MONEY, TOKENS, AND GAMESBlockchain’s Next Billion Users and Trillions in Value

Citi GPS: Global Perspectives & Solutions
March 2023

Citi is one of the world’s largest financial institutions, operating in all major established and emerging markets. Across these world markets, our employees conduct
an ongoing multi-disciplinary conversation – accessing information, analyzing data, developing insights, and formulating advice. As our premier thought leadershipproduct, Citi GPS is designed to help our readers navigate the global economy’s most demanding challenges and to anticipate future themes and trends in a fast-changing andinterconnected world. Citi GPS accesses the best elements of our global conversation and harvests the thought leadership of a wide range of senior professionals
across our firm. This is not a research report and does not constitute advice on investments or a solicitations to buy or sell any financial instruments.
For more information on Citi GPS, please visit our website at www.citi.com/citigps.

Citi GPS: Global Perspectives & Solutions

March 2023

Ronit Ghose, CFA
Head of Future of Finance
Citi Global Insights

Sophia Bantanidis
Future of Finance Analyst
Citi Global Insights+44-20-7986-4028 |ronit.ghose@citi.com+44-20-7500-9655 |
sophia.bantanidis@citi.com

Nisha Surendran
ICG Lead forTokenization
ICG Digital Assets, Citi

Kaiwan Master
Future of Finance Analyst
Citi Global Insights

Ronak S Shah
Future of Finance Team
Citi Global Insights+44-20-7986-0247 |kaiwan.hoshang.master@citi.com+44-20-7986-3960 |ronak.sharad.shah@citi.com

Loubna Regragui
Product Manager
ICG Digital Assets, Citi

+44 20-7986-7766 |nisha.surendran@citi.com

Yirou Yu
FinTech & Blockchain
Citi Business Advisory
Services+1-212-723-4131 |yirou.yu@citi.com+44 20-7986-0490 |loubna.regragui@citi.com

With thanks to:Henri Arslanian
Co-Founder & Managing
PartnerNine Blocks Capital Mgmt

Bob Blower
CEO
Clarency.com

Nanne Dekking
Founder & CEO
Artory Inc.

Samuel Falic
Co-Founder & President
BlockBar Inc.

Stani KulechovFounder & CEO
Aave Companies

Morgan McKenney
CEO
Provenance Blockchain
Foundation

Silvio Micali
Professor
MIT

Aaron Powers
Co-Founder & CEO
Hunit

Jessica Renier
Head of Digital FinanceInstitute of International
Finance

Sunil Senapati
Chief Operating Officer
XinFinRuth Wandhöfer
Partner
Gauss Ventures

Zooko Wilcox
Founder & CEO
Electric Coin Co.

John Wu
President
Ava Labs

Ryan Wyatt
President
Polygon Labs

Steven Biekens, Shearin Cao, Julien Donnet, Chelsea Lo, Martin Masser, Ciarán McGonagle,
Adnan Memon, Ioana Niculcea, Opeyemi Olomo, Puneet Singhvi, Ajit Tripathi, Stephanie Wake,
Jack White, and Vasant Viswanathan.

March 2023

Citi GPS: Global Perspectives & Solutions

MONEY, TOKENS, AND GAMESBlockchain’s Next Billion Users and Trillions in Value
Kathleen Boyle, CFAManaging Editor, Citi GPS

Can you always spot disruptive innovation? When we hear the story of how theinvention of the automobile hastened the demise of buggy whip companies, we
often question why the disruptive potential of gas-powered cars wasn’t noticed. In
the modern era, most people buying digital cameras in the 1990s would havescoffed at the idea that in a few years’ time, we would all be carrying aroundcameras in our mobile phones.
The potential for tokenization via blockchain has been talked about as beingtransformative for the past few years but we are not quite at the point of mass
adoption. Unlike automobiles or more recent innovations like ChatGPT or the
Metaverse, blockchain is a back-end infrastructure technology without a prominent
consumer interface, making it harder to visibly see how it could be innovative.
But we believe we are approaching an inflection point, where the promised potentialof blockchain will be realized and be measured in billions of users and trillions ofdollars in value. Successful adoption will be when blockchain has a billion-plus
users who do not even realize they are using the technology. This is likely to be
driven by the adoption of central bank digital currencies (CBDCs) by large central
banks as well as tokenized assets in gaming and blockchain-based payments onsocial media. By 2030, up to $5 trillion of CBDCs could be circulating in major
economies in the world, half or which could be linked to distributed ledger
technology. Tokenization of financial and real-work assets could be the killer use
case driving blockchain breakthrough with tokenization expected to grow by a factorof 80x in private markets and reach up to almost $4 trillion in value by 2030.
We first wrote about tokenization in the 2021 Citi GPS report Future of Money:
CBDCs, Crypto, and 21st Century Cash. At the time, China was starting to pilot testits (CBDC) and other central banks were warming up to the idea of their own digitalcurrencies. In recent months, central banks in multiple large countries haveannounced plans for CBDCs this decade, giving almost 2 billion people theopportunity to experiment with digital currency.
To be successfully adopted into the mainstream, blockchain needs the help oftechnology enablers, including (1) decentralized digital identities, (2) zeroknowledge proofs, (3) Oracles, and (4) secure bridges. The legal plumbing also
needs to be altered to enable smart legal contracts that will provide a whole new setof rails for global commerce and finance to run on. Regulatory considerations arealso necessary to allow adoption and scalability without the hindering innovation.
Although we think mass adoption could still be six to eight years away, momentum
on adoption has positively shifted as governments, large institutions, andcorporations have moved from investigating the benefits of tokenization to trials andproofs of concept.

© 2023 Citigroup3

Blockchain: The Opportunity
and the Addressable NeedBILLIONS OF USERS
Blockchain user numbers will be boosted by daily activity. The success of blockchain adoption will be measured by when it is being usedby a billion plus end users who do not even realize they are using the technology. Blockchain-based products can make a significant
impact in terms of wide consumer adoption in digital currency, especially central bank digital currency (CBDCs), gaming, and social.

3 billion

CBDCs could
be used by

Art and collectibles,
NFTs, and digitalcollectibles could
create new paths
for content creators
and unlock newWith overgamers currently,
we expect 50mn100mn could be Web3
users by 2025, withestimates rising as
Web2 hits include
tokens

2-4 billion
users globally by2030, 50% of
which could be
DLT-linked

monetization
opportunities

TRILLIONS OF VALUE
Almost anything of value can be tokenized and tokenization of financial and real-world assets could be the “killer use-case”
blockchain needs to drive a breakthrough. We forecast $4 trillion to $5 trillion of tokenized digital securities and $1 trillion of
distributed ledger technology (DLT)-based trade finance volumes by 2030.

Opportunity
Tokenization Total Addressable Market (US$ Trillions)

Source: SIFMA, Preqin, Savills, Finadium, and Valuates

2030E non-financial corporateand quasi sovereign debt

2030E realestate funds

2030E private equity/
venture capital$187 trillion$20 trillion$7 trillion

2030 Estimate$1.5 trillion
Tokenized

2030 Estimate$0.7 trillion
Tokenized

2030 Estimate$1.9 trillion
Tokenized© 2023 Citigroup

2030E securities
financing and collateral

2030E tradefinance$42 trillion$12 trillion

2030 Estimate$0.5-$1.0 trillion
Tokenized

2030 Estimate$1.0 trillion
Tokenized

TECHNOLOGY ENABLERS
Blockchain promises something that is in parts a replacement of a current functioning system and in parts new capabilities
and operating models. From a technology specification perspective, blockchain needs to have transaction scale and throughput,strong guarantees of security, on-chain identity, privacy, Oracles, bridges, and good user experience.

Technology Drivers

Description

How It Helps Blockchain Adoption

Decentralized
Identity

Leverages blockchain while
enabling data privacy andprotection for individuals

Drives adoption by providing individuals the ability toaccess and navigate the digital ecosystem leveraging selfsovereignty and sharing details on a "need-to-know" basis

Zero Knowledge
ProofsSeparate knowledge fromverification

Allows for scaling by moving computations off-chain in averifiable way and privacy by keeping data, transactions,and computations hidden but publicly verifiable

OraclesServe as a bridge between
the blockchain ecosystemand external data sources

Allows blockchain applications to access data stored
outside the blockchain

Secure Bridges

Enable users to moveassets from one blockchain
to another

Drives adopooin by enabling interoperability between
different networks and avoiding siloed ecosystems

LEGAL ENABLERS
Contract creation and execution can be a painful process, making it ripe for disruption. Technology-enabled smart
legal contracts, are legally binding agreements with obligations performed automatically by a computer. They are
dynamic, connect to outside data sources, and allow for human involvement where necessary.

Uses Cases for Smart
Legal Contracts
Real Estate/PropTech

Using distributed ledger
technology (DLT) in smart
legal contracts can:

Escrow Payments

Increase longivity and independenceInsuranceEnhance trust and eliminate silos

Supply Chains

Create a tamper proof record

 anaging Breaches in
M
Service Level Agreements

Increase security

Derivative Agreements

Create a single source of truth

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Citi GPS: Global Perspectives & Solutions

March 2023

Contents
Introduction

8

Billions of Users

20

Trillions in Value

58

Trade Finance76[C.] Technology Enablers

86

How Big Is the Market for Emerging Technologies? .............................. 9
Four Key Takeaways From This Report ............................................... 10
Defining Blockchain, DLT, and Web3 ................................................... 13
Defining Tokenization? ......................................................................... 14
Challenges Bringing Real World Assets On-Chain .............................. 16
A Conversation With Henri Arslanian on the ChatGPT Moment for
Blockchain ................................................................................................... 18
Central Bank Digital Currencies (CBDCs) .................................................. 22
Key Takeaways on CBDCs .................................................................. 22
Why CBDCs? ....................................................................................... 23
What Are CBDCs? ................................................................................ 24
To DLT or Not to DLT? That Is the CBDC Question ............................ 26
Risks and Implications of a CBDC ....................................................... 27
Case Studies ........................................................................................ 28
A Conversation With Jessica Renier on CBDCs ........................................ 33
Gaming ........................................................................................................ 35
Five Key Takeaways on Gaming and Web3 ........................................ 35
Increasing Demand for Digital Experiences ......................................... 37
A Conversation With Ryan Wyatt on Gaming and Web3 ........................... 38
Social .......................................................................................................... 40
A Conversation With Stani Kulechov on Decentralized Social as a Driver for
Blockchain Adoption.................................................................................... 42
Art, NFTs, and The Metaverse.................................................................... 46
Traditional Art on the Blockchain .......................................................... 46
Five Key Takeaways on Blockchain and Traditional Art ...................... 46
A Conversation With Nanne Dekking on the Art of Tokenization ............... 48
New Forms of Digital Art (NFTs) ................................................................. 52
How Do NFTs Work? ............................................................................ 52
Bringing Collectibles On-Chain ............................................................ 53
Adoption of Web3 by Consumer Brands .............................................. 53
A Conversation With Samuel Falic on Authenticating Rare Wines andSpirits With NFTs ........................................................................................ 56
Tokenization of Digital Securities ......................................................... 58
Benefits of Tokenization ....................................................................... 63
Beyond Tech: What Is Needed to Scale Securities Tokenization? ...... 69
A Conversation With John Wu on Tokenization ......................................... 71
A Conversation With Morgan McKenney on the Future of Finance andBlockchain ................................................................................................... 73

Trade Finance and the Opportunity ...................................................... 76
Inefficiencies in Trade Finance: The Old and The New ....................... 77
Blockchain for Trade Finance ............................................................... 79
Digital Money 2.0 for Trade Settlement ................................................ 80
A Conversation With Bob Blower on the History and Future of Trade
Finance ....................................................................................................... 82
A Conversation With Sunil Senapati on Blockchain Use in Trade Finance 84
Decentralized Identity.................................................................................. 89© 2023 Citigroup

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Citi GPS: Global Perspectives & Solutions

Need for Decentralized Identity ............................................................ 90
Identity in the Web3 World ................................................................... 92
How Does Decentralized Identity Work? .............................................. 94
Risks of Digital Identity ......................................................................... 97
A Conversation With Dr. Ruth Wandhöfer on Why Digital Identity Matters to
Web3 ........................................................................................................... 99
Zero-Knowledge Proofs ............................................................................ 103
What Is a zk-SNARK? ........................................................................ 104
Specific Zero-Knowledge Proof Use Cases ....................................... 106
Trusted Setups in Zk-SNARKS .......................................................... 109
A Conversation With Prof. Silvio Micali on Zero-Knowledge Proofs andScalability .................................................................................................. 111
A Conversation With Zooko Wilcox on Application of zk-SNARKS .......... 114
Blockchain Oracles ................................................................................... 115
Oracles: A Prerequisite for Blockchain Use Cases ............................ 115
How Does a Blockchain Oracle Work? .............................................. 116
Types of Blockchain Oracles .............................................................. 116
Importance of Oracles in Blockchain and Web3 Applications ............ 117
Potential Risks and Challenges .......................................................... 119
Secure Bridges .......................................................................................... 120
How Do Bridges Work? ...................................................................... 121
Bridge Exploits .................................................................................... 122
Moving Beyond Asset Bridges............................................................ 123
Different Types of Interoperability Protocols ...................................... 123
Looking Ahead .................................................................................... 126[D.] Legal Enablers

127

Appendix 1: How Real-World Assets Are TokenizedAppendix 2: Digital FMIs Scaling Infrastructure
Appendix 3: DAOs as a Foundation for Web3

151
153
156

Smart Legal Contracts .............................................................................. 127
Smart Contracts vs. Smart Legal Contracts ....................................... 129
Anatomy of a Smart Legal Contract ................................................... 131
Do Smart Legal Contracts Need DLT? ............................................... 134
Use Cases of Smart Legal Contracts ................................................. 136
Regulatory Considerations ................................................................. 141
SLCs and the Future .......................................................................... 143
A Conversation With Aaron Powers on How Smart Contracts Can
Transform Finance .................................................................................... 146© 2023 Citigroup

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Introduction
Disruptive technologies change the state of doing things: how we live, work, spend,
invest, interact, and more. Blockchain — and the associated Web3 concept — are
disruptive technologies. They attract controversy and debate, as well as inspire
dreams and disillusionment. In this report, we explore some of the key drivers thatwill take blockchain technology to the next billion users, and potentially trillions ofdollars of economic activity.
As classically defined by Clayton Christensen in The Innovator’s Dilemma:“Disruptive technologies bring to a market a very different value proposition thanhas been available previously. Generally, disruptive technologies underperform
established products in mainstream markets. But they have other features that a
few fringe (and generally new) customers value. Products based on disruptive
technologies are typically cheaper, simpler, smaller and, frequently, moreconvenient to use.”1
Blockchain fits many of the characteristics set out by Christensen — tokenized,
programmable assets with atomic settlement (instant and simultaneous) are adifferent value proposition than existing fiat money or financial assets. The adoptionof public blockchains (e.g., cryptocurrencies), has happened initially in niche
communities, such as the technologically savvy, as well as among those living incountries that are peripheral to core financial markets, including Argentina, Nigeria,
and Ukraine.
However, blockchain as a disruptive technology is different from many others. As it
involves the transfer of financial value, it enters the realm of money — a highly
regulated domain in most countries. Hence, while the blockchain revolution beganon the periphery, to be powered to mass adoption it needs the support of sovereign
institutions, regulated financial institutions, and large companies — as well as the“degens” and the rebels, who are core to innovation, change, and progress.
By 2030, the growth of blockchain will bemeasured in billions of users and trillions ofdollars

Those who have been promised the benefits of blockchain for many years might roll
their eyes. But this time may well be different. To be sure, blockchain is not about tohave a ChatGPT moment. Blockchain is a back-end infrastructure technology, moreakin to cloud computing than artificial intelligence (AI) or the Metaverse, which havea more prominent consumer interface. So, why do we believe the growth ofblockchain by 2030 will be measured in: (1) billions of users, and (2) trillions ofdollars?
 Billions of Users: Blockchain user numbers will be boosted by daily activity —spanning money, games, social, and more. Successful blockchain adoption will
be when it has a billion-plus end users who do not even realize they are using
the technology.

– Money: Countries with populations totaling approximately 2 billion are likely toexperiment with distributed ledger technology-linked (DLT-linked) central bankdigital currencies (CBDCs).
– Games: The next generation of gaming will include tokenized assets, initiallydriven by Asian games and appealing to power users.

1 Clayton M. Christensen, The Innovator’s Dilemma: When New Technologies Cause

Great Firms to Fail (Harvard Business Review Press, 1997, updated 2016).

© 2023 Citigroup

March 2023

Citi GPS: Global Perspectives & Solutions– Social: Micropayments, including in Metaverse games, will likely beblockchain-based. Large consumer brands will also help power Web3
adoption.
 Trillions of Dollars: We estimate up to $5 trillion could move to newer digitalmoney formats such as CBDCs and stablecoins by 2030, of which roughly half
could be DLT- or blockchain-linked. Legal reforms and greater interoperability
could drive up to $1 trillion of tokenization in global trade finance by 2030.
Securities and funds are the big private-sector, tokenization prize. We estimate
up to $5 trillion of non-financial corporate and quasi-sovereign debt; repo,
securities financing, and collateral market; and alternative assets, such as realestate, private equity (PE), and venture capital (VC), could be tokenized by 2030.
Industry estimates for total tokenization volumes are even higher.

 Technology and Legal: Bringing billions of users and trillions of dollars ofinvestments into the blockchain ecosystem requires a change in thetechnological and legal plumbing that is needed to support, maintain, andoperate the system. These changes could include blockchain-based identity
solutions, privacy solutions enabled by zero-knowledge proofs, Oracles toconnect/feed real-world data on-chain, and of course, a strong regulatory andlegal framework that would allow individuals and institutions to embrace this newtechnology.

How Big Is the Market for Emerging Technologies?
Out of all emerging technologies, blockchain
has the highest total addressable market
growth forecast

Blockchain and Web3 today are relatively small markets (see Figure 1). Whenassessing total addressable market (TAM) size and time to impact (i.e., the numberof years to reach early majority adoption), we look at several sources. The largest of
the emerging technologies today is AI, a general-purpose technology with use
cases across nearly every aspect of society and the economy, impacting bothconsumer-facing and infrastructure layers.
Mass adoption for AI could be as early as 2-4 years driven by the rapid recent
increase in data availability and computing power, improved algorithms, and models
that have led to products such as ChatGPT, which have caught mass publicattention. Blockchain, on the other hand, could take longer for mass adoption (6-8
years perhaps) due to the need for collaboration among participants,
standardization of platforms, as well as interoperability, and compatibility withexisting systems and software.
However, while challenges exist, including the current, poor consumer user
experience and high cost of integration with existing institutional structures,consensus forecasts for TAM growth are the highest for blockchain among
emerging technologies. Why? Because large institutions, governments, andcorporations are now beginning to adopt it, albeit initially in trials and proofs ofconcept. As we discuss in the report that follows, we may be at the tipping point forchange in this domain.
Notably, in this report we focus on the real-world and tangible use cases ofblockchain technology — not the speculative, trading side of the business, which
often attracts much media attention due to its color and volatility.

© 2023 Citigroup9

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Figure 1. Estimating the Impact of Emerging Technologies: Revenue TAM and Time to Impact

Note: Size of bubble represents estimated 2027 Total Addressable Market (TAM) in billions of U.S. dollars.
Source: Citi GPS

Four Key Takeaways From This Report
Blockchain will have a significant impact on
digital money, followed by gaming as well as
art and collectibles

 Billions of Users: A key area where blockchain/DLT will make a significant

impact is in digital money. The world of money is being turned on its head with
CBDCs of major currencies coming our way towards the second half of thisdecade, with many CBDC projects being partially DLT-linked. Get ready for
CBDC versions of the euro (EUR), British pound (GBP), and Indian rupee (INR).
Together, these four jurisdictions constitute more than 25% of the global
population and 22% of global bank deposits. Hence, we think CBDCs could haveat least 2 billion users and $5 trillion-plus in circulation, and half could be using
partly DLT-linked models.
There are big figures for gaming, with over 3 billion gamers in 2022 — anenormous slice of the population. This means only a relatively small proportion ofgamers need to participate in blockchain-based games for them to be a success.
Gaming will lead the way in “making blockchain big” from a bottom-up
perspective. A small number of the most active gamers from Asia will likely adopt
the next generation of Web3 games in the next 1-2 years, triggering an inclusionof tokenization aspects by leading Western and global games studios. The typicalgamer does not care about the underlying technology, blockchain, cloud, orotherwise. Web2 or mass market consumer brands will be the key driver of
adoption — so Web3 will not replace Web2 but will nestle inside it, Russian dolllike.
Art and collectibles are also moving onto the blockchain because these industries
resonate with one of blockchain’s key features, namely trust and provenance, as
well as the ability for a broader range of owners to invest via fractionalization.

© 2023 Citigroup

March 2023

Citi GPS: Global Perspectives & Solutions

Similar to the arts, entertainment industries such as music, will use blockchain
technology in the form of non-fungible tokens (NFTs). This provides a new pathfor content creators (be they artists, singers, dancers, or fashion brands) toconnect directly with their fans or audiences, affording these creators and brands
new revenue streams. Brands from Nike to Uniglo are already embracing NFTs
and in-game assets in an attempt to capture younger generations and keep theirbusinesses relevant. In fact, Amazon is planning to launch an NFT marketplace
for its 167 million Prime users in the U.S. in 2023. It will be interesting to see how
those figures increase if this development goes global.
We estimate tokenized private markets willreach up to $5 trillion by 2030

 Trillions in Value: Tokenization of financial and real-world assets is en route.

Moreover, almost anything of value can be tokenized — from wine to financial
assets to everything in between. Tokenization of financial and real-world assets
could be the killer use case blockchain needs for breakthrough, especially for
private market assets. Despite currently having a marginal market share (lessthan 0.1% in annual issuance as of now), we project tokenization to grow by afactor of over 80x in private markets and reach up to around $4 trillion in value by2030. The significant benefits of tokenization, especially for private funds andsecurities, will likely drive demand-side uptake, leaving behind expensive
reconciliations and settlement failures while embracing operational efficiencies,
fractionalization, and accessibility to a wider range of market participants.
Beyond private market tokenization, we expect $1 trillion of the repo, securities
financing and collateral market could be tokenized by 2030.
Later in the report, we take a dive deep into tokenization for certain types offinancial assets, including digital securities. We examine the main ingredientsbeyond the blockchain tech need to scale securities tokenization, namely anentirely digitized workflow, support from traditional finance (TradFi) layers, techneutral laws, standardized taxonomy, interoperable platforms, and standards, toname just a few. As a standalone, tokenization may offer positives, but thebenefits need to offset the integration costs of adding the new disruptive
technology to the existing legacy stack — and this is as much a coordination andculture question as a tech one.

The big inflection point for the digitization of
trade finance is an upcoming UK legal
reform, which will make the acceptance ofdigital documents acceptable undercommon law — a solid first step for
blockchain deployment

In the world of financial services, trade finance and blockchain have had an
uncomfortable relationship in recent times, with many projects ending up in thegraveyard. But change may be underway: Encouraging regulatory developments
designed to pave the way for trade documentation to be digitized are solid firststeps for blockchain deployment. The big inflection point for the digitization of
trade finance is the upcoming UK legal reform that will make the acceptance ofdigital documents legal under common law — a huge step for the global tradefinance industry, as around 80% of global volumes are governed by English law.
 Technology Enablers: There is a long shopping list of technological

specifications that blockchain must have — ranging from transaction scale tostrong user experience (UX) and user interface (UI) — to reach billions of users,
combined with four key technology drivers that will drive mainstream blockchain
adoption:– Decentralized Digital Identities: Give users power and control over theirpersonal data, including how and by whom it is used. Digital identities form the
backbone of any digital ecosystem and are the core building block to deliver
the decentralization promise enshrined in Web3.

© 2023 Citigroup

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– Zero-Knowledge Proofs: Preserve privacy while still being able to use theunderlying data, which has been one of the major stumbling blocks for publicblockchain adoption faced by large corporations. Zero-knowledge proofs
provide an elegant solution that capitalize on the promise of blockchain withoutcompromising on the confidentiality and privacy of information.
– Oracles: Bridge the world of blockchain to real-world data off-chain. They are
the mega connector between these two worlds. Blockchain will go nowhere
without them.
– Secure Bridges: Offers a solution enabling users to move assets from one
blockchain to another. As different blockchains are being built for different use
cases on different chains, there is a need for these to interoperate and not beworking in silos, to avoid fragmentation and limited adoption.
 Legal Enablers: The next wave of contracts (“Contracts 2.0) is underway withthe development of smart legal contracts (SLCs). A smart legal contract isdefined by the UK Law Commission as “a legally binding contract in which someor all of the contractual obligations are defined in and/or performed automaticallyby a computer program.”2 DLT brings unique benefits to the table compared toconventional web platforms, e.g., longevity of decentralized ledgers that fit wellwith the nature of legal agreements; enhanced levels of security through the useof cryptography and hashing techniques; and the provision of a single source of
truth through their consensus mechanism and tamper-proof nature. As such,
DLTs would be the most favorable technology to underpin SLCs.

Regulatory analysis spearheaded by the Law Commission in the UK andemerging regulatory development, which will recognize the digitization of trade
documentation, have lowered the barriers to adoption. According to Aaron
Powers, co-founder and CEO of Hunit, these contracts will provide a whole new
set of rails for global commerce and finance to run on. There are multiple use
cases ranging from property to service level agreements. However, we believethat given the nature of these contracts — they are based on conditional logic,
meaning that if X happens then Y follows — they will be suited for more basic
agreements.

2 UK Law Commission, Smart Legal Contracts: Summary, November 25, 2021.

© 2023 Citigroup

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Citi GPS: Global Perspectives & Solutions

Defining Blockchain, DLT, and Web3
Blockchains are a peer-to-peer network based on cryptography that creates adecentralized, immutable ledger that records information and transactions free fromany central authority. Blockchains can be either public or private.
Distributed Ledger Technology (DLT) refers to a digital database held andupdated by distributed network participants independently, without any central
authority. Notably, while all blockchains are distributed ledgers, not all distributed
ledgers are blockchains. Below, we summarize key differences between
blockchains and DLT:
Figure 2. Distributed Ledger Technology vs. Blockchain

Source: Blockchain Council, 101 Blockchains, Citi GPS

Web3, as it is often called, refers to the third iteration of the internet and is based onownership and decentralization, which is facilitated via blockchain. Web3
decentralization could result in a more transparent environment and help address
issues of ownership and control from the Web2 world.
As we explain in this report, a key driver of Web3 and blockchain adoption will be
Web2 consumer companies and established traditional financial institutions. We
believe Web3 will run in parallel with Web2 and in some cases will be nested inside
it — think of the Russian Matryoshka nesting dolls!

© 2023 Citigroup

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Figure 3. A Framework for the Evolution of the Internet: Web1 vs. Web2 vs. Web3

Source: ResearchGate, Wordpress, Citi GPS

Defining Tokenization?
Tokenization refers to the creation of tokens,which are pieces of code on a blockchain, torecord information about underlying assets,
including their attributes or characteristics,
status, transaction history, and ownership

Tokenization refers to the creation of tokens, which are pieces of code on a
blockchain, to record information about underlying assets and liabilities including
their attributes or characteristics, status, transaction history, and ownership. Tokens
enable the trade and transfer of ownership and titles of value directly via a digitalledger. At a high level, tokenized assets can be separated into two categories: Real-World Assets: These represent highly illiquid, bespoke assets such as realestate, art and collectibles, agriculture, climate assets, and intangible assets likecarbon credits and intellectual property. Real-world assets could also include
financial assets that are not traded frequently or easily, such as trade invoices,private loans, or mortgages, and are not usually categorized as “securities.” Financial Assets: These refer to the creation of tokens that represent existing

financial value such as money, stocks, bonds, commodities, and funds. (See The“Trillions in Value” section for a deep-dive analysis of this important topic.)

In theory, almost anything with monetary value can be tokenized.3 In this report, we
argue that among the best use cases of tokenization will be money (CBDCs) andprivate financial assets, especially illiquid ones, and over time, in-game assets.

Sizing the Tokenization Opportunity
Tokenization of real-world assets unlocks a
new way to monetize illiquid assets

According to a BCG and ADDX study, tokenization of global illiquid assets is
estimated to be a $16 trillion business opportunity, or nearly 10% of global GDP by
2030.4 This includes $3 trillion in home equity, $4 trillion in listed/unlisted and other
equity, $1 trillion in bonds and investment funds, $3 trillion in other financial assets,
and $5 trillion in other tokenizable assets.

3 Ravi Chamria, “Comprehensive Guide on Tokenized Real-World Assets,” Government

Blockchain Association, December 1, 2022.

4 Sumit Kumar et al., “Relevance of On-Chain Asset Tokenization in Crypto Winter,”

BCG x ADDX, August 2022.

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The total addressable market for tokenization could, at least theoretically, be as
high as the total value of global assets, running into the hundreds of trillions ofdollars. But do we really need everything to be on the blockchain?
– JOHN WU, PRESIDENT OF AVA LABS5
 We believe the private/unlisted market is more suitable for blockchain adoption

due to the resulting liquidity, transparency, and fractionalization. For public
securities across sectors, tokenization will also provide other benefits in areas
such as efficiency, collateral use, golden sources of data, and ESG tracking.

 We are very early in the process of these products growing but, based onconversations with internal and expert domain experts, we forecast $4 trillion to$5 trillion of tokenized digital securities by 2030, assuming 1% of corporate andquasi-sovereign bonds, 7.5% of real estate funds, and 10% of PE/VC funds and
2% of repo, securities financing and collateral markets are tokenized.

 Accompanying securities in tokenization will be the trade finance market, which

could see up to $1 trillion of DLT-based volumes, or around 8%-10% of global
trade finance volumes, by 2030.

 We will need the support of large financial institutions, which are increasingly

focused on tokenization and the support of the law, where notable changes aretaking place in areas such as English law, which governs most international tradefinance.

Why Tokenize Real-World Assets?
Tokenization of real-world assets unlocks a new way to monetize illiquid assets. For
example, a numismatist or philatelist can tokenize their rare collection of coins or
stamps by fractionalizing and sharing ownership of assets with buyers across theworld and delivering custody of underlying assets to a museum for display andsafekeeping. This could help them retain partial ownership and also unlock liquidity.
Artists can also create videos on social media and sell NFTs representing rights to
use their videos for marketing and commercial activities, thereby generating yield on
their intellectual property (IP) without giving a share to centralized platforms.
Tokenization also unlocks new ways of financing infrastructural assets — roads,
heavy machinery, and public goods — and opens new financing avenues for small
companies and small and medium enterprises (SMEs) through direct-to-retaildecentralized finance (DeFi) channels. Tokenization offers possibilities forblockchain technology to solve traditional problems, such as lack of transparency,
liquidity, and democratized access. Tokenization also helps improve the efficiency ofholding real-world assets on investor balance sheets, by potentially reducing
liquidity capital asks and easing the collateralization process.

5 Citi Global Insights, “Bridging Banks and Blockchain: Avalanche Deep Dive,” webinar,

October 19, 2022.

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 Real Estate: Traditional real estate often struggles with poor transparency,

illiquidity, and multiple intermediaries. Blockchain could be a good fit as a single,
shared source of truth in a market with multiple players, all working withoverlapping data and the need for constant reconciliation. Tokenization could
also help reduce minimum investment amounts and open up asset discovery.

 Art and Collectibles (e.g., wine, cars, Pokemon cards, etc.): Tokenization ofart and collectibles can help increase transparency, act as a proof of provenance,increase liquidity, and offer decentralized ownership, including the ability to
fractionalize the asset to a group of investors. We discuss this more in detail in
the Art and Collectibles section.

 Unconventional Commodities: Commodities ranging from gold to agricultural

products are increasingly being brought on-chain.

– Agriculture: Platforms like Agrotoken use Oracles and real-world proof ofgrain reserves to create stablecoins backed by commodities such as soy, corn,
and wheat, offering new funding solutions.
– Climate-Focused Projects: Blockchains can help record and transfer carbon
credits reliably between suppliers and those with demand while also reducing
the entry threshold for carbon trading.

Challenges Bringing Real World Assets On-Chain
A fragmented regulatory landscape and alack of a unified taxonomy are major
scalability hurdles for digital assets

Common scalability hurdles for digital assets include a fragmented legal andregulatory landscape across different jurisdictions and a disunified taxonomy orclassification standard at global scale. The tokenization of real-world assets may
also encounter additional challenges, which we elaborate on below:
 Interoperability Issues: Having multiple blockchains can lead to interoperability

problems while interacting with centralized backend systems outside blockchain
ecosystems, as well as across new architectures built on different chains.

 Lack of Experienced Custodians: There is a limited number of third parties withexpertise in safe-keeping tokens and underlying real-world assets.

 Duplication and Unauthorized Tokenization: While information on publicblockchain is publicly visible, there is a lack of surveillance and standard practice
to slash duplicated or unauthorized tokens linked to underlying assets.

 Real-World Liquidity Risks: On-chain liquidity tends to be deeper than that in

the real world, likely due to fractionalization and democratized market access.

 Elevated Cyber Risk: More technological development is needed to enabletransparency on blockchain without revealing the actual information of borrowers
and asset owners. The most widely used present solution for privacy are zeroknowledge proofs (ZKPs). Tokenization also creates additional risk related totheft and loss of tokens due to cyberattacks on blockchains and digital wallets.

 Difficulty of Full Disintermediation: Internet-of-Things (IoT) technology andOracle networks used for asset appraisal and status reporting of underlying realworld assets are still at a nascent stage and may take time to reach large-scalecommercialization. Until then, many crucial steps such as evaluation, accounting,and reporting may still rely on human expertise and manual labor just liketraditional finance.

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As the infrastructure supporting tokenization continues to develop and mature, we
expect to see more blockchain-native assets, with their entire life cycle being
managed and completed on-chain.

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A Conversation With Henri Arslanian on the
ChatGPT Moment for Blockchain
Q: Blockchain has been talked about for several years. What is holding it
back? What is the ChatGPT moment for blockchain/Web3 adoption?
Henri: We have seen a lot of discussions around blockchain and distributed ledger
technology since 2015. However, blockchains need to be seamlessly integrated into
our daily activities for mass adoption. The technology needs to be easy to use forthe common person, such that they do not even know when they are using it.
For example, when we connect to WiFi on our smartphones, we access the internet,
without understanding the protocols and infrastructure operating behind the scenes.
A similar integration is needed for blockchain and Web3 tools. We are not there yet.

Henri Arslanian is the co-founder andmanaging partner of Nine Blocks CapitalManagement, an institutional-grade hedge
fund manager focused exclusively on digitalassets. Henri was previously a partner andglobal crypto leader at PwC. Henri is also
the author of numerous best-selling crypto
and fintech books, including The Book of
Crypto (Palgrave, 2022), which became a
global top 10 bestseller in financial services,
and The Future of Finance (Palgrave, 2019),
which became not only a global top 10 bestseller in financial services but was also
recognized as one of the “Best FinTech
Books of All Time” by BookAuthority.

More recently, we are seeing interesting developments. For example, Coinbase
launched an Ethereum layer 2 solution, called Base, which is designed to offer adeveloper-friendly platform for people to build decentralized applications (dApps) byaccessing the front-end of the Coinbase interface, without actually knowing if they
are dealing with DeFi, NFTs, or other layer 2 solutions.
In my view, blockchain offers tremendous benefits, with potential use cases
spanning digital identity, digital proof of address, digital birth certificates, digitalacademic degrees, and digital land title deeds. Development of blockchain for anyof the above use cases could lead to a significant boost in mainstream adoption.
In the near term, I am most excited for the gaming sector. The gaming industry has
over 3 billion users already. Today, several games operate in the Metaverse or a
Metaverse-like ecosystem, where blockchain can be adopted for in-game
purchases of new skins for avatars, weapons, real estate, or other accessories. I
see a lot of scope for synergies between the gaming and digital asset industries.
Q: Which industries are likely to be most and least impacted by blockchain in
the next 5-10 years?
Henri: In my view, every industry is likely to be impacted by emerging trends inblockchain and digital assets. Industries unable to quickly adapt to change, or ones
with several intermediaries, are likely to be most impacted. Humans, by nature,
adopt a protectionist approach when faced with radical change. A relatable example
could be the early response from traditional taxi operators across major cities
following the introduction of Uber services.
Today, we see a similar situation with law societies and legal bodies taking action
against LawTech and RegTech startups. In my opinion, traditional legal services areoften cumbersome, with large volumes of complicated documents requiring timeand money. Startups are exploring the use of AI, machine learning, and blockchain
to make these services more accessible and easier to use for the general public.
Embracing blockchain could help remove process inefficiencies. However, industry
bodies are often looking to protect their members (e.g., lawyers and notaries)
against making access to justice more accessible. This is similar to how the taxi
unions tried to ban and take action against Uber in its early days.

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Looking at other industries, traditional auditing processes rely on a sampling oftransactions, as it is very difficult to review all transactions, especially in large
companies. Accounting firms and standard setters can explore the use ofblockchain, enabling continuous audits by putting transactions on-chain.
Over the next 5-10 years, I see great potential for an autonomous future. We could
have self-driving cars transport us from location A to B. The car I own could thenself-drive other passengers when I am not using it and thus bring me a return on myinvestment. This example can be extended to other verticals as well. The car could
be connected to the financial ecosystem, where it periodically checks the best
refinancing rates in the market. It could also help find the cheapest and mostsustainable source of energy for charging. The list goes on.
Most of these examples are of automation or AI, but for transactions to work, thebackend systems need to be linked to some form of blockchain or DLT. Blockchain
combined with AI can have tremendous synergetic benefits.
Q: Can central bank-issued digital currencies (CBDCs) play a significant rolein driving blockchain adoption in the years ahead?
Henri: In my view, we are likely to see mainstream adoption and usage of CBDCs
in the next few years, both for retail and wholesale use cases. The unfortunate
events around the crypto collapses in 2022 and the ensuing concern and fears in
the digital asset market are only likely to accelerate CBDC development.
According to Bank of International Settlement (BIS) data, over 90% of the global
central banks are exploring or running pilots and experiments for CBDC use.
Countries such as the Bahamas and Nigeria have already launched their CBDCs,
known as Sand Dollar and eNaira, respectively. Several other countries, like India,
are running pilots. The e-CNY pilot in China has already scaled to several hundred
million users.
CBDCs are likely to remain a political and societal debate in the foreseeable future.
Proponents of CBDCs cite advantages such as reduction of corruption, which
ordinarily occurs in paper-based money that is not easily traceable. Tax evasion
prevention could be another benefit, as CBDCs help eliminate the shadow
economy. On the flip side, critics cite concerns over user privacy and the potential
for excessive government controls. However, CBDCs are a key area to monitor,
especially the progress in emerging and developing markets like India, China, andAfrica.
Q: How can we protect ourselves in a digital world with deepfakes andskepticism? Can blockchain help build trust?
Henri: Looking ahead, I see deepfakes and frauds continuing to grow in quantityand quality. The use of blockchain can help mitigate some concerns by establishingauthenticity and provenance.
Blockchain is also important for the content creator economy. Today, Web2
platforms own user-created content. This poses risks should the platform operator
unilaterally decide to restrict or delete it. Web3 can help transfer ownership back to
the users. Web3 can also help create a content-vetting mechanism, using theindependent users from its community model, to help detect fakes and frauds.

