 competing
currencies in the space, which

shows how quickly innovation has exploded, even beyond bitcoin the
currency. There are many other alternative currencies — altcoins, as they’re
known, use the same basic technology of a decentralized asset ledger using
consensus in the network with Satoshi’s algorithm. Some of these currencies
are inflationary, some deflationary, some use demurrage or negative interest
rates, some are charitable and redistribute a proportion of the income to
charitable organizations." At the end of the day, bitcoin is programmable
money. When you have programmable money, the possibilities are truly
endless."22 The architecture of bitcoin is peer-to-peer because every
participant in the network speaks the bitcoin protocol on an equal level.
There are no special bitcoin nodes; all nodes are the same. Peer-to-peer
means that when you send out a transaction to the network, every peer treats

21 Antonopoulos, Andreas M. , 2016, The Internet of Money, Page No. 33.
22 Antonopoulos, Andreas M, 2016, The Internet of Money, Page No. 19.

it the same. It has no context inside the peer’s system other than what it gets
from the network. An interesting issue in distributed systems is this issue of
context and state. If you log in to Facebook and you have an account with
Facebook, you’re not using a protocol. All of the state is controlled by
Facebook. You have a login session and all of the data is held by them. We
call that architecture client-server. Bitcoin is different because it’s peer-to-
peer, just like email or TCP/IP.23

Starting in the 1970s, we have seen the world begin to adopt digital
currencies. When people call bitcoin a “digital currency,” they’re missing
the point. Euro is a digital currency; the US dollar is a digital currency. Less
than 8 percent of these currencies exist in physical form; the rest is bits on
ledgers. But the fundamental difference is that these ledgers are controlled
by centralized organizations, whereas in bitcoin, they’re not. Bitcoin has a
decentralized network, an open network. Bitcoin isn’t a digital currency. It’s
a cryptocurrency. It’s a network-centric money. A network that allows you
to replace trust in institutions, trust in hierarchies, with trust on the network.
The network acting as a massively diffuse arbiter of truth, resolving any
disagreements about transactions and security in a way where no one has
control.24

2.6. SMART CONTRACTS

Smart contracts are lines of code that are stored on a blockchain and
automatically execute when predetermined terms and conditions are met. At
the most basic level, they are programs that run as they’ve been set up to

23Antonopoulos, Andreas M, 2016, The Internet of Money, Page No.30.
24 Antonopoulos, Andreas M , 2016, The Internet of Money, Page No. 42.

run by the people who developed them. The benefits of smart contracts are
most apparent in business collaborations, in which they are typically used
to enforce some type of agreement so that all participants can be certain of
the outcome without an intermediary’s involvement.25

The key properties of smart contracts are:

§ Autonomy

§ Decentralization

§ Auto-sufficiency

Autonomy implies that after a smart contact launches, the deal initiator does
not have to participate any more in the process. Smart contracts are not
focused on one central server but are distributed by various network points
so they can be referred to as being decentralized. Auto-sufficiency supposes
that contracts are able to collect money, realize transactions, distribute
resources, issue and spend funds to allow a larger capacity of storage and
computation power.

The main advantages of smart contracts include: -

§ agent neutrality in signing deals;

25 Nigel Gopie, (Published on 02/07/2018), Retrieved from
https://www.ibm.com/blogs/blockchain/2018/07/what-are-smart-contracts-on-blockchain/, Last
Visited on 27/11/2018 at 11:41 am

§ automation in signing deals, time saving: excludes human
participation in transactions, everything is done by the
prescribed programm code;

§ safety: data in the decentralized registry cannot be lost and
cyber attacked;

§ precision: no mistakes can be made due to the absence of
hand-filled forms.

Blockchain is the ideal space for smart contract storing. As a decentralized
system it does not require intermediaries to be present at the time of
realizing transactions or signing deals. Smart contracts are stored in the
distributed registry as a one time written code. They carry out their work
thanks to a computer network which controls the blockchain. Thus, if a code
is written in a proper way, nobody will be able to change it.

The use of smart contracts has just begun to be popular. Existing limitations
of the development of such a type of deal signing due to some technical
aspects can soon disappear To write and transfer smart contracts in
blockchain the system uses a powerful encryption system and has a
language specific completeness as per Turing. Just to compare, a Bitcoin
protocol with its much narrower functionality only permits monetary
transactions and it does not offer the possibility to store smart contracts or
transfer assets.

Smart contracts can be used in lots of everyday life situations, but its
greatest potential is in the financial sector. Smart contracts help solve the

issue of mistrust between parties and business partners. For example, if
company ‘A’ sells shares or any other product to company ‘B’ and the
parties do not trust each other, they will choose an arbitrary who can help
them in case of any difficult situations. If company A sends shares (through
the code they are encrypted in) through blockchain storage it is only after
company B pays money, that they will get the shares. It is possible for you
to write in the code as a transaction condition that the shares will be
transferred to the party after the money is deposited into the account. So,
first, the algorithm checks the balance and then the deal will be signed.
Unfortunately, the smart contract potential in the financial sphere is not
unlocked to full working capacity. The main limitations are transaction time
and cost. Also, it should be mentioned that for various industries there are
not enough specialized projects. One such project is Red Pulse, a Chinese
start-up in financial consulting. This is a decentralized information platform
for exchanging up-to-date info and knowledge about market trading with
the RPX token bounty system.

Like any other technology, smart contracts have their own disadvantages:

§ The consumers are quite suspicious because it is a new
technology and they do not understand it yet.

§ Making changes. For example, you may change your mind
about renting an apartment, but the data is already registered
and it is technically difficult to make corrections. This may
bring mistakes into the system and make it less safe.

§ One can keep and save data in smart contracts safely and it
is void of any distortions, only if the code is written perfectly
and precisely. Humans can be tired or make clerical errors
and thus the whole system is endangered.

§ The third-party agents do not disappear but start playing a
different role. The need for lawyers experienced in IT
increases in the future because the programmers of smart
contracts will need consultations for making new kinds of
contracts.26

26 Retrieved from https://hackernoon.com/advantages-and-disadvantages-of-smart-contracts-in-
financial-blockchain-systems-3a443145ae1c, Last visited on 27/11/2018 at 11:45 am