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Billions of Users
Some of the key areas where blockchain-based products can make a significant
impact on consumers will be in money, gaming, and social. In this chapter, we
discuss how blockchain is revolutionizing this space, why is it happening now, andhow it could reach billions of users.
Nearly 2 billion individuals from India,
Europe, and the UK could use CBDCs,
which may be partly DLT-linked by 2030

First, let us look at digital programmable money (i.e., central bank digital currencies—CBDCs). There will likely be tokenized versions of major currencies such as theeuro (EUR), British pound (GBP), and Indian rupee (INR) in use during the 2020s,
in addition to the Chinese renminbi (RMB), which has already been trialed for acouple of years. Together, these four jurisdictions constitute more than 50% of the
global population and 35% of global bank deposits.
We discussed CBDCs in detail in a previous Citi GPS report, titled Future of Money:
Crypto, CBDCs, and 21st Century Cash. Since then, interest in CBDCs has only
increased among policy makers. In recent months, we have had large country
central banks announcing CBDC plans, including India and the EU.
The technology choices are still being ironed out, but distributed ledger technology(DLT) and blockchain options are being considered. About 20% of deposits are
forecast to move to tokenized money formats.6 Hence, we think CBDCs overall
could have 2 billion users and over $5 trillion of value in circulation — of which
about half could be on a DLT-linked model.

In the next 1-2 years, we could see 100
million gamers move to blockchain-based
games

Gaming could potentially be one of the biggest segments for bottom-up Web3
consumer adoption. In 2022, over 1 million unique active wallets connected to gamedApps daily in 2022.7 With the advent of improved Web3 games, especially from
Asian studios in the next 1-2 years, we could see the most active gamers (nearly
100 million “whales”) move over to blockchain-based games. This could trigger arush by mainstream gaming studios to incorporate blockchain and tokenization
elements in their games.
The emergence of Web3 and the growth of the creator economy empowers users to
own their content. And Web2 companies are getting in on the action with one social
media forum onboarding millions of users into Web3 through their “collectible
avatars” (NFTs).

We believe new technologies like blockchain and NFTs can allow creators tobuild deeper relationships with their fans…
– NEAL MOHAN, CEO OF YOUTUBE8

6 Bank of England, “New Forms of Digital Money: Discussion Paper,” June 2021.

7 Sara Gherghelas, “DappRadar x BGA Games Report — 2022 Overview,” DappRadar,

January 26, 2023.

8 Andre Beganski, “New YouTube CEO Is Bullish on Web3 Tech Like NFTs and theMetaverse,” Decrypt, February 20, 2023.

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Consumer brands and fashion labels like Adidas, Nike, Burberry, and Gucci areembracing NFTs and in-game assets in an attempt to be part of the next big culturaland marketing trend. In April 2023, Amazon plans to launch a NFT marketplace forits 167 million Prime users in the U.S., and this initiative could go global thereafter.9

9 Michael Bodley, “Amazon NFTs Will Be Tied to Real-World Assets, Token Possible,”
Blockworks, March 6, 2023.

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Central Bank Digital Currencies (CBDCs)
Key Takeaways on CBDCs
Until now, only smaller CBDC projects havebeen based on DLT; however, in the coming
years, we could see some major central
bank CBDC (or parts of it) based on DLT

India, the UK, and Europe are all planning tolaunch CBDCs — potentially DLT-linked —during the 2020s

1.

More Big Countries Catching Up: Initially, only a few smaller island nations
and Nigeria launched CBDCs and China was in advanced stages ofresearching and piloting a CBDC. Now, major countries in terms of economy,
currency, and population size are warming up to the idea of CBDCs. For
example, the central banks of India, the UK, and Europe have been making
plans to launch CBDCs (potentially DLT-linked) before the end of the decade.

2.

Billions of Users: Taking into account only Europe, India, and the UK, there
are about 2 billion individuals and businesses that could be using some form of
CBDC. Businesses in countries with multi-CBDC bridge arrangements would
also use DLT-linked CBDCs, although their domestic CBDCs would be nonDLT-linked.

3.

Technology: Until now, only the smaller CBDC projects have been based on
DLT. However, we can envision some major banks issuing DLT-based (orpartially DLT-based) CBDCs and India’s retail CBDC could have some sort of
DLT. China’s participation in the mCBDC Bridge is based on a DLT.

4.

Money Mobilized: Central banks estimate up to 20% of deposits could
transition to newer digital money formats.10 We could have $5 trillion of CBDCs
circulating in major economies in the world in this decade, half of which could
potentially be DLT-linked.

CBDCs are increasingly relevant as a financial policy and plumbing question.
Collectively, the EUR, GBP, and INR constitute around 15% of the world’s monetarybase (i.e., M0, which is currency in circulation and money being held by banks inreserves), or $15 trillion, and 22% of the global narrow money (i.e., banknotes andcoins, plus overnight deposits), at $71 trillion. Central banks estimate up to 20% of
the deposits could transition to newer digital money formats.11 We could have $5
trillion of CBDCs circulating in major economies in the world in this decade, of whichhalf could be DLT-linked.
Besides individuals, millions of businesses and importers/exporters will use bilateralor multi-CBDC (mCBDC) arrangements developed between different countries. For
example, the mCBDC Bridge between China, Hong Kong, Thailand, and the UAE
uses DLT and is piloting different use cases, starting with cross-border foreignexchange (FX) trade settlement (discussed in detail in the “Trade Finance” section).
Interest in CBDCs continues to increase among policymakers. Central banks’
accelerating interest has been driven by the announcement of a private sector
stablecoin, Libra, led by Meta (then Facebook); China being in advanced stages ofwork on an e-RMB (or e-CNY); the growth of digital finance in general, and theacceleration of this mega-trend during the COVID-19 pandemic.

10 Bank of England, “New Forms of Digital Money: Discussion Paper,” June 2021.
11 Ibid.

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Figure 4. Positive and Negative Stance of Central Banks on CBDCs (Number of Speeches)

Note: Search on “CBDC,” “digital currency,” and “digital money.” Classification based on authors’ judgement.
Score takes value of -1 if speech stance clearly negative or if explicitly said there was no specific plan at present
to issue digital currencies. Value of +1 if speech stance clearly positive or project/pilot launched/in pipeline.
Other speeches (not displayed) have been classified as neutral. The material is available on the BIS website freeof charge: www.bis.org.
Source: Citi GPS, BIS Working Paper "Rise of the Central Bank Digital Currencies: Drives, Approaches, andTechnologies"

Growth of CBDCs during the 2020s will have implications for:
 Domestic Payment Systems: CBDCs could be competition for existing payment

rails.

 Digital Wallets: State-backed digital tokens could spur growth of digital wallets.
 Bank Balance Sheets: Partial replacement of deposits, reserve requirements.
 Cross-Border Flows in CBDCs: CBDCs could partially replace correspondentbanking.

 Sovereign Competition: Will currencies with a tokenized version be used more?
 Technology: Many of the CBDC projects are partially DLT-linked.

We discuss these points in greater detail in the rest of this chapter.

Why CBDCs?
CBDCs are increasingly important infinancial and monetary policy questions andcould also work as an efficient tool tomobilize bank reserves

A survey on CBDCs by the Bank for International Settlements (BIS) suggests
emerging markets and developing economies (EMDEs) report a higher motivation
for issuing CBDCs versus advanced economies. Financial inclusion and domestic
payment efficiency remain top motivators for CBDC development amongst
EMDEs.12

12 Anneke Kosse and Ilaria Mattei, BIS Papers No 125: Gaining Momentum — Results ofthe 2021 BIS Survey on Central Bank Digital Currencies, Bank for International
Settlements, May 2022.

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Private forms of digital money often create closed loops wherein users are not able
to transact with other users or merchants outside of the system. Moreover,convertibility to different forms of money is also restricted. A CBDC acceptednationwide would act as an interoperable payment instrument.
Another use case, not much discussed, is to act as a tool for bank reserves andbalance sheet management. UK banks hold around £947 billion ($1.2 trillion) worthof reserves with the Bank of England, while the minimum quantity of reserves
needed by UK banks may be around £325 billion to £480 billion.13 CBDCs could
work as a replacement of these reserves.
Bank reserves held at the central bank are not transferable, and hence not fungible.
However, central bank-issued money, including a CBDC, is fungible. If CBDCs aretreated as high quality liquid assets, banks can use them as collateral to borrow(repo). CBDCs could be seen as a balance sheet and liquidity management tool for
central banks and commercial banks.
Work around researching and launching CBDCs has partly accelerated in responseto the launch of a private stablecoin. However, ironically, the successful launch andadoption of CBDCs would lead to more stablecoin projects becoming mainstream.
This is because the stablecoin protocol is now able to hold reserves in CBDCs,
which are more stable and liquid than money market instruments.

What Are CBDCs?
CBDCs are central bank-issued digitalmoney denominated in the national unit ofaccount and representing a liability of thecentral bank

A CBDC is central bank-issued digital money denominated in the national unit ofaccount, and represents a liability of the central bank.14 It is the liability of a central
bank that is the key distinguishing feature between other forms of digital payment
instruments (e.g., card payment, e-money, credit transfer) which are liabilities ofprivate institutions.
The money flower (Figure 5) was first published by BIS in 2017, which makes it
quite old, but still classic and relevant as it captures examples of money from thepast, present, and future.15 BIS distinguishes between two possible forms of
CBDCs: (1) a widely available, consumer-facing payment instrument targeted atretail transactions and (2) a restricted-access, digital settlement token for wholesale
payment applications.

13 Bank of England, “What Do We Know About the Demand for Bank of England

Reserves?,” February 2023.
14 Anneke Kosse and Ilaria Mattei, BIS Papers No 125: Gaining Momentum — Results ofthe 2021 BIS Survey on Central Bank Digital Currencies, Bank for International
Settlements, May 2022.
15 Morten Bech and Rodney Garratt, Central Bank Cryptocurrencies, BIS Quarterly
Review, September 2017.

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Figure 5. Money Flower: A Taxonomy of Money

Source: BIS Quarterly Review "Central Bank Cryptocurrencies." Material available freely at www.bis.org

In terms of verification of payment, both token-based CBDCs and account-based
CBDCs are possible. In payment economics, the way of verification distinguishes
two kinds of payment systems: tokenized and account-based.
 Token-based CBDC: Coin, notes, and electronic stored value are examples of

the tokenized system. In a token-based CBDC, claims are honored based on
demonstrated knowledge, e.g., digital signature. However, KYC-ed wallets, i.e.,
wallets verified for “know your customer” rules, can also be used. Token-based
CBDC are also called value-based CBDC.

 Account-based CBDC: An intermediary verifies the account holders’ identity fortransactions, e.g., banking account and cards. In an account-based CBDC,
ownership is tied to an identity and transactions are authorized via identification.

Figure 6. Account-Based Access vs. Token-Based Access

Source: BIS speech titled "Digital Currencies and the Future of the Monetary System." Material available freely at www.bis.org.

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To DLT or Not to DLT? That Is the CBDC Question
We expect some major CBDCs to be
blockchain-based, either in full or in part

Many of the smaller-currency CBDCs are DLT-linked (see Figure 7). We expect
some major CBDCs, in full or in part, could also be blockchain-based — although
the major sovereigns appear to want to primarily rely on a centralized ledger due topolicy preferences (e.g., China). The domestic implementation of many of the major
CBDCs is expected to be on a centralized ledger, mainly due to policy preferencesand efficiency gains at scale.
We expect cross-border CBDCs could be primarily DLT- or blockchain-based, forthe sake of ease and because it could bring down the cost and time of foreignexchange transfers, thereby creating operational efficiencies. It could also
disintermediate layers of correspondent banking and lead the race of superior
currency technology.
For example, Project Icebreaker is a collaboration between the Bank of Israel,
Norges Bank, Sveriges Riksbank, and the BIS Innovation Hub that is testing thetechnical feasibility of conducting cross-border and cross-currency transactions
between different DLT-linked CBDC proofs of concept. The aim is to gain a deeper
understanding of the technologies used, as well as to identify the key technical andpolicy choices and trade-offs that central banks would need to consider in designing
CBDC implementations that facilitate cross-border payments.
China is currently well ahead of major peers in developing a CBDC (referred to as
e-RMB, e-CNY, or Digital Currency Electronic Payment or DCEP) and is already at
the point of extensive pilot testing. Given the country's sprint to becoming acashless society, we expect fast adoption of DCEP over the next five years relative
to other CBDCs.
The e-RMB does not have a fixed path on its technical route. The central bank has
initiated a “horse racing” model where several designated operators have adopted
different technical routes for developing DCEP. We believe the core ledger willremain a centralized one with DLT options possible at the distribution layer.

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Figure 7. Select Central Banks' CBDC Projects
Country / Region

Announcement
Year

StatusRetail /WholesaleTechnology

DLT / Non-DLT

Australia

2022

Research

Wholesale

Ethereum

DLT

Australia

2021

Research

RetailEthereum

DLT

Bahamas2022

Launched

RetailNZIA Cortex DLT

DLT

Bhutan2021

Research

Retail, Wholesale

XRP Ledger

DLT*

Brazil2022

Proof of concept

RetailCanada

2016

Pilot

Wholesale

Canada2017

Research

Wholesale

China

2022

Pilot

RetailEswatini

2022

Research

RetailEuro Area

2020

Research

Retail, Wholesale

DLT
R3 Corda

DLT
Non-DLT*
Non-DLT

Filia

Non-DLT
Non-DLT*France

2022

Pilot

Wholesale

DL3S

DLT

France

2022

Pilot

Wholesale

DL3S

DLT

Hong Kong

2021

Research

RetailDLT*mBridge2022

Research

Retail

DLT
DLT

India

2022

Pilot

Retail

India

2022

Pilot

Wholesale

Jamaica2022

Launched

Retail

Japan

2021

Proof of concept

Retail

Japan

2016

Research

Other

Nigeria

2022

Pilot

RetailHyperledger Fabric
Ethereum, Hyperledger Besu

Norway2022

Proof of concept

RetailSaudi Arabia

2022

Research

CBDC

Singapore

2022

Pilot

WholesaleSouth Africa

2022

Research

Wholesale

Non-DLT*DSC

Non-DLT
Non-DLT*
DLT
DLT
DLT
DLT*
DLT*

QuorumDLT

South Korea

2022

Proof of concept

RetailNon-DLT*

Sweden2017

Proof of concept

RetailDLT

United Arab Emirates

2022

Research

RetailDLT*

United Kingdom

2022

Research

RetailNon-DLT*

U.S. Fed CBDC

2022

Research

Wholesale

Non-DLT**Denotes Citi estimates.
Source: Citi GPS, CBDC Tracker

Risks and Implications of a CBDC
Out of the 100+ central banks involved in CBDC research, development, andpiloting, only three central banks have officially launched CBDCs: Nigeria, theBahamas, and Jamaica. Others are in pilot stage, most significantly China, India,
Japan, and the UAE.
China was the first large economy to pilot a CBDC in April 2020. However, theresults from these live CBDC projects and the pilots are quite unimpressive.
The risks and implications of CBDCs include: Central Banks Competing with Private Players: CBDCs could potentially

increase competition in a country’s payments sector — either directly bycompeting with existing forms of payments, or indirectly by competing withprivate payment and digital wallet players if the CBDC is designed as a platform
open to private payment providers.

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 Loss of Privacy: Risk of excess surveillance and loss of privacy of private

citizens’ transactions are often cited as a risk and a hindrance for uptake of acentral bank digital currency. CBDC transactions will not be anonymous, unlike
traditional cash transactions.16 For example, Nigeria’s digital currency faced
criticism citing potential surveillance and curbs on freedom.17 Ways to address
such fear could include making data visible only to the financial intermediaries,
such as banks and third-party payment companies, and not automatically to thecentral banks.

 Loss of Bank Deposits: The Bank of England (BoE) estimated 20% ofhousehold and corporate bank deposits may flee from banks to new forms ofmoney.18 As a result, banks may replace the lost deposit money with wholesalefunding that is costlier than customer deposits. The higher cost will have to bepassed on to the borrowers through increased lending rates. Disintermediation ofbanks could also affect efficient monetary policy transmission. Notably, theEuropean Central Bank (ECB) is considering a cap of €3,000 for holding digitaleuros, and the Bank of England is considering a cap of £10,000-£20,000 for
digital pounds.19

 Limited Uptake: In the Bahamas, the per capita value of CBDCs is just 86 centscompared with the per capita cash value of $1,365. Less than 0.5% of Nigerians
are using the eNaira. Outstanding e-RMB is at only $2 billion or 0.13% of
outstanding monetary base, or M0 and 0.005% of M2, as of December 2022.
Reasons for the slow update range from inertia and complexity to a lack of digital
literacy.

Case Studies
Case Study 1: Digital EuroThe ECB is working with euro area national banks on the subject of introducing a
digital euro. The investigation phase started in October 2021 and is expected totake nearly two years. The ECB is exploring how a digital euro can be designed anddistributed, as well as its impact on the market. After the third quarter of 2023, it willtake another three years of building to go live, so the earliest launch of the digitaleuro will be 2026 or beyond.
Why is the ECB looking into launching a digital euro? According to the ECB, it
is considering launching a CBDC in Europe to respond to the increasing demand forsafe and trusted electronic payments. Having digital money issued by the central
bank would provide an anchor of stability for the payment and monetary systems. A
digital euro would also strengthen the monetary sovereignty of the euro area andfoster competition and efficiency in the European payment sector.

16 Bank of England and HM Treasury, The Digital Pound: A New Form of Money for

Households and Businesses, February 7, 2023.

17 Abubakur Nur Khali, “Nigerian Election and Naira Crisis is Fueling Bitcoin Adoption,”

Forbes, March 1, 2023.

18 Bank of England, “New Forms of Digital Money: Discussion Paper,” June 2021.

19 Lorenzo Burlon et al., Working Paper Series: The Optimal Quantity of CBDC in aBank-Based Economy, No. 2689, European Central Bank (ECB), July 2022; Bank ofEngland and HM Treasury, The Digital Pound: A New Form of Money for Households
and Businesses, February 7, 2023.

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A progress report, released in December 2022, outlined a set of design anddistribution options and the role of the Eurosystem and intermediaries.20 The ECB isstill in the investigative stages regarding what technology it will use for issuing andsettling a digital euro.
Funding and defunding functionalities would enable the end user to top up or
withdraw digital euro holdings by transferring money in or out of private money orcash. Furthermore, waterfall and reverse waterfall functionality will be an added
feature that can be activated at user discretion — this means pushing funds fromthe digital euro wallet in excess of the threshold limit to a linked private account at
the time of receiving a payment, and vice versa.
Subsequent progress reports will assess further functionalities such as
programmable payments, cross-currency payments, and additional distribution
models.

Case Study 2: Digital Pound
The Bank of England and HM Treasury published a digital pound consultation paperin February 2023 arguing it is likely that a retail, general purpose digital central bankcurrency — i.e., a digital pound — will be needed in the UK. This would be a new,digital form of money, issued by the BoE for use by households and businesses foreveryday payment.21
The central bank’s motivation and drivers for a CBDC include geopolitical concerns,
a decline in cash usage, developments in the digitization of money from non-bankplayers, and improving cross-border payments.
The BoE is in the initial exploration stage, and the work over the next 2-3 years will
inform its decision and reduce the lead time to launch should the decision at the endof this stage be to implement the digital pound. The digital currency could then be
introduced in the second half of the decade.22
Over the past decade and half, cash transactions in the UK have fallen from 62% in2006 to 15% in 2021.23 The cost of accepting card payments for the smallest
merchants is four times higher than for the largest merchants. Innovation in publicmoney, toward a a digital format of cash, can likely reduce payment costs andimprove efficiency in payments.
The technological functionalities emerging in money and payments, such as
decentralized finance, blockchain, and smart contracts, are outside the traditional
financial sector and could be applicable in the design of a digital pound.
A digital pound risks disintermediation of the banking sector and will have an
influence on financial intermediaries’ balance sheets, income statements, businessmodels, and services. While holding limits can act as a mitigant, there may be
additional risks should the limits be higher than anticipated. During the introductory
period, an individual limit of £10,000-£20,000 may be imposed.

20 ECB, Progress on the Investigation Phase of a Digital Euro: Second Report,

December 21, 2022.

21 Bank of England and HM Treasury, The Digital Pound: A New Form of Money for

Households and Businesses, February 7, 2023.

22 Ibid.

23 UK Finance, UK Payments Markets Summary 2022, August 2022.

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The proposed digital pound is based on a platform model where the central bankwould issue the digital pounds recorded on the core ledger. The platform model
would be technology-agnostic — meaning the central bank could issue a digitalpound on a centralized database or through distributed ledger technology.24
UK policymakers say a digital pound could complement and support new forms ofprivate digital money and payment services if designed appropriately, e.g., by acting
as the “bridging asset” between different platforms enabling convertibility. The
ledger will allow private sector players to connect to the core ledger via Application
Programming Interfaces (APIs). The private sector would provide a wallet interface
where users can interact.
While the consultation paper is focused primarily on a retail CBDC, for the BoE thisis not a question of simply retail or wholesale. They are working extensively on bothareas, including through the renewal of Real Time Gross Settlement (RTGS), butthey are also investigating other models. This rhetoric shows a shift from the notionthat the BoE is not looking at wholesale CBDCs.

Case Study 3: Digital Rupee
The Reserve Bank of India (RBI) has launched CBDC pilots in both wholesale andretail segments. The pilot in the wholesale segment was launched in November
2022, with use cases limited to the settlement of secondary market transactions ingovernment securities. Potentially, some layers of the CBDC tech stack could be ona centralized system with others remaining on distributed networks.
The pilot in the retail segment was launched in December 2022 within a closed usergroup (CUG) comprised of participating customers and merchants. This pilot hascomponents based on blockchain technology.
Given the success of the United Payments Interface (UPI), India’s highly regarded
digital payments scheme, why is a CBDC needed?
 Backing: A CBDC is backed by India’s central bank — the RBI — while UPI isbacked by several commercial banks. Moreover, UPI settlements areaccomplished through central bank money.

 Better Settlement and Finality: Unlike UPI or other digital payments, CBDC will

move from the payer’s wallet to the receiver’s wallet without any intermediation ofbanks. This reduces settlement risk in the financial system and enables finality.
As of January 2023, some major banks had technical decline rates (transaction
failures) of around 2%.25

 Anonymity and Privacy: Digital currency will not leave a digital footprint, and no

third party can find transaction details (buyer and sender names, transaction
values, etc.) as the information is not available from any bank or intermediary.

24 Government of India Press Information Bureau, “Central Bank Digital Currency(CBDC) Pilot Launched by RBI in Retail Segment Has Components Based on
Blockchain Technology,” December 2022.
25 NPCI, “UPI Ecosystem Statistics: January 2023,” accessed March 21, 2023.

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 Cost Considerations: Reserve banks and commercial banks incur costs of INR

210 billion ($2.5 billion) annually in handling physical currency and INR 126
billion for settling UPI transactions (assuming 0.1% blended merchant discountrate, or MDR).26

 Extend Use to Cross-Border Payments: The initial focus of the digital rupee ison domestic payments, but once scaled it can be used for cross-border
payments. This can help with remittances and provide strategic sovereign
flexibility.

Case Study 4: Digital Dollar
There are three U.S. CBDC or tokenized dollar projects: (1) the Digital Dollar
Project (DDP), (2) Project Hamilton by the Federal Reserve Bank of Boston andMIT’s Digital Currency Initiative, and (3) CBDC-related exploration at the Federal
Reserve Board (FRB).27
The DDP is a non-profit, non-governmental organization devoted to catalyzing the
research, exploration, and real-world experimentation of a potential digital dollar. Its
initial May 2020 whitepaper proposed a model of a potential digital dollar for publicconsideration to test and evaluate through a series of pilots and other research
initiatives.28 In November 2022, the DDP completed its first private sector-initiated,
simulated, U.S. CBDC pilot in partnership with the Depository Trust and Clearing
Corporation (DTCC) and with technical support from Accenture.29
The core tenets of DDP’s model are: (1) tokenized architecture, (2) being
complementary to cash and digital money, (3) distribution via commercial banks, (4)user privacy, (5) monetary policy neutrality, and (6) promotion of private sector
participation and innovation.
The two-phased Project Hamilton involved researching the technical aspects of aU.S. dollar CBDC and creating a design for a modular, extensible transaction
processing system. In February 2022, the project released some open-source
research software, one of which was blockchain-based and the other of which was
non-blockchain-based. The project concluded in December 2022.
The FRB has made no decisions on whether to pursue or implement a CBDC.
Instead, it is just the exploring potential benefits and risks of CBDCs throughtechnological research and experimentation. 30
In parallel with the above mentioned CBDC projects, the Regulated Liability
Network (RLN) was launched in November 2022 as a 12-week proof of concept withmembers of the U.S banking and payments community, and the New York
Innovation Center, which is part of the Federal Reserve Bank of New York.

26 Tufts University Fletcher School Institute for Business in the Global Context, The Costof Cash in India, June 2020; Reserve Bank of India Department of Payment andSettlement Systems, Discussion Paper on Charges in Payment Systems, October 3,
2022. The source cites a 0.25% cost for P2M UPI transaction. We assume blended 0.1%
for all transactions.
27 Digital Dollar Project, White Paper 2.0: Revisiting the Digital Dollar Project’s
Exploration of a U.S. Central Bank Digital Currency, January 2023.
28 Digital Dollar Project, Exploring a US CBDC, May 2020.
29 DTCC, Digital Dollar Project and DTCC: Security Settlement Pilot, November 2022.
30 Board of Governors of the Federal Reserve System, Money and Payments: The U.S.
Dollar in the Age of Digital Transformation, January 2022.

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The pilot explores the feasibility of an interoperable network of digital central bankliabilities and commercial bank digital money using distributed ledger technology.
The RLN is an important step in the development of an always-on, programmable,
multi-asset financial system. As of March 2023, the pilot is being conducted in a test
environment using simulated data, and a report summarizing the fIndings will be
released in 2023.
In February 2023, Congressman Tom Emmer proposed a bill aimed at limiting the
Fed's ability to issue a CBDC. This could slow the progress on a digital dollar.

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A Conversation With Jessica Renier on CBDCs
Q: Why are central banks more in action with CBDCs now compared to five
years ago?
Jessica: Many central banks around the world are doing research with the primary
goal of buying themselves optionality. This is optionality to launch a CBDC — retailor wholesale — should they determine it advantageous to do so, which they have
not yet determined. China, which is, and has been ahead here for some years in
CBDC development, is quite certain. However, it is more recent activity by a major
western economy, specifically Europe, that is motivating greater interest in having
the optionality to launch — if enough use cases are met, enough risks can be
managed, and enough jurisdictions move forward with them. There are geopolitical
implications under consideration, not just economic.
Jessica Renier is Managing Director andHead of Digital Finance at the Institute ofInternational Finance. Jessica has anextensive background in financial services
and digital finance, with broad exposure tointernational policy, including positions at the
U.S. Department of the Treasury, Deloitte
Consulting, Federal Reserve Banks of New
York and Dallas, J.P. Morgan Securities andthe Hoover Institution. Most recently,
Jessica served as Program Associate
Director for the Housing, Treasury, andCommerce Departments, as well as the
Small Business Administration, within the
White House’s Office of Management andBudget.

The rise of interest and activity in cryptoassets and stablecoins over the last five
years has put more pressure on central banks to innovate and on governments toevaluate national security implications of technological advances in payments
technology. In last few years, work on CBDCs has gone from internal conversations
and desk research to consultative reports to gather public and private inputs on
potential risks and benefits, to examining design features and digital walletthresholds, to central banks building and testing proofs of concept. We are still far
from real due diligence, however, on any of the risks or potential designs in practice.
Agustín Carstens, General Manager of the Bank for International Settlements (BIS)in his speech on February 22, 2023 at the Monetary Authority of Singapore (MAS)stated that CBDCs and tokenized deposits replicate existing forms of money in atechnologically superior way, while preserving what he has previously referred to as
the “the soul of money.” The speech goes on to highlight BIS’ forward thinking onwholesale as well as retail CBDCs, again, putting this in the context of tokenizeddeposits being a critical component of the future of a technologically superior
financial system.
Q: Given that some smaller CBDC projects have been blockchain/DLT-linked,
what will be the tech stack for major currencies like GBP, EUR, USD, and INR
be?
Jessica: Several economies are pursuing sovereign digital currencies, all referred
to as CBDCs, and yet they look very different from each other from a technology
standpoint. If central banks do proceed, I do not see consensus yet on the best way
to build one — and I am not certain a consensus will be reached on the technicallevel. Different countries have different reasons for pursuing a CBDC, whether they
be related to the status of their existing infrastructure, types of payments andvolume of funds that flow through their currency, differences in privacy policies, ordifferences in the ability of a given country to support the maintenance and securityof such a system.
There has been and continues to be much excitement and belief that blockchain
technology could solve a range of problems or bring efficiencies to processes thatwould benefit from being made technologically superior. I have no doubt that it will.
That said, we are seeing the normal arc of innovation here, too. Investors get
excited about a new or emerging technology, they test many hypotheses for its use,
and then determine which realize value and which do not.

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There are many use cases where blockchain will not be a good fit, and that is to be
expected. It is very possible that countries find during their CBDC research that theobjectives that their jurisdiction may be looking to achieve are not actually served bya blockchain or particular DLT-linked solution.
Q: Is the United States being left behind in the race to CBDCs? What are theimplications of wholesale CBDCs on the U.S. dollar?
Jessica: I do not think the U.S. is being left behind on the CBDC front. In the arc ofinnovation, some people always want to be out of the gate first and others take a bit
more time to evaluate the use cases and technology to assess the fit whileobserving early lessons learned by those who are first out of the gate. There are stillothers who will take their time, watch it for a little longer, think more about it,evaluate the pros and cons more extensively, and then scale more quickly if andwhen they decide to proceed. Not everyone is positioned to do this. Some do nothave the same capabilities or market dynamics to contend with as others, which
typically drive this type of decision.
We often hear the mantra in entrepreneurial circles “innovate fast and fail fast.” By
doing this, you avoid dragging out or exacerbating the downside of the failure andget busy implementing important lessons that were learned that may allow you to
succeed the next time. However, CBDCs are sovereign currencies. A sovereign
currency cannot afford to fail. It is not one of many digital assets or cryptocurrencies
whose value can be wiped out without severe systemic impacts. The U.S. dollar is
the world’s reserve currency and clearly does not have the option to fail, but it does
have the ability to scale quickly.
Being first is less important for some than for others. I do not think the U.S. is‘behind’ by accident. The U.S. is exactly where it intends to be. That said, it isunderstandable that other countries may want to develop CBDCs on a fastertimeline. There are potentially significant geopolitical implications in the case of newwholesale CBDC systems that may reduce some dependence on the U.S. dollar in
the execution of world trade where most invoices are denominated in dollars.
Irrespective of whether the U.S. ultimately launches a CBDC, U.S. entities such as
the Digital Dollar Project and MIT’s Digital Currency Initiative, among others, areadvancing leading research, conducting pilots, and catalyzing public discussion
around appropriate principles for CBDCs — principles that are already and will, no
doubt, continue to influence the thinking of both U.S. authorities and other countries
pursuing CBDCs.

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Citi GPS: Global Perspectives & Solutions

GamingFive Key Takeaways on Gaming and Web3
We spoke with Ryan Wyatt, President of Polygon Labs, on the future of gaming in
the Web3 world. We feature our full conversation further into the report; below are
five key takeaways from our discussion.

© 2023 Citigroup1.

Gamers Do Not Care About Technology and Innovation: Gamers do not
typically care about the underlying technology powering their favorite games.
For example, how often have you sought to understand the benefits of cloudcomputing and what it means for gaming? Do you determine which particularmulti-player game to play based on whether it is hosted on Amazon Web
Services or Google Cloud? The moment gamers have a Web3 equivalent of
their existing game(s), they will likely switch as Web3 games can enableearning while playing their (new) favorite game.

2.

Challenges with Play-to-Earn Games: Ryan expresses his view that theeconomics in play-to-earn games are often complex, while the gameplay tends
to be rudimentary and not much fun. Furthermore, content was missing in thefirst generation of Web3 games, so gamers did not cling onto a game andmake it a big hit. However, a few interesting concepts emerged from the playto-earn model, such as the idea to reward users for participating in games,
which can offer several interesting use cases.

3.

Power of Web3 and Blockchain in Gaming: Games like Minecraft andRoblox already offer elements of ownership via mini-games, mods, andcosmetic items. However, one can imagine the power of putting these elements
on-chain, improving visibility and portability, and allowing gamers to sell items
or trade them with friends inside or outside the game.

4.

East vs. West in Game Development: New gaming models (e.g., mobile orfree-to-play) often originate from countries in the Eastern hemisphere.
Countries such as South Korea, followed by Japan, are among the hotbeds ofgaming innovation. By contrast, gaming studios in the Western hemispheretend to be late adopters but help drive mass adoption.

5.

Inflection Point: With over 3 billion gamers worldwide today, we are likely to
see nearly 50 million to 100 million adopt games with some element of Web3 orblockchain by 2025. Gamers in Asia are likely to be the early adopters.
However, it is useful to focus on the revenues and not the user numbers — asmall fraction of global gamers account for the lion's share of money spent ongames. We are likely to see a significant shift in transaction spends from offchain to on-chain in the coming years. The disproportionate shift by heavy
spenders to blockchain-based games is likely to be the inflection point for theentire ecosystem to incorporate token- and blockchain-based games.

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Gaming is the largest category in the entertainment industry, with revenues
exceeding those of the film and music industries.31 The gaming market is sizeable,with nearly 3.2 billion gamers as of 2022, based on data from Newzoo (see Figure
9).32 Even if blockchain-based games are adopted by only a fraction of the total
gaming community, this could translate to significant adoption numbers in theblockchain and Web3 ecosystem.
The gaming industry is intrinsically wellsuited for blockchain, with gamers broadly
having a good understanding of digitalownership and virtual assets

In our view, the gaming industry is intrinsically suited for blockchain. Gamers aretech-savvy, with most already having a good understanding of digital ownership andvirtual assets. The emergence of Web3 and the rise of new economic models, suchas play-to-earn, aim to empower gamers with ownership of their in-game assets.
These digital assets can range from cryptocurrencies to in-game resources that are
tokenized on the blockchain. But this has not really worked well so far.
Up to now, blockchain-based games are often developed by crypto-native folks witha greater focus on in-game tokens and monetization, versus the need to makegames fun and exciting. Hardcore gamers often criticize the shallower and simpler
gameplay in blockchain-based games. Some gamers also worry NFTs and in-gametokens could be yet another tool to extract more money from gamers.

Out of the huge number of people who play games online, only a relatively small
number need to participate in blockchain-based games for them to be a success.
– RYAN WYATT, PRESIDENT, POLYGON LABS33
The next generation of game developers is already working to incorporate digitalasset components into fun games. This should help address the gaming community
concerns and drive adoption rates. For example, the recently concluded Dookey
Dash competition by Yuga Labs delivered a fun gaming experience for the Bored
Ape Yacht Club community, attracting participation from all over the world anddemonstrating the growing importance of NFTs in gaming.
We believe the next iteration of blockchain-based games will include digital asset
elements with other models beyond play-to-earn games. Regular pay-to-play or
free-to-play games will include blockchain elements, possibly even without thegamer’s explicit awareness.

31 Ryan Parreno, “Gaming Is Five Times Bigger Than Movies Now,” Gameranx,

December 13, 2022.

32 Newzoo, Global Games Market Report 2022, July 2022.

33 Richard Waters et al., “Will the Crypto Crash Derail the Next Web Revolution?,”Financial Times, July 6, 2022.

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Figure 8. Different Economic Models for Gaming

Source: Citi GPS

Increasing Demand for Digital Experiences
There were over 3.2 billion gamers
worldwide as of 2022

The number of gamers worldwide grew from 2.7 billion in 2019 to 3.2 billion in 2022
(Figure 9). Two years of pandemic- and lockdown-fueled growth have likely helped
2020 and 2021 see a noticeable jump in number of gamers, including new andlapsed players. 34
Figure 9. Global Number of Gamers

Source: Newzoo (www.newzoo.com)

According to data from Newzoo, the global games market was forecast to generate$184 billion in 2022. By region, Asia accounts for nearly half of the global revenue
pie; followed by North America, with 26%; and Europe, 18%.35
Gaming has played a crucial role in shaping
the Metaverse and Web3 ecosystem, with
games like Roblox and Fortnite boasting
millions of users

The buzz around the metaverse, especially in late 2021 and early 2022, has
amplified the transition to the virtual world. The gaming industry has played afundamental role in shaping the Metaverse, with games like Roblox and Fortnite
boasting hundreds of millions of users and offering users goals and objectives toachieve in a virtual gaming environment.

34 Newzoo, Global Games Market Report, July 2022.
35 Ibid.

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March 2023

A Conversation With Ryan Wyatt on Gaming
and Web3
Q: Why do we need blockchain-based games? How early are we likely to see
new releases?
Ryan: An increasing number of gamers who buy in-game assets and merchandise
want the ability to sell or trade it, much like they can with physical items in the realworld.
But end-gamers do not care about the underlying technology; they only want to play
an exciting game, not understand the benefits of cloud computing for gaming or
inquire if the game is hosted on Amazon Web Services or Google Cloud. In myview, having a public distributed ledger that is visible for the entire ecosystem isenough to justify the product-market fit of building an in-game marketplace.
Ryan Wyatt is the President of Polygon
Labs, leading the business team working tohelp advance the Polygon ecosystems
across various products. Before serving as
President, Ryan was the Chief Executive
Officer of the Polygon Studios division,
which was the gaming, NFT, and Metaverse
vertical. Before Polygon, Ryan spent almost
eight years at Google, where he created
YouTube's gaming vertical and built it into
the video platform's second-biggest
business, generating billions in revenue.

While blockchain-based games are a distinct category today, I expect all games toleverage blockchain as the underlying infrastructure in the coming years. Gamedevelopment often follows a four- to five-year cycle, and we could see new games
leveraging on-chain elements using Unreal Engine as early as the second half of2023 or the beginning of 2024.
Q: Why have early blockchain-based games and the play-to-earn model notbeen very successful?
Ryan: I have never been very interested in the play-to-earn gaming model, as themodel does not fundamentally work from a tokenomics perspective. The economicsof play-to-earn games are often structured in a complex manner. Most games also
tend to be very rudimentary and not much fun to play. This has led to pushbackfrom the gaming community.
However, a few interesting concepts emerge from the play-to-earn model. For
example, the idea of rewarding users for participating in games can offer several
interesting use cases.
Q: Several games today already include elements of ownership. Why do westill need blockchain for ownership?
Ryan: Games such as Minecraft or Roblox already offer elements of ownership,
whereby gamers can spend money to buy different components such as minigames, mods, and cosmetic items. Gamers are responding positively to this but
wait until you give them more power and ownership over their in-game assets. They
are likely to be even more engaged. Imagine if you put in-game assets on-chain
today; gamers could now start to sell these assets or trade them with friends.
Innovation in game development is seldom driven by customers telling developers
what the latter should build. Consumers did not ask developers for cloud gaming,
multi-player games, mobile games, or play-to-earn games, and they certainly are
not going to ask for blockchain-based games.
In-game assets on-chain is likely to be net positive for everyone in the ecosystemand help create a free-flowing economy. Gamers can have visibility of different ingame assets, who owns them, and how they can be purchased. Developers canalso enforce creator royalties, allowing the content creator to receive royalties every
time the digital item is resold. This could materially change the business model ofgame developers.

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Q: Who is likely to lead new blockchain-based game development in the next
one to two years?
Ryan: I see a lot of momentum for blockchain-based games from developers in the
Asia-Pacific region. New gaming models, such as mobile games and free-to-play,often originate from countries in the Eastern hemisphere, while studios in theWestern hemisphere tend to be late adopters. Gaming studios in the East can beseen as lead indicators for innovation, while studios in the West help drive adoption.
Over the next one to two years, large reputable game developers in Asia are likely
to launch blockchain-based games. This is likely to include non-Web3-native andWeb3-native cohorts of gaming studios, as well as other developers who have leftlarge established studios to develop their own blockchain-based games.
In my opinion, we could see the release of a big breakout game from the native
Web3 developer group initially, which is then likely to be replicated by otherdevelopers. I would closely watch game developments in South Korea, followed by
Japan. In the long term, game development by studios in the Western countries islikely to drive mass adoption.
Q: We currently have over 3 billion gamers worldwide. Of this, how many arelikely to play games with some element of Web3/blockchain by 2025?
Ryan: I should first point out that the statistic of over 3 billion gamers worldwide is avery broad number. It includes the casual gamers who started playing Candy Crush
two months back while waiting at the LAX airport lounge, as well as the hardcore
gamer doing this for several years.
In terms of the number of gamers, I would estimate nearly 50-100 million are likely
to adopt games with some element of Web3/blockchain by 2025.
However, I am more fascinated by the potential revenue pie for in-game Web3
and/or blockchain-based assets. In my opinion, this is likely to be the big driving
force for blockchain-based games. Even today, a small fraction of global gamers
account for the lion’s share of money being spent on games (let us refer to them as“whales”).
Over time, we are likely to see a significant shift in transaction spends in games
from off-chain to on-chain. One hundred million gamers shifting to blockchain-based
games, from a total of over 3 billion gamers worldwide, may not seem like much.
However, the disproportionate shift in value of wallet (i.e., the shifting of whales toWeb3) is likely to be the inflection point for the gaming ecosystem.

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SocialImagining Social Media on a New Path
Web3 proponents cite the need to build a new system that is decentralized.
Blockchain-based social media could help authenticate identities, verify accounts,
and infuse transparency in the process. Blockchain’s ability to create a shared,
immutable digital record of transactions could also help users see where particular
information originated in order to judge its credibility. This could help build trust.

Web3 social media can help authenticate
identities, verify accounts, and build trust

Companies such as Aave are building decentralized social media platforms likeLens Protocol, where users have ownership of their cryptographic profiles as
opposed to being locked to a specific Web2 platform. Users can mint a profile,
follow others, and create and collect publications, completely on-chain. Ownershipof content and control over the distribution channels remains with users.

I believe that creating more access to blockchain-based technology requires
non-financial applications. People will come into the blockchain space not onlyby the financial play, but from using decentralized social media and playing
games. I believe games and social media might be the way that most of thepeople get their awareness about the blockchain as a technology.
– STANI KULECHOV, FOUNDER AND CEO OF AAVE COMPANIES36

Sizing the Creator Economy
In the Citi GPS report The Creator Economy: Getting Creative and Growing, weestimate the market for the creator economy is currently about $60 billion per year
and will grow nearly 9% through 2024, when it should approach $75 billion. Many
segments of this economy are growing in double-digit percentages.
Figure 10. Sizing the Creator Economy Market ($ billion)

Ad-based video+ eCommerce+ eSports+ Fee-based video+ Education+ Podcasts+ Metaverse+ Donations+ Mobile game creation+ Publishing= Totalmemo: growth

2017
7.4
3.3
1.3
0.3
0.7
0.2
0.1
0.3
0.1
0.0
13.5

2018
9.8
3.9
1.5
0.3
1.2
0.4
0.3
0.4
0.2
0.0
18.0
33%

2019
12.8
5.0
2.2
0.4
1.6
1.1
0.5
0.8
0.3
0.0
24.6
36%

2020
16.7
10.3
4.2
2.4
2.0
1.6
0.9
1.0
0.4
0.0
39.5
61%

2021
25.6
13.5
5.3
3.3
2.7
2.1
1.9
1.3
0.5
0.1
56.5
43%

2022E
25.9
13.3
5.8
3.9
3.3
3.0
2.3
1.6
0.9
0.2
60.1
7%

2023E
27.1
13.6
6.3
4.3
4.1
3.7
2.8
1.8
1.1
0.2
65.2
8%

2024E
30.4
15.7
6.9
4.7
5.0
4.2
3.3
2.0
1.5
0.3
74.0
13%

CAGR
CAGR
'17-'21 '21-'24E
37%
6%
43%
5%
43%
9%
85%
12%
42%
22%
80%
26%
109%
20%
48%
15%
53%
39%
211%
50%
43%
9%

Source: Citi GPS

36 Citi GPS, Metaverse and Money: Decrypting the Future, March 2022.

© 2023 Citigroup

March 2023

Citi GPS: Global Perspectives & Solutions

Blockchain-based social media platforms aim to take social media on-chain, offering
the benefits of enhanced privacy, ownership of personal data, and greater control ofuser-generated content. Most platforms also offer digitally native tokens formonetization of creator content. However, decentralized social media networks arestill nascent, and the user experience is not as rich as in their traditionalcounterparts.

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March 2023

A Conversation With Stani Kulechov on
Decentralized Social as a Driver for Blockchain
Adoption
Q: What is Aave and your journey to setting up Aave?
Stani: “Aave” means ghost in Finnish. The reason for naming the network Aave isbecause we build technology that is decentralized. After building the software, wegive ownership to the user community, essentially becoming a ghost at this point.
The software and protocols operate via smart contracts on the blockchain with
community governance.
I started building blockchain-based applications in 2016, while a law student. The
first version of the Aave Protocol back in those days was called ETHLend (short for
Ethereum lending). It was a proof of concept of how cryptographic assets could betraded on an ongoing basis on the blockchain, as well as used as collateral toborrow liquidity and earn yield.
Stani Kulechov is the Founder and CEO of
the Aave Companies, a softwaredevelopment company that builds opensource, blockchain-based software. Aave
Companies are best known for creating the
Aave Protocol, a decentralized, open
source, and non-custodial liquidity protocol
which allows users to supply crypto-assets(i.e., earn interest on them) and borrow
crypto-assets. He is a seasoned
entrepreneur with extensive experiencedeveloping technology in the crypto,
blockchain, FinTech, and — most recently— social media spaces. In 2017, Stanireleased ETHLend, one of the first DeFi
dApps and soon after, the Aave Protocol. In
2022, Aave Companies introduced Lens
Protocol, the Web3 social layer that allows
users to own their social profile and enables
developers to build social media applications
on top of Lens or integrate Lens features
into existing blockchain applications.

In 2017, we introduced the Aave Protocol — a peer-to-protocol that allows users to
supply and borrow cryptographic assets and earn yield. The protocol is now fully
decentralized and operated by the Aave Decentralized Autonomous Organization(DAO).
Over the years, with support from the Aave DAO, we have contributed new updates
to the Protocol, with the focus on creating a more capital-efficient and risk-averse
protocol. The latest version, currently V3, secures about $5 billion in total value
locked (TVL) across multiple networks.
The Aave Protocol has been deployed on the Ethereum main network, Polygon,
Avalanche, and on layer 2 networks, such as Optimism and Arbitrum. At Aave Co.,
our vision is a people-powered internet that benefits all. At the heart of this isbroadening access — to finance and other markets. The Aave Protocol helps create
globally-accessible markets, offering a liquidity pool where all participants haveequal rights to the same yield, irrespective of their location.
Bitcoin and Ethereum gave us the idea of owning our assets without third-party
intermediaries such as banks and brokerages.
We are also enabling users to own their social profile and not be beholden to aparticular social media platform. Creating this kind of social capital ownership is
important, as unlike financial capital, which many people don’t have and if they do, it
can’t be spent, social capital is owned by everyone and can be held for a lifetime. At
Aave, we focus on creating technology that increases access and is open, secure,transparent, and governed by users.
Q: What is Lens Protocol? Why do we need decentralized social media?
Stani: Lens Protocol is the blockchain social layer that aims to enable users to own
their social capital. It is another use case on the blockchain, such as finance was.
On Lens, users create a universal profile. They own their social profile, data,
content, and followers. We call this social capital, and it is valuable, as we see largesocial media companies have garnered huge wealth from owning users, usergenerated content, and followers.

© 2023 Citigroup

March 2023

Citi GPS: Global Perspectives & Solutions

What is great about social capital is that we all have it. It is the digital version of theconnections we make, our personal networks, the time we spend with our friends
and in communities and groups or one-on-one, and the ideas we share andconsume. In the case of digital social media, we often have greater connections
online.
With Lens Protocol, you own your social profile cryptographically as an NFT. It is
secured and guaranteed by the blockchain. You are not locked into a specificplatform, and if you move between Web3 applications, you take your profile,content, and followers with you. In fact, by making connections with otherindividuals in Web3, you can effectively create your own social graph, distribution,and monetization.
Creating greater adoption to blockchain-based technology requires new, nonfinancial, applications. Blockchain adoption will increase with new use cases suchas decentralized social media and games.
Later, some of these new blockchain users will become DeFi users as well, but themost important thing is to be able to use blockchain without necessarily having
financial assets. The way we build Lens Protocol (and the way other builders are
creating applications on top) is to create compelling new experiences, where thetechnology is in the background and users feel like they're using traditional
applications that are easy, compelling, and engaging.
Ideally, user activity happens on the front end or the application layer. When users
post, comment, or mirror content, their activity is reflected immediately. There are nogas fees (i.e., transaction costs) and users don't have to sign in with their crypto
wallet. The blockchain technology functions on the backend and is seamless. When
we make the technology easy to use, more people will come into Web3 and thenuse the whole Web3 economy.
In Figure 11, you can see Lenster — a desktop, third-party, community-based
application built on top of the Lens Protocol. There are also mobile applications,such as Orb, built on top of Lens that are intuitive and fun. I'm writing here “gm,Ronit and Citi.” When I post, the content is reflected right away, like on traditionalsocial media. But my post is indexed on the blockchain.
We are trying to break the concept of having one Ethereum address (i.e., wallet),
where you store all your assets and blockchain interactions. There could be a
scenario where you have one address that secures your financial assets, andanother one that holds other types of activities that are guaranteed and secured on
the blockchain too, but also owned by you.

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March 2023

Figure 11. Snapshot of Lenster Platform Built on Top of Lens Protocol

Source: Citi GPS

Q: Why does an average user care about blockchain-based social media?
Stani: In my opinion, blockchain allows builders to create new and novel user
experiences and applications. It is not easy to compete directly against existingsocial media giants who have billions of users. That defeats the purpose. The idea
is to invent new experiences and monetization models that attract users, brands,
and creators.
For example, we see new applications and use cases being built in blockchain
finance all the time. Innovation and improvement are happening across products,
services, and platforms. The same will occur in Web3-based social media. By
creating Lens and a social media layer, we are making it easy for builders to create
new experiences, interests, crafts, and applications on top of Lens, with Lens
infrastructure in the background.
It is easier to build with Lens Protocol, as it is open and provides tools andinfrastructure for builders, and it has a built-in user base of people with a Lens
profile.
All applications built on Lens protocol are growth-hacking the user base together.
Every application can then choose how they curate content for users from that
common pool of users.
Q: How different are Web3 social media’s incentives and monetization
strategies from Web2?
Stani: In Web2-based social media platforms, users create data and provide it to
the platform. Platforms then use this data to know more about their users and sellthem services and products they might be interested in, such as via personalized
ads and marketing campaigns. One could argue the platform makes money byextracting users’ attention from the data they provide.

© 2023 Citigroup

March 2023

Citi GPS: Global Perspectives & Solutions

Web3 social and Lens has a different dynamic. Users are not locked into individual
platforms. When you own your social graph and your profile, the applications andalgorithms have to work for you, because you have the freedom to move to otherapplications and take your profile, content, and followers with you. For this reason,
the application experience and algorithms must keep you engaged.
This change in dynamics means that as a user, you can choose how you monetize
yourself and which experiences and applications align with your interests. You are
not locked into a specific application at all. I think that's the biggest point of value.
Lens also has built-in monetization tools that allow you to monetize your content.
All content posted (i.e., user-generated content) can be collected as NFTs — like anasset class. For example, a song or art piece can become an asset that other users
view and collect as an NFT, helping content creators monetize their assets.
Users can also “mirror” this content and earn mirroring fees (think of this as
monetizing the Repeat or Share button). Users can build any kind of monetization
rules around their content. Importantly, users own and control their social graphwithout relying on the platform. This also means they do not have to leave behind
their profile, content, and followers if they decide to move to another platform.
Q: The Lens Protocol is set up as a DAO. What are the benefits andchallenges of operating a DAO? What are DAOs best suited for?
Stani: This is a very fascinating and philosophical question. In my view, most ofwhat we have built are public goods. Public goods are governed openly, allowing
users to make decisions jointly, express opinions, and achieve consensus together
via discussion and voting.
Governance of a DAO is slower than operating a company with concentrated
decision-making powers. In my view, starting a new project with concentrated
decision-making makes sense if you want to make quick progress. However, oncethe product reaches scale and delivers utility, it does not need extensive changes.
Product ownership should be transferred to the community at this stage.
Lastly, it is also important to note that even while operating a DAO, there might be aneed for continued updates, features, and other changes to enhance the protocol.
This requires good alignment with stakeholders in order to keep the protocol
relevant, competitive, and secure.

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March 2023

Art, NFTs, and The Metaverse
Traditional Art on the Blockchain
Trust, which blockchain can help enforce, isthe most important factor in the art world

Trust is the most important factor in the art world. Blockchain technology can help
enforce trust without compelling anyone to trust one single individual or institution.
Tokenization of art helps enable the storage of information on-chain bycryptographically “signing” the artwork, embedding due diligence certificates on
smart contracts, and thus keeping the information accessible to all.
In November 2018, Christie’s raised nearly $318 million in the Barney A. Ebsworth
Collection sale.37 The auction was recorded on Artory’s permissioned blockchain
and was the most valuable art auction to be recorded on a blockchain.

Five Key Takeaways on Blockchain and Traditional Art
We sat down with Nanne Dekking, Founder and CEO of Artory Inc., New York andArtory GmbH, Berlin, to discuss the future of blockchain technology in the traditionalart market. Below are five key takeaways from our discussion.
1.

Establishing Trust in the Art Market Is Complicated: The art market isplagued with fraud, forgery, and theft. Building a trustworthy registry of digitalrecords without any central authority can be difficult.

2.

More Trust Is Always Good: The use of blockchain does not signify traditional
market players cannot be trusted. On the contrary, it suggests they can betrusted more, as all information is captured on an immutable record.
Reassurance in the art market is not new.

3.

Blockchains Help Enhance Provenance: Blockchains enable the creation of
an immutable record with ownership history, independent appraisal comments,
certifications, etc., throughout the life cycle of an artwork. These due diligencecertificates, also known as asset tokens, are close to being legally bound,
digital representations of proof of ownership.

4.

Traditional Players Are Adapting to Change: Despite their initial reluctance,
artwork owners and traditional galleries, such as Sotheby’s, Christie’s, andPhillips, are now seen collaborating with blockchain-based companies to create
digital certificate tokens to capture all information related to the artwork.

5.

New Artwork Investment Opportunities Are Arising: Digital certification ofartwork can also be wrapped in a security token, creating institutional-grade
investment opportunities in high-value art and collectibles. Art-focused funds
based on the blockchain create a transparent ecosystem for potential investors
by offering intricate access to artwork data, individual performances, anddiligence updates.

For more thoughts, see our full conversation with Nanne Dekking further in thereport, where we discuss the on-chain storage of information related to physical art,
the response of traditional art market players to emerging technologies, and thepotential for other asset classes to be brought on-chain.

37 Christie’s, “The Barney A. Ebsworth Collection Sale — a Landmark for the American

Art Market,” December 12, 2018.

© 2023 Citigroup

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Citi GPS: Global Perspectives & Solutions

Case Study: Art Tokenization, Sygnum, and Artemundi
Swiss digital asset bank Sygnum, and art investment company Artemundi, partnered in 2021 to tokenize Picasso’s Fillette aubéret painting, enabling investors to purchase and trade “shares” in the artwork called Art Security Tokens (ASTs).38
Art security tokens allow fractional ownership of fine art masterpieces within the Swiss regulatory/legal framework. Here, directownership in the artwork — not a fund or investment vehicle holding the painting — was tokenized, with legally binding
ownership under Swiss DLT law. While the Fillette au béret was priced at CHF4 million, professional/institutional investors of
Sygnum could invest in and trade these ASTs, representing fractional ownership in the painting for as low as CHF5,000. Thissignificantly lowers the barrier to art as an asset class to high-net worth investors.
Figure 12. Fillette au béret at an Art Event at Kunsthaus

Source: Sygnum and Artemundi

38 Sygnum, “Sygnum Bank and Artemundi Tokenize a Picasso on the Blockchain,” July

15, 2021.

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March 2023

A Conversation With Nanne Dekking on the Artof Tokenization
Q: Can you describe blockchain and art for us — the discovery, eureka
moment, and relevance?
Nanne: It is complicated to build trust in the art market. We often trust someone
because they happen to know the right information. However, buying an artwork
should never be about an individual; it should be about the best individuals who canmake a fair judgment about the artwork. Unfortunately, trust in the art market ishindered by the lack of any centralized repository containing all catalogs andindependent appraisals of the artwork. We often ponder how technology can
mitigate risks in the art market.

Nanne Dekking is the Founder and CEO of
Artory Inc., New York and Artory GmbH,
Berlin with 25+ years of global expertise andinfluence in the art market. Artory connects
the art market with the digital-first, financial
ecosystem. Combining leading technology,
art expertise, digital certification, andtokenization, Artory secures on theblockchain verified artwork information fromexpert partners. In his former position at
Sotheby’s New York, Nanne was Vice
Chairman and the Worldwide Head of
Private Sales. He was the Chairman of theBoard of Trustees of The European Fine Art
Fair (TEFAF) through June 2020 and is acurrent advisory board member of the
Responsible Art Market Initiative.

I was lucky to be introduced to the concept of blockchain by renowned art collector
and businessman Hasso Plattner when I was Vice Chairman at Sotheby’s Auction
House. This eventually led to the founding of Artory in 2016, with the aim ofconnecting the art market with the digital-first financial ecosystem.
In 2019, we made history by registering the Barney A. Ebsworth Collection, one of
the largest collections of American Art ever sold at auction, on the blockchain in
collaboration with Christie’s. We were also the first company to enable living artists
to cryptographically sign off on a token to create immutable certificates ofauthenticity.
Use of blockchain can enable the creation of an immutable record of information,such as provenance and transactions. Information about an artwork can be securely
stored on-chain as a static record. These are known as asset tokens and are close
to being legally-bound, digital representations of proof of ownership.
It is also valuable to create a record of auditable statements made by individuals
throughout the life cycle of an artwork. Customers can check this information on theblockchain, with details of when and by whom the information was verified. Thesedue diligence certificates can be securely stored on-chain using smart contracts.
They are also dynamic in nature and can be periodically updated with new
information, including annual valuations, condition reports, or insurance updates.
However, one must understand that not everything on the blockchain needs to be
public. We work on the model of permission-based access to information. The
public part of an artwork’s information is stored on-chain, and for the private
information, attestations of diligence can be stored on-chain. Underlying data
supporting the attestation is stored safely off-chain. Only select individuals canaccess the private information related to their specific artwork.
We can also take the artwork token with due diligence certificates a step further bywrapping it in a security token. This enables art-focused funds to create atransparent ecosystem for potential investors with intricate access to different
artwork pieces the fund has invested in. For example, investors holding portfolio ofartwork can get exclusive access to artwork data, individual performances, anddiligence updates.

© 2023 Citigroup

March 2023

Citi GPS: Global Perspectives & Solutions

Figure 13. Examples of Art Non-Fungible Tokens (NFTs)

Source: Artory

Q: As an art investor, why do we need blockchain to establish trust, especiallysince we already have well-known trusted subject experts?
Nanne: As in all businesses, some subject experts in the art market can be trusted
more than others. However, why should an investor or collector depend on any
individual or the inconsistent ways they store information? If one can be trusted,
why not ensure all gathered information is stored in a centralized, secure platform?
Let me illustrate this with an example. In 2022, we worked on a project with Galerie
Steinitz in Paris and Christie’s. Galerie Steinitz is an internationally renowned
dealership in classic 18th- and 19th-century decorative art. In 2022, Christie’s
hosted the sale Provenance Revealed: Galerie Steinitz, featuring a collection ofmasterpieces of the decorative arts. It was important for them to highlight the robust
and storied provenances of the pieces, as authenticity for these types of pieces isusually confirmed by a validated chain of ownership. A few pieces sold, for example,
had stamps from the palace where the French royal family stayed in the 18th
century. Information was signed off and validated by both Steinitz and Christie's,
and both parties were keen to tokenize this trust information through Artory.
Do you know for sure everything is correct? Of course, you can never be completely
certain, but at least you know who created the statement.
For people who buy those 18th-century pieces, they at least see a record of who
said what, and at what point in time. In my opinion, this is more important than justtrusting any particular individual. Visibility into who is making the statement isextremely important, and Artory secures this information with the blockchain. The
statements on the blockchain are as only good as those individuals and institutions
making the statements. As the saying goes, garbage in, garbage out. This is why
Artory only ever allows trusted experts to record statements on the blockchain.

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March 2023

Q: How can one ensure information stored on the blockchain corresponds toa particular physical artwork?
Nanne: Frauds and fakes exist in the art market. Several companies are exploring
the use of unique identifier technology to ensure real-world assets have a physicallink to the associated blockchain information. Most simply rely on high-resolution
images to compare with the originals, but such results vary over time based on theangle of photography, humidity in the environment, or inevitable changes in
condition. Companies are also experimenting with use of tags that can be placed
discretely on an artwork, alerting individuals if someone tries to remove them.
However, I have yet to come across a technology that holds up in litigation.
For now, artworks are best kept in custody, where trust systems and workflows arein place to ensure everything captured on the blockchain corresponds to thephysical artwork in storage.
Q: How have traditional players reacted to use of blockchain and NFTs in art?
Nanne: In the early days, as a knee-jerk response, the art market was not very
keen on blockchain. Some questioned if there were reasons not to trust traditionaland established market players, or if the traditional model was not truthful to clients.
In reality, that was not the case. The use of blockchain did not signify traditional
players could not be trusted; on the contrary, it suggested they could be trusted
more.
Reassurance in the art market is not new. The European Fine Art Fair (TEFAF), oneof the biggest art fairs in the world, uses an independent vetting committee for each
artwork it shows. This is not to suggest that people do not trust TEFAF’s dealers;rather, it adds an additional layer of reassurance. Every artwork in the fair is likely togo through nearly 90-100 independent appraisers.
The use of blockchain in art will create trust and reassurance in the artwork being
sold. Blockchain allows for the creation of secure digital certificates for an artwork,
containing information related to the artwork, from credible art institutions (e.g.,
Christie’s, Sotheby’s, and Winston Art Group). Blockchain can also enable on-chain
storage of contractual agreements related to the artwork using programable smart
contracts.
Blockchain’s uses in art are gaining prominence. Artwork owners and galleries are
now collaborating with Artory to create tokens with digital certificates to capturestatements made about their artworks. The market has also seized opportunities tosell new forms of art — NFTs. New players like OpenSea created NFT
marketplaces, while traditional players like Sotheby’s, Christie’s, and Phillips arealso active in the space.
Q: Can blockchain and NFTs be used for other real-world assets, beyond art?
Nanne: In my view, NFTs like Artory’s asset tokens play a crucial role in providing
assurance of authenticity and provenance. They reassure users that information
stored on-chain, related to the physical asset, is captured in a secure manner andcannot be edited or tampered with. This information can also be linked to thephysical asset and securely transferred as ownership changes hands. As a result,tokens can be associated with a number of physical assets, including real estate,classic cars, gemstones, and other collectibles. The tokenization process ultimately
prepares real-world assets for the rapidly developing Web3 financial ecosystem.

© 2023 Citigroup

March 2023

Citi GPS: Global Perspectives & Solutions

NFTs also support the creator economy by assigning value to, and proving
ownership of, digital artworks. NFT marketplaces enable discovery of newcollectors, and many marketplaces offer automatic enforcement of resale royalties
in a digital artwork secondary market.

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March 2023

New Forms of Digital Art (NFTs)
Digital art has come a long way from the first image on the blockchain in 2011 — in
Bitcoin block 138725, a tribute to cypherpunk and cryptographer Len Sassaman —an image of Sassaman created with ASCII art.
The use of blockchain for art, via NFTs, exploded into the mainstream in March
2021, with the sale of the digital artwork Everydays: The First 5000 Days by digitalartist Mike Winkelmann, popularly known as Beeple, for $69 million at Christie’s.
A total of 3.8 million sale transactions of art and collectibles, worth $9.5 billion,
occurred between March 2022 and February 2023, according to data from
nonfungible.com.
Unlike in the physical world, where artists do not get a revenue share fromsecondary sales, NFTs can be crafted to ensure the artist gets a percentage ofsubsequent secondary sales after an initial minting.
The shift to digital has led to a stronger focus on diverse artists and genres, and on
artists who work outside mainstream platforms. We expect this trend to continue inthe foreseeable future, along with new synergies between auction houses, galleries,
artists, and collectors, as well as sustained growth in private sales.
The economy and community built around NFTs has dragged prominent influencers,
venture capitalists, and business personalities into its fold (some as paid sponsors).
Two projects specifically worth noting are:
 CryptoPunks: A collection of 10,000 pixelated characters built and generated

procedurally from a project in 2017, which exploded into the mainstream in 2021,
with the cheapest “punk” ranging anywhere around $30,000 and the rarest
fetching close to $10 million.

 Bored Ape Yacht Club (BAYC): An NFT collection with a fixed supply of 10,000

unique Bored Ape NFTs on the Ethereum blockchain and a reported all-time
trading volume of $1.3 billion by March 2023.39 The Bored Ape also doubles as
the Yacht Club member card and grants users access to members-only benefits.

How Do NFTs Work?
Like all other forms of assets, art and collectibles need the same guarantees ofpermanence, openness, and “nonfungibility” for them to be counted as intrinsicallyvaluable. As NFTs are recorded on the blockchain, it adds “permanence” to the itemthat outlives the creator. NFTs are created from within smart contracts on theblockchain, by the process of “minting” — i.e., creating an NFT, typically an ERC721 token, from a digital asset and recording it on the blockchain.
NFTs usually do not store the digital asset itself on the blockchain (to do so would
incur storage costs in the thousands or millions of dollars, as every contract in the
Ethereum blockchain must be stored on every full node on the network), but instead
contain a URL that points to the metadata, usually stored via decentralized filestorage systems such as InterPlanetary File System (IPFS) or Arweave.

39 Based on data from OpenSea.io as of March 11, 2023.

© 2023 Citigroup

March 2023

Citi GPS: Global Perspectives & Solutions

Figure 14. How Do NFTs Work?

Source: Citi GPS

Bringing Collectibles On-Chain
Corporate brands are exploring the use of
exclusive digital collectibles in the Web3
ecosystem

Aside from digital art, collectibles are also finding their way on-chain. This includes
video clips, digital trading cards, music clips, and more. Corporate brands are
exploring the use of exclusive digital collectibles in the Web3 ecosystem. Simply
put, collectibles represent digital assets created, encrypted, and stored on a
blockchain.
It is now possible for fine wine aficionados to own a piece of their favorite winery or
distillery through tokenization. NFTs enable collectors to invest in luxury wine or
spirits, with the physical assets held in custody in a temperature-controlled
warehouse and allows them to trade these collectibles on a blockchain.
For example, the BlockBar platform enables luxury brands to issue NFTs against
their collection of wines and rare spirits. The primary objective is to own exclusive
wine and spirit bottles as well as trade them on the secondary marketplace, while
the physical bottle remains in a safe, temperature-controlled warehouse.

Adoption of Web3 by Consumer Brands
Corporations are experimenting with NFTs
to drive customer loyalty, engagement, andmarketing© 2023 Citigroup

In the Citi GPS report Metaverse and Money: Decrypting the Future, we captured
the popular use cases of NFTs, including in digital collectibles, fashion and luxury,
gaming, and social tokens to name a few. Corporate adoption of NFTs and othertokens is picking up traction and could potentially be the vector that brings a billion
users on board.

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March 2023

Corporates across the spectrum, notably Starbucks, Nike, Disney, and others, areexperimenting with NFTs to drive customer loyalty, engagement, and marketing. Ecommerce platform Shopify is launching a Web3 toolkit to enable merchants toeasily create Web3 commerce experiences.

Creating and Engaging with Brand-Centric Communities
Beyond the art world, blockchain can beused as a way of recording the authenticity
of other physical goods using NFTs

Consumer brands, fashion labels, and luxury goods are embracing NFTs and theWeb3 ecosystem. Below are examples of some brands making early moves: Adidas: Recently announced an NFT collection titled “Into the Metaverse,”

comprising virtual wearables for the Metaverse, with physical clothing to match.

 Balenciaga: Designed virtual outfits and various accessories for Fortnite avatars.
 Burberry: Announced a partnership with Mythical Games to launch NFTs in its

flagship, player-owned Blankos Block Party blockchain game.

 Gucci: Attracted headlines when a single virtual bag sold for $4,000 through“Gucci Garden,” a pop-up world on the gaming environment Roblox.

 Nike: Acquired digital sneaker maker RTFKT Studios. Also built an immersive

world, Nikeland in Roblox, featuring Nike buildings, arenas, and fields where
players can compete in mini-games.

 Uniqlo: Partnered with Microsoft to sell virtual outfits for Minecraft players.

Using blockchain as a way of recording provenance is going beyond art. It extends
to the authenticity of other physical goods by uniquely identifying a specific physicalobject on-chain using NFTs.
This link of the physical object to its NFT could be achieved by using Radio
Frequency Identification (RFID), Near-field Communication (NFC) tags, Quick
Response (QR) codes, or unique identifier numbers. Veracity Protocol, a Web3technology company, brings a novel approach to this “linkage” by leveraging microstructure-based authentication.
The underlying principle here is that an object’s surface area has intrinsicallyrandom properties, and when this micro-structure of an object is captured opticallyby even an iPhone, it enables unique identification of that specific object (even in a
mass-production scenario). This technology is finding use cases in luxury goods,
critical industrial components, and collectibles.
NFT-based digital assets can act as a sealof authenticity for physical assets, creating
more trust, especially in the high-end
collectible market© 2023 Citigroup

NFT-based digital assets can act as a seal of authenticity for their corresponding
physical asset, creating more trust, especially in the high-end collectible market.
Specific use cases for corporates and brands include:March 2023

Citi GPS: Global Perspectives & Solutions

 Creating Marketing “Buzz”: A leading brand could collaborate with street artists

or digital artists to create unique versions of their products for auction; ownershipof the product can then be transferred and evidenced via an NFT token. For
example, Amazon is working on offering its customers the ability to purchase
NFTs tied to real-world assets, delivered to their doorstep.40

 Event-Ticketing and Driving Loyalty: NFTs can be used to simplify (or improve

the security of) existing processes. For example, a brand could launch a special
edition product or an event where an NFT is used to “gatekeep” access. It candouble as a ticket that can be used for admittance via a QR code. The ticket
might include images or videos, so it becomes a collectible.

Figure 15. Tokenization of Luxury Bags

Source: Veracity Protocol

Super-Charging Customer Loyalty Programs
A Web3 loyalty program could provide brands with direct insights and help
incentivize favorable shopping and engagement behavior. Consortiums andinteroperability across loyalty tokens of different brands could help make erstwhilesiloed programs more attractive, while also helping brands capture a long tail ofless-engaged users.
For example, Starbucks launched a Web3-based rewards program, Starbucks
Odyssey, allowing Starbucks Rewards members to earn and purchase digitalstamps. Members can also buy and sell these collectible stamps in the marketplace.
These digital reward stamps are issued as NFTs and can be used to unlock benefits
such as access to exclusive events or limited edition merchandise.

40 Michael Bodley, “Amazon NFTs Will Be Tied to Real-World Assets, Token Possible,”
Blockworks, March 6, 2023.

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A Conversation With Samuel Falic on
Authenticating Rare Wines and Spirits With
NFTs
Q: What is the role of blockchain in the wine and spirits industry?
Samuel: Counterfeiting in the wine and spirits industry is a real problem. Wine andspirits have been known to be forged, relabeled, or watered down, especially withlimited edition and collector pieces. Certifying genuine wine and spirits can bedifficult.
Use of blockchain in this space can enable storage of information related to thebottle on-chain, facilitating provenance. Customers can securely and reliably accessinformation on their wine and spirits at any point until the point of consumption. This
includes information on the bottle’s origin, certifications of sustainable harvest
methods, number of units produced, virtual tasting room experiences, and more.
Samuel Falic is the Co-Founder andPresident of BlockBar Inc., which sells wineand spirits, authenticated via blockchain,directly from luxury brands. Samuel cofounded the company with his cousin, Dov
Falic, in 2021.

In addition to proving authenticity and provenance, the use of blockchain and newage digital platforms helps consumers and investors get direct access to thewineries and distilleries of rare collectible bottles worldwide. Ease of access andcreation of a marketplace also offer investors an alternative asset class.
Meanwhile, technology helps wineries and distilleries build a database of superpremium customers whom they can target for new releases. The platform also
attracts younger demographics to the wine and spirits collectibles market who may
not have otherwise been active in the space via the traditional store model.
Q: Can you tell us more about BlockBar?
Samuel: BlockBar.com sells luxury wine and spirits authenticated via blockchain
and obtained directly from luxury brands, offering bottle owners access, storage,
insurance, global shipping, and a secondary marketplace. Each NFT corresponds toa physical bottle. Bottles released on the BlockBar platform are rare and editioned
in batches as small as one.
Customers own the physical bottle, which is safely stored by BlockBar in acentralized warehouse. A digital version of the bottle (i.e., an NFT) serves as a proofof authenticity and verification of ownership. BlockBar proves authenticity via the
Ethereum blockchain. The digital NFT is stored in wallets protected by Fireblocks.

Figure 16. How Does BlockBar Work?

Source: BlockBar Inc.

Similar to other NFTs, these digital bottles can be sold, transferred, exchanged, orgifted on the secondary marketplace built by BlockBar. Any sale, transfer, or
exchange of the digital NFT also results in the ownership transfer of the physicalbottle, although the physical bottle remains intact in BlockBar’s centralized storage.

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Consumers also have the right to receive physical delivery of their bottle, if they are
keen to consume it. When a consumer chooses to redeem the NFT and receive
physical delivery of the bottle, the associated NFT is permanently burnt.
Q: Any details on customer demographics or prominent markets for yourbusiness?
Samuel: BlockBar currently has over 500,000 active users. Over 80% of ourcustomer base are Millennials in the age group of 27-42 years. Further, Gen Z in the
age-group of 21-26 years makes up a little over 10%, while the remainder is madeup of Boomers and Gen X of over 43 years of age.
In terms of prominent markets for business, most of our users are from the UnitedStates, United Kingdom, Singapore, Hong Kong, Germany, and Mexico.
Q: Can blockchains be used for other collectibles as well, beyond wine andspirits?
Samuel: In my opinion, there is extensive market potential for wine and spirits, andwe anticipate exponential growth in the foreseeable future. We see high-end luxury
spirits as a growing asset class for alternative investments.
Additionally, blockchain technology can also be used to democratize access to arange of other high-end luxury goods that necessitate proof of authenticity,
provenance, and transparency of ownership records.
In my view, there is scope to explore use of blockchain in the luxury watch or highend sneaker businesses as well. However, it is crucial to have direct access to the
manufacturer in order to establish authenticity and eliminate counterfeits.
Figure 17. Example of BlockBar NFT

1.

Proof ofauthenticity

2.

Verification ofownership

3.

Right to redeem
the physical bottle

Source: BlockBar Inc.

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Trillions in Value

Tokenization of Digital Securities
With the global outstanding equity and fixedincome market valued at over $250 trillion,
traditional securities could represent thebiggest use-cases for tokenization

 Why Important? The global outstanding equity and fixed income market isvalued at over $250 trillion; thus, traditional securities have the potential torepresent one of the biggest use cases for tokenization.41 We believe theprivate/unlisted market is likely to adopt tokenization faster due to the resulting
benefits of liquidity, transparency, and fractionalization.

 What Is the Total Addressable Market (TAM) Size? We are very early in theprocess of these products growing but — based on conversations with internaland expert domain experts — we forecast $4 trillion to $5 trillion of tokenizeddigital securities, assuming 1% of corporate and quasi-sovereign bonds, 7.5% ofreal estate funds, 10% of private equity and venture capital funds and $1 trillionof securities financing and collateral activity are tokenized. Accompanying thetokenization of securities will be the trade finance market, which could see up to$1 trillion of volumes based on distributed ledger technology (DLT), or around
8%-10% of global trade finance volumes, by 2030.

 Why Now? We will need the support of large financial institutions, who areincreasingly focused on tokenization and the support of the law, where notablechanges are taking places in areas such as English law, which governs mostinternational trade finance.

 What Is the End State? The end state is digitally native infrastructure forfinancial assets in which DLT and smart contracts open up new capabilities,
features, and new delivery mechanisms that are hitherto unimaginable intraditional infrastructure. We discuss this in greater detail through the rest of thischapter.

Figure 18. Tokenization TAM in Trillions of Dollars

Note: We assume 6.5% nominal GDP growth rate for all asset classes. We estimate 1% of NFC & Quasi Sovereign Debt, 7.5% of Real Estate funds, 10% of PE/VC, and 2%of Securities Lending & Borrowing to be tokenized by 2030
Source: SIFMA, Preqin, Savills, Finadium, Valuate, Citi GPS

A security is a tradable financial asset or instrument, but the legal definition mightvary by jurisdiction. “Digital Security” can be loosely defined as “a tradable financial
asset or instrument that has a digital representation on a DLT through tokenization.”
We await exact legal definitions from various jurisdictions, which are just emerging.

41 Securities Industry and Financial Markets Association (SIFMA), 2022 Capital Markets

Fact Book, July 2022.

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What are the motivations for the traditional financial industry looking toward
tokenization? Traditional assets like stocks, bonds, and funds are for the most part asolved problem in terms of access, trading, and transparency.
So why does BlackRock CEO Larry Fink believe “the next generation for markets,the next generation for securities, will be tokenization of securities”?42
Why does WisdomTree founder Jonathan Steinberg ponder, “What could(tokenization) do to ETFs? What ETFs did to mutual funds? And that’s a question
about the wrapper. So that’s about tokenization…”?43
What is the driving factor behind the likes of private equity giants like KKR, Apollo,
and Hamilton Lane setting up tokenized versions of their funds on digital exchanges
and venues like Securitize, Provenance Blockchain, and ADDX? And why are someof the largest asset managers such as Franklin Templeton and WisdomTree
experimenting with tokenizing mutual funds on public blockchains such as
Ethereum or Stellar?

Why Tokenize Traditional Financial Assets?
Distributed ledger technology (DLT) andtokenization offer an entirely new tech stackthat lets stakeholders perform all activities
on the same shared infrastructure operating
as one “golden source” of data

Traditional financial assets are not broken, but sub-optimal as they are limited bytraditional systems and processes. Certain financial assets — such as fixed income,private equity, and other alternatives — have been relatively constrained while othermarkets — such as public equities — are more efficient. Given the difficulty ininvesting in and trading certain financial assets versus public equities, current
allocations into these assets may be subdued.
The financial industry may have lapsed into accepting the sub-optimality andaccounted for it in the way they invest in these assets by under-allocating such
assets in their portfolios while paying a premium for assets with operational access.
Assumptions that investors do not want certain asset classes might have been
made on those assets just being harder to access, or more expensive andcumbersome to manage.
Today, different parts of the financial market infrastructure run on different rails,
some built in the days of COBOL and Telex. Payment runs on its own tech stack, as
does asset discovery and pre-trade matching, while clearing and settlement is on
yet another stack.
The financial industry has multiple layers of intermediaries working on the samedata, but they do so in their own silos and require a lot of back-and-forthreconciliation. Cross-border payments go through multiple hoops on thecorrespondent banking infrastructure. Post-trade settlement on funds and bonds
goes through a sequential process flow of Central Security Depositories (CSDs) andCentral Counterparty Clearing Houses (CCPs), all introduced to reducecounterparty risk and settlement failures in traditional workflows.

42 New York Times Events, “BlackRock CEO Larry Fink on ESG Investing,” YouTube,

November 30, 2022.

43 VettaFi, “Jonathan Steinberg on The Blockchain Interviews,” July 29, 2022.

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What DLT and tokenization offer is an entirely new tech stack that lets all
stakeholders do all activities on the same shared infrastructure as one golden
source of data — no more expensive reconciliation, settlement failures, waiting forthe faxed documents or “originals to follow” by post, or investment choices being
restricted by operational difficulty in access. But these are just operational
efficiencies — this is not the promised end-state.

What Is the End State?
The tokenization end state includes adigitally native financial infrastructure,accessible globally, operating 24x7x365 with
DLT-powered smart contracts

The end state is a vision of a digitally native financial asset infrastructure, globally
accessible, operating 24x7x365 and optimized with smart contract and DLT-enabled
automation capabilities, which enable use cases impractical with traditional
infrastructure.
New product features could range from debt instruments paying daily, hourly, oreven by the minute cash flows to embedded live ESG (environmental, social, andgovernance) tracking in any security, to flexible tailor-made funds based on eachclient’s investment profile or philosophy. Fund tokens could do accreditation checks
at the level of the instrument. The digital infrastructure could also expand market
access of these instruments to targeted accredited and high-net worth investors,
matching products better to risk profile, and enabling smarter and simper
distribution.
Apart from different ecosystem players potentially using a shared “golden-source”
infrastructure, different asset classes could be represented on the same ledger,
unlike today. A cash token can be handled in a similar way to a bond token,
although they are conceptually and functionally different. The nuances of each
asset can be captured at a smart-contract level (for instance, restricted holding
periods for a fund token and sanctions screening for a cash token). A smart contract
can then be programmed to auto-trigger cash token payouts for corporate actions ordividend payouts. The possibilities with token-level control and automation areendless. But this needs an entirely new “smart” infrastructure that supports
programmability, verifiability, and trustless integrity. Enter DLT and tokenization.

But There Is Skepticism…
Despite the promised benefits, several traditional players are skeptical. The
challenge with the mainstream narrative on tokenization is if each benefit is looked
at in isolation, it probably does not offer a lot of delta. It does not answer thequestion of “So what?” Do investors really want 24x7 bond trading? Settlement
failures in U.S. equities are not a particular problem. For private funds, use of
emails with an excel template works well given infrequent trades. We do not reallythink investors care about secondary liquidity, as they have not asked for it.
Alternative assets are hard and expensive to access, so we are not likely to include
them in our models. The list goes on.
But putting all benefits together, there is critical mass. For example, there is value in
24x7 seamless liquidity, for use case such as collateral, atomic and instantsettlement, easy asset discoverability, conditional payments and corporate actions
controlled by smart contracts, completely new product features, and compliance
enforced at the token level.

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Why Is Adoption So Slow? Gradual, Then Sudden?
Anecdotally, we are referring to changing an aircraft’s engine while it is still flying at
30,000 feet. Further, the new engine requires complete rewiring, while still being“backward compatible” with the old systems.
 Legal and Regulatory Framework: A key factor holding back tokenization

initiatives is the lack of an established legal and regulatory framework to support
tokenized instruments. A few European jurisdictions, such as Switzerland,
Luxembourg, France, Germany and now the UK, as well as Asian jurisdictions
such as Singapore and the Philippines, have begun to create these models,
resulting in early transactions being based in these areas.

 Building New Rails: Tech entrepreneur Andreas Antonopoulos refers to“infrastructural inversion” when new technology infrastructure is laid on top of theold, creating conflict.44 There is initially a lot of resistance — the new technology
feels slow and sub-optimal compared to the old one it is replacing, as it must
interoperate with the existing technology. This adds layers and costs — theantithesis of what the new technology set out to solve. Similarly, we are talking
about building out entire new rails of financial market infrastructure, replacing thefunctioning rails handling trillions of dollars daily.

 Potential Disintermediation: To make matters worse, some of the players who

are required to invest and drive change could likely see their existing roles
centered on intermediation disappear, or at the very least morph into new roles,
involving a lot of investment. Workflows and behaviors need change and new
mindsets. Process flows need to upgrade from sequential, synchronous
processing based on each intermediary doing one task in the flow and thenhanding over to the next, to asynchronously and simultaneously accessing andworking on the shared data in parallel.

 Lack of Standards and Interoperability: The industry needs standards andinteroperability. Different financial market infrastructures (FMIs) and consortiums
are working on the same problem in parallel, but with no clear interoperability or
standardization. This leads to silos in initiatives today. As DLT adoption gains
critical mass, there will be more drive to standardization and interoperability.

 Fractured Liquidity: Scenarios that include fully digital infrastructure with native

digital issuance of tokens also face challenges, but of a different kind. The
operational process might be supercharged, but liquidity is fractured in different
venues and pools, delaying triggering of the network effects needed to drive
more adoption.

 Public Blockchain Infrastructure Not a Straightforward Fit: To complicate

things further, a lot of the connotation around public blockchain has been sulliedby the narrative around cryptocurrencies, price volatility, and scams, but thetechnology underlying these is based on strong fundamentals that should deliver
a better experience, new products and capabilities, and increased digitization.

44 Andreas Antonopoulos, “Bitcoin and the Coming ‘Infrastructure Inversion’ - Zurich

Meetup March 2016,” YouTube, April 2016.

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However, retrofitting public blockchain infrastructure to traditional FMIs makes
the problem worse rather than better. Trustlessness, one of the main problems
solved by public blockchains, is not a problem today in the traditional world.
Banks trust each other and there are all sorts of controls built in place to penalize
errant behavior by regulated entities. However, reconciliation, settlement failure,
and traceability are problems. In the context of applying public blockchain to FMI,
transaction speed and throughput, liveness and data availability, and transactionlevel privacy are important for institutions.
These are, however, only growing pains and will pass as the ecosystem matures,the technology develops, and adoption grows. Once this intermediate,skeuomorphic “straddle” state is crossed, the new disruptive technology breaks
free from the old and ideally directionally trends towards the envisioned endstate. We have seen this play out historically time and time again — withelectrification, with the internet, with SWIFT (Society for Worldwide Interbank
Financial Telecommunications) electronic messaging — new DLT-based financial
infrastructure needs critical mass before Metcalfe’s Law takes over with its
network effects. We still have a long way to go before DLT-based FMIs andtokenization get there.
Tokenization initiatives have grown considerably in the last few years, but it isequally key to focus on the challenges from current initiatives and potential
learnings from it. One such example is the Australian Securities Exchange (ASX). In
2015, ASX embarked on re-platforming its Clearing House Electronic Sub-register
System (CHESS) with a DLT-linked alternate to provided enhanced clearing,
settlement, asset registration, and post-trade issuer services. Arguably, the initiative
aimed to change the tech stack without related changes in the business process.
Several issues led to repeated delays and the eventual pausing of the project, withthe team going back to the drawing board for a new approach. ASX wrote off $165
million in investment, despite having a very high-quality technology that promised
considerable efficiencies. Potential learnings from the program, which may be
applicable to other ongoing distributed ledger implementations include: Need for a comprehensive change in the management governance program forall stakeholders, given the complexity of switching from a centralized legacy
system, built decades ago, to a distributed infrastructure.

 Need to take a phased approach in tackling complex transformations with bite-

sized delivery plans.

 Need to rework business workflows for distributed environments that have higher

latency than centralized systems, and also capitalize on new functionalities
enabled by DLT/smart contracts.

 Need to carefully optimize on- and off-ledger processing to get the best out ofcentralized and distributed models.

Regardless, Leading Ecosystem Players Are Bullish on Tokenization
The benefits of tokenization outweigh its
complexity and will likely lead to adoption,
albeit in a phased manner© 2023 Citigroup

Regardless of complexity, the benefits of tokenization could be significant and will
likely lead to adoption, albeit in a more phased manner. Capital markets players areevaluating the potential opportunities offered by tokenization of traditional assets,
but the biggest focus is on traditional FMIs.

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 Traditional FMIs have a large existing user-base, trade volumes, and assets

under management: With the real estate market standing at over $300 trillion,
securities at over $250 trillion, regulated open-end funds over $60 trillion, andwith private markets growing rapidly, even 1% of the total market share is in thetrillions.45 Early mover advantage could be massive.

 In certain jurisdictions, there is relatively clearer regulatory and legal basis forfinancial assets, even as crypto assets face regulatory headwinds.

 Holding real-world assets and financial assets in tokenized formats will drive new

portfolio alpha/structuring opportunities and more flows in the market.

 Market structures could change fundamentally due to digitization andtokenization, and the winners would likely be entities that adapt and change tothe new operating model.

 Traditional FMIs might be one of the first ones impacted by the use of DLT andface a threat of disintermediation if they do not act quickly

Benefits of Tokenization
While the immediate benefits for traditional liquid financial assets are focused on
clearing, settlement, custody, and asset servicing, illiquid assets have a muchbroader scope for upside and scalability from tokenization.
 Liquidity: High-value illiquid assets may benefit from tokenization as it allows

fractionalization which makes it easier to trade in them, transfer ownership, andupdate records. Fractionalization may significantly improve liquidity for high-value
illiquid assets by lowering investment minimums, and catering to personalized
liquidity or collateral needs (by being able sell or collateralize only a fraction of ahigh-value asset and enjoy appreciation/yield on the rest of it).

 Distribution: Tokenization would likely provide operational efficiencies, which

would take out costs that can be passed on to investors, facilitating broader
access. The entire distribution process — from creating tokens to transferring
ownership — can be completed on-chain without rent-seeking intermediaries,
and theoretically anyone connected to the internet can open a wallet to own
tokens.46

 Enable Access: Although still subject to regulatory constraints, tokenization canhelp individuals access certain assets traditionally only available to institutional
clients or a niche group of investors.47 Besides, people in less developed regionsof the world, with limited access to banking and brokerage firms, can also
potentially gain exposure to securities and other real-world assets to benefit fromasset appreciation.48

45 Paul Tostevin, “The Total Value of Global Real Estate”, Savills, September 2021;
SIFMA, “2022 Capital Markets Fact Book,” July 2022; ICI Global, “Worldwide Regulated
Open-End Fund Assets and Flows,” March 22, 2023
46 Kristin N. Johnson, “Disintermediation and Decentralization in Financial Markets,” The
Regulatory Review, May 4, 2021; McKinsey & Company, “What Is Blockchain?”,December 5, 2022.
47 SEC Small Business Capital Formation Advisory Committee, Expanding Retail Accessto Private Markets, November 2019.
48 Rajeev Tummala, Rachel Roch, and Xin Yi Tan, “The 10x Potential of Tokenisation,”
HSBC Insights, August 20, 2020.

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 Wider Appeal: The idea of tokenization appeals to a younger, technologically-advanced demographic and investors with different backgrounds compared toplayers that prefer traditional securities and platforms. Therefore, establishedcorporates and traditional finance (TradFi) players may use tokenization to
expand target audience.

 Opportunities in Smaller Companies: Many real-world assets face significant

friction to accessing financing in TradFi. Tokenization of certain assets, such as
crops, account receivables, and equity shares of small and mid-size enterprises(SMEs), can open more possibilities for financing, capital raising, and investment
opportunities for asset owners and those who invest in them. 49

 Operational Efficiency: Smart contracts enable smoother, faster, and potentiallycheaper issuance, trading, and post-trade processes, affording improved
communication between issuers, investors, dealers, and market infrastructures.
This could, in theory, also reduce trade errors and transaction costs. The
combination of smart contracts and other interoperable protocols can carry out
crucial functions together, which may be applied to processes like know yourcustomer/anti-money laundering, margin calculations, and the application of
corporate actions.50 They also increase servicing efficiency through automatedcalculations and conditional payments, increased flexibility in corporate voting,and smarter investor communications. Finally, blockchain-based infrastructures
have the potential to offer shorter and more flexible netting, clearing, andsettlement cycles.

 Composability: Tokenization of real-world assets and financial assets may

enable innovation by allowing them to be exchanged, mixed, and combined withcrypto assets. It enables the financial industry to create new products.51 Assetmanagers and wealth managers can create more diversified and flexible
portfolios consist of real-world, financial, and crypto assets accessible through asingle digital wallet. The composable nature of tokenized models may alsoenable streaming cash flows, alternative data-driven covenants, and varying
investor treatment in traditional financial assets.

 Trust Minimization and Transparency: Trading of real-world assets, and of

financial and intangible assets such as securities, art, and real estate, andintellectual property, is often dependent on trust among buyers, sellers andsometimes brokers and other third parties with expertise on law, valuation, andtransaction. Smart contract-enabled tokenized assets can automatically executeand record transactions and transfer ownerships when pre-set conditions aremet, eliminating counterparty risk.52 Use of Internet-of-Things (IoT) and Oracle
networks may also further reduce need for human reporting and the evaluation ofcertain data and information of assets under custody.

49 AlphaWallet, “How to Empower Small Businesses with Tokenization, the True Killer

App for Ethereum,” March 25, 2020; Abdulla Bin Touq and Mirek Dusek, “Digital Tokens
Could Transform the Economies of the Middle East and North Africa - if the GovernanceKeeps Up,” World Economic Forum, March 24, 2021; LCX, “How Tokenization Can Bring
Every Asset to the Digital World,” August 18, 2020.
50 Citi Business Advisory Services, Industry Revolution Volume IV – The Convergence of
the Crypto and Traditional Economies: How Investment Managers Can Deliver Value ina Decentralized “NewFi” World, June 2021.
51 Citi Business Advisory Services, Industry Revolution Volume V, June 2022.
52 Ashish Sinha et al., “Smart Contracts Could Improve Efficiency and Transparency in
Financial Transactions,” S&P Global, October 2022

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Blockchain’s immutable and transparent nature also makes it harder to commit
fraud, and even when fraud happens, blockchains can act as a comprehensive
audit trail to help auditors more easily prove the fraud compared to manuallyparsing through documents.
Tokenization of real-world assets, especially real estate, art, and collectibles,
brings much-needed transparency and traceability to provenance and appraisals.
Blockchain can automatically update the historical record of ownership with eachtransaction and record time-stamped signatures of appraisals, offering clear
proofs of the quality and authenticity of the real-world assets.53 The historicalaccuracy of the appraisers can become visible on-chain, providing a moretransparent view of their expertise, and price discovery becomes easier withvisibility into real-time prices at which assets were traded. 54
The above benefits of tokenization may apply to all types real-world and financial
assets, yet certain types are riper and more suited for disruption than others, andthe next section demonstrates how current use cases are challenging traditional
business models.

Deep Dive Into Traditional Securities Tokenization
The use of blockchain can yield benefits
across the life cycle of digital securities, themost immediate being operational
efficiencies unlocked in clearing, settlement,
custody, and asset servicing

The use of blockchain and DLT can unlock benefits along the full life cycle of digital
securities, with the most immediate opportunities being operational efficiencies
unlocked in clearing, settlement, custody, and asset servicing. Long-term impact islikely to come from new DLT-enabled product capabilities and primary andsecondary liquidity for illiquid asset classes.
When we refer to digital securities, there are two broad approaches to tokenization:
 Tokenized Outstanding Securities: Refers to the immobilization of anunderlying traditional security in a digital infrastructure and reissuance in a
tokenized format. This is currently the most common and widespread approach.
The use of DLT to record transfer of securities can improve the efficiency of
existing processes as paperwork and manual processes are eliminated (subject
to local regulatory requirements), while also allowing for fractionalization and use
as collateral. Before these benefits are unlocked however, the operating model
could temporarily look more complex as now there are two infrastructures being
run and maintained — the off-chain and on-chain versions, and the tokenized
securities need to interoperate with the off-chain infrastructure. Valuable benefits
include instant settlement, broader distribution across the full accredited
investors pool, and use for collateral or repo.

 Native Digital Security Tokens: Refers to the process of issuing fresh securities

directly onto DLT infrastructures and holding them in DLT-linked wallets. While
outstanding examples remain limited for now due to regulatory constraints, this iswhere the largest impact is expected in the long-term.

53 Citi Global Insights, “The Art of Tokenization: An Overlap of Blockchain & Art,”

November 23, 2022.
54 The CLG Podcast, “Tokenizing Real-World Assets with MakerDAO’s Teej Ragsdale,”
podcast, accessed March 21, 2023; Andrei Larion, “Real Estate Tokenization,” University
of Florida Warrington College of Business, August 26, 2022.

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Native issuance allows us to not only unlock the operational efficiencies listed
earlier, but is unfettered from having to sync or be backward compatible withtraditional operating model. This opens the door for new and innovative productfeatures like flexible coupons, ESG tracking, and dynamic portfolio reallocation.
Until native issuance hits critical mass, however, there would be fractured
liquidity given clear demarcation between off-chain and on-chain liquidity inassets that have a non-tokenized form and a digital form on-chain.
Figure 19. Tokenization of Off-Chain Assets vs. Digital Native Issuance
Tokenization of Off-chain Assets

Digital Native IssuanceRe-birth of existing assets

Birth of new assets
Digital representations exist on-chain

Underlying assets also exist off-chain55

Underlying assets exist only on-chain55

Akin to securitization drawing an analogy fromtraditional financeA step towards dematerialization where digitalforms replace physical forms entirely

Usually pool together assets and issue digitaltokens that act as “stores of value” and carry
the rights associated with these underlying
assetsPowered by public key cryptography that
boosts functionalities like atomic and instanttransferability, token-level compliance, andconditional settlement

Real World Assets: real estate, collectibles
like art and wine agriculture, and nonconventional commodities

Real World Assets: intangible assets like
intellectual property (IP)Financial Assets: stocks, bonds, commodities,
and funds issued, traded, and managed both
on-chain and off-chain

Financial Assets: stocks, bonds, and funds
issued, traded, and managed solely on-chain
Private Assets: loans

Source: Citi GPS

Notably, tokenization of real-world and financial assets may facilitate a phased
glidepath to DLT adoption under a more well-managed and compliant environment
given the existing financial infrastructure and regulations of the underlying assets.
Tokenization can act as an on-ramp for legacy assets into the digital ecosystem,
which may enable an organic transition of capital into new digital structures, thus
avoiding a disruptive migration or drawn-out existence of parallel infrastructures.
Appendix 2 contains a summary of digital financial market scaling infrastructure andecosystem players supporting digital securities, between new digital disruptors andtraditional FMIs scaling to adapt to the new technology.
While the tokenization of outstanding securities is under exploration, recent activity
in the native issuance of digital securities has focused on bonds. Bonds are a good
fit for tokenization given current market challenges with existing friction points, aswell as a supportive and innovative issuer community, primarily amongsupranationals, who have been some of the biggest drivers of innovation
historically.

55 Marcelina Fryszka, “Two Types of Asset Tokenization on Ethereum,” Medium, August

10, 2021.

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Figure 20. Examples of Major Native Digital Securities Pilots
IssuerKfW

UBS Group

Currency

EUR

CHF

EUR

GBP

Size

EUR20 million

CHF375 million

EUR100 million

GBP50 million

Legal Regime

German Law

Swiss Law

French Law

Luxembourg

Luxembourg

Exchange
Listing

Not listed

SIX / SDX

Not listed

SOL (Securities Official
List section in the LuxSE)

SOL (Securities Official List
section in the LuxSE)

Issue Date

Dec 2022

Nov 2022

Apr 2021

Nov 2022

Jan 2023

Tenor

2 years

3 years

2 years

2 years

2 years

Pricing

2.381%

2.330%

0.000%

2.507%FRN

Infrastructure

Clearstream, on D7
digital post-trade platform

SDX

Forge

DAP by GS

Orion by HSBC

Settlement

T+0

T+0 on SDX
T+2 on SIX

T+1
Using CBDC (BdF)

T+0
Using CBDC (BdF)

T+2

Custody

Traditional

SDX/SIX

Wallets bybookrunners

Wallets by bookrunners

Wallets by bookrunners

Key
Innovation

European Investment Bank (EIB) Digital bond in the form
 Can be held in Private permissionedof central register Public permissioned
both CSDs of SDX
blockchain
security based on theblockchain issuanceand SIX and Prospectus was filed
German Electronic
using ETH
tradable on bothwith a regulator
Securities Ac(eWpG)

 Combination of private andpublic blockchains Deal record on publicblockchain mirror that provides
increased transparency on an
anonymised basis

Source: Company Websites, Citi GPS

Sample Use Case: Digital Securities as Collateral
A key securities market segment that faces significant operational friction and could
derive immediate benefits from tokenization is the collateral/securities borrowing
and lending market, or as it is colloquially called, the repo market.
Existing trade and post-trade processes
remain largely manual and inefficient, but
new DLT-based solutions to these are
emerging

Although it transacts over $2 trillion in monthly volumes, the market’s existing tradeand post-trade processes remain largely manual and inefficient, consuming
significant risk capital.
Several new DLT-based digitization and tokenization initiatives have emerged totarget this large and inefficient market by creating digital collateral records on DLT
infrastructure. Once digitized, these can be part of a single, seamless collateral poolenabling faster collateral flows (this is useful for rapidly growing flows such as
variation margin postings in the over-the-counter derivatives market) by tapping into
smart contract features like atomic and conditional settlements.
Platforms such as HQLAX, JPMorgan’s Onyx repo platform, and Broadridge’s DLT
Repo have begun to process billions in securities lending volumes already and havepotential to scale up further. This would bring significant operational and capitalsavings to the industry.
Given current industry momentum, it seems feasible that digital collateral markets
could become the first scaled use cases for digital tokenized securities flows.

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Sample Use Case: Private Fund Tokenization
Historically, investment in private market funds has been a challenge for retailinvestors, and the space has been largely restricted to large institutional investors
and ultra-high net worth individuals.
A stated objective of the alternative-assets ecosystem is to increase allocation toretail investors, such as accredited investors and the mass-affluent segment. The
mass-affluent segment currently allocates around 6% to alternative assets, while
institutions allocate 30%-50%.
Figure 21. Investor Portfolio Allocations (%)

Portfolio Allocation (%)

Traditional Investments (Stocks & Bonds)
22%

26%

78%

74%

HNW

Pensions

Alternatives
6%

46%
94%
54%

UHNW

Mass Affluent

Source: Citi GPS
Tokenization could solve private-market
investment challenges related to highminimum investment amounts, long holding
periods, limited liquidity, underdeveloped
secondary markets, fractured asset
discovery, complex investment processes,
and lack of investor awareness

Challenges underpinning this continued under-allocation are high minimum
amounts for investment; long holding periods; limited liquidity, including the lack of awell-developed secondary market; fractured asset discovery options; complex andmanual investment processes; and a lack of investor awareness and education,
among others.
Tokenization, along with wider digitization of the end-to-end workflow, promises tosolve a number of these challenges. Although we are in the early days, asset
managers are testing the waters by launching digitized versions of popular funds.
Private-market investment firm Hamilton Lane partnered with digital securities
exchange ADDX to tokenize a share class of its popular global private asset fund,leading to a decrease in the minimum ticket size to $10,000 from $125,000 or more,through traditional, non-tokenized distribution channels.56 This also opens up
investors to the option of being able to trade these funds on the digital exchange.
Late in 2022, alternative asset manager KKR also tokenized its healthcare fund on
Avalanche, a public blockchain, using digital assets firm Securitize.57 Meanwhile,
private equity firm Apollo launched investment management operations with fintech
Figure on the Provenance blockchain to launch new tokenized funds.58

56 Hamilton Lane, “Private Markets Leader Hamilton Lane Partners With ADDX To Offer

Tokenized Access To Its Global Private Assets Fund, In Major Foray Into Asia,” March
29, 2022.
57 KKR Press Release, “Securitize Launches Fund Providing Tokenized Exposure to
KKR Fund for the First Time in the U.S.,” September 13, 2022.
58 Apollo, “Apollo and Figure to Collaborate on Blockchain-Enabled Initiatives,” July 14,
2021.

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Citi GPS: Global Perspectives & Solutions

Beyond Tech: What Is Needed to Scale Securities
Tokenization?
Multiple things still need to be put in place toscale securities tokenization

 Digitization Before Tokenization: Before tokenization can have a meaningful

impact on the workflow, the entire workflow must be digitized. To the extent thatlegal documentation is captured in a digitally native way (rather than by scans
and PDFs), it enables composability with smart functionalities. Different
jurisdictions are prioritizing laws and regulations that enable digital documents tobe legally valid, and this would pave the way for more adoption (covered further
in the “Trade Finance” section). Later in this report, we also cover in-depth smart
legal contracts, which have promising potential to assist automated execution,
including using real-world data captured through Oracles.

 Support from Traditional Finance Players: If established financial service

providers could widen their approach to adopting the emerging and fragmented
DLT network, they may help normalize adoption of tokenization for investors.
TradFi players’ involvement could standardize processes and enable consumer
acceptance around tokenization.

 Technology-Neutral Laws: As issuance momentum builds, pilots and proofs ofconcept have explored the boundaries of innovation within current financial
services legislation and tested associated legal and regulatory frameworks.

These have led to prioritization of a clear need to have flexible technology-neutral
laws around clearing and settlement, and new digital-native infrastructures for
trading and settlement of tokenized assets. The European Union’s new pilot
regime for market infrastructures based on distributed ledger technology (the DLT
Pilot Regime), which recently went live in March 2023, is one such effort to spur
innovation by providing a clear regulatory and legislative sandbox.
 Interoperable Platforms and Standards: Further, existing pilot transactions

point to the need for interoperable platforms and standards; failing both, liquidity
will get fragmented and siloed, and the DLT initiatives will struggle to hit criticalmass. User experience has a long way to go, especially for the majority of
traditional investors unfamiliar with the concepts of tokens and wallets.

 Digital Cash Infrastructure: Digital securities also require digital cash

infrastructure to enable delivery versus payment (DVP), a key tenet of settlement
automation. New digital cash infrastructures are emerging, such as Regulated
Liability Network, Partior, and Fnality, which could help automate the cash leg ofthe transactions. Central Bank Digital Currencies (CBDCs) could also play apivotal role, as discussed earlier in this report.

 Industry and Governmental Collaboration: Scaling would require industry andgovernment collaborations in creating supportive regimes that incentivize andencourage innovation. As noted earlier, only a few jurisdictions have begun tocreate these models, resulting in early transactions being based in thesejurisdictions.

 Standardized Taxonomy: Common scalability hurdles for digital assets include

the fragmented legal and regulatory landscape across different regions and thelack of a global unified taxonomy and classification standard.

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Open Question: What Is the ChatGPT Moment of Tokenization?
What will be the use case, product, or enabling regulation that propels the gradualcautious experimentation with tokenization to mainstream attention? This remains
an open question.
Will it possibly be the multi-trillion-dollar repo market tapping out new efficiencies
and balance sheet optimization, saving millions — if not more — for participating
institutions? Could it be the average investor on the street getting access to esotericprivate funds in a highly liquid format? Could it be a new regulatory framework thatenables traditional financial assets crossing the threshold into DeFi-like use casesand on public blockchain?
The ChatGPT moment for the tokenization of financial assets remains to be seen.

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Citi GPS: Global Perspectives & Solutions

A Conversation With John Wu on Tokenization
Q: How can blockchain help financial services and other industries?
John: Blockchains benefit not just companies in the financial services space, but allenterprises, through operational efficiencies in exchanging value. While Software asa Service (SaaS) firms also try to make things more efficient, they often achieve thisby connecting siloed, monolithic servers and optimizing workflows with automation.
When you start with a single source of truth, instead of creating APIs (Application
Programming Interfaces) or reconciliations across servers, you instantly start with amore efficient construct. This is the promise of blockchain. Blockchains enable
workflow automation and database management with everyone having the sharedsource of truth.
John Wu is President of Ava Labs. In thisrole, he leverages his expertise from over 20
years as a fintech executive and technology
investor to create a blockchain-enabled
solution for originating, issuing, and trading
financial assets. John was previously CEOof the SharesPost Digital Assets Group,
enabling compliant token trading of private
shares and funds. Prior to that, he was atechnology investor and founder of Sureview
Capital, a global hedge fund backed by theBlackstone Group.

The other use of blockchain is for tokenization of an asset. When you tokenize an
asset, it transfers the right of ownership into a digital form on a blockchain. This
offers ease of use for owning and transferring assets, as the rules aroundownership and transfer are embedded into the code. As a result, one does not needas many lawyers, auditors, and other intermediaries.
These are the two major benefits of blockchain for institutions, not just financial
services — efficiency of the database structure and tokenization. Blockchains offer
a more eloquent solution for ownership rights and transfer of assets.
KKR, a private equity firm, partnered with the Avalanche platform and Securitize, analternative trading system, to tokenize a part of one of their private equity funds onchain. It enables the qualified purchasers to gain access to those private equity
funds in a more direct way with lower investment minimums. After a year's time, theidea would be to introduce secondary-market liquidity into traditionally illiquid
assets.
Q: For what asset classes do you see the most value in tokenization? Why?
John: The more complicated the asset class, the more value tokenization can add.
In structured products, you have so many different participants all trying to figure out
the transparency of the data and then get a pricing on the data. If you're a smaller
entity, you have limited access and transparency to the complicated and illiquid
assets.
Historically, illiquid assets tend to have more intermediaries and are more suited for
disruption by blockchain and tokenization. Intain, an asset-backed securities
administration platform for institutional borrowers and investors, is moving its
tokenized marketplace to Avalanche and is starting to realize the benefits.
On the other end of the spectrum, tokenization can enable emerging market
participants to have access to public market assets in developed markets.
Q: Will tokenization of private securities be a game changer for blockchain?
John: I personally am very excited. Moreover, I was also previously the CEO of acompany that tokenized private securities. Hence, my excitement is multi-fold.
In my opinion, it is very hard to get access to private securities today, unless you
are an institution. Blockchains can help tokenize these securities and widen access.

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From a technology perspective, one can easily fractionize the concept of brokerdealer custody legally. One broker-dealer can be on the company’s cap table, butthey can fractionalize and let smaller investors own smaller portions of the shares
and are allowed to trade that private security.
I believe this is a great opportunity. Until recently, individual investors did not have
many opportunities to invest in private companies before they went public. Hence, I
am very passionate about enabling access to illiquid private securities forindividuals and smaller investors.
Q: Where are we in the context of financial institution and enterprise interestin blockchain adoption?
John: There are still a lot of tools and infrastructure that need to be put in place tototally obfuscate away all the infrastructure continually being built in this space.
Over the past two years, we have seen a lot of institutional-grade infrastructure
being built and integrated across chains, enabling institutions to directly participate
in services such as custody, staking, and wallets. We have come a long way toenable greater institutional participation, but we have not yet hit lift-off velocity, as
people are experimenting in a slow manner.
On a scale of 1 to 100, where 100 represents full adoption, in my view, we are still inthe early stages, probably near 20 or 25 on the scale. However, just twelve months
ago, we were near 5 or 10 on the scale, and just 24 months ago, we were at 1 or 2.
We have come a long way in the last 1-2 years, but we have an equally long way togo for mass adoption. In my view, we will be close to mass adoption when we reacha level of 50 on the above scale. Presently, we are still at the lower end. For
reference, reaching a level of 100 would signify we do not even talk about
blockchain anymore and use it seamlessly in our daily lives.

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Citi GPS: Global Perspectives & Solutions

A Conversation With Morgan McKenney on the
Future of Finance and Blockchain
Q: Why is blockchain important? Why do we need it in financial services?
Morgan: Blockchain in finance enables participants to bilaterally transact andinstantaneously settle with any counterparty — known or unknown. This istransformational, and significantly different from the way traditional finance
operates. Today, we typically rely on intermediaries to deliver financial services on
assets we own, but do not control — we rely on our banks to make payments, movefinancial assets, and purchase and sell stock on our behalf.

Morgan McKenney is the CEO of
Provenance Blockchain Foundation.
Previously, Morgan spent nearly 20 years at
Citi in a range of senior executive operatingroles, including Chief Operating Officer for
the Global Consumer Banking business andleading large payment businesses.
Provenance Blockchain is an open-source,
public blockchain designed for financial
services and leveraged by 60+ financial
institutions that have transacted in digitalassets across lending,marketplace/exchange and payments.
USDF, bank-minted tokenized deposits, will
also leverage Provenance Blockchain post
regulatory approval.

Several innovations in financial systems across jurisdictions have led to real-time
settlements, but much of this still operates only domestically and in silos (this is notapplicable for cross-border transactions) and is often restricted to the payments
space. While there is a growing focus on digitalization of banking services, much ofthis tends to be at the consumer app layer, while the middle and back officecontinue to run on existing systems that require extensive reconciliation acrossparticipating intermediaries.
Most other financial assets, such as foreign exchange transactions and mortgages,
still do not settle in real time. This leads to costliness and time-inefficiency, while
also locking up capital for potential operational and counterparty risk.
Blockchain opens up the possibility for two parties to directly enter into a transactionand exchange digital assets in real time, irrespective of their location and without
any intermediaries, such as banks. Use of blockchain could also help improve
process efficiency, saving time and reducing costs.
Blockchain is finance’s internet moment. This is the first time we can re-architect
how finance is done today at the infrastructure level, and in doing so, create
significant business benefits that also benefit end-consumers.
Blockchain will transform the assembly line of the finance factory by enabling deeprooted innovation, particularly in the middle- and back-end layers of the ecosystem.
An asset created to be digitally native can then be serviced, financed, andsecuritized on the blockchain, offering substantial downstream benefits.
Q: What business opportunities does blockchain offer beyond efficiency?
Morgan: First, blockchain allows for fractionalization (i.e., miniaturization) andtokenization of various asset classes. High-value assets can be sliced up into
smaller affordable pieces. For instance, why get a mortgage for $1 million to makeinvestments in housing properties? This may be out of reach for most people.
Instead, customers can get a mortgage for just one-fifth of the property (i.e.,$200,000).
Second, blockchain allows for broader access, especially in the case of private
assets. When assets are put on-chain, more users can gain access to private
assets, as price discovery becomes much easier. Investors also do not need to lockin their capital for several years and can exit more easily, if desired, with the help of
secondary liquidity opportunities. As these assets can now be valued, owners canalso receive lending on the assets for liquidity. The tokenization of private assets islikely to help drive investor participation in previously illiquid asset classes.

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Lastly, blockchain can help reduce the cost to serve, thereby driving financial
inclusion. Traditional banks would love to broaden their customer footprint if they
could, but the cost to serve is just too expensive. This boils down to theinfrastructure constraints and high cost of serving customers using old legacy
technology. What if you could lower your marginal cost of adding a new customer byusing blockchain? Lower costs to serve customers combined with fractionalization
could help banks drive financial access to a previously unserved customer segment.
Q: What are the blockchain use cases in financial services?
Morgan: In my view, one of the killer use cases for blockchain technology is in theprivate asset space, for example: private market securities, alternative assets, realestate, and private funds. These assets typically lack easy price discoverability andare not readily transferable. Thus, acquiring privately-issued assets can be timeconsuming and cumbersome. Blockchain can enable issuance of equity interest onchain.
Moving issuance on-chain can also facilitate secondary offerings to investors. For
example, employees of a private company can sell their shares to prospective
investors. The companies can also control who can and cannot subscribe to theirshares. All these records can be updated on the blockchain in real time.
By contrast, public equity markets tend to be very large and highly liquid. They are
therefore not the best use case for blockchain technology.
Q: If blockchain is a game changer, why has adoption been very slow?
Morgan: When we think about traditional financial institutions, we often think oflegacy infrastructure. A typical large bank processes between $5 trillion and $6
trillion of payments daily on behalf of its customers. Given the risks, traditional
financial institutions prefer to rely on tried, tested, and proven technologies andprocesses. While we have seen experimentation with blockchain technology forseveral years, 2022 marked the first year of true adoption by financial institutions intheir core businesses.
However, there are some challenges that need to be overcome for large-scale
adoption.
Firstly, institutional adoption typically tends to be slower due to large businessvolumes and the potential for risk.
Secondly, blockchain is not a plug-and-play technology. You have to do a complete
business re-engineering to create an amazing customer experience. So, institutions
need to re-architect their processes, deploy new digital solutions, and re-think
governance procedures throughout their ecosystems. This can prove very
challenging, especially for adopting a technology still at a nascent stage. FinTechs
such as Figure, showcase how blockchain can be leveraged in the lending andprivate asset space, as well as with firms working to build capabilities that makeadoption easier for institutions. But this will take time to evolve and be embedded.
Blockchains are also known for their transparency, as each is a shared ledger. Thisis definitely a cause of concern for financial institutions, especially in the context ofprivacy — how do you restrict others from knowing what the institution is doing on
behalf of its customers? Financial institutions also need to ensure their services are
only provided to customers with full know-your-customer (KYC), necessitating theneed to develop for new KYC/anti-money laundering (AML) solutions on-chain.

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Lastly, in order to buy financial assets on-chain and to receive sale proceeds
thereof, one needs digital money with atomic settlement. Regulatory clarity on theuse of digital money is of paramount importance. In our view, banks should beleading in the representation of deposits and money in bank accounts on
blockchain, given their regulatory frameworks and risk management strengths.
Blockchain technology is complicated, and several building blocks still need tomature. If we draw an analogy to baseball, we are still in the first or second inning.
For mass adoption, the technology needs to be extensively pressure-tested.
However, there is growing global attention on blockchain and Web3 technologies
with strong capital flows, and a lot of work is being done in this space.
In my opinion, we are unlikely to see widespread adoption of blockchains tomorrow— it is a marathon, and we are sprinting. We are likely 5-10 years away from mass
adoption of blockchain globally. However, the benefits of blockchain are significant,and will catalyze adoption in the longer term, particularly in financial services.
Increased regulatory clarity, as well as improved capabilities on digital identity andthe authentication of user credentials, is only likely to boost adoption.
Q: Why do we need a permissionless blockchain? How do you manage risks?
Morgan: There is an ongoing debate on permissioned versus permissionless
blockchains. The most valuable platform companies today — for example, Apple,
Google, and Amazon — help bring buyers and sellers together with the help of an
innovative platform. For instance, Apple offers an open innovation platform whereina developer can build an app and publish it on the app store in order to monetize it.
Permissioned blockchains are too similar to the very permissioned intermediatedfinancial services of today. They do not provide enough incremental benefits, given
the challenges of adoption.
Permissionless, on the other hand, takes open innovation and harnesses the powerof human creativity to build the future. “Permissionless” means something is open
for anyone to build, join, and participate in. This is consistent with the use of digitaltechnology to democratize access to financial services globally. In my opinion,internet platforms of the future will be on open, permissionless blockchains thatleverage the power of open innovation and encourage access.
Public and permissionless does not mean you need to compromise on standards
and governance. The risks of a public open system are and can be managed in a
number of ways. For example, we require governance by the community for any
code changes or new smart contracts. Asset issuers can embed restrictions into
their tokens in terms of where those assets can go. KYC credentialing can beembedded at the protocol layer. We also have technology to help monitor andmitigate risks by scanning the entire network for any compliance gaps. For example,
several companies today scan all wallet addresses for sanctioned behavior with theaim to identify how many steps away a wallet holder is from illicit funds. This
technology can then restrict any transactions from a sanctioned wallet.

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Trade FinanceTrade Finance and the Opportunity
Legal reforms and greater interoperability
could drive up to $1 trillion of tokenization in
global trade finance by 2030

Trade finance is a set of techniques or financial instruments used to mitigate therisks inherent in international trade, ensuring both payment to exporters and thedelivery of goods and services to importers.59 Trade finance is a large market, worth
about $8 trillion in 2022 and likely to grow to $12 trillion by 2030 (assuming thesame compound annual growth rate of 5.4% on the 2029 forecast of $11.6 trillion).60
The World Trade Organization (WTO) estimates trade finance plays a key role infacilitating and supporting as much as 80%-90% of international trade. Legal
reforms and greater interoperability could drive up to $1 trillion of tokenization in
global trade finance by 2030.
Trade finance was one of the earliest discussed enterprise use cases forblockchain, and for many years, it has been a graveyard of grand announcements
and dashed expectations. However, just possibly, this may all be about to change.
We are not going to see all of trade move to a blockchain-based solution, or even amajority, but interesting change is underway. This time may well be different.

For businesses, being early adopters and willing participants in an electronic
trade document transfer network will immensely help their operations. Besides
freeing them from holding onto paper documents, it greatly enhances transaction
speeds by cutting document delivery times from days to minutes.
– STEFAN KUKMAN, CEO OF CARGOX, A BLOCKCHAIN-BASED DOCUMENT TRANSFER COMPANY

Almost 80% of global trade has English law
as its governing law, and soon English law islikely to start accepting electronictransferable records

One driver of change is upcoming legal reform. Almost 80% of global trade has
English law as its governing law, and soon English law is likely to start accepting
electronic transferable records.61 This is a potentially material change with farreaching consequences for the digitization of trade finance. It should also help
reduce the almost 30 billion paper documents printed and flown daily.62
The Model Law on Electronic Transferable Records (MLETR) was first introduced in2017 by the UN Commission on International Trade Law (UNCITRAL) and adopted
by Bahrain, Singapore, Abu Dhabi, and others by 2021. MLETR applies toelectronic transferable records — bills of lading, bills of exchange, international
guarantees, letters of credit, other receipts, and similar.
Why is it relevant? Up to now, only paper documents were legally binding undercommon law in most countries. Making the electronic form of documents legallybinding will be greatly beneficial by improving the speed and security oftransmission, permitting the reuse of data, and automating certain transactions
through smart contracts. Digitizing trade documents is the first step to the use ofdigital assets in trade finance.

59 U.S. Department of Commerce International Trade Administration, “Trade Finance,”2022.

60 Valuates, “Global Trade Finance Market Research Report,” January 2023.

61 London Court of International Arbitration, 2021 Annual Casework Report, June 2021;

UK Parliament, “HL Bill 57,” PDF, accessed March 21, 2023.

62 UK Government, “Paperless Trade for UK Businesses to Boost Growth,” October 12,

2022.

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Digital transformation is projected to offer cost reductions in global international
trade and increased trade volumes of up to $9 trillion, or around 10% of global
GDP.63 Legal reform could bring total benefits from paperless trade to $1 trillion
across the commonwealth countries by 2026, and similar benefits are also expectedin Asia.64
A second driver of change is a greater focus on interoperability. Previously, banks
and companies deployed private networks and closed group consortiums — thiswas the equivalent of some people using SMS messages, others on WhatsApp, andanother group on Telegram. But now, there is a greater awareness of the need forcommunication between networks — to have a network of networks.

Inefficiencies in Trade Finance: The Old and The New
Blockchain has the potential to transform
global trade and supply chains by reducing
intermediation costs, fraud, effort
duplication, and information asymmetry

Several industries have made revolutionary changes, primarily by bringing down
barriers to information availability and exchange. Trade — and as a result, tradefinance — remains highly paper-based and is one of the least digitized parts of the
global financial system. Emerging technologies, including AI, blockchain, andothers, have the potential to transform global trade and supply chains by reducing
the high intermediation costs, frauds, duplication of efforts, and informational
asymmetries.

Figure 22. An Illustration of Different Players and Documents Typically Involved in the Traditional Trade Finance Process

Source: The Boston Consulting Group, “Digital Innovation in Trade Finance: Have We Reached a Tipping Point?" October 201763 Loughborough University and Tech NGI, “The Digital Transformation of International

Trade,” September 13, 2022.
64 The Commonwealth, Quantitative Analysis of the Move to Paperless Trade, April
2022; Yann Duval, Chorthip Utoktham, and Alexey Kravchenko, “Impact of
Implementation of Digital Trade Facilitation on Trade Costs,” UN ESCAP ARTNeT
Working Paper No. 174, January 2018.

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 Authenticity and Access to Documentation: Typical shipments can involve up

to 20 different documents, printed out at varying shipment stages for a host of
players. The process involves significant manual input of the same data bydifferent parties, leaving room for errors and fraud due to fragmented and noninteroperable interfaces or technology systems.65 Lack of knowledge of electronic
trade document transfer is a major barrier to global adoption.66 According to Bain
& Company, 50% of a bank’s cost for a letter of credit arises from the manual
handling and checking of documents, potentially leading to delays and errors.67

 Legal and Regulatory Landscape: International trade still relies to a large

extent on a special category of trade document, which is dependent on being
physically possessed, transferred, and delivered. Digital copies of trade
documents were not accepted under law. Although UNCITRAL passed new rules
in 2017, they were not initially adopted by any major jurisdictional law, but somecountries now follow them.68 Limited regulations around blockchain have led to alack of common process standards and information disclosure, hampering wider
adoption. Data localization laws also pose constraints for blockchain networks
with entities from multiple nations.

 Close-Looped Blockchain Network: Several private technology players,logistics companies, and financial intermediaries have built bespoke networks to
put trade finance processes on-chain, but most have been close-looped. Thus,
they failed to build a sufficient critical mass of players. Supply chain blockchainsneed adoption not just at the distributor/producer level, but across the entire
chain, including suppliers, logistics partners, banks, and financiers.

 Interoperability and Lack of Standards: Incompatibility between disparate

digital platforms has slowed technology adoption.69 As supply chains become
more data-driven and interact with multiple ecosystems, interoperability across all
systems interacting with the blockchain will be crucial. A lack of common
standards often hinders the seamless flow of data throughout the supply chain.

 The Old and The New: Blockchain development is in its early days, and its

implementation in trade and supply chains faces several challenges, including an
inability to integrate with existing infrastructure. Legacy systems and manual
operational processes still need to be updated and automated to a certain extent
to be plugged into blockchain, and before that happens, blockchains may not beable to substantially transform the trade finance industry. Before digital assets
adoption, you need digitization, but the trade ecosystem is very paper-based.

65 Kati Suominen, Revolutionizing World Trade: How Disruptive Technologies OpenOpportunities for All (Redwood City: Stanford University Press, 2019); IMDA Singapore“International Trade and Logistics,” last updated November 30, 2022.
66 CargoX, “Market Report: Industry Blindspots Blocking Adoption of Digital Trade
Documents Transfer,” September 1, 2022.
67 Glen Williams et al., “Distributed Ledgers in Payments: Beyond the Bitcoin Hype,” Bain
& Company, June 12, 2016.
68 United Nations Commission on International Trade Law, “UNCITRAL Model Law on
Electronic Transferable Records,” July 13, 2017.
69 CargoX, “Market Report: Industry Blindspots Blocking Adoption of Digital Trade
Documents Transfer,” September 1, 2022.

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Blockchain for Trade FinanceIn an increasingly digital world, the acceptance of electronic/digital versions of
documents for trade finance will drive blockchain adoption.
 Digital Identity, Document Digitization: Digital ID and the full digitization of

documents using blockchain can help improve supply chain visibility, build mutual
trust, and improve authentication of ownership. Digital ID may be used for theverification of individual identities (buyers, suppliers, or inspection agencies) or
the identification of assets for inventory and shipment tracking.

 Operational Efficiency: Blockchain creates and upholds a single version of

documentation that each party can access and edit in real time, eliminating theneed for duplicative manual processes and the potential for forgery, resulting intime and cost savings. Digital documents could enable atomic settlement — assoon as the goods or services are delivered, payments using digital money 2.0
could ensure instant settlement and finality. Later in this section, we discuss theuse case of a multi-central bank digital currency (mCBDC) for trade settlement
across different countries.
According to Jerry Foster, Chief Technology Officer and co-founder of Plex
Systems:“Blockchain technology ensures that, as contracts are altered, each party has a
copy of the contract that is updated in real time. If two parties don’t have a way ofensuring they are continuously operating on the same contractual obligations byleveraging a shared and immutable contract document, they risk operating under
outdated contractual requirements as the document changes.”“Multiple departments within an enterprise are responsible for maintaining,
tracking and executing different parts of a contract. Often, separate departments
are also storing contracts in different ways, leading to siloed information. Thismeans contract updates and operations may not be shared with the entire team,including legal departments.”70
 Cost Reduction and Smaller Clients: Traditional trade finance involves a lot of

manual paperwork and cumbersome legacy systems that can be labor-intensive
and expensive. Banks do not have enough monetary incentive to service smaller
clients in trade finance, leaving a $1.6 trillion gap.71

 Goods Syncing and Fund Flow: Today, trade financing, settlement, and goods

movement are not connected to each other, so each party has to keep a track ofdetails such as financing, logistics, and ports. Blockchain, with the help of smart
contracts, digital documents, and digital currencies, could be an opportunity toaddress this disconnect.

70 Jerry Foster, “Emerging Blockchain Uses for Supply Chain: Overcoming Labor andTime Shortages With Smart Contracts,” Forbes, February 23, 2023.

71 Asian Development Bank, “2016 Trade Finance Gaps, Growth, and Jobs Survey,”

September 2016.

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 Risk Reduction: Businesses may feel more comfortable transacting throughblockchain knowing that smart contracts can disenable unilateral changes. DLT
makes it easier to examine the reputation of buyers and sellers through publicly
visible transactions and potentially eliminate dishonest actors. It also can help
reduce commercial risk, defined as “the risk of non- and delayed payment
caused by the importer’s insolvency or cash-flow problems.”72

 User Experience: User Interface (UI) and user experience (UX) may be morefriendly with the vendor-researching, negotiation, and end contract process all
happening on chain, potentially with a single API.

Furthermore, additional benefits can be realized by syncing alternate data, such as
ESG, business key performance indicators (KPIs), KYC analyses, risk assessment
results, and insurance appraisals, which can be easily bundled on single platformusing blockchain. Also, existing networks like SWIFT can be a data/messaging
contributor to an open blockchain ecosystem in trade finance to accelerate adoption
and interoperability.

Digital Money 2.0 for Trade Settlement
The People's Bank of China, the Central Bank of the UAE, and the BIS Innovation
Hub (by the Bank for International Settlements) joined the mCBDC bridge with the
Bank of Thailand and the Hong Kong Monetary Authority (HKMA) to facilitate realtime, cross-border foreign exchange payments on the distributed ledger technology.
International trade settlement was chosen as the first business use case to bepiloted on mBridge.
Local currencies play limited roles in international trade. Depending on sources,
50%-60% of global trade is denominated in U.S. dollars.73 This is due to therelatively high transaction costs associated with most regional currencies comparedwith those of major currencies.74 In 2020, the correspondent banking model costs(excluding foreign exchange costs) were nearly $120 billion for $23.5 trillion worth ofcross-border transfers.75
The mCBDC pilot consisted of the four participating jurisdictions directly on themBridge. The pilot differs from other multi-CBDC projects and pilots in two ways: (1)the settlement of international payments happened directly on the common platform
and not on each country’s domestic payment systems, and (2) paying and receivingbanks carried out transactions directly with each other.
The mCBDC pilot aims to demonstrate the ability of DLT network- and central bankissued digital currency to improve cross-border payment speed and efficiency, as
well as to reduce costs and settlement risk.

72 U.S. Department of Commerce International Trade Administration, Trade Finance

Guide: A Quick Reference for U.S. Exporters, July 2022.

73 BIS, “Revisiting the International Role of the U.S. Dollar,” December 5, 2022; Carol

Bertaut, Bastian von Beschwitz, and Stephanie Curcuru, “The International Role of the
U.S. Dollar,” Federal Reserve, October 2021.
74 Junko Shimizu, “Exploring Local Currency Usage to Reduce Exchange Rate Risks in
Asia,” ASEAN+3 Macroeconomic Research Office (AMRO), January 30, 2019.
75 Oliver Wyman and J.P. Morgan, Unlocking $120 Billion Value in Cross-Border
Payments: How Banks Can Leverage Central Bank Digital Currencies for Corporates,
November 2021.

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Citi GPS: Global Perspectives & Solutions

Technical Details: mBridge Ledger (mBL)
After experimenting with different technology architectures in earlier phases, theproject team developed a new native blockchain for mBridge, the mBridge ledger(mBL). In this approach, different modules such as payment, foreign exchange,
capital management, and compliance are decoupled and modularised toaccommodate the evolving needs from different jurisdictions.
The multi-central bank digital currency(mCBDC) pilot project aims to demonstrate
the ability of DLT networks and CBDCs toimprove cross-border payment speed andefficiency, lower settlement risks, andreduce costs

At the core of the mBL are the central banks, which each run a validating node that
operates the mBL consensus protocol. Each central bank can onboard its domestic
commercial banks onto the platform, and the commercial banks of each jurisdiction
are all connected to the onboarding central bank and hence to the validating core of
the mBL. Once onboarded, commercial banks can transact on behalf of their clients,
extending the reach of the platform.
The mBL consensus protocol is a private, permissioned, and distributed system.
The mBL uses a consensus mechanism named HotStuff+. However, the platform isconsidering a new consensus mechanism named Dashing, which is being tested. It
uses triple-certificate security, a process in which three certificates with different
thresholds are used under different network circumstances. Hence, higher efficiency
and robustness are achievable relative to current consensus protocol.

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A Conversation With Bob Blower on the History
and Future of Trade Finance
Q: What is the history of trade finance? When was the last innovation in tradefinance?
Bob: The whole principle behind trade finance is to provide a guarantee of
payments to an exporter based on the flow of documents between the buyer andseller. It also gets involved in the contractual relationship of the underlying
commercial transaction. This process requires a lot of documents evidencing
ownership of goods, bill of lading, and more. The bank manually reviews them toensure all documents are valid and in accordance with terms of the letter of credit
before approving payment.

Bob Blower is the CEO of Clarency.com, a
B2B payments platform, and the founder ofJindau.com, an innovative token-based
working capital platform. Bob has held
senior roles in trade finance for HSBC,
National Bank of Abu Dhabi, Standard Bank,and others. He began his career in financeover four decades ago at HM Treasury,
working on fiscal, monetary, and regulatory
topics.

Trade finance involves multiple parties — the shipping company, logistics company,
insurers, and various other individuals and agencies who want to see and review
the documents.
The letter of credit or bill of exchange has been used in Europe since theRenaissance period. In fact, the 90-day windows on letters of credit are based on
the duration of time required to travel from Italy to London. Funnily enough, we still
use that same time duration for some financial commitments, even today.
Letters of credit were traditionally governed by internationally recognized rules inEnglish law, rather than national law. The International Chamber of Commercecreated a voluntary framework for commercial banks to apply to transactions
worldwide; the framework is updated regularly to reflect changing legal conditions.
The fundamental process has not changed for almost 300 years. Letters of credit
existed only as paper documents; they were regularly issued by telegraph in the late
19th century. Only in 1973, with the creation of SWIFT, did banks began to migrate
to electronic messages, initially telex-based, to convey the terms of credit.
Q: Why did blockchain consortiums in supply chain and trade finance fail?
Why will it work this time around?
Bob: In my view, the people who experimented with blockchain consortiums so far
predominantly tried to do it from a technology point of view.
However, the recognition in law that the electronic obligation is the same as paperbased obligation was never achieved. So how will companies adopt suchtechnology and not get into legal or regulatory trouble?
Presently, if I receive a bundle of physical documents, my obligation is to check andverify those documents. But I could generate the same documents electronically inseconds and digitally review and check them in microseconds.
English law is changing right now, and it is going to be a game-changer for tradefinance. Acceptance of electronic documents will legitimize a lot of blockchain
initiatives, which have been trying to bring efficiencies to trade finance since 201516.
I am positive about blockchain solving serious pain points in trade finance, but not
until it addresses the rule of law and the rules under which it has functioned untilnow.
I also see a coordination problem.

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The blockchain initiatives in trade finance have been closed loop until now, so they
worked well for collaboration in a controlled environment. However, peers struggled
when it came to dealing, transacting, or interacting with peers out of the network. To
work smoothly, peers needed to be in existing platforms to prevent the need forreconciliation between on-chain and off-chain interactions, data, and transactions.
In my view, participants need to be connected at the roots. For example, if twobanks agree on common blockchain standards, transactions can be processed
successfully. Computers at both banks can verify the documents are confirmed andconform with the credit I have received through the bank — this is harmonization ofstandards and platforms.
If one could get the five largest banks in each market to agree on a network andplatform, the rest of the industry would soon follow. Changes in law will further
institutionalize the space, and coordination among supply chain participants will
drive the adoption of blockchain technology in trade finance.
Q: What are the economic benefits of this legislation in terms of cost savings
or value add in trade? What does the adoption look like in the near- to
medium-term?
Bob: The Centre for Information Management at Loughborough University held aworkshop on the Digital Transformation of International Trade in September 2022
and concluded that digital transformation could result in an 80% cost reduction in
global trade while increasing trade volumes by over 40%.
In my view, trade finance has seen very little innovation in the last 300 years, butdigitization on the back of changes in legislation could result in a massive economic
benefit. A single change in law is likely to reduce the time it takes to send and clear
documents, also resulting in economic benefit.
However, I do not anticipate rapid blockchain adoption anytime soon. We are first
likely to see greater digitization, which could lead to greater institutional coordinationin this area. By 2030, we could see 8%-10% of trade finance on the blockchain.

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A Conversation With Sunil Senapati on
Blockchain Use in Trade Finance
Q: Why have previous blockchain initiatives and pilots in trade finance failed?
Sunil: Blockchain is an ideal technology for trade finance and meets its primaryneeds of real-time tracking of cargo and documents, increasing transparency,
reducing counterparty risk, enabling automation and swift settlements, and reducing
transaction costs. The trade finance process involves verification of documents,
authentication, transfer of titles from party to party, and multiple parties operating indifferent jurisdictions and on different platforms, and it is a mammoth coordination
task.

Sunil Senapati is Chief Operating Officer –Trade and Payments at XinFin, an opensource hybrid blockchain protocol. He has
25+ years of experience in Technology,
Consulting, and Trade. He has held various
positions and worked closely with CXO-level
executives providing business
transformation using technology. Previously,
he has worked with Maersk, Oracle, Bolero,and MonetaGo.

Until now, some consortiums have created bespoke blockchain and non-blockchain
platforms. For example, in 2018, IBM and Maersk founded TradeLens, a
blockchain-enabled trade platform. TradeLens provided every entity involved in
global trade with the digital tools to share information and collaborate securely.
However, in November 2022, the platform and the offerings were discontinued, as
global industry collaboration could not be achieved.
TradeLens could not reach the level of commercial viability necessary. This was acollaboration and adoption problem. A platform led by a shipping major is not seen
as a neutral party. TradeLens was the brainchild of a shipping company and atechnology company, but they had trouble onboarding banks. One reason: no legal
framework that accepted digital documents.
Q: What is changing on the legal front?
Sunil: No major jurisdiction or regulator accepted digital documents in supply chain
and trade finance up until recently. This led to limited uptake of any digitization
solution in trade. There are billions of paper documents transferred and flown
around daily. This process needed to be digitized.
While many companies used digital documents on a bilateral basis, the industry
needed mass adoption, and for mass adoption we need regulatory and legal clarity.
The United Nations Commission on International Trade Law (UNCITRAL) adopted
the Model Law on Electronic Transferable Records (MLETR) in 2017.
MLETR aims to enable the legal use of electronic transferable records both
domestically and across borders. Some jurisdictions, such as Bahrain, Singapore,and Abu Dhabi, adopted the rules between 2018-21, which is a start but notenough, as more countries need to legally recognize the use of electronic
documents in trade.
On October 12, 2022, The Electronic Trade Documents Bill (HL Bill 57) was
introduced in the House of Lords in the UK Parliament to provide digital trade
documents the same legal footing as their paper-based equivalents and to give UK
businesses more choice and flexibility in how they trade.
If passed, this bill will modernize old legislation such as the Bills of Exchange Act
1882 and the Carriage of Goods by Sea Act 1992 and will make the UK one of thebiggest global trading countries in the world to legalize electronic trade documents.
Presently, around 80% of world trade is based on English law.
Q: Will it work this time? Why will we see blockchain adoption in tradefinance?

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Sunil: One of the drivers for adoption of blockchain in trade finance is that the UK isgoing to start accepting digital documents as part of international trade. This is
groundbreaking because given that most of global trade follows English law, it
makes digital documents in most of international trade acceptable in a court of law.
This grants much-needed legal and regulatory clarity to trade participants, and evenbanks, to start their digitization processes. Electronic transferable records may beparticularly relevant for certain business areas, such as transport and logistics andfinance.
English law accepting electronic documents will be a game-changer for tradefinance and blockchain’s adoption.
Moreover, the blockchain networks are becoming friendly because they haverealized that if they operate in silos, they are not going to get critical mass to carryon operations, let alone see mass adoption. The industry is also experiencing a“network of networks,” which essentially connects the individual blockchain
networks so they are interoperable.
The learnings from the blockchain and supply chain industry, as well as the
openness of legal and regulatory bodies, will help the flow of information in the
supply chain and trade finance sector get faster.
Q: What percentage of global trade flows will involve digitized flows and use
the blockchain for part of their process by 2025? By 2030?
Sunil: Tough to give a number, but with more countries accepting electronic trade
documents, I feel we should see this percentage moving to two digits by 2025.
By 2030 and beyond, we are likely to see greater adoption, with interoperability
taking the digitized flows to higher percentages. Wider adoption will require simpler
applications, low or no costs to use the basic functionalities, and new liquidity
providers to support the trades.

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[C.] Technology Enablers
Four core components will drive mainstream
adoption of blockchain

In this section of the report, we address the big question: What key components oftechnology are needed to drive mainstream adoption of blockchain? We then delve
into four core technology drivers:
 Blockchains enable pseudonymous or anonymous identities. How do we tie

these new features to real-world identity and/or authentication? We outline thesolution stack around decentralized identities and recent developments in thisspace.

 Zero-knowledge (zk) proofs are key for driving blockchain adoption through two

impactful applications: scaling and privacy. ZK proofs could be the gamechanging technology that allows institutions and large enterprises to use publicblockchain without comprising the confidentiality of proprietary data.

 Blockchains can only work on data that is available on-chain and cannot accessreal-world data or information. Oracles are central to connecting blockchains toreal world data and information. We map out how Oracles work and highlightimportant applications where Oracles are used.

 The future is likely to be inherently multi-chain. Interoperability between chains isfundamental to ensuring we do not end up in a siloed infrastructure. We explore
why secure bridges are fundamental to interoperability and scaling.

Blockchain Adoption Is Much Slower Than Internet Adoption:
The internet was available for commercial use starting 1995, and by 2005, it had hit
its first 1 billion users. While this was a remarkable journey of exponential growthmarked by booms and busts, the internet had found its product-market fit with over
15% of the global population in just about 10 years of being available
commercially.76
Blockchain, in contrast, has a much slower adoption cycle. Fourteen years since thelaunch of the first bitcoin blockchain, we are estimated to be at 420 million crypto
users globally in 2023, well under the 1.8 billion internet users accumulated over thecomparable period.77

Slow Adoption — It Is Not Just the Technology:
The internet enabled a “net-new” capability — the information superhighway.
Blockchain, by contrast, will create change in part by replacing a current functioning
system (the value-transfer layer), but also by advancing a new ideology (selfsovereignty and decentralization), and offering new capabilities and operating
models (digital tokens and on-chain functionalities) — all with a layer of speculative
price action and volatility thrown in. To complicate things further, the technology
brushes up against the core of the monetary system and regulations and needs tointeroperate with existing infrastructure. So, when is blockchain not a good fit?
We do not envisage DLT-based financial
infrastructure fully replacing traditional
financial market infrastructure

Notably, blockchain has a number of use cases for which it may not be appropriate
and throwing blockchain at a problem could actually degrade user experience, suchas in the cases shown below:

76 Max Roser, Hannah Ritchie, and Esteban Ortiz-Ospina, “Internet,” Our World in Data,

accessed March 20, 2023.

77 TripleA, “Cryptocurrency Ownership Data”, accessed March 20, 2023.

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Citi GPS: Global Perspectives & Solutions– Systems run by centralized entities (where trust is not an issue) andinfrastructure operated and maintained by one party (where a shared golden
source of data is not relevant) may not be suited to blockchain. The
infrastructure components in several financial markets rely on high-frequency,
millisecond-level, low-latency trading data and execution, and fundamentally,present-day blockchains and DLT might not be appropriate in these situations,as they introduce significant latency for transaction confirmation.
– Systems reliant on serialized workflows may also not be a good fit, unlessbusiness processes are re-engineered to fit a distributed system.
Blockchain will find product-market fit where
distributed infrastructure exists with a sharedsource of data, cryptographic verifiability,and decentralized control

We do not envisage DLT-based financial infrastructure fully replacing traditional
financial market infrastructure (FMI). Instead, blockchain will find product-market fit
doing what it does best — operating where a distributed infrastructure with a sharedsource of data, cryptographic verifiability, and decentralized control is material,
leaving other areas in the domain of traditional FMIs.
From a technology specification perspective, we believe blockchain needs to havethe items listed below in order to scale to billions of users: Transaction scale and throughput (how many transactions a system can process

over a period of time) matching traditional finance.

 Strong guarantees of security: safety, liveness, and data availability.
 On-chain identity and a way to map to real-world identity (which can be disclosed

selectively).

 Privacy of user identity and transaction data.
 Connectivity between real-world data and information and blockchain.
 Interoperability, i.e., the ability to transfer data and assets across different chains.
 User experience (UX) and user interface (UI) including native mobile support.

Transaction scalability and throughput improvement are focus areas of the publicblockchain ecosystem, with different layer 1 (L1) chains — the base-level chain in a
network — having their own approach to these problem areas. At a fundamental
level, scalability, security, and decentralization have trade-offs, and it is hard toachieve all three at once — as captured by Ethereum co-founder Vitalik Buterin’s“blockchain trilemma” concept. There is a lot of ongoing work on scaling with layer 2(L2) chains, rollups (which gather transactions onto the main chain), sharding(which horizontally splits a database into smaller data sets, or shards), and modular
blockchain features. With technology improving, there is an expectation thatblockchains will reach throughput levels comparable to traditional applications,although the jury is still out on how long this could take.

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For blockchains to instill confidence in handling mainstream high-value transactions,they must consistently provide strong guarantees of security: safety, liveness, anddata availability. “Safety” means assurance that nothing bad will happen (i.e., thatthe blockchain will not reach an invalid state — a “state” can be thought of as asnapshot of blockchain transactions at a point in time). “Liveliness” implies thecorrect thing will happen (i.e., that the blockchain eventually reaches a valid state
given some time, even if there are temporary delays). Data availability (i.e.,ensuring nodes have full access to block data) is also a key requirement, especiallyin the context of rollups, which enable the scaling of blockchain by executing
transactions off the main chain.
Improvements in blockchain UX/UI are
needed, and there are several ongoingprojects in this space

Switching gears to the end-user: As covered in earlier sections of the report, UX andUI in the blockchain/Web3 space have a long way to go to drive mass consumer
adoption. So far, users have needed to get used to new concepts, including custodyof cryptographic keys, hot and cold wallets, remembering an arbitrary list of 12 keywords, and “signing” transactions that look cryptic and unreadable.
“Being your own bank,” or being personally responsible for your asset and activities,
is a lot harder in practice than in theory, with even experienced developers or longtime players losing access to their cryptographic keys or being hacked. There is a
lot of ongoing work in this space, including human-readable accounts like Ethereum
Name Service (ENS) and the latest news from ETHDenver in early 2023 regarding
Ethereum upgrading to “Account Abstraction,” which could make Ethereum
accounts more user-friendly by enabling customizable features.
A recent Cointelegraph Magazine article captures the features of accountabstraction below:78“Benefits include two-factor authentication, signing transactions on your phone, thesetting of monthly spending limits on an account, the use of session keys to playblockchain games without constantly having to approve transactions, decentralized
recovery of wallets; smart accounts can be configured to autopay bills andsubscriptions — the list goes on.”In addition, there is pioneering work on making Web3 suitable for native use on
mobile phones. In June 2022, Solana Labs announced the launch of its Web3 Saga
mobile phone. The company describes the phones as “a premium mobile
experience that enables you to trade tokens while waiting in line for coffee, mint
non-fungible tokens (NFTs) on your morning commute, and have instant access tothe dApps you love most, anywhere, anytime — all powered by Android,” according
to its website.79 An integrated secure element microchip on the phone enables
securing cryptographic private keys at a hardware level, while the wallets on thephone never directly interact with the keys. With the phones slated for launch in2023, it remains to be seen if mobile UX can do to Web3 adoption what it did toscaling the internet.
In the next few sections of the report, we dive deeper into technologies driving
identity, privacy, Oracles, and bridges.

78 Andrew Fenton, “‘Account Abstraction’ Supercharges Ethereum Wallets: Dummies
Guide,” Cointelegraph Magazine, March 1, 2023.
79 Solana Mobile, “Saga: Web3 in Your Pocket,” accessed March 5, 2023.

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Decentralized Identity Decentralized identity is a core technology component that will enable

regulatorily compliant uses of blockchain while still preserving
anonymous/pseudonymous access.

 Decentralized identifiers can potentially flip the model from big technology

platforms owning our identity data to self-sovereignty.

 Decentralized identity introduces a new paradigm of sharing identity information

on a “need-to-know” basis for different use cases. It is likely to minimize the“digital footprint” users leave with Personal Identifiable Information (PII) data on
the internet.

When it comes to identity, the role of any form of identification is the ability toconfirm that “I am who I say I am.” In short, it is all about authentication.
We use various forms of identity to authenticate ourselves in our daily lives, such as
for unlocking our phones (e.g., face ID, fingerprint), entering offices (e.g., accesscards), and traveling (e.g., passports, national IDs).
These different authentication types vary with the nature of the access request andare often specific to certain systems — i.e., you need a password, SMS, or OneTime-Password to access your email account, but to cross the border with anothercountry, you need a legal form authenticating your identity (e.g., a passport).
Identity is about authentication

However, the internet does not have a built-in user authentication system or identity
layer. This has led to a host of authentication solutions and logins, individually
managed by different applications.
These identities are mostly centralized and siloed, come with limited rights, andcome with the condition that we act in a certain prescribed way. Centralized
identities are also prone to theft and censorship.
Digitization has changed the way we do most things — transact, interact, and trust.
We see development of decentralized versions of everything (e.g., money, finance,and social media), though we are yet to see mass adoption.

Decentralized identity is an essential
component in enabling the growth andwidespread adoption of decentralized
applications and services in the Web3
ecosystem

Decentralized identity is an important building block to deliver the decentralization
promise of Web3 or blockchain. This does not imply a lack of centralized parties in
identity issuance or verification, but that the mechanism of owning, sharing, andverifying identity is done in a permissionless, decentralized manner. However, theadvent of decentralized self-sovereign identity will help us: (1) drive Web3 adoption,and (2) address the shortcomings of centralized identity, including portability andcensorship.
However, decentralized identity solutions are in a nascent stage of development
and pose risks, including: (1) software and security challenges, (2) loss or theft ofprivate keys, (3) malicious nodes intercepting and cloning personal information, and(4) surveillance capitalism or the commodification of personal data.

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Digital identity is our access key to the digital ecosystem, and blockchain is the
future of finance and can help make digital identity more secure.
– DR. RUTH WANDHÖFER, INDUSTRY EXPERT, NED, CHAIR OF THE PAYMENT SYSTEMSREGULATOR PANEL, VC PARTNER

Identity: From Beads to Biometrics
About 100,000 years ago, individuals used jewelry and beads to communicate
wealth, family ties, and personal identity. Tattoos and body art were also used toconvey a person’s status, ancestry, and membership in a particular group as early
as 4000 B.C. 80 Around 3800 B.C., the Babylonian empire and later the Roman
empire made a common practice to collect citizens’ data and issue identity
documents.81
Fast-forward to the 15th century, King Henry V created a document (i.e., a modernday passport) for English citizens to prove their identity in foreign countries.
Throughout the 20th century, countries developed various national identification
methods, and in 1977, we have the first record ever of the computerization of
personal identification.
Following on, the 21st century has been all about biometrics. In 2004, the U.S.
deployed statewide automated fingerprint databases. In 2010, India introduced
Aadhar, the world’s largest biometric digital ID system, which captures citizens’
fingerprints and iris scans and assigns them a unique 12-digit number. Belgium
issued electronics ID cards (eIDs) as part of the Belgian Personal identity Card
Project (BeIPIC), initiated in 2003. The eID enabled citizens and residents to avail
themselves of government services and saw 100% adoption by 2011.82

Need for Decentralized Identity
A passport functions as a legal identity, which provides certain rights — fromcrossing borders to opening bank accounts — whereas a digital identity provides
various rights in the borderless world of the internet. Like every technology, we haveseen digital identity transform over the years.
We evolved from our simple email example of digital identity in Web1 to the only
slightly more secure and further siloed forms of digital identity in the Web2 era thatallowed users to rent digital space (which we explain below). Today, we are at thecusp of an emerging concept of decentralized on-chain self-sovereign identity in the
Web3 era. This may permit users to own their identity and help them authenticate
their digital content and digital assets.
We need to enable decentralized digital
identity to enable Web3

As internet use cases grew in the Web2 world, we saw the emergence of various
authentication solutions and logins issued by different platforms (e.g., Google,
Apple, Facebook) that allowed users to “read and write,” i.e., Web2-enabledinteraction.

80 Katina Michael and M.G. Michael, “The Proliferation of Identification Techniques for

Citizens Throughout Ages,” University of Wollongong, 2006.

81 Veriff, “The History of ID,” May 10, 2022.

82 Thales Group “Electronic ID Cards in Belgium: The Keystone of eGovernment,”

accessed March 20, 2023.

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Large platforms may have become the gatekeepers and controllers of therespective types of digital identity, enabling the right to access, while users became“renters” of the digital space with limited rights. Web3, as the next iteration of theinternet, enables “read-write-own” capabilities along with the promise ofdecentralization, censorship-resistance, and sovereign ownership.

Decentralized identity and verifiable credentials technology will become a gamechanger resulting in a metamorphosis of the identity space.
– SUBHA TATAVARTI, CHIEF TECHNOLOGY OFFICER, WIPRO LIMITED
Decentralized identities are generated froma completely neutral protocol, using puremath

Decentralized identities are digital identities generated by a completely neutral
protocol, from pure math. Web3 enables users to be identity owners, different fromtheir earlier roles of being renters. Web3-based decentralized identity is notmainstream yet, but it could help us address the shortcomings of Web2-based
identities.
Why do we need decentralized identity? Why does decentralized identity matter forthe adoption of blockchain and Web3?
 Centralization: In a centralized system, the user is completely dependent on theplatform issuing the digital identity (e.g., Google, Facebook). This creates asingle point of failure. For example, if one uses Google login credentials to sign
up to an audio or video streaming platform and the login credentials are stolen or
blocked, one could lose access to all accounts and websites that use this identity
for authentication.

 Silos vs. Interoperability: Web2-based digital identity is siloed in the sense thatit can only be used for access, identification, and authentication on a single
platform. Admittedly, federatedID allows users to use their digital identities from
BigTech platforms, such as login with Google, login with Apple ID, and login with
Facebook, to access other sites. However, if a user loses their Apple, Google, orFacebook ID, they will lose also access to other platforms. With international
technical standardization, Web3-based identity could be developed such that it isinteroperable. This would allow users to carry their Web3-based ID acrossplatforms and services.

 Censorship-Resistance: Web2-based digital identity is issued and controlled bycompanies, leaving users with very little choice or control. We have seen multiple
examples of the deplatforming of users by BigTech platforms. This means all user
data, content, and contributions can be lost any second at the discretion of asingle company or a person. Web3-based identity is not issued by BigTech, but iscryptographically signed and owned by the user, meaning nobody can take itaway. Components of Web3-based identity can be issued by centralized parties,
but control and presentation of these identifiers are solely in the hands of theuser.

 Data Privacy: Today, centralized platforms control a user’s identity and personal

data. Digital identity solutions offer privacy and control over users’ personal data.
This requires implementation of privacy-preserving mechanisms, like zeroknowledge proofs, to protect personal information from unauthorized access or
misuse.

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 Security: In centralized systems, identity security is ensured by the security ofcentral servers and databases, but these “central honeypots” are open to attackby malicious actors. For example, LastPass, an online password management
service, revealed in December 2022 that hackers obtained user information suchas billing and email addresses, usernames, telephone numbers, and IP
addresses.83
Digital identity on a distributed network is harder to penetrate and compromise as
robust cryptographic mechanisms, as well as consensus and distribution
protocols, can protect against wrongful access, thefts, and misuse. The different
digital identity attributes (e.g., age, university degree, work history, carregistration) are distributed across the network and thus, there is no central
honeypot with all identity attributes that can be hacked.

Figure 23. Evolution of Users and Identity in Various Iterations of the Internet

Source: ResearchGate, WordPress, Citi GPS

Identity in the Web3 World
Digital identity in the Web3 world refers to aunique, verifiable, and decentralized
representation of an individual or entity on
the blockchain

Digital identity in the Web3 world refers to a unique, verifiable, and decentralized
representation of an individual or entity on the blockchain. It typically includes
personal information, such as names, addresses, social media accounts, and otheridentifying characteristics, that is stored in a secure and decentralized manner.
Web3 digital identity solutions aim to provide individuals and entities more control
over their personal data and the ability to use it in a secure and trusted manner inonline transactions and interactions.

83 Ben Demers, “Struggling LastPass Suffers New Data Breach. Is Your Account at

Risk?” Kiplinger, accessed March 20, 2023.

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Self-sovereign identity puts users in control. In accordance with the principle ofdata minimization, users consent to specific datapoints to be shared as opposed
to sharing everything. User data is not stored in one centralized place. They caneither store their data themselves or avail of third-party trust providers to do so.
– DR. RUTH WANDHÖFER, INDUSTRY EXPERT, NED, CHAIR OF THE PAYMENT SYSTEMSREGULATOR PANEL, VC PARTNER
Digital identity solutions also make it possible to integrate blockchain technology
into various existing systems and applications, which makes it more accessible to awider audience.
A digital wallet will hold a user’s social credentials, digital assets, personalaccounts, biometrics, etc. Protected by private keys, the user can decide to
selectively expose their identity credentials for different use cases as they deem fit.
Polygon ID
In March 2023, Polygon released a self-sovereign identity infrastructure stack built on zero-knowledge proofs. The new
infrastructure offers users a way to verify their identities while safeguarding the privacy of their personal data.
Polygon ID can be used to build off-chain credentials such as diplomas, driver’s licenses, or national IDs. Polygon ID can enable
users to store and update digital assets (including avatars and objects), achievements, and progress to be used across different
games and within the metaverse.
The Polygon ID stack is an open-source license, allowing developers to leverage zero-knowledge technology within their
existing compliance processes without sacrificing user privacy.
The Polygon ID is based on three main modules: identity holder, issuer, and verifier. These three entities form what is commonlyreferred to as the triangle of trust, where trust must exist between a verifier and an issuer.
Every identity is identified by a unique identifier called a DID (Decentralized Identifier), and every identity-based information isrepresented via a Verifiable Credential (VC). VCs are issued by an issuer to an identity holder, who generates zero-knowledge
proofs of the VCs issued and presents these proofs to the verifier for verification.
Figure 24. Polygon ID's Triangle of Trust

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How Does Decentralized Identity Work?
Decentralized identity is based on public key cryptography. Users are assigned
public-private key pairs, with the public key generating a unique address and theprivate key functioning like a password that is used for authentication. It is worth
noting, however, that the public key encryption is not quantum-proof.
The private key, housed in a Web3 wallet, can then be used to connect to Web3
websites and decentralized applications, bringing one’s digital wallet into different
apps for seamless interoperability.
According to the World Wide Web Consortium (W3C), the international standards
organization that lays out specifications for decentralized identity, a decentralized
identifier has the following necessary characteristics:84
 Decentralized: There should be no central issuing agency.
 Persistent: The identifier should be inherently persistent, not requiring thecontinued operation of an underling organization.

 Cryptographically Verifiable: It should be possible to prove control of theidentifier cryptographically.

 Resolvable: It should be possible to discover metadata about the identifier.

A good example of a decentralized identity stack is Ethereum Name Service (ENS)— an open-source, blockchain-based identity protocol. ENS enables users to createa unique username NFT that resolves to a wallet and eventually allows them tocarry a unique ID across Web3 applications.
ENS is a protocol for human-readable crypto addresses and decentralized domainnames. It is similar to DNS (Domain Name System), i.e., a system that assigns
human-readable domain names to internet protocol (IP) addresses in Web2.
For example, one can send ERC-20 tokens (fungible or non-fungible) toronitghose.eth instead of a long cryptographic address. It is much easier toremember and easier to do business with (transact) in the Web3 world whenidentification is simplified.
ENS registrations rose in 2022, driven by crypto users rushing to secure the “.eth”
namespace. We expect other identity or decentralized social protocols may launch
their own native namespaces such as .crypto or .lens.

84 W3C Working Group, “Use Cases and Requirements for Decentralized Identifiers,”

W3C Working Group Note, March 17, 2021.

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Figure 25. Ethereum Name Service (ENS) Registrations (in millions)

Note: Data as of February 9, 2023.
Source: Dune Analytics, Citi GPS

Sign-In with Ethereum, launched in 2021, enables users to use their Ethereum
account and associated ENS name as identifiers across multiple services, including
off-chain applications. Users can use their Web3 wallet of choice to connect to theunderlying Ethereum accounts and their ENS names to log into applications.
Verified credentials are core building blocksof the decentralized identity technology
stack

In the context of decentralized identity, “verified credentials” are core building blocksof the technology stack. Verifiable credentials are a digital, cryptographicallysecured version of physical and digital credentials, which people can present toorganizations that need them for verification. Employee experience certificates,
digital passports, and digital driver’s licenses are some examples of identity
documents that can be issued as verifiable credentials.
Where are decentralized identities stored? A Web3 identity wallet is an applicationthat can be used to store data about an individual's identity. Unlike traditional digitalwallets, which are controlled by central authorities, Web3 identity wallets aredecentralized and can be controlled by the individual.
Decentralized identity and verifiable credentials in a Web3 wallet can be used toconnect to decentralized apps (e.g., decentralized social and gaming), which we
believe are in early stages of development but could be drivers of blockchain mass
adoption.

Self-Sovereign Identity: Applications and Use Cases
Self-Sovereign Identity (SSI), or Decentralized Identity (DID), is a method of identitythat gives control of information back to the user. It eliminates the need to store
personal information on a central database and enables individuals greater control
over what information they would like to share. SSI, or DID, is a user-centric, usercontrolled approach to exchanging authentic and digitally signed information.

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We think self-sovereign identity could be the passkey to interact in the Web3 worldof decentralized finance, decentralized social, and an open Metaverse, among
others. A 2022 report by the company cheqd estimates self-sovereign identity’s total
addressable market at around $550 billion.85 McKinsey estimates full digital identity
coverage in just the seven focus countries they analyzed could add 3%-13% toGDP in 2030.86
 Wipro: In February 2023, Wipro Lab45 launched the Decentralized Identity andCredential Exchange (DICE) ID. DICE ID is blockchain based and enables theissuance and verification of tamper-proof, self-verifiable digital credentials. DICE
ID securely stores authorized personal information issued by verified issuers
directly in the user's identity wallet. All data is encrypted and embedded, and theuser only receives it into their own identity wallet. This digital wallet can be used
to share identity credentials with current or potential employers, healthcare or
financial services providers, or educational institutions, among others.87

 Microsoft: In 2021, Microsoft’s digital identity team launched a digital identity

network called ION, a new framework for users to authenticate themselves. The
decentralized identity network has been live on the Bitcoin network and functions
as a layer 2. In the same way that Lightning Network uses Bitcoin’s network forpayments, Ion uses Bitcoin’s blockchain to create digital IDs for authenticating
identity online. A public key and its associated private key are used to verify if auser owns an ID.

 AID:Tech: AID:Tech provides enterprise-level solutions to international NGOs,

governments, and corporates. Through the delivery of digital entitlements
through blockchain technology and digital identity, AID:Tech addresses some of
the largest obstacles in global development, including legal identity, financial
inclusion, and corruption. Its Self-Sovereign Decentralized Digital Identity, whichacts as a gateway to digital services, is built on W3C standards and is compatible
with AID:Tech's interoperable digital identity protocol.88

 European Citizens and Businesses: The European Digital Identity Wallet will

be available to EU citizens, residents, and businesses who want to identify
themselves or provide confirmation of certain personal information. It can beused for both online and offline public and private services across the EU. It
gives full control to users to choose which aspects of their identity, data, andcertificates they share with third parties, and keeps track of such sharing. The
digital identity wallet is expected to go live by 2024.89

85 cheqd, Self-Sovereign Identity: How Big Is the Market Opportunity? 2022.

86 Olivia White et al., Digital Identification: A Key to Inclusive Growth, McKinsey Global

Institute, April 2019.

87 Wipro, “Wipro Lab45 Taps Into the Power of Blockchain Technology to Change theParadigm in Digital Identification and Verification,” Press Release, February 22, 2023.

88 Irish Times, “Aid:Tech’s Technology Will Put People In Charge Of Their Own Data,”

November 28, 2019.
89 Alessandro Mascellino, “EU Says It Can Have a Digital ID Wallet By ’24 Regardless of
Challenges,” Biometrics Research Group, November 14, 2022.

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Identity Enables AccessSelf-sovereign identity is the passkey todecentralized finance

What is the impact of not having an identity?
Globally, just under 850 million people do not have a legal identity.90 Without an ID,
they cannot open a bank account, get a loan, receive government benefits, or evenaccess basic healthcare.
In today’s age, not having a digital identity is as detrimental as lacking a legal
identity, as one cannot access basic benefits of the internet such as education,news updates, and work opportunities, among others. Having an on-chain
decentralized identity enables users to directly interact with different protocols andplatforms without needing BigTech corporates as guardians.
Self-sovereign identity could be the passkey to decentralized finance. As we saw inprevious chapters, blockchain could bring efficiencies to finance and could be thefuture of finance; similarly, blockchain-based identity (on-chain identity) could be a
crucial element to engage with decentralized finance.
Digital identity solutions might be necessary for scaling blockchain to billions ofusers, as they provide a secure and reliable way to identify individuals and entities
on the blockchain network. We may need to enable decentralized digital identity toenable Web3.
While centralized platforms have access to all information linked to the account (i.e.,facial features, location, sign-ins, interactions, and payments), a key advantage ofdecentralized identity is that the user should be able to decide which pieces of
information to share with individual applications depending on the use case andspecific requirements. This limits potential risk of credential theft or loss.
Globally, firms and platforms are exploring Web3 applications and how they canembed a certain degree of decentralization. Whatever the platform might be —public or private, centralized or decentralized, permissioned or permissionless —user identity is of utmost importance. We might just need to look for solutions thatare future proof, interoperable, and censorship free.

Risks of Digital Identity
Risks include bugs or vulnerabilities in code,
loss of private keys, malware-infected
devices, potential for state or personal
surveillance, and concerns aroundblockchains not being decentralized enough

There are always risks involved in emerging technologies and their applications.
The industry and the ecosystem learn key lessons as they deploy thesetechnologies for various use cases. There are risks involved with the use ofdecentralized identity, and we discuss some of these below:
 Code Vulnerabilities: Decentralized identity can leverage blockchain andinteracts with various applications. Networks and applications are based oncomputer code, which could have bugs or other vulnerabilities. If a bugged codefails to authenticate a valid identity or authenticates a stolen identity and allows
access on that basis, it could lead to losses (e.g., financial or brand loss).

 Loss of Private Keys: Distributed networks are secured on the assumption thatprivate keys are stored safely by their owners. However, humans are capable ofmaking mistakes, and the loss of private keys to malicious actors could bringserious financial loss to the identity owner.

90 World Bank, “Identification for Development (ID4D) Global Dataset,” 2022.

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 Compromised Cookies/Access Tokens: In a standard internet browsing

experience, a user typically gets a cookie or an access token that will identify
their session. Today, if a user authenticates to a service using a decentralized
identity, the identity could for some time depend on a single cookie and not on
the decentralized system. If malware infects the user’s phone or laptop, it could
potentially steal that cookie or access token after identity authentication.

 Surveillance Capital: Digital identity, unlike legal or paper-based identity, leaves

behind a massive digital footprint that could serve as an arena for state or private
surveillance. There could be systematic recording of all personal, financial, andgeographical data from the online activity and interactions in order to predict
future behavior of the users.

 Insufficient Decentralization: One of the common critiques of blockchain

networks is that they are not decentralized enough. Arguably, some nodes could
be malicious and try to intercept someone attempting to use their decentralized
ID with the aim of stealing or modifying it, or even piggybacking into the systemusing the same credentials.

The rise of identity theft highlights the need for stronger and more secure ways forpeople to authenticate themselves. Decentralized identity offers some exciting
possibilities, but it also presents novel cybersecurity challenges and new attack
vectors.

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A Conversation With Dr. Ruth Wandhöfer on
Why Digital Identity Matters to Web3
Q: Describe digital identity — is it just authentication in a digital
environment?
Ruth: Digital identity is about proving who I say I am in a digital way.
If we look at the evolution of the internet, Web1 had static webpages, where users
read content, and access to websites and applications was basic. Think about thetraditional email applications, which we accessed using an email address and analpha-numeric password.
Moving to Web2, the internet became more interactive. People could create,
upload, and exchange content. Security and authentication evolved from simple
static passwords to dynamic passwords (e.g., one-time passwords sent via SMS).
Dr. Ruth Wandhöfer is a Partner at Gauss
Ventures, an early stage FinTech VC firm.
Prior to that, Ruth was the Global Head ofRegulatory and Market Strategy with Citi’s
Treasury and Trade Solutions business forover a decade. Ruth is also an independent
Non-Executive Director at various firms
including a bank, an exchange, a technology
firm, and a Fintech and previously at adigital identity firm. She advises
governments, financial institutions,
FinTechs, and industry associations, as wellas provides training and coaching.

In the current Web2.5 world, authentication procedures are still a mix of old andnew technologies. For example, enrolling for a new account at most banks stillrequires uploading a copy of a passport. Albeit some neobanks have adopted
technologies like video call-based onboarding and fingerprint/iris scanauthentication.
In my view, biometrics could offer a seamless solution for authentication. Multi-nodal
biometrics, combining different biometric credentials for authentication, is likely togain prominence. Biometric authentication is also more tamper proof, as it relies on
elements within us and thus a combination of multiple biometric credentials makes
hacking difficult to impossible. Web3 could further adapt these technologies, making
the authentication process even more secure.
Q: How will digital identity work for Web3?
Ruth: Web3 is built on the promise of decentralization and aims to give control backto individual users by eliminating centralized platforms that often store tons of
personal user information. Web3 aims to provide individual users with more options,
including the choice to have their own trusted third-party provider that will act as anintermediary between them and the desired application. Web3 is built on theideology of user control, user consent, and data minimization. Think of it as having
your own secret vault to store all your identity information securely either yourself
via an app or with the help of trusted third parties. And when accessing services,
you only share the necessary information.
Contrast this with what we find most prevalent today. Most of us are aware of HTTP
cookies on websites — we see them every day while browsing on the internet.
Unfortunately, many websites are designed in such a manner that users cannot
access a particular service until they consent to all the terms and conditions, which
often involves a blanket agreement to share their personal information. Suchconsent journeys are manipulative, inevitably forcing you to share data in order toobtain access. It shows you how nothing is for free as you pay with your data. Web3
aims to reverse this power dynamic.
Q: Please elaborate on a few use-cases of digital ID in the Web3 ecosystem.
Ruth: Web3 is not there yet, rather it is in evolution and development. However, we
can still discuss this from a conceptual standpoint.

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If a user wants to access a gaming platform in the Web3 world — most platforms
often restrict entry to only those above the age of 16 or 18 years — digital identity
plays a crucial role here to prove their age to the platform.
Looking at the payments space, most transactions in today’s Web2/2.5 world are
executed using debit or credit cards; but as we gradually move to Web3, we could
see a greater role for cryptocurrencies and stablecoins. While transacting incryptocurrencies does not need users to share identity credentials (as they aremostly pseudonymous), users still need to initiate transactions with their private key.
The Metaverse of the future is likely to offer a range of services from banking,social, gaming, and commercial shopping. All of these are likely to require the user
to share credentials in order to gain access and participate. However, we should bein a position of greater control over our data to only share the necessary information
with different service providers in order to enable authentication.
Q: Are we ready to take back control of our data as a society? Are we
adequately informed to take personal accountability?
Ruth: That is the crux of the matter. The Web3 ecosystem has to be developed withthose safeguards built in. Web systems need to be designed in a manner such thatusers do not just casually consent to cookies for convenience. Users need to bewell-informed and moved away from the mindset of “I do not care what I am giving
up for it.” While users should ideally read the small print, Web3 systems should bedesigned to be more intuitive with data minimization and consent built at the core.
This enables users to consent specifically to data points being shared with theoption to enlist the support of trusted third-party providers, who securely store andshare the user’s data on their behalf. Note that users could decide to store theircredentials with different trusted third-party providers to ensure more data security
through distribution.
Admittedly, this approach may not fix today’s social media platforms, where people,
especially the younger generation, share everything with everyone, without properly
evaluating the potential dangers.
The dark web is flooded with volumes of personal data/identities, including email
addresses, passwords, and bank cards. This has led to the commercialization ofdata, resulting in significant data risks including identity theft. Social media in the
Web3 world is likely to need a complete re-engineering.
Users need to be informed and educated on the potential dangers of misuse of theirinformation in order to move away from sharing all their data with everyone. Tools
using cryptography or zero-knowledge proofs can be implemented to curtail sharingof unnecessary data. Web3 systems need to bring more personal agency andcontrol, while also protecting individual user rights.
Q: Describe the regulatory developments in Europe in context of users
accessing Web2/Web3 platforms?
Ruth: Europe has commenced work on a digital identity framework. Across Europe,an EU regulation covering electronics identification and trust services (eIDAS) for
electronic transactions within the single market has been in place for some time. In
parallel, we have seen a number of national developments on electronification ofnational identity, such as in Belgium. Markets such as the Nordics have established
a form of bank ID, allowing citizens access to a host of bank and non-bank services.

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More recently, the European Union has announced the rollout of a European eidentity wallet starting from April 2023. Member states are expected to provide thison demand to eligible users by 2024. The identity wallet is aimed at citizens,
residents, and businesses located in the EU with a broad set of use cases, which
include holding digital versions of one’s passport, driving license, other travel
documents, health records and even banking relationships.
The use of this type of e-identity wallet has the potential to offer limitlesspossibilities. Imagine, I live in France and notice cheaper mobile plans in Belgium. I
could use my European e-identity wallet to enter into a contract with a Belgium
network provider and buy my mobile plan from them (not from a firm in France). I
could also open a bank account in Germany or rent a bicycle during my holidays in
Amsterdam using my e-identity wallet. The e-identity wallet can even be used to log
into social media or email platforms, rather than being forced into their proprietarysign-on mechanism.
Q: What is self-sovereign identity?
Ruth: Self-sovereign identity is about bringing back control over your digital identity
by leveraging new technologies and processes such as distributed ledgers anddecentralization. This can help a user create an identity and self-certify it.
In a self-sovereign identity system, the user is able to both create and control
decentralized identifiers. Identity credentials can range from e-commercetransaction histories to social media accounts or data from any issuer. For instance,
I may have a university degree certified by my university, which is the issuer of thedegree. If I want to apply for a job, I may need to prove that I have a degree. The
roles of issuers and validators are still relevant in self-sovereign identity. The verifierin this case will be the prospective employer, who would ask my university toauthenticate the degree. The validator is my university, which validates mycredential (the degree) so I can share this information directly with my prospective
employer through the self-sovereign identity using a digital wallet.
Self-sovereign identities give users greater control over data and privacy with builtin principles of consent and data minimization.
Q: What are the key ingredients to using digital ID across different
technologies such as decentralized and centralized ledgers?
Ruth: In my opinion, the success of digital identity hinges on the principles ofstandardization, recognition, and interoperability. From a standardization viewpoint,
the W3C Consortium is working on technical standards for use in digital identity
across the web, albeit this is likely to take time.
For any form of identity, it is important for it to be mutually recognized. For example,
a digital identity should be recognized across digital and physical borders, enabling
the users to access services and products seamlessly. There is also a need forregulators to build a global consensus around the principles of data minimizationand consent.

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Achieving interoperability could prove to be a challenge across different platforms,
especially as we bridge Web2 and Web3 worlds. The Web2 world is mostly built
around public key infrastructure, while the new Web3 world is likely to be based on
distributed ledgers, blockchain, and zero-knowledge proofs where alternatives topublic key infrastructures (PKIs) will have to be considered, in particular in light ofthe emergence of quantum computing. Admittedly though, Web3 is still in its
infancy, and we will likely see more innovation across data, hardware, and network
solutions in the future.
For further reading, please refer to Ruth’s book titled Redecentralisation: Building
the Digital Financial Ecosystem, published by Palgrave Macmillan and launched in
March 2023 (ISBN is 978-3-031-21590-2).

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Zero-Knowledge Proofs
Zero-knowledge proofs drive blockchain
adoption through scaling and privacy

Why are zero-knowledge proofs important to scaling blockchains? How caninstitutions use public blockchains for transactions when a large majority oftransactions — between suppliers, customers, employees, and other counterparties— are proprietary or confidential?
Zero-knowledge proofs are key for driving blockchain adoption through two
impactful applications: Scaling, by moving computations off-chain in a verifiable way.
 Privacy, by keeping data, transactions, and computations hidden, but still

enabling their correctness to be publicly verifiable.

Zero-knowledge proofs have powerful applications in privacy solutions beyond
blockchains but are especially relevant in the context of public blockchains, as they
provide a solution to a fundamental problem with using them for large institutions(where all participants can see data and easily trace wallet identity to real world
entities).

What Is a Zero-Knowledge Proof?
A zero-knowledge proof (zk proof or ZKP) is, in simple terms, a proof that separates
knowledge from verification. We use terms such as “succinct” and “argument” below
as a way to help ease understanding, but these terms are not rigorously defined.
From high-school mathematics, most of us are familiar with the concept that, inorder to prove something, we need to disclose the statement we are trying to prove
and walk through the steps of the proof in sequence. But when a statement isproven in “zero-knowledge,” the prover proves a secret statement to the verifier
without leaking any information about the statement. We can loosely consider theseas “blind-proofs.”
In cryptography, this “proving” process is usually accomplished interactively, withthe verifier asking a sequence of questions to the prover, and the prover answering
them. These questions could involve, for instance, “opening up” the solution at
specific locations to prove that the solution is correct, but this “proving” is done in a
way that does not leak information about the whole, secret solution. Repeatedenough number of times at different points, there is high probabilistic assurance thatthe prover knows the solution, although no information about the solution itself leaks
during this interchange. This proof can also occur in a non-interactive way, but thatwould likely require a pre-processing step at both the prover and the verifier.
This abstract concept of proving in zero knowledge is best explained by a simple
example, as laid out in the note “Applied Kid Cryptography or How to Convince YourChildren You Are Not Cheating.”91

91 Moni Naor, Yael Naor, and Omer Reingold, “Applied Kid Cryptography or How toConvince Your Children You are Not Cheating,” PDF, March 1999.

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Consider two characters, Alice and Bob, who are playing the children’s game“Where’s Waldo?” In this game, the goal is to find Waldo in a book, a character
usually in a red hat and a striped red shirt, page after page, in a sea of colorfulpeople. In the example, Alice knows where Waldo is on a page of the book but
wants to prove to Bob that she knows this, without revealing the exact location on
the page to Bob.
According to the authors of the note, a low-tech solution for this problem could
involve Alice using a large piece of cardboard (larger than the book) with a small
rectangle cut in the middle. Alice could then put the rectangle on top of the bookwhile Bob is not looking to position Waldo to be visible through the cut-out. Bob now
has proof that Alice knows where Waldo is but learns nothing beyond that.
Figure 26. Illustration of Zero-Knowledge Proofs
Alice sets out to prove to Bob that she knows
the secret, without revealing the secret
I know a“secret”

I don’t know what
the secret is, but
I’m convinced
Alice knows it

WITNESSI know the solution: here’s a sample answer for
you to verify

CHALLENGE

That works, now prove this: Verifier picks anotherrandom question from the set of questions

RESPONSE

Prover: AliceI know the solution: Prover calculates the answer
and returns it to the Verifier (would be infeasible
without using the “secret” for the calculation)

Verifier: Bob

Source: Citi GPS

This immensely powerful concept — separating knowledge from verification — wasfirst introduced by Shafi Goldwasser, Silvio Micali, and Charles Rackoff in theirseminal 1989 paper “The Knowledge Complexity of Interactive Proof Systems.”
Their work won Micali and Goldwasser the Turing Award in 2013, widely referred toas the “Nobel Prize in Computing.”
ZKPs are critical for enabling privacy on
public blockchains to drive institutional
adoption

As noted earlier, zero-knowledge proofs have powerful applications in privacy
solutions beyond blockchain but are critical for enabling privacy on publicblockchains to drive institutional adoption. They provide us an elegant solution to“have our cake and eat it too” by capitalizing on the transparency and publicverifiability of a blockchain, without diluting the confidentiality and privacy of theinformation being written to it.

What Is a zk-SNARK?
The most popular zero-knowledge technique for blockchain applications is zkSNARKS, a kind of zero-knowledge proof that is much easier to verify than it is tocompute (e.g., to prove). Verification of this type of proof is usually in the order of afew milliseconds and with small proof sizes (in hundreds of bytes), even for large
statements being proved.92

92 Zcash, “What Are zk-SNARKs?” accessed March 20, 2023.

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Perhaps the most powerful cryptographic technology to come out of the last
decade is general-purpose succinct zero-knowledge proofs, usually called zkSNARKs.
– VITALIK BUTERIN, CO-FOUNDER OF ETHEREUM93
So, what is a “SNARK”? It is not “mocking irreverence” or an “imaginary animal” asa simple web search tells us; within the context of our discussion, a SNARK stands
for Succinct Non-Interactive Argument of Knowledge.
An “argument” is similar to a proof, but it is computationally rather than statisticallysound (i.e., it is impossible to break in practice with limited computational power).
Typically, proofs are interactive and require the prover and verifier to exchange
messages, as the prover works to convince the verifier of the proof of a statement. A“non-interactive” proof flips this model and attempts to prove the statement in one
shot with no interaction between the prover and verifier. It may, however, need a“trusted setup” phase to enable proving in a non-interactive way. “Succinct” here
implies the proof is short and quick to verify. The last keyword, “Knowledge,” relates
to the concept of sharing information about the statement the prover is trying toprove to the verifier. The default-mode is for knowledge to be shared; a zk-SNARK,
however, is a SNARK that enables proving statements in a zero-knowledge way.
As renowned cryptographer and Stanford professor Dan Boneh explains, the way
zk-SNARKS solve the privacy problem on a blockchain while retaining publicverifiability is by users posting “commitments” to the blockchain, rather than postingtransaction data to the blockchain.94 A commitment is a cryptographically encrypted
proof that keeps the data secret (like a sealed bid in an auction — once committed,
these cannot be modified) but can later be opened to reveal what is inside. One can
now attach a zk-proof to the commitment that the transactions in it are valid, andanyone can check the zk- proofs to convince themselves that the committed data isvalid without learning any information about the data contained within. This notion
can be generalized to proving a statement that any specific set of “rules” wasfollowed in the commitment posted, by attaching a proof that proves rule-conforming
behavior in a zero-knowledge way.
There are applications of zk-proofs beyond blockchain, especially in establishingidentity or authentication, without divulging the underlying data. The succinctness
property of a zk-SNARK enables us to verify transactions or data in a fraction of thetime it takes to do the underlying computation.

93 Vitalik Buterin, “An Approximate Introduction to How zk-SNARKs Are Possible”,

January 26, 2021.
94 Dan Boneh, “Episode 100, Dan Boneh on the Past, Present and Future of
Cryptography,” Zero Knowledge, podcast, October 23, 2019.

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SNARKS…are such an important tool because they help resolve thisfundamental conflict in blockchains: they help us move from a totally publicblockchain to a private blockchain while preserving all the properties oftransparency and public verifiability.
– DAN BONEH, CRYPTOGRAPHER AND HEAD OF APPLIED CRYPTOGRAPHY GROUP AT STANFORD
UNIVERSITY95

Specific Zero-Knowledge Proof Use Cases
Zk-SNARKS enable privacy and scalability

Zk-SNARKS enable two main properties relevant for blockchains: privacy andscalability. Privacy comes from the zero-knowledge property of zk-proofs, where theprover is able to prove a statement to the verifier without revealing the secret.
Scalability comes from the succinctness property, where verifying a statement isorders of magnitude faster than running the computations needed to prove a
statement.
 Privacy-Enabled Public Blockchain Transactions: Zcash, the first widespread

application of zk-SNARKs, was developed by cryptographer and cypherpunk
Zooko Wilcox, along with other researchers, and is a fork of bitcoin blockchain
enabling privacy-protecting transactions. Zcash is based on the peer-reviewed
Zerocash protocol, which was published at the IEEE Security and Privacy
conference in 2014.

Zcash offers three parameters of privacy protection — one can encrypt thesender’s address, recipient’s address, and amount — or a combination of theseusing “shielding.” At the highest level of protection, a fully shielded Zcash
transaction has all three parameters fully encrypted and private.
According to the company, ZCash is fully compliant with anti-money launderingand counter-terrorist financing (AML/CFT) requirements set up by the Financial
Action Task Force (FATF) and is designed to comply with the Travel Rule.96
While there is a need for privacy-enabled public blockchain transactions, it isespecially critical that this privacy infrastructure is built in a way that is compliant
with regulations to ensure these do not become a conduit for breachingregulatory controls on transaction monitoring and recordkeeping.
 Cryptographic Attestation of Personhood: The web-performance and security

company Cloudflare introduced “Cryptographic Attestation of Personhood” toenable browsers to authenticate “proof of humanness” to servers without
divulging device or user identity details.

95 Ibid.

96 Zcash, “Zcash Regulatory & Compliance Brief,” PDF, June 2020.

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Cloudflare estimated that humanity spends about 500 human years each day on
solving CAPTCHAs (Completely Automated Public Turing test to tell Computers
and Humans Apart), the challenge-response setup that forces us to click on
buses, bicycles, and boats to prove that we are human, and not bots.97 Although
this is one slightly trivial first use-case, the concept of using zk-proofs forauthentication extends wider than CAPTCHA, and Cloudflare has designed a zkproof that enables browsers to authenticate users to servers without sending
across identifying information. The solution built by Cloudflare is not based on zkSNARKs (as these were deemed computationally expensive to prove98) but
based on elliptic curve cryptography, with some modifications.
 Proof of Membership: The above example from Cloudflare is a specific use-case of attestation of personhood as implemented for hardware devices, but zkSNARKS can be used for more general “proof of membership” use-cases.
Vitalik Buterin, the founder of Ethereum, explains this elegantly in his blogpost,summarized below in non-technical terms:99
Consider a simple function f(x,w) that evaluates to True or False depending on
public and private inputs as illustrated in Figure 27. Barring private input w, which
is a secret known only to the prover, the rest of the left-hand side of the equation— the function itself and public input x — are not secret. With a zk-SNARK, one
can prove that one has a secret w that enables this function f to evaluate to True,and this can be verified by the verifier without knowing the secret w. In nonrigorous terms, the function only evaluates to true if there is a valid secret input,
so the verifier can be assured that if the function returned True, there has to be avalid secret.

Figure 27. Illustration: What Does a Zk-SNARK Do?

Source: Vitalik Buterin, “Some Ways to Use Zk-SNARKS for Privacy,” June 15, 2022.

97 Thibault Meunier, “Humanity Wastes About 500 Years Per Day on Captchas. It’s Time

to End This Madness,” The Cloudflare Blog, Cloudflare, May 13, 2021; Watson Ladd,“Introducing Zero-Knowledge Proofs for Private Web Attestations with Cross/MultiVendor Hardware”, The Cloudflare Blog, Cloudflare, August 12, 2021.
98 Proving a zk-proof is usually much more computationally demanding than verifying inthis scenario. The browser is doing the proving to the server that is doing the verifying.
99 Vitalik Buterin, “Some Ways to Use ZK-SNARKs for Privacy,” June 15, 2022.

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In the case of a “proof of membership” use case, one wants to prove that an
Ethereum wallet w is a part of a group of white-listed or verified wallets, listed inx. The verification function f(x,w) evaluates to True only if the user is able todemonstrate they own the private keys for wallet w and that wallet w is part of thelist of white-listed wallets (i.e., the key works for the wallet and it is part of thewhite-list — together making the secret valid). Using these inputs, the proverruns the zk-SNARK proving algorithm, which generates the proof that evaluates
to true, if and only if the above function evaluates to true.
 Verification in Cloud Computing: Zk-SNARKS are part of a wider universe of“verifiable computations,” which is the concept of outsourcing computations withan assurance that the validity and correctness of the computations can beascertained.

In this setup, a single reliable PC can monitor the operation of a herd of
supercomputers working with possibly extremely powerful but unreliable softwareand untested hardware.
– LÁSZLÓ BABAI ET AL., “CHECKING COMPUTATIONS IN POLYLOGARITHMIC TIME,” 1991100
The above claim, published in 1991, is highly relevant to today’s cloud-centric
world. While cloud computing lowered the setup infrastructure costs and madecomputational investment “elastic” (i.e., growing or shrinking with demand), it
also brought with it challenges regarding the reliability, correctness, and integrityof the data stored as well as the computations undertaken by the remote cloudinfrastructure.
One solution to the above problem, without making any trust assumptions on thethird party making the computations, is to have the remote third-party return acryptographic “proof” along with its results. The proof proves the computations
were done correctly and can be verified without re-executing all thecomputations. Given all the developments in cryptography in the last decade andhalf, the time taken to verify the proof is orders of magnitude shorter than thetime taken to run the computations.
 Scaling Blockchains via Roll-Ups: As Stanford professor and cryptographer

Dan Boneh puts it on the Zero Knowledge Podcast with host Anna Rose:“So because a Layer 1 blockchain is so expensive, and, you know, notparticularly a fast computer, it actually now makes a lot of sense to outsource
computation to a GPU and have the GPU prove to the blockchain that what it did
is correct. And that's literally the kind of the reason why zk-rollups and zk-bridges
and all that have taken off.”101
This is the core concept behind different roll-ups — outsourcing computations —that are now scaling Ethereum, a slow and expensive computer.

100 László Babai et al., “Checking Computations in Polylogarithmic Time,” Proceedings ofthe 23rd Annual ACM Symposium on Theory of Computing, January 1991.

101 Dan Boneh, “Episode 256: New ZK Use Cases with Dan Boneh,” Zero Knowledge

podcast, November 30, 2022.

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Sharding has been adopted by Ethereum toscale its capacity

 Ethereum Danksharding Scaling Solutions: Apart from the use of zk-rollups

for scaling Ethereum, polynomial commitment schemes —the core building
blocks used in zk-proofs — are also used in Ethereum’s new danksharding
scaling solution. Sharding is the technique of horizontally splitting a database toincrease its data handling. It is one of the techniques adopted by Ethereum toscale its capacity — by splitting the Ethereum ledgers into chunks or “shards.”
Danksharding is a new sharding design introduced in Ethereum that builds in
Ethereum’s rollup-centric roadmap to scaling. Instead of increasing space fortransactions themselves on the Ethereum layer 1, danksharding provides more
space for “blobs” (Binary Large Objects) of data, without the Ethereum protocol
attempting to interpret what these blobs of data mean. These data blobs are thenused by roll-ups that do the computations on their own chains and submit proofs
on the Ethereum layer 1. This essentially changes Ethereum from a singlethreaded, slow computer to a multi-threaded, faster one.

Trusted Setups in Zk-SNARKS
Some examples of zero-knowledge construction need trusted setups, i.e., theirinitial parameters need an element of trust to set up the system. But once set up,
the system does not need any trust to operate. This small window of trust needed atinception has led to many interesting “ceremonies,” or one-time procedures, toorchestrate the setup in a trust-minimization way, including the esoteric-sounding“Powers of Tau” ceremony.
In this ceremony, participating entities generate Powers of Tau, where tau is arandom secret value that the entities destroy after the initial phase is created. It is
critical that once the trusted setup is finished, the secret data that led to its creationneeds to be destroyed to ensure there is no iota of doubt about a potential backdoor
on the protocol. This is done in interesting ceremonies where people break thecomputers that generated these passphrases or destroy them in other ways.

Of Secret Ceremonies, Radioactive Waste, and Propane Torches
The first public instance of a trusted setup ceremony was the one that birthed the privacy-enabling cryptocurrency Zcash.
In a riveting article titled “The Crazy Security Behind the Birth of Zcash, the Inside Story,” technology writer Morgen Peck covers
the secret birthing ceremony of the cryptocurrency, in what she calls a “cloak-and-dagger cocoon of digital secrecy.”
The project, a fork of the Bitcoin blockchain, introduces a layer of encryption enabling the masking of the identity of the senderand the receiver and the value of the transaction. Prior to launching the zk-SNARK setup needed for the protocol to run,developers used certain highly secretive private keys, one by one in a multi-party computation setup (with each key being
known to only one developer) to make the mathematical parameters for the zk-SNARK circuit work. It was extremely critical thatthese original secret keys were destroyed once created. If there was even an ounce of doubt that those keys could be accessedby any individual after the launch of the protocol, a potential backdoor could exist, completely invalidating the entire propositionof the currency (i.e., the key holder can mint themselves incremental supply of the coin at their will).
In the case of Zcash, the generation of keys was split between five developers, each in a different part of the world, using an airgapped computer (not connected to the internet) that was a last-minute purchase from a random computer store to prevent
hackers pre-installing the devices with tracking software). The computer was destroyed right after it had fulfilled its role in key
generation.

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Figure 28. How Do Trusted Setups Work?

Source: Vitalik Buterin, “How Do Trusted Setups Work?” March 14, 2022.

Morgen Peck explains it very well in her analogy below:102“I’ll hazard an analogy in order to explain more generally how this works: Let’s say you have a recipe, and you want to use it tomake a single cake that is going to feed everyone in the world and that’s the only cake that anyone is allowed to eat, ever. You
have to have a recipe to bake the cake, but you also have to make sure no one can ever make it again. So, you split the recipe
up into six parts and you design a baking process that allows each participant to add their ingredients and mix them into thebatter without the others (or anyone else) seeing what they’re up to. After pulling the cake out of the oven, you burn all thepieces of the recipe.”
In this analogy, the recipe is the bad key, the cake is the zk-SNARK parameters, and the person hiding the ingredients anddoing all of the mixing is a cryptographic algorithm.
Each of the five developers, who were called “station operators” as they each operated their station on how to generate a pieceof the parameters needed, then destroyed their secret keys. One of the ceremony participants boxed his laptop within aluminum
foil lined cardboard and did his computations when driving across Canada and burned his computer with a propane torch when
he was done.
The follow-on 2018 Powers of Tau ceremony of Zcash (for an upgrade of the protocol) used nuclear waste from Chernobyl togenerate random numbers for the secret key generation. A portion of the 2018 event also took place in a private plane flying at
3,000 feet over Illinois and Wisconsin to ensure privacy.103

102 Morgen E. Peck, “The Crazy Security Behind the Birth of Zcash, the Inside Story,”

IEEE Spectrum, December 2, 2016.

103 Nikhilesh De, “Latest Zcash Ceremony Used Chernobyl Waste,” CoinDesk, January

28, 2018.

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A Conversation With Prof. Silvio Micali on
Zero-Knowledge Proofs and Scalability
Q: What are zero-knowledge proofs (ZKPs)?
Silvio: People want secure ways of interacting and transacting on the internet withpeople they don’t know or trust. The world has transitioned from using encryption todigital signatures to secure protocols and now to an emerging technology known as
zero-knowledge proofs (ZKPs).
ZKPs allow you to guarantee that the information is true without disclosing any of
the information. ZKPs enable separation of knowledge of data from the proof thatthe knowledge exists. In other words, ZKPs enable authenticating the existence offacts (identity, asset weights, payment proofs, etc.) without disclosing the fact itself.

Silvio Micali is a computer scientist,professor at the Massachusetts Institute ofTechnology (MIT) and the founder of
Algorand, a proof-of-stake blockchain
protocol. Micali's research at the MIT
Computer Science and Artificial Intelligence
Laboratory include cryptography, zeroknowledge technologies, pseudorandom
generation, secure protocols, and economic
mechanism designs.
One of the preeminent cryptographers of ourtime, Micali’s transformative work on
complexity theory led to him being the fatherof key core components of modern
blockchain, including Zero-Knowledge
Proofs, Verifiable Random Functions, andProbabilistic Encryption.
Micali is a recipient of the Turing Award incomputer science, often referred to as theNobel Prize of computing, in addition tonumerous other accolades such as the
Gödel Prize (in theoretical computerscience) and the RSA prize (incryptography).

ZKPs can be leveraged to provide data authenticity and privacy in a variety ofcommercial and non-commercial applications.
Q: Why are ZKPs relevant for blockchain?
Silvio: Privacy is a fundamental right and a necessity for individuals, businesses,
and corporations alike. Blockchain has the potential to be very useful to companies
and financial institutions, but you don’t want it to compromise on the privacy ofusers and their transactions.
Banks and financial institutions might want to use blockchain for trading, payments,
and a variety of finance processes, leveraging the technology for the mid-office andback-office efficiencies it can bring. However, on-chain data is available to anyone
and everyone. Anybody can see the private transactions between two clients of abank.
ZKPs can mask this information and just confirm that the payment is made orreceived and the nodes on the blockchain will believe that information. No
information such as payment amount, goods or services delivered, or payment
terms will be disclosed publicly.
ZKPs can be thought of as a driver of mass adoption for enterprise, institutional
blockchain.
Q: What excites you most about blockchain?
Silvio: Blockchain technology is a distributed ledger that satisfies three crucial
properties. First, everybody can read the ledger. Second, everybody can write his or
her own legitimate transactions on the ledger. And third, nobody can alter not only
the content of the transaction in the ledger, but also the order of the transaction in
the ledger.
These properties generate added trust and transparency that was previously
unavailable. Communication of information and the entire network having acommon knowledge of the transaction are two different things. Blockchain promotes
common knowledge of all transactions and the network state across all nodes.
Blockchain is an unmediated transactional platform. I have nothing against
mediators when they add value, but if the job of a mediator is to enable the verytransaction that is being mediated, then we might be better off replacing thatmediator with technology. It also enables tokenization and fractionalization of any
assets — securities, commodities, currencies, and real estate, among others.

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Q: According to the “blockchain trilemma” a blockchain network cannot haveenough of all three — security, scalability, and decentralization. How does
Algorand’s consensus mechanism get around the blockchain trilemma?
Silvio: Blockchain trilemma is where any distributed network can’t have all three
attributes at the same time — scalability, decentralization, and security. How do wesolve it?
There are different technologies. For example, proof-of-work, which underlies
Bitcoin, simply says to create the next page of a ledger, let's have a computational
game. The first one in the world to solve a very complex cryptographic riddle, andpresent the solution, has the right to append the next page of a ledger.
That is a good solution, but there are problems. It needs thousands of super
specialized computers to solve the cryptographic riddle to have even a chance toappend a page of a ledger. When expenses go up to create a new page of ledgers,
fewer and fewer people can afford these expenses and the network becomes very
centralized.
In another technology, called delegated proof-of-stake, it's very simple. You create agroup of say 10 people, and it's their business to append pages to the ledger onbehalf of the users. By not involving many people as decision makers, you scale the
network, but it doesn’t solve for decentralization.
Algorand, on the other hand, can achieve all three attributes. The way we solved
the trilemma is a little bit counterintuitive. We have 10 billion consensus tokens.
Then you select 1,000 tokens. These 1,000 tokens belong to members of the
network, and these members form a committee, which approves the next block.
The network is distributed as we have 10 billion tokens, and everybody having atoken has a chance to participate. To summarize, the trilemma issue applies to mostblockchains, but not to Algorand, as the consensus mechanism is structured like acryptographic lottery — anyone with a token has a chance of being selected as avalidator. Algorand also offers speed, low cost, scalability, and distribution.
Q: Can you describe different types of proof-of-stake mechanisms — e.g.,pure proof-of-stake and delegated proof-of-stake?
Silvio: Proof-of-stake is not a single technology but a portfolio of technologies.
Delegated proof-of-stake is like a club. If you are invited to the club, good for you. If
you are not part of the club, bad for you, because only those invited into the club
can decide every transaction in the distributed network.
In delegated proof-of-stake, the security of the entire economy depends on thehonesty of a small delegate group within the economy. In Bitcoin, that group is theminers. In Algorand, anybody can participate. Technically, in Algorand, you can havehundreds of millions of people participating in consensus.
Another difference is that a pure proof-of-stake blockchain, which Algorand is basedon, doesn’t fork. A fork is a chain that splits away from the main chain and forms a
separate chain of ledger, creating uncertainty for everyone involved. An unforkable
blockchain like Algorand guarantees that all transactions are final and ensures asset
ownership is not lost.

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A third key difference is that there is transaction finality in less than 3.7 seconds.
The technical ability of supporting hundreds of millions of entities participating inconsensus translates into censorship resistance. In Bitcoin or in delegated proof-ofstake blockchains, you can’t propose a new block unless you have enormous
computation capacity or are part of the club, respectively. In Algorand, even if you
hold a very small stake, such as 1/10,000 of the total stake, and even if you
participate in consensus with only a laptop, you have the mathematical guarantee of
proposing a block, and to post transactions on the blockchain that others mayotherwise censor, at least twice a day!
Q: What are your views on new developments that affects blockchain andWeb3 security (e.g., post-quantum cryptography)?
Silvio: It is important that the chain is secure against quantum computers that do
not yet exist, because whenever they become available, you don't want to hack the
chain backwards. We are going to make our blockchain quantum secure.
In my view, something that is not capable of evolving over time is not going to last
very long or remain relevant for very long. We must have a blockchain which
incorporates the best and the latest technologies. To do this, you must be able toput capabilities in the blockchain similar to what Algorand has done from the very
beginning.
We have embedded in the mechanism the ability to evolve in a consensual manner.
Any time there is an upgrade of the protocol, the majority of the participants toconsensus must agree, and then that upgrade is used from that point onwards. You
want a mechanism that upgrades consensually.

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A Conversation With Zooko Wilcox on
Application of zk-SNARKS
Q: Where are zk-proofs as a technology, today? What will drive theiradoption?
Zooko: Zero-knowledge proofs are highly customized for each use case and they
have not yet hit general-purpose technology adoption. We can think of this like an“application-specific integrated circuit” mode of semiconductor chips, where each
integrated circuit is designed for a specific use case but is yet to hit generalmultipurpose use.

Zooko Wilcox is the Founder / CEO of
Electric Coin Co., that launched privacyfocused cryptocurrency Zcash in 2016.
Zooko is an original cypherpunk, longstanding technologist and entrepreneur. His
work spans decentralized systems,
cryptography, and information security. He
has contributed to an array of projects, manyof which champion privacy implementations,
including DigiCash, Mojo Nation, ZRTP,“Zooko's Triangle,” Tahoe-LAFS, BLAKE2,
and SPHINCS, to name a few.
Zcash is the first widespread commercial
application of zk-SNARKs. The
cryptocurrency was built to empower
economic freedom and was created from theoriginal Bitcoin code base with several key
improvements, namely privacy-preserving
shielded addresses and a community
development fund.

In a historical context, we can compare where zero-knowledge technology is today
to the development of Public Key Infrastructure (PKI) cryptography in the 1990s.
Prior to the launch of the early commercial-use browser, Netscape Navigator, PKI
had very limited use cases, although it showed promising potential. With the launchof Netscape, public key cryptography found a ready mainstream use case as
Netscape implemented SSL — a Secure Socket Layer protocol that underlies thecore of internet security today — using RSA public key cryptography. Today, zeroknowledge is in the pre-Netscape era of adoption and is at the cusp of toolingdevelopment.
The state of zero-knowledge research and tooling has been advanced by the publicblockchain and cryptocurrency ecosystem in their search for solutions forblockchain-scaling and identity solutions that preserve privacy. Nearly 80% of use
cases are driven by scaling and 20% by identity. Tools being developed will enableapplication developers to build use cases leveraging zk-proofs without needing tounderstand the complex mathematics behind the technology, which will drive
mainstream adoption.
Q: What is a good fit for zk-proofs in application?
Zooko: Whether to use zk-proofs or just encryption depends on whether there is aneed to validate the encrypted data. If an entity X is going to post some encrypted
data on the blockchain, and other third parties are not concerned whether this dataneeds to be examined for correctness or validity, then a zk-proof is not needed inthis scenario — encryption will suffice. But if there is a requirement to provide someassurance about the encrypted data, this can be accomplished using zk-proofs.
In the case of Zcash, a privacy-protecting cryptocurrency that’s a fork of the Bitcoin
blockchain, the sender, receiver, transaction amount and reference fields are
encrypted. But it does not suffice to only encrypt the data, as there needs to be away for the validators to verify the encrypted data does not have a “double spend”
situation (where the sender could send the same coins to two parties). Zk-proofs
provide a way to provide confirmation that there’s no double spend, without having
to reveal the underlying unencrypted data to the verifiers.

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Blockchain Oracles
Oracles are a prerequisite for scaling
blockchain Blockchains, by their design, can only access and work on data that is “on-chain.” Oracles can be thought of as an application programming interface (API)that helps connect blockchains with the real world and bridge data between thetwo worlds.

 Oracles are a prerequisite for scaling blockchain as without access to real-world

data, use cases across financial markets, insurance, and Web3 will be restricted
only to the subset that lives fully on-chain.

 Currently, we find most work on Oracles being done in the decentralized finance(DeFi) space. However, we should start to see more Oracles being built out by
regulated financial institutions for market and pricing data.

Oracles: A Prerequisite for Blockchain Use Cases
Blockchain Oracles act like a bridgeconnecting smart contracts on blockchain toreal-time, off-chain data

Blockchains do not have the ability to connect to the outside world, hence they areunable to incorporate external information into their logic. This is where blockchain
Oracles come in. Oracles help securely bring takes off-chain data sources and puts
it on-chain, so it can then be used in smart contracts.
To put it simply, a blockchain Oracle is a third-party service that serves as a bridge
between the blockchain ecosystem (on-chain) and external data sources (off-chain).
They function like APIs but in the context of a blockchain.
Let us use an example to convey this concept better. Assume you want to buy ahouse and register the agreement on the blockchain but pay for it via traditionalbanking channels through a bank transfer or by bank cheque. A smart contract
executed between the parties could help irreversibly execute the transaction basedon set of coded conditions. However, since the payment is done off-chain (viatraditional banking channels), a blockchain Oracle needs to bring this data on-chain
to enable the smart contract to verify proof of successful payment, and thenautomatically transfer a tokenized ownership deed to the homebuyer.
Figure 29. Prominent Oracles in Select Blockchains
Blockchain

OraclesAvalanche

API3, Chainlink, DIA, Pyth Network

BNB Chain

API3, Band Protocol, Chainlink, DIA, Flux, Pyth Network

CardanoAPI3, Chainlink, Charlie3, Orcfax, PIGY Oracle

CosmosBand Protocol

EthereumBand Protocol, Chainlink, Flux, iExec RLC, Nest Protocol, Orai, Pyth Network, UMA

Polygon

API3, Chainlink, DIA, Flux, Pyth Network, UMA

SolanaChainlink, DIA, Gravity, Pyth Network, Switchboard

Terra

Chainlink

Tron

Bridge Oracle, Wink

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How Does a Blockchain Oracle Work?
Oracles help bridge the information gap between on-chain and off-chain data bycreating a hybrid smart contract. A hybrid smart contract is comprised of a
combination of on-chain contract code and off-chain Oracle node.
In a typical transaction, the on-chain contract code of the Oracle receives data
requests from other smart contracts and passes it on to the off-chain Oracle node.
The Oracle node is then able to source and verify external information by querying
external databases using APIs in order to collect the requested data. This collected
data is then transmitted back to the smart contract’s storage using the on-chain
contract code.104

Types of Blockchain Oracles
 Software and Hardware Oracles: Software Oracles are most commonly used

for price feeds on decentralized exchanges (DEXs). They analyze and deliver
digital data such as exchange rates or prices from websites and other databases.
For example, a smart contract executed to buy 100 equity shares of Company A,
should its price hit a certain target. In this instance, an Oracle would provide
accurate and immutable data on the stock price. Oracles are not restricted to justprice feeds, but also other data such as weather, geographic, and economic
information.
Hardware Oracles, on the other hand, deliver data from the physical world using
information from devices such as temperature sensors, video cameras, motion
sensors, smart tags, Radio Frequency Identifications (RFIDs), and other Internetof-Things (IoT) devices. For example, a hurricane insurance policy linked to asmart contract in conjunction with a hardware Oracle can help monitor external
wind speed and notify the insurer should the wind speed cross a certain
threshold.

 Inbound and Outbound Oracles: The words “Inbound” and “Outbound” in thecase of an Oracle refer to the flow of real-world information and data. InboundOracles bring real-world information into the blockchain and are among the mostcommonly recognized types of Oracles today. One example is fetching
information on market prices of equities or stocks and providing it to the smart
contract for decentralized finance (DeFi) transactions. Inbound Oracles can also
be used to provide weather data to a smart contract for automatic insurance
claim settlement or providing sports data to settle prediction markets.
Outbound Oracles take information/instructions from the blockchain to an
external source to execute a certain action. For example, a smart contract
programmed to unlock an IoT-enabled smart lock of a warehouse following
receipt of payment from a particular crypto wallet address.

 Centralized and Decentralized Oracles: Centralized Oracles are operated by asingle entity, responsible for running the Oracle and being the sole provider ofdata for the smart contract. Users of a centralized Oracle have to implicitly trust
the entity to provide unbiased data sources. While centralized Oracles can be
efficient, they are also prone to a single point of failure should they get hacked,
manipulated, or shut down.

104 Ethereum, “Oracles”, Accessed March 24, 2023.

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Decentralized Oracles aim to overcome the limitations of centralized Oracles by
relying on multiple Oracle nodes and external data sources. This leads toincreased data credibility. They also promise to eliminate the risk of a single pointof failure by aggregating multiple data points to arrive at a single point of truth.
However, decentralized Oracles can take a relatively longer time to aggregate
data from multiple sources, when compared to centralized Oracles.
By offering smart contracts off-chain
execution capabilities, Oracles expand theuse cases for blockchain technology

 Compute-Enabled Oracles: These Oracles help perform complicatedcomputations securely off-chain and relay it to smart contracts on-chain.
Computations handled by these Oracles may often be impractical to perform onchain due to a variety of reasons, including block constraints or the sheer cost ofcomputation.
Oracle computations help extend the capability of smart contracts by increasing
scalability and cost-efficiency. Additionally, they also offer access to features suchas verifiable randomness that assigns randomized characteristics to NFTs, offchain aggregation, and transaction automation. Compute-enabled Oracles canalso be used for layer 2 scaling solutions.

 Human Oracles: These refer to instances where humans manually provide data

feeds to a blockchain Oracle. Human Oracles are often used with complex datathat cannot be collected automatically to feed into the blockchain or that requirein-depth research. To maintain authenticity of the information being relayed to thesmart contract, human beings are involved to verify their identity
cryptographically.

 Contract-Specific Oracles: These Oracles are often designed from scratch tofor use by a single smart contract. However, they are impractical for multiple
smart contracts, as multiple Oracles would need to be deployed.

Importance of Oracles in Blockchain and Web3
Applications
Smart contracts running on Ethereum or other blockchains cannot ordinarily accessdata stored outside the blockchain (i.e., off-chain). Oracles solve this problem byoffering off-chain execution capabilities to smart contracts, thus expanding the usecases for blockchain technology. We highlight some prominent Oracle use-cases
below.

You need some kind of Oracle to tell you, ‘Did it actually rain in this particulararea?’ If you want to have assets that mirror other financial assets, you need an
Oracle. If you want a prediction market, you need an Oracle.
– VITALIK BUTERIN, CO-FOUNDER OF ETHEREUM105
 Decentralized Finance (DeFi): The DeFi industry, whether they are lending

markets, liquidity aggregators, derivative protocols, or algorithmic stablecoins,relies extensively on Oracles.

105 Elizabeth Licorish, “Ethereum Co-Founder Vitalik Buterin on Why Smart Contracts

Need Oracles,” Chainlink Today, June 7, 2021.

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Developers rely on Oracles to bring off-chain data into their decentralized
applications (dApps). The most widely recognized use case of Oracles are pricefeeds used in DeFi transactions. Oracles can also be used to provide market
prices for collateral assets, enabling platforms to determine how much they canborrow from the system and when to trigger liquidations.
As more traditional assets come on-chain (e.g., tokenized bonds, stocks, realworld assets), proof of reserves is likely to become a necessity, with Oracles
expected to play an even larger role with external financial market data.
 NFTs, Gaming, and Web3: Blockchain Oracles can support dynamic NFTs

which can change in appearance or distribution based on external informationsuch as time of the day, weather conditions, etc.
Additionally, compute-enabled Oracles are also capable of generating a verifiablerandomness function (VRF) that assigns randomized traits to NFTs so the rarity
of NFTs is randomly assigned when they are minted. VRF can also provide fairrandom numbers for on-chain gaming dApps and NFTs.

 Digital Identity: Oracles can be an effective solution to attest information about auser’s identity, certificates, or other documents on-chain that were originallystored or generated off-chain. Blockchain-based identity solutions can also help
users monetize their own data, track its usage, and share it easily in a securemanner.

 Supply Chain and Trade Finance: Blockchain use in supply chains can help

increase trust and transparency. Oracles play a crucial role, as smart contracts
on blockchains need to interact with trusted and verified real-world data such as
GPS data about shipments, data from supply chain ERP (Enterprise Resource
Planning) systems, or customs data about shipped goods.

 Smart Legal Contracts: Smart legal contracts (SLCs) can interact with external

data sources using Oracles and import data from web services or APIs. This
allows the SLC to use external data as part of its decision tree and allows for therecording of the conditions under which the SLC was executed.

 Insurance Products: Oracles are relevant in insurance smart contracts forgathering external data, which can be used to confirm that conditions forpayment have been met, allowing the insurance company to payout claims
automatically, in-line with the pre-defined logic of the smart contract.

For example, Oracles can gather external information on flight delays, which canthen be used to validate automatic claim payments for passengers.
 Automatic Trade Execution: As mentioned, Oracles are highly effective in

keeping track of changes in stock prices, foreign exchange (FX) markets, or
cryptocurrencies and can help execute buy/sell orders in response to externalchanges. This makes them relevant for managing derivatives, automatic trade
execution orders, and other risk management techniques.

As use of blockchain technology continues to grow, we expect to see moresophisticated and secure Oracle solutions. Integration of blockchain with otheremerging technology such as artificial intelligence (AI) and smart IoT devices arelikely to drive further growth of Oracles, especially in process automation.

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Potential Risks and Challenges
Oracles are a vital link in the blockchain
ecosystem — however, they are not risk free

Oracles are a vital link in the blockchain ecosystem as they provide the underlying
data used by self-executing smart contracts. However, Oracles are also prone toseveral risks, some of which we discuss below.
 The Oracle Problem: This refers to the conflict between security, authenticity,and trust in Oracles, which are developed by third parties. Since Oracles provide
external data essential for the execution of a smart contract, they are in aposition to retain a significant degree of influence over the smart contracts. Thispotentially removes the trustless nature of smart contracts as part of adecentralized network.

Further, Oracles are unable to provide trustless verification when dealing withreal-world assets on the blockchain. For example, in the case of a transfer ofownership of a house on the blockchain, smart contracts need to rely on
additional third parties to verify if the former owner has indeed vacated thehouse. The need to rely on additional third parties likely further removes the killer
feature of trustless applications.
 Security Mechanism: Since Oracles act as a bridge connecting external

information with on-chain data, they are not part of the main blockchain
consensus. This means they are also not part of the security mechanism
provided by public blockchains. As a result, a compromised Oracle would likely
mean the smart contract relying on it is also compromised.

 Man-in-the-Middle Attacks: Oracles are also prone to man-in-the-middle

attacks, whereby malicious actors gain access to the data flow between the
Oracle and the smart contract, with the intent to modify or falsify the data.
Man-in-the-middle attacks could also result in interruptions or delays and may
even prevent the smart contracts from executing code.

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Secure Bridges
 The future is inherently multi-chain, as different blockchains are being built andoptimized for different use-cases with varying design choices. This has led to theneed for interoperability between chains and the emergence of blockchain
bridges as a potential solution.

 Below, we lay out the various design choices in the blockchain ecosystem withrespect to bridges and the trade-offs therein. Bridges could potentially be theweak point of a multi-chain world and need careful consideration.

 Bridges fit within a wider requirement for more generic messaging, smart contract

calls, and other types of cross-chain communication. This is especially relevant in
the context of driving mainstream financial services adoption, where messages
and data need to be transferred between different institutions or blockchain
ecosystems.

Need for Interoperability in a Multi-Chain World
Since Bitcoin was launched in January 2009, there has been a sharp rise in thenumber of blockchains, ranging from generalized smart contract platforms such as
Ethereum to application-specific chains. According to data from Coingecko, there
are currently hundreds of blockchains in existence. Value is still concentrated on a
few chains, but diversity has increased in recent years.
Figure 30. Total Value Locked per Blockchain
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%

Source: DeFiLlama, Citi GPS
The future of blockchain is inherently multichain, as varying use-cases have different
design needs© 2023 Citigroup

The blockchain industry is still young, but in our view, it is unlikely that one
blockchain will act as the sole settlement layer in the future. The future is inherently
multi-chain, as varying use cases have very different design needs (e.g., consensus
mechanism, security, monolithic versus modular, throughput). However, building
blockchains in isolation optimized for specific stated purposes may result inincompatibility, which in turn increases the risk of fragmentation. To ensure that thevalue will not be stuck on isolated islands, blockchains need to be able to talk toeach other. Enter bridges.

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How Do Bridges Work?
Blockchain bridges have emerged as a potential solution to the rising need forinteroperability. Bridges refer to protocols or intermediaries that enable users tomove assets from one blockchain to another. One popular model is the lock-andmint model.

Blockchain bridges refer to protocols orintermediaries that enable users to moveassets from one blockchain to anotherIn the lock-and-mint model, a user has a token on Blockchain A but wants to use it
on Blockchain B. A bridge can help make this possible (illustrated in Figure 31).
 Step 1: The user sends tokens from Blockchain A to a smart contract controlled

by the bridge that locks the tokens.

 Step 2: The bridge has a smart contract deployed on Blockchain B, which willmint an equivalent number of tokens on Blockchain B. This is often a “wrapped”
version of the original token.

 Step 3: The tokens will then be sent to the address of the user. The user can

now use the tokens on Blockchain B (e.g., lend it, post as collateral).

If a user wants their tokens back on Blockchain A, they need to send the wrapped
tokens to the bridge-controlled smart contract that will burn the wrapped tokens on
Blockchain B, unlock tokens on Blockchain A and send them back to the user.
Figure 31. Lock-and-Mint Bridges

Blockchain A

1

2

3
Blockchain B
Source: Citi GPS

Figure 31 is a simplified example and there are different ways a bridge operates. In
many cases, the asset does not move from one blockchain to another. It is locked
and burned on one chain, while new tokens are simultaneously unlocked andminted on the other chain. Mechanisms like this allow users to utilize a “wrapped”
version of Bitcoin (BTC) on the Ethereum blockchain.

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There are other variations possible, such as the deposit and withdraw model. In thiscase, a bridge is managing a pool with tokens on each chain. Here the user
deposits tokens in the pool on the source chain, and the bridge will then send theequivalent number of tokens from the liquidity pool to the destination chain at theuser address. The advantage is that the user receives the native token, not awrapped version. It thus does not have to rely on the security of the bridge anymore
once the transaction is finished. Wrapped Bitcoin (WBTC) is currently the largest
bridge, with nearly $3.5 billion in total value locked, based on data from
DeFiLlama.106
A problem with each bridge launching their own version of wrapped tokens is thatthey are not fungible. As a result, liquidity gets fragmented. For example, WBTC is
not the only wrapped version of BTC; several others, such as hBTC, tBTC andiBTC, also exist. To solve this, LayerZero launched the Omnichain Fungible Token(OFT), a new token standard that aims to overcome this problem.

Bridge Exploits
The popularity of bridges has led to anumber of exploits, which were by far thelargest category of stolen funds, amounting
to nearly $2.5 billion in 2022

Like all nascent technologies, blockchains are prone to vulnerabilities and so areblockchain bridges. The popularity of bridges has also led to a number of exploits,
which by far were the largest category of stolen funds, amounting to nearly $2.5
billion in 2022 (Figure 32).
Figure 32. Exploits by Type, $ millions

Source: Token Terminal, Citi GPS

The largest exploit occurred with Ronin, a bridge built for the game Axie Infinity,
where more than $600 million were stolen.107 Likewise, PolyNetwork was also
exploited for over $600 million, followed by BSC Bridge.
In a multi-chain world, interoperability protocols are a key piece of the infrastructure.
Any weakness here can be traced to core design choices of how assets are bridged
between networks.

106 Data from DeFiLlama as of March 8, 2023.

107 REKT.News, “Ronin Network – REKT,” March 29, 2022.

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Citi GPS: Global Perspectives & Solutions

Moving Beyond Asset Bridges
Most bridge solutions were initially focused on moving tokens across blockchains.
However, the long-term potential of interoperable blockchains goes beyond thisfunctionality.
Besides moving tokens across blockchains,blockchain bridges’ use cases include DeFi
lending and NFTs…

Potential use cases include DeFi lending and borrowing in a chain-agnostic way,where the loan and collateral sit on different blockchains, as well as decentralizedexchanges that pool liquidity from different chains. Other examples include NFTs
that would allow users to access their utility, but from on another chain or agovernance mechanism that allows users to vote cross-chain.
These use cases require solutions that allow for more generic messaging, smart
contract calls, and other types of cross-chain communication. In other words,
general cross-chain message solutions are needed. These protocols allow any
arbitrary data to be sent across blockchains, not just tokens. Several projects suchas Connext, Hop, and LayerZero are working on generic interoperability protocols.

…and they also play a crucial role in driving
blockchain adoption of regulated financial
institutions

This becomes especially important in the context of driving blockchain adoption
among regulated financial institutions. Different consortium initiatives or bank-led
blockchains would result in an ecosystem where messaging, data, and assettransfer between blockchains are critical to establish interoperability to achieving
scale on use-cases straddling different institutions. This goes hand-in-hand withstandardization requirements as well. ISO 20022 standards for SWIFT messages
have set an open global standard for financial information. It is critical that interblockchain messaging and bridging also evolves to open standards that fit theneeds of the regulated financial industry.

Different Types of Interoperability Protocols
Three broad types of interoperability
protocols exist based on the type of verifier

While bridges and cross-chain protocols broadly do the same thing — i.e., enablecommunication between blockchains — there are several ways of achieving this,and they cannot be all be put in one bucket.
However, there is no perfect design, and each choice poses some trade-offs.
Looking at the different types of interoperability protocols, we believe it all boils
down to the verifier, i.e., who is verifying the data that someone is trying to send
across chains? In our view, there are three types of verifiers: Externally Verified: An external party verifies transactions between blockchains.

These validators do not belong to either of the two blockchains but are part of thebridge. Users are required to trust the new set of validators instead of thevalidators of the underlying blockchains.

 Locally Verified: Only parties involved in the transaction will verify the message

versus all validators of each chain.

 Natively Verified: All validators of the two blockchains verify the message. Thisis typically done by running a light client node of both chains.

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Figure 33. Three Types of Verifiers

Source: Connext, Citi GPS

Each of these types pose certain advantages and disadvantages. Before expanding
further on this, we look at the “interoperability trilemma,” as formulated by Arjun
Bhuptani, the founder of Connext.108

The Interoperability TrilemmaInteroperability protocols can fully satisfy
only two of three properties simultaneously— they can be trustless, generalizable, or
extensible

The interoperability trilemma states that interoperability protocols can only fully
satisfy two of three of the following properties simultaneously. They can be: Trustless: A trustless protocol does not introduce additional security

assumptions. In other words, it inherits the security from the underlying
blockchains. Users do not have to rely on a third party to execute transactions. In
general, the more trust-minimized, the more secure a bridge is.

 Generalizable: The bridge cannot only transfer assets between chains but cancommunicate any kind of arbitrary data.

 Extensible: It is very easy to extend the bridge to other blockchains.

108 Arjun Bhuptani, “The Interoperability Trilemma,” Connext Blog, October 1, 2021.

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Figure 34. Interoperability Trilemma and Different Verification Models

Source: Connext, Citi GPS

In reality, trustlessness is a spectrum. Externally verified bridges are trusted
solutions, since they rely on external validators. Natively verified bridge solutions
are more trustless since the trust remains on the blockchains associated with thecross-chain transaction.
Each of the verification models depicted in Figure 34 (external, local, native)
satisfies two of the three properties of the trilemma.
 Externally Verified Protocols: These allow for general cross-chain messaging

and can be relatively easy be expanded. The downside is that users need to fully
trust the external verifiers. Despite the tendency of lower security, this is the mostpopular type of bridge, also because they are typically cheaper and are easier todeploy. Examples: Multichain.

 Locally Verified: These are relatively trustless and are easy to extend to otherblockchains. The disadvantage is that these systems typically don’t support
generalized data messaging. Examples: Hop, Connext V1.

 Natively Verified: These are the most trustless type and allow for generalized

cross-chain messaging. On the other hand, these types are difficult to extend dueto the heterogeneity of the blockchain designs. Examples: IBC, Polkadot.

There are some protocols that aim to solve the trilemma through optimistic bridges.
Optimistic bridges use fraud proofs to send data across blockchains, which issimilar to how optimistic rollups aim to solve the blockchain scalability trilemma.
In such a framework, users can send any kind of data across chains, but it is not
immediately finalized. Instead, there is a time window where “watchers” can submit
fraud proofs if they observe fraudulent data. If no such proof is submitted within thetime window, data sent to the destination chain can be considered finalized. It is
worth noting, however, that optimistic bridges introduce a new trade-off, namely:
latency.

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Figure 35. Optimistic Bridges

Source: Connext, Citi GPS

Looking Ahead
While the interoperability landscapecontinues to evolve with new technology, we
expect natively verified protocols todominate, as they are more trustless

We believe interoperability protocols could become an increasingly important piecein the crypto infrastructure. It is likely that natively verified protocols will dominate,
as they are more trustless. That said, it remains to be seen how the interoperability
landscape will evolve. Some exciting areas include: Applying zero-knowledge technology to interoperability is an area being exploredthat could allow interoperability protocols to be truly trustless.

 Applications may apply across chains through cross-chain apps. Currently,

applications are mostly multi-chain (deployed on multiple blockchains), but notcross-chain (i.e., they are not really composable).

 Bridges could be modular, similar to many blockchains that have become

modular.

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March 2023

Citi GPS: Global Perspectives & Solutions[D.] Legal Enablers
Smart Legal Contracts
We enter into multiple contractual agreements on a daily basis without evenrealizing, such as when buying a cup of coffee, taking public transport, orpurchasing a favorite item online. Although invisible, contracts form a major part ofour day to day lives. They are ubiquitous.
In other activities, both in our personal and business lives, they appear in a much
more visible way. Think about the last time you made an investment — perhaps youbought some shares or crypto or bought a home — or perhaps you got a new job orsigned an agreement with a supplier. Putting it into context, 60%-80% of business
transactions are governed by contracts.109
When you reflect on contracts, they are often associated with long negotiation
processes to agree on the clauses and contents, multiple reviews and re-drafting ofdifferent versions until finally an agreement is reached, which is usually lengthy andoften written in complex legalistic language that is difficult to understand. While law
firms and enterprises use technology tools that greatly help the contract creation
process, the end result is a written document, often in the form of a PDF file, that
requires following through exactly as described.
Contracts are ubiquitous; they govern 60%80% of business transactions
The lengthy completion and execution
process of contracts means they are ripe fordisruption

The painful process behind contract creation, involving lengthy text and complex
language, means that sometimes contracts are not read at all and just signed (i.e.,
when was the last time you read the terms of service when you downloaded anapp?). Yet when something goes wrong, it comes down to the details of thecontract: what was agreed, what was the intention of the contracting parties, andwhat was the contract governance. Make a mistake and not only will it cost you, but
you may be missing out on a massive opportunity. Poor contract management alone
is estimated to cost companies 9% of their bottom line, according to World
Commerce & Contracting.110 In a study on outsourcing contracts, KPMG writes thatmost organizations are leaving significant value on the table and missing out on
40% of the identified potential of the contract because of poor contract
management.111
So, contracts are everywhere, whether we like it or not. Each of them creates alegal relationship between two (or more) parties but leaves it to those parties tofigure out for themselves how they manage it. Therefore, we should pay attention to
how we fulfill contracts, as they are relevant both in a business context and in our
personal lives. Contracts have been ripe for disruption for quite some time anddevelopments in technology have taken contracts to the next level promising
automation speed and security.

109 Based on an infographic by Selectica, appearing in Cotrill Research, “Contract

Manager Software by the Numbers,” September 6, 2013.
110 World Commerce & Contracting, “Poor Contract Management Continues to Costs
Companies 9% of Their Bottom Line,” April 29, 2020.
111 KPMG, A Clearer View From the Top: Nordic Shared Services and Outsourcing Pulse
Survey 2019, 2019.

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What do contracts 2.0, or smart legal contracts (SLCs), bring to the table? And
what, if anything, do they have to do with blockchain? According to Aaron Powers,
Co-founder and CEO of Hunit, they will provide a whole new set of rails for global
commerce and finance to run on.
We put SLCs under the microscope in this chapter and dive deep into theiranatomy. We learn that blockchain has certain benefits compared to conventional
web platforms, and as such, would be the most favorable technology underpinning
SLCs. These benefits include: the independence of decentralized ledgers, which fits
well with the nature of legal agreements; the enhanced levels of security due to theuse of cryptography and hashing techniques; the provision of a single source of
truth through their consensus mechanism; and being tamper-proof.
SLCs are not widely adopted yet, but trillions
of SLCs could be entered annually

Although such contracts are not yet widely adopted, we anticipate their uptake will
accelerate as work has already started on analyzing and removing regulatory
barriers to innovation. The UK is leading the way in this area, as the UK Law
Commission completed their advice to the UK government in November 2021
confirming SLCs can be accommodated in current legal frameworks. There areother favorable regulatory developments on the horizon, particularly with emerging
rules around trade digitization, paving the way for SLCs such as the Electronic
Trade Documents Bill. This bill was only introduced in October 2022 and at the timeof writing is with the House of Lords in the report stage. Completion is likely a few
years away, and we do not have a timeline on implementation.
There are multiple use cases ranging from property to service-level agreements.
However, we believe that given the nature of these contracts — they are based on
conditional logic (i.e., if X happens then Y follows) — they will be suited for morebasic agreements. With respect to value, while no specific SLC figures exist, Sir
Geoffrey Vos, a senior judge in England on civil matters, alluded to the possibility
that “trillions” may be used annually.112

I would expect English law and UK dispute resolution to prove a popular
foundation for the trillions of smart legal contracts that we may then expect to beentered into annually.
– SIR GEOFFREY VOS, MAY 6, 2019113

Origin of Smart Legal Contracts
Nick Szabo: A smart contract is a set ofpromises, specified in digital form, including
protocols within which the parties perform on
the other promises

The concept of smart contracts is not new — it goes back three decades. It wascoined by Nick Szabo, an American computer scientist, in an article he wrote backin 1994 and expanded on in 1996.114

112 Trustnodes, “Trillions of Smart Legal Contracts May Be Expect Says Senior Judge,”

May 6, 2019.

113 Ibid.

114 Nick Szabo, “Smart Contracts,” 1994; Nick Szabo, “Smart Contracts: Building Blocks

for Digital Markets,” 1996.

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In the latter, Szabo uses the following definition: “A smart contract is a set ofpromises, specified in digital form, including protocols within which the parties
perform on the other promises.”115 His definition gives us a good idea of the main
smart contract ingredients: namely, a set of promises, a digital format, andprotocols.
Going back in time and thinking about where the world was in 1994-96 from atechnology perspective, smart contract technology was not at the forefront of what
was being developed: 1994 was the year of the Web with the first International
World Wide Web conference held at CERN in May and 1996 was the year of theDVD.116 Smart contracts entered the spotlight with Ethereum as a key building blockof decentralized applications. According to the Ethereum organization, “A ‘smart
contract’ is simply a program that runs on the Ethereum blockchain. It's a collectionof code (its functions) and data (its state) that resides at a specific address on the
Ethereum blockchain.” The organization further explains smart contracts as being“computer programs stored on the blockchain that allow converting traditional
contracts into digital parallels.”117

Smart Contracts vs. Smart Legal Contracts
What do smart contracts look like, and are they synonymous with SLCs? Let us
take a closer look at both. From a visual perspective, smart contracts look like astring of code. Below is an example of a smart contract written in Solidity language.

115 Nick Szabo, “Smart Contracts: Building Blocks for Digital Markets,” 1996.
116 CERN, “A Short History of the Web,” Accessed March 29, 2023.
117 Ethereum Organization, Introduction to Smart Contracts© 2023 Citigroup

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Figure 36. An Example of a Smart Contract Written in Solidity

Source: Gustavo Ansaldi Oliva, Ahmed E. Hussain, and Zhen Ming (Jack) Jiang, “An Exploratory Study of SmartContracts in the Ethereum Blockchain Platform,” Empirical Software Engineering, Vol. 25, 1864-1904, 2020.

However, while the terms are often used inaccurately and interchangeably, smart
contracts and SLCs are not the same thing. There is no universally agreed-upondefinition, and the terminology is evolving. For the purposes of our report, we draw
a distinction: SLCs are a type of smart contract — a subset of smart contracts —but with different characteristics than smart contracts.
 SLCs may or may not use blockchain — in contrast to smart contracts, which use

blockchain. We discuss blockchain below.

 SLCs are intended (in form and structure) to create legally binding agreementsthat are compliant with the legal and regulatory requirements of their intended
jurisdiction. Legal enforceability is rarely a consideration in smart contracts.

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The UK Law Commission specificallydefines smart legal contracts as “a legallybinding contract in which some or all of thecontractual obligations are defined in and/or
performed automatically by a computer
program”

Citi GPS: Global Perspectives & Solutions

As described by the UK Law Commission, smart contracts can be used to define
and perform the obligations of a legally binding contract. The Commission
specifically defines smart legal contracts as “a legally binding contract in whichsome or all of the contractual obligations are defined in and/ or performed
automatically by a computer program.”118
 Due to smart contracts’ lack of legal enforceability, the syntax of the code used ina smart contract is the subject of agreement between two parties — they do nothave legal enforcement as a fallback. In contrast, SLCs include agreement upon
both the intent of the parties and how automation will be used in the fulfillment ofthat intent. This allows for the involvement of the court system in the event ofdispute, mis-execution, or malfunctioning computer code.

 In contrast to smart contracts, smart legal contracts are more dynamic tochanging circumstances — to achieve legal compliance, they must include terms
that allow them to be paused, modified, or rectified.

 While both smart contracts and SLCs can connect to and use outside data

sources (referred to as Oracles when used for smart contracts), the legal
enforceability of SLCs enhances their ability to use human assistance in theirself-execution. Roles like auditors, inspectors, or agents can use Oracles tocertify under penalty of law that actions have occurred that are specified in thelegal agreement but are outside of the capability of an SLC to verify.

Anatomy of a Smart Legal Contract
SLCs can be broken down into three categories with varying degrees of automation
lending themselves to different levels of adoption in practice:
SLCs fall into three categories with different
degrees of automation and adoption– The SLC that would lend itself to being most widely adopted is a natural
language contract combined with code. It uses the code of a computer
program to execute the contractual obligations (note: the code does not define
the contractual obligations).
– At the other end of the spectrum are code-only contracts, where bothcontractual terms and execution are done by the code. There is no natural
language version underpinning the contract. Their use is rare in practice.
– Somewhere in the middle are hybrid contracts, where some of the terms aredefined in code and some of the contractual obligations are executed by thecode.

118 UK Law Commission, Smart Legal Contracts: Summary, November 2021.

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Figure 37. The Three Types of Smart Legal Contracts119*We have edited the above illustration per our understanding
Source: The UK Law Commission, Citi GPS

On the face of it, if we look at the black and white text (i.e., the natural language) in
the image below, SLCs look very similar to ordinary legal agreements. Their
anatomy and functionality, however, is quite different.

119 Ibid.

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Figure 38. Four Key Features of Smart Level Contracts

Source: Hunit, Citi GPS Payment Identifiers: SLCs can create and embed International Bank AccountNumbers (IBANs), or any other identifiers such as blockchain “public keys” for“on-chain” payments, in the text of the contract, which are exclusively managed
by the SLC and its terms. This means payments made to an SLC (via the IBAN)
will be handled quickly and accurately and will result in the SLC verifying that apayment requirement has been met. For example, an SLC-based corporate bondmay receive a gross sum amount for the borrower’s interest payment anddistribute payments onward to each individual bondholder. The payment
automation is created through a banking integration service, which creates thebridge between the SLC and the global banking system.

 Polls/Questions: The SLC contains polls (or an equivalent series of questions).

These polls require that identified parties (i.e., signatories to an agreement orservice providers to it) answer questions for parts of the contract that cannot be
digitized, as they are based on subjective assessments or require some sort ofexternal activity to take place. It is this part of the SLC that requires human
involvement. This is important, as many legal agreements contain terms thatcannot effectively be fulfilled without the assistance of human actors. For
example, a contract may be subject to X number of audits taking place every
year before payment can be sent. The poll might therefore ask: Have X numberof audits taken place? A human would answer the question, and depending on
the answer, the next stage of the contract can be performed.

 The SLC Connects APIs: This allows the SLC to use external data as part of its

decision tree and enables the recording of the conditions under which the SLC
was executed. It can also make an SLC’s data, such as its terms or its execution
history or status, available to external systems through APIs. This is important forenterprises that have a large portfolio of contracts on their books. A “data lake” ofcontract data on which other technologies like machine learning can be applied
to extract insights and make business decisions.

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Insights can include how contracts are being performed, where they are failing,where there are disputes, where an enterprise may have a concentration of
exposure to legal risk, and where there are repeated failures like an SLC being
breached multiple times. These insights can be put on a contract heatmap, on
the back of which business decisions can be made to improve performance(such as choosing a different supplier if the current one is repeatedly breaching
the terms of the contract).
SLCs do not need DLT to perform

For SLCs using blockchain, the bridge between the contract and the external
data set can be provided by an Oracle application. These applications bring offchain data on the blockchain for the SLC to deploy. Without them, an SLC
running on a blockchain would be restricted to only accessing on-chain data. We
explain how these are incorporated in the insurance use case below.
 SLCs Define Asset Behavior: This is important for financial applications. Not all

financial assets can be sold everywhere in the world and to every type ofinvestor. Some cannot be sold to retail investors, for example, or may haverestrictions on secondary sales that include first rights of refusal for existing
investors or the execution of a deed of adherence to the SLC governing theterms of the investment. The SLC can include terms in the code to make sure all
the necessary checks have taken place before an asset can be purchased in a
primary or secondary transaction.

Do Smart Legal Contracts Need DLT?
The short answer is that SLCs do not need distributed ledger technology (DLT) to
perform, as expressed clearly by the UK Law Commission.120 SLCs could, forexample, be deployed on a conventional cloud-based web service.

Smart legal contracts can be performed automatically by computer programs
without the use of DLT.
– THE UK LAW COMMISSION
It is therefore not surprising that when the UK Law Commission consulted on smart
legal contracts, their analysis was not limited to those which deploy DLT, and thisconclusion was informed by the large majority of consultees who agreed that any
analysis of SLC should be technology neutral.
It is equally unsurprising that SLC industry consortia, such as the Accord Project,take a more tech-neutral approach to SLCs and as such do not solely focus on DLT.
The Accord Project is a non-profit organization that builds open-source code anddocumentation specifically for SLCs.

120 Ibid.

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It is anticipated DLT will be more widelyadopted for SLCs due to the additional
benefits the technology provides

Where SLCs deploy DLT, the sections of the legal agreement that include selfexecuting automation are recorded in code that can be run by the chosen DLT
network. Non-automated (natural language) portions of the agreement and therecords that result from the network’s running of the SLCs automation are also
recorded by the DLT network. DLT network protocols such as Ethereum,
Hyperledger, Corda, and Stellar all may be potentially used for SLCs. Early
indications are that the sector’s preference falls towards permissioned (i.e., access
controlled — see below for further detail) DLT networks where security and costs
can be more carefully managed.
It is anticipated that DLT will be more widely adopted for SLCs due to the additional
benefits it provides compared to conventional web platforms, namely: Longevity and Independence: Legal agreements can last a long time. Think

about a bond that has a duration of multiple years, or a mortgage loan that istaken out over a 25-year term. Decentralized ledgers are able to exist as long as
one of the parties — a node on the ledger — maintains a copy of the ledger.

 Enhancing Trust and Eliminating Silos: An SLC’s data records and automation

are counterparty-neutral: equally accessible to both parties while not under thecontrol of either. This increases transparency of the state of an agreement’s
completion, enhances the accuracy of an agreement’s completion, and improves
trust both between the parties and in the outcome of the legal agreement.

 Tamper-Proof: Records stored on a DLT cannot be tampered with after the fact.

This is important because it means that the contracting parties can safely rely onthem without worrying about the risk that they may have been tampered with ormodified unilaterally.

 Security: While Web3 servers can be compromised and breached, the DLT

architecture that runs on top of them uses powerful encryption and multi-party
consensus protocols. DLT architectures maintain their security, even if there is ahack at the server on which they are running.

 Single Source of Truth: A blockchain has a built-in way of authenticating entries

to the database, called “consensus,” ensuring that there is a “single source of
truth” that has been confirmed by the parties to the network. When it comes totransactions, by way of example, they are verified without a central counterparty
in the middle. Instead, they are verified on a peer-to-peer basis using a
consensus mechanism to ensure this common single source of truth. This isparticularly important in the context of legal agreements when things go wrong
and there is a legal dispute. The parties to the dispute can be certain about whichis the true legally binding agreement on which to base their case.

If DLT is deployed in SLCs, then there is a choice of which type of DLT to use. It canbe a permissioned or a permissionless system, or possibly somewhere in between.
(It does not have to be one or the other, and as DLT develops, it may be possible toincorporate permissioned elements into permissionless DLT systems.)
 Permissioned Systems would be appropriate where knowing the identity of theparties is important to execute the contract.

 Permissionless Systems would be more appropriate in cases where it isacceptable for any node to see data on the ledger, in contrast to permissioned
systems, which limit visibility to the transacting parties.

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Use Cases of Smart Legal Contracts
Although SLCs are in their infancy in termsof adoption, we are on the cusp of change:
Regulatory barriers are being removed, andthe technology is use-case agnostic

We understand from speaking with experts that SLCs are still at their infancy interms of adoption, but we are on the cusp of change. First, as the use cases arevast and varied, the technology is use-case agnostic. Second, various regulatory
and legal barriers are being removed, with the UK leading the way, as discussed
below.
Key use cases are covered below. While they are very different to each other (asnoted, the beauty of SLCs is that they are use-case agnostic), what they have incommon is the automation of a specific process or task once certain conditions aremet (in other words, once certain events have been triggered). SLCs containclauses that rely on data to check if conditions have been met and outline terms forpayment or transfer of ownership. They can also be used for the transferring offunds into one’s wallet once certain conditions have been met. Payment can be in
fiat, in a crypto asset, or in a Central Bank Digital Currency (CBDC), as and whenthese become widely available. It will depend on what payment instrument the user
decides to use and what payment instrument the service provider decides to offer(an insurance provider may only choose to offer payout in fiat, for example).
Notably, although an SLC’s automation may eliminate the operational need forcertain roles like agents or notaries, in many cases, these roles are required bycurrent regulations and cannot be eliminated in their entirety. In the below example
of an SLC escrow agreement, the buyer and seller both enjoy the benefits of SLC
use, but a regulated escrow agent is still required to officiate the transaction. In thiscase, the SLC allows the escrow agent to perform its role in a far more efficient andrisk-free manner. While this may appear to be an unnecessary complication, theescrow agent fulfills the critical role of accepting legal liability for any error that may
arise in the transaction.
 Real Estate and Proptech: In the property purchase process, an SLC can be

programmed such that the money be transferred to the seller, once legal title in
the property is registered to buyer. Or in a leasehold scenario, an SLC can be
programmed to say your lease comes to an end on a certain date unless you pay
money on day X, in which case your lease will automatically review for anotheryear. For real estate purchases requiring lending and borrowing through amortgage, an SLC would remove the need for intermediaries in the chain. The
SLC can be programmed to issue a mortgage offer the moment all checks anddocumentation has been received.
SLCs can also be used in combination with the tokenization of real-world assets.
Tokenization in this context enables digital ownership and transfer with eachtoken representing a fraction — like a share — in the ownership of the overall
asset. SLCs can contain all the clauses and conditions that need to be met to
trigger an event occurring (e.g., fractional ownership is recorded and ownershipis transferred to the buyer once payment has been made and received).
While tokens and tokenization have been a core use of smart contracts anddecentralized finance, they are an interesting use case for SLCs because thetokenization of conventional assets like real estate requires the use of a legally
viable ownership structure. In this example, the underlying real estate may be
owned by an SPV corporation, which uses tokens to represent equity shares. An
SLC-based shareholder agreement would establish this legal structure and would
define the terms of purchase and ownership of the corresponding tokens,
ensuring that a novel form of real estate ownership (token purchase) is
harmonized with the legal framework of property title possession and transfer.

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Escrow Payments: Linked to the property use case where escrow is used tobuy and sell property, an escrow is where a third party holds money or property
until certain terms of the contract have been met. The firm Transpact brought thisto life by automating the escrow payout process using SLCs. Two parties agree
on the terms of the contract in natural language, and the buyer pays Transpact.
Once the SLC conditions are met, the funds are automatically released. If theconditions are not met, the funds are returned to the buyer. The whole cycle isautomated and self-running. Figure 39 below illustrates what an SLC escrowagreement looks like.
Figure 39. Visual Illustration of a Smart Legal Contract Escrow Agreement

Source: Hunit

This process is underpinned by a technical ecosystem that makes the SLC
escrow agreement possible for an escrow agent to assist in the sale of a vessel.
In Figure 40 below, the boxes in blue show objects that exist in a multi-node
distributed ledger network. The boxes in brown show objects provided by the SLC
platform provider (not based on a DLT network), and the orange box shows anexternal third-party service.

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Figure 40. Smart Legal Contracts Technical Ecosystem for Escrow Agreement

Source: Hunit

Continuing with the example above of an escrow agreement used whenpurchasing a vessel, the SLC can be deployed in different steps and interaction
points. We cover some of the main ones below:– To disburse the escrow funds once certain predefined conditions have beenmet (for example, a technical inspection of the vessel may need to becompleted), an SLC will contain identifiers such as IBANs, as described in the
anatomy of the SLC. If the conditions are met, the SLC will allow for thetransfer of funds.
– An SLC can be used to check that all the conditions have been satisfied (e.g.,
the necessary documentation has been received, any inspections have takenplace, and required forms have been signed). The buyer and seller can thensubmit a request for the SLC to transfer the funds.
– The transaction closes once buyer and seller have submitted a transfer
request for the SLC to transfer funds, any transfer notices have been signed,
and funds have been received. The escrow agreement then terminates.
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Notably, in addition to the interaction points above, the SLC’s platform messaging
service can also be used for parties of a contract to send each other notificationsof contractual significance. Such messaging services help establish a clear,auditable, and legally protected record of communication that includes timestamps.
 Insurance: SLCs can be used to automate the payment of claims. Think about

the last time your flight was delayed. The SLC would clearly define what event
needs to take place for a payout to occur (e.g., the flight needs to be delayedover X number of hours). To do so, the SLC connects to airport databases, tracks
flight numbers and timings (e.g., an Oracle could be used to connect to an offchain database such as a flight tracker, check by how many hours the flight isdelayed, and then transmit this information on-chain for the SLC to use), andtriggers a payout as soon as a flight is delayed at level that satisfies theinsurance policy, as illustrated in Figure 41 below.

The same logic applies to other types of insurance claims beyond travel as long
there is a need for an insurance payout contingent on a specific event occurring.
However, that not all types of insurance-related use cases can be fully
automated. There are insurance claims that require a physical inspection of anasset (e.g., a building) before payout. In these cases, the SLC can rely upon an
agent to perform the physical inspection and certify to the SLC that payout isdue.
Figure 41. Simplified Smart Contract Coding Example121

Source: European Insurance and Occupational Pensions Authority (EIOPA) Supply Chains: These have been put to the test and have been under stress on

the back of the COVID-19 pandemic. Their reliance on multiple parties andpaper-based documentation makes them ideal candidates for SLCs. Traderelated documentation can be turned into SLCs so that the payment is executed
when specific events occur in the supply chain (e.g., the delivery of goods
triggers payment or instruction for further goods to be manufactured or reordered, or payment is triggered after the expected date of delivery for the
goods).

In addition to payment execution (and similar to the above-mentioned escrowexample), the SLC can be used to record an event or message when something
happens, such as an unforeseen event that can have an impact on the contract.

121 European Insurance and Occupational Pensions Authority (EIOPA), Discussion

Paper on Blockchain and Smart Contracts in Insurance, 2021.

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For example, a container with goods critical to your supply chain is on a ship. The
ship has an accident, or someone breaks into the container. This information
would need to be monitored (separate from the SLC with the help of monitoring
technologies used in supply chains) and then recorded on the blockchain ledger
used by the SLC. Depending on the event that has occurred, further humaninvestigation may be required before funds can be released.
 Managing Breaches in Service Level Agreements: This could be an

agreement with any supplier or provider of a service, such as a technology
service like a cloud service provider. Coming back to the different types of SLCs,
part of the agreement will be written in natural language, and another part of theagreement will be in computer code. The point is that the SLC would have built-in
code to instruct a payout or make a credit (or whatever has been agreed
between the contracting parties) when there is a breach in the service level. The
service being provided would need to be monitored from a trusted source, anddata on the services would need to be collected and recorded to identify any dropin agreed service levels. The trusted source would have to link with the part of
the SLC that is in computer code. Where a breach in the service level occurs, thecontract executes. If the contract already has embedded payment identifiers,
payout occurs (see the section “Anatomy of a Smart Legal Contract”). Thismeans that the parties to the contract would not have to take any action
themselves to request an instruction for payment.

 Derivatives Agreements: The International Swaps and Derivatives Association(ISDA) has been working for several years on promoting the digital standards
that will ultimately serve as the basis for the development of smart contracts inthe derivatives industry.122

ISDA’s work in developing common legal and documentation standards aims to
reduce transacting inefficiencies within the derivatives ecosystem and will provide
a foundation upon which new technologies can be developed and implemented.
ISDA’s recently published Digital Asset Derivatives Definitions provides a good
example of how increased contractual standardization can support thedevelopment of smart contracts.123 The key operative provisions within these
Definitions have been drafted using a controlled semantic structure, expressing
most contractual provisions as a series of parameterized conditions andconsequences. This allows the operational mechanics of the Digital Asset
Definitions to be distilled into a series of “if/then” statements, facilitating theirtranslation into computer code for future implementation within DLT-based
infrastructure and smart contracts.
Digitization of documentation, with supporting processes and data, allows the keycommercial and operational terms within legal agreements to be more closelyaligned with, and consistent with, the operational and business processes they
support, allowing for increased automation of those processes.

122 ISDA, “Joint Association Letter on a Digital Future for Financial Markets,” July 29,

2020.
123 ISDA, “ISDA Launches Standard Definitions for Digital Asset Derivatives,” January
26, 2023.

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ISDA Create (a tool made by ISDA and Linklaters providing an end-to-end
solution automating the creation, negotiation, and execution of derivatives
contracts) plays a central role here by facilitating the online creation andnegotiation of derivatives documentation and transforming previously
unstructured legal agreement data into structured data.124
ISDA Create can then translate this structured data into operational data withinthe “Common Domain Model”— a machine-readable and machine-executabledata model for derivatives products, processes, and calculations — for
implementation within computable or smart contracts.125
ISDA has also published legal guidelines for the development of smart
derivatives contracts with respect to equities, foreign exchange, interest rate andcredit derivatives.126 These papers provide an introduction to the various
derivatives products for readers who are designing and implementing technology
solutions for these products; they highlight which aspects of these contracts arelikely to provide the best opportunities for automation within a smart contract.
As noted, there are limitations as to when SLCs can be deployed. Some contractual
obligations may not be suitable for automation by a computer program because
they are not based on conditional logic (i.e., if A happens then B follows) and are
therefore difficult to translate into code. These include situations that require
humans to exercise their discretion and judgement. We therefore anticipate that
SLCs will be deployed for more basic contracts or use human input, as discussed,
to make these determinations.

Regulatory Considerations
The current law of England and Wales issufficiently flexible to accommodate SLCs

Like with all technological innovations, SLCs can only be adopted and eventuallyscaled if they are not hindered by rules and regulation.
The UK Law Commission has addressed the question of regulating smart legal
contracts with respect to English law. Their findings are important not just in thecontext of the UK, but also on the global stage given the importance of English law
in business transactions.

The flexibility of our common law means that the jurisdiction of England andWales provides an ideal platform for business and innovation, without the needfor statutory law reform.
– THE UK LAW COMMISSION
According to an Oxera report:“English Law was selected as the most frequently used governing law by 43% of
600 survey respondents, and was often used in transactions with little or no otherlink to the UK. Similarly, it is estimated that English law comprises 40% of all
governing law in global corporate arbitrations.”127

124 ISDA, “ISDA Create,” accessed March 25, 2023.

125 ISDA, “ISDA Common Domain Model,” October 14, 2019.

126 ISDA, “Memoranda: ISDA Smart Contracts,” October 16, 2019.

127 Oxera, Economic Value of English Law, prepared for Legal UK, October 5, 2021.

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Furthermore, the report highlights that English law governed approximately £250
billion of global mergers and acquisitions in 2019.
In its November 2021 advice to the UK government, the Law Commission considers
whether current well-established principles of contract law (by analyzing therequirements that form legally binding contracts) can accommodate SLCs. It
concludes that the current law of England and Wales is sufficiently flexible toaccommodate SLCs. 128 The UK Law Commission’s findings build on earlier work
conducted by the UK Jurisdiction Task Force (UKJT), which concluded the same intheir Legal Statement.
In Europe, the European Commission proposed a draft regulation in February 2022,
the so-called Data Act, with the aim of harmonizing rules on fair access to, and useof, data.129 This Act does not distinguish between smart contracts and SLCs. The
SLC terminology is new. It will be interesting to see how the market responds to thisAct and if there will be developments to align the definitions as the Act goes throughthe various drafts and stages in the EU’s legislative process.
The Act serves to fill regulatory gaps and is drafted with the spirit of removing
barriers to smart contract adoption by setting standards and requirements regarding
smart contracts of data sharing. Furthermore, in Italy, the Federation Autonoma
Bancari Italiani (FABI, a federation whose mission is to protect bank workers) has
weighed in on SLCs, explaining that they are different from smart contracts and thatthey would have to adhere to Articles 1321 and 1325 of the civil code.130
In Asia, the Court of Appeal in Singapore, in the case Quoine Pte Ltd v. B2C2 Ltd,the judges had to decide how to apply the law of mistake (a principle of contractlaw) to contracts formed by deterministic algorithms.131 Although the case did not
involve smart legal contracts, it may form how the law is applied to smart legal
contracts using deterministic algorithms in the future. The majority judgment
demonstrates how traditional principles of contract law can be adapted to apply tocontracts run by technology without the need to rip up and re-write the rulebook.
These regulatory developments are positive news for SLC adoption. It comes as arelief that SLCs can be accommodated within existing regulatory frameworks
without large-scale reform. Reform not only takes time but also creates an uncertain
environment, and operating in a regulatory vacuum hinders business adoption.
Beyond regulatory considerations, SLCs do not come without risks: Unreliable External Inputs: SLCs rely on external data sources to determine if

the terms have been fulfilled for the contract to perform. It is therefore key for thesource of the data to be trusted, accurate, and secure.

128 UK Law Commission, Smart Legal Contracts: Summary, November 2021.

129 European Commission, “Proposal for a Regulation of the European Parliament and of

the Council on Harmonised Rules on Fair Access to and Use of Data (Data Act),” PDF,
February 23, 2022; The Data Act decines smart contracts as: a computer program stored
in an electronic ledger system wherein the outcome of the execution of the program isrecorded on the electronic ledger.
130 Federazione Autonoma Bancari Italiani (FABI), “Smart Legal Contract,” (Italian
language), video, accessed March 22, 2023.
131 In the Court of Appeal of the Republic of Singapore, “Judgment,” PDF, Quoine Pte
Ltd v. B2C2 Ltd, Civil Appeal No. 81 of 2019, accessed March 22, 2023.

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 Inaccurate Codes and Bugs: It is possible for coders to misinterpret theintention of the contracting parties, resulting in the code not performing as
expected (or indeed, intended). It is also possible for code to contain bugs.
Anyone seeking to use SLC should be aware of these risks upfront. The UK Law
Commission explains that the difficulties involved in rectifying codes will probably
depend on the technical specifications of the smart contract platform, including
whether there is a built-in rectifying functionality.

The extent of any practical difficulties in rectifying coded terms will likely dependin the technical specifications of the particular smart contract platform, such aswhether it has relevant built-in functionality to rectify the coded terms.
– THE UK LAW COMMISSION
 Cyber Risks: Codes are subject to cyberattacks and hacks. Anyone deploying

SLCs needs to be mindful of such risks and consider putting in place appropriate
mitigation measures if such events occur. This can be through the introduction of
escape hatches that can stop the contract subject to consent from the contracting
parties. The natural language version of the code should flesh out cyber risks
and mitigating action, and any SLC enterprise platform should conform tointernational standards on information security (i.e., ISO 27001 standards) or
equivalent.

SLCs and the Future
What the SLC market lacks is a set of principles or standards. These principles
would prevent bias in code, ensure that the set of coders is diverse, and make clearthat developers can be held to account if they aid and abet violations of the law.
We have already seen signals that would be in line with a direction of travel that
holds smart contract developers to account. For example, Brian Quintenz,
Commissioner at the Commodity Futures Trading Commission (CFTC), addressed
the question of who should be held responsible if a smart contract is not executed incompliance with rules, saying, “a strong case could be made that the codedevelopers aided and abetted violations of CFTC regulations,” and that “the CFTC
could prosecute those individuals for wrongdoing.”132

132 Commodity Futures Trading Commission, “Remarks of Commissioner Brian D.

Quintenz at the 38th Annual GITEX Technology Week Conference,” Public Statements &Remarks, October 16, 2018.

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Instead, I think the appropriate question is whether these code developers could
reasonably foresee, at the time they created the code, that it would likely be usedby U.S. persons in a manner violative of CFTC regulations. In this particularhypothetical, the code was specifically designed to enable the precise type ofactivity regulated by the CFTC, and no effort was made to preclude its availability
to U.S. persons. Under these facts, I think a strong case could be made that thecode developers aided and abetted violations of CFTC regulations. As such, the
CFTC could prosecute those individuals for wrongdoing.
– BRIAN QUINTENZ, COMMISSIONER AT THE COMMODITY FUTURES TRADING COMMISSION(CFTC)
Indeed, this approach of apportioning liability has been used in U.S. statelegislation, either recently passed or still under consideration, providing legal status
to Decentralized Autonomous Organizations (DAOs) in Utah and New
Hampshire.133 These DLT-based organizations devolve all decision making to theirmembers via voting mechanisms and lack the typical structures of directors andchairpersons. Under these state laws, the members of a DAO voting for an actionthat results in the DAO acting illegally will be held personally liable.
For the technologists, one element to highlight, which we believe will have a more
important role in the future, is the so-called “reasonable coder” who can foresee
how a code in development may violate regulations. Logically, these coders will bein demand, as they will be called upon to assist the courts when interpreting coded
terms in a contract. Coded terms can be subject to interpretation, and there can bea divergence between what the code means and how it executes. To this end, the
Law Commission confirms that reasonable coders will be relied upon instead ofcomputers when it comes to interpretation issues.
For the legal profession, upgrading contracts to SLCs will require thought —perhaps more so than before — on eventualities and on how risks will be allocatedwhen things go wrong, and baking these into the contract. This includes doing athorough analysis of what could happen in the future, setting out the different steps
and procedures to get there, and including these in the SLC using polls. As SLCs
become more widely used, it will also be interesting to observe to what degree they
replace lawyers in certain areas of corporate contract work. Think about escrows or
asset purchases: A solicitor will not be required to check if the funds have been
received before proceeding to payment.
The UK Law Commission has set out a nonexhaustive list of issues contracting parties
may wish to consider for their SLCs

The UK Law Commission has set out a non-exhaustive shopping list of issues that
contracting parties may wish to consider for their SLCs.134 It would make sense foranyone wishing to deploy such contacts in the future to review these issues to avoid
disputes and limit any uncertainty as to how the contract would be treated underlaw. The list also includes what should be considered where the SLC deploys DLT.

133 Utah State Legislature, “H.B. 357 Decentralized Autonomous Organizations

Amendments,” accessed March 24, 2023; BillTrack*50*, “NH HB645,” accessed March24, 2023.
134 UK Law Commission, “Smart Legal Contract, Summary,” November 2021.

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Further regulatory change is on the way in the UK with the Electronic Trade
Documents Bill, which was introduced into Parliament in October 2022.135 This Billis a big step forward in the move to digitize paper-based trade documentation andto making digital documents legally recognized. Similar regulatory change is taking
place in Singapore with the Electronic Transactions (Amendment) Act, which
recognizes electronic equivalents of transferable trade documents such as bills of
lading, promissory notes, and bills of exchange. If these documents are digitized,
legally recognized, and combined with DLT, then we have a good starting point fromwhich to automate the documents and turn them into SLCs.
While the developments happening in the UK and in Singapore are encouraging, astrade is a global business, any legislative change will need to happen on a global
scale and in multiple jurisdictions. This will enable digital documents to be tradedsuccessfully, as they go through multiple countries during their life cycle and shouldbe accompanied by the building of new infrastructure for using them, as well as bymajor players coming together to form industry consortia.
The creation of regulatory sandboxes could
help SLCs gain mass adoption

Looking into the future, what could help SLCs gain mass adoption — and thus takeblockchain adoption into the billions — is the creation of regulatory “sandboxes” totest out the application of technologies under the watchful eye of regulators. We
have witnessed these come to fruition since 2016, with the Financial Conduct
Authority being the first regulator to market. These sandboxes have been replicatedand tailored by regulators around the word. The initiative has now gone global with
the introduction of the Global Financial Innovation Network (GFIN) — a global
sandbox, in other words. Different technologies have been tested in suchsandboxes, from AI to privacy-enhancing technologies that comply with anti-money
laundering and know your customer (AML/KYC) rules. It is not a far cry to imagine
an SLC sandbox coming to market in the future. This is an important space towatch.

135 UK Parliament, “Electronic Trade Documents Bill,” PDF, accessed March 22, 2023.

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A Conversation With Aaron Powers on How
Smart Contracts Can Transform Finance
Q: What are smart legal contracts (SLCs)? How are they different from realworld legal contracts?
Aaron: Legal contracts are everywhere. KPMG estimates 60%-80% of all business
operations are either driven by legal obligations or are somehow constrained bythem. But, despite pervading all commercial and financial transactions, they are theworld’s last great analog holdout.

Aaron Powers is the CEO and Co-founder of
Hunit. Hunit allows any law office, financialgroup or enterprise to create distributed
ledger-based, self-executing smart legal
contracts without having to write a single lineof code. Hunit works with aims to unlock
new opportunities for the growing private
investment market and the legal
professionals serving it. Hunit operates
across the UK, Norway and the U.S. Hunit’s
embedded technology development partner,
Revelry Labs, which has deep blockchain
and financial industry experience.

Smart legal contracts are like standard natural language agreements but include
embedded automation that transforms the contract from an archive of intention into
an active business tool — the legal agreement and the tools used to execute it
become one and the same. In other words, smart legal contracts are like an
operating system for global commerce and finance to run on. As further benefits,
smart legal contracts incorporate Web3 primitives such as immutability,transparency, and trustlessness.
This means we can integrate a smart legal contract with the global banking system.
For example, if at a certain point in time of a contract's execution, one party needs
to send money to the other, this can be achieved by sending the payment to thesmart legal contract, which in turn records receipt. This money can then be
distributed onwards according to the terms of the agreement.
Smart legal contracts can also interact with external data sources and import datafrom web services or APIs (Application Programming Interfaces). At the same time,
structured data generated by the smart legal contract, as it executes its life cycle,
can be made available to external systems (e.g., enabling portfolio dashboarding forlarge institutions with big portfolios of legal agreements).
A smart legal contract complies with the regulatory framework that defines what is
and is not a legal agreement. SLCs also recognize important elements like thepreemptive rights of courts and bankruptcy trustees. Aspects such as title law andforce majeure events all need to be incorporated into smart legal contracts.
Q: Why do we need smart legal contracts? What are the use cases of smart
legal contracts?
Aaron: The future of finance with tokenization, decentralized finance (DeFi) and themetaverse require natively digital legal solutions. At a basic level, smart legal
contracts are use-case agnostic and will serve as the layer that marries these new
digital ecosystems and the legal frameworks that governs them.
However, there are trillions of conventional legal agreements signed every year thatcan be recorded as SLCs. We do not need to wait for DeFi to move mainstream for
SLCs to start adding value to society — one can use smart legal contract forbusiness and consumer agreements today. This could be something as mundane
as non-disclosure agreements or for sophisticated use in financial instruments,
especially in areas that have not been effectively digitized, such as alternative
assets.
We estimate, there are nearly $1.4 trillion of newly issued PDF-based private
market investment instruments annually that can be transformed by SLCs. The
status quo necessitates significant manual intervention and high costs for fulfillingthese agreements. Furthermore, this creates the risk of costly errors.

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In my opinion, smart legal contracts represent one of the great breakout moments
for Web3 — they have the potential to bring this technology to more people andcompanies than any other Web3 application. In the long-run, there is only one usecase for smart legal contracts — to record and improve upon the wide variety oflegal agreements in use today. However, in the more immediate term, industries
driven by large numbers of financial transactions that don’t currently have effective
digital infrastructure represent their first market inroads. This includes sectors likeprivate market financial instruments, power markets, shipping, and construction.
Q: Are smart legal contracts recognized in the UK legal system? How do theyinteract with existing law?
Aaron: The UK Law Commission started a public consultation to look at smart legal
contracts and how they could work with the existing UK law. While our initial
discussions were very constructive and highlighted the feasibility of smart legal
contracts, regulators were concerned with a few key areas.
To solve for these concerns, we successfully worked with the support of the UK
Jurisdictional Task Force, a division of the Ministry of Justice, as well as the
Solicitors Regulation Authority (SRA). During this period, we defined at a verypractical level how a smart legal contract needs to behave in order for it to exist
under current regulations.
The final piece in the puzzle was the Digital Trade Documents Act in the UK, whichis removing the requirement for certain types of documents to be presented inphysical form in order for them to be valid and effective. This allows for thedematerialization of all documents such as bills of lading and other bearer bondtype structures.
Today, smart legal contracts are ready to use in the UK and we are working todeploy them everywhere.
Q: Where are we in the U.S. in the context of smart legal contracts? Are legal
systems flexible in non-common law countries to accommodate smart legal
contracts? Where is continental Europe in terms of SLC?
Aaron: The U.S. poses a unique challenge as we have essentially 50 different, butsimilar legal regimes. However, both, the UK and the U.S. are common law
systems. Thus, the work done to gain regulatory support in the UK largely translates
to the U.S., although there are still a few aspects that need to be reviewed andchanged.
Importantly, in a common law environment, it is the court precedents that create theregulatory approach to different areas. This may not be as proactive as what we areseeing in the UK, but inroads are being made in the U.S. For financial applications,
the SEC is continually clarifying its position on the use of Web3 technology and all
big players in the space are looking hard at the aspects of smart legal contracts.
There are a number of EU countries that have passed the requisite legislations
around dematerialization of documentation, digital signatures etc. Of course, in a
Napoleonic legal environment, there is a need for the boxes to be drawn ahead oftime. At this point, we have some use cases that potentially touch on uses in France
and we have not found ourselves butted up against any structural issues.

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However, the warmest welcome we have received for smart legal contracttechnology so far has been in the UK. Nonetheless, it is my opinion that the wave ofsmart legal contracts is fast approaching, and it would be difficult in 2023 to argue
that the analog agreement structure will continue in the medium to long term (either
in finance or elsewhere).
Q: Can you elaborate on the use-cases for smart legal contracts?
Aaron: The technology behind smart legal contracts is use-case agnostic. As an
example, our own shareholder agreement is about 50 pages with about 17
instances where automation makes sense and could provide value. The rest of theagreement is in natural language terms that either have limited operational impact
or include disclaimers, acknowledgements, etc. With a few exceptions, theautomation that is being embedded can be used across a broad spectrum ofagreement types — it is the natural language of the agreement that gives theautomation its context. Think of how many types of agreements contain conditions
precedent or have a procedure to deliver something in response to payment — thesame underlying automation can be reused over and over.
To give you some ideas about how self-executing legal agreements can change
business, think of a non-disclosure agreement where confidential materials areeither sent via or displayed by the NDA itself. Once the non-disclosure period oragreement terms have ended, access can be denied automatically. This can reducemanual intervention of deleting files or restricting access and actually make the NDA
an enforceable document.
Within finance, we are currently working to deploy a set of fund offering documents.
These are agreements a limited partner would sign when investing in a hedge fund.
Thanks to automation, smart legal contracts can provide efficiencies in the areas ofKnow Your Customer, accreditation, and onboarding, etc. SLCs help automate
processes around subscriptions into the fund, performing delivery versus payment
for fund shares. In this use, smart legal contracts help create economies of scale forfund managers and admins.
We can also extend this use case further to trading parameters, albeit the latter isstill under development. We know hedge funds have different parameters they
commit to with investors — for example, minimum diversification, max leverage, etc.
The current paradigm is that these commitments are made, trades are executed on
the trading desk, and at the end of every week, the compliance department checks
through to make sure trades were not out of balance. In case of breaches, one
needs to evaluate the size and extent of breach and if it warrants for users andregulators to be notified. This can be a long back-and-forth process.
Using smart legal contracts, trading platforms will receive their trading parametersfrom the contract itself, creating an end-to-end digital link between the agreement
signed with the investor and the trading desk’s performance. This can lead to asignificant reduction in risk, whilst also improving efficiency.
A consumer-focused example is from the automotive sector. We are exploring theuse of smart legal contracts for business model innovation. A buyer or lessee cansign a smart legal contract while purchasing or leasing a new car. This smart legal
contract can then be integrated with banking systems, allowing for loan repayment
or lease payments to be paid automatically from the customers bank account(possibly using the EU’s Second Payment Services Directive, or PSD2
architecture).

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So far, so normal. But taking it a step further, the smart legal contract can also be
integrated with the car’s diagnostics, gathering various data points on kilometers
driven, service intervals, malfunctioning equipment, etc. This additional information
can then be linked to the fee structure for the leased car, with potential penalties forlate servicing, accidents, etc. Using external data connections, smart legal contracts
can also be used to ascertain if the car is properly insured, and failure to do so
could possibly disable the car ignition altogether.
An important point to mention is that under today’s model, customized agreements
drive big increases in cost and manual tasks. But when the automation used to fulfill
smart legal contracts is embedded in the agreement itself, they are a cost-effective
solution for a car manufacturer to offer a wide variety of commercial models aroundmobility services.
My last example relates to litigation finance. A typical company in the retail litigation
space may offer between 1,500 and 2,000 small-scale loans per month. These
companies then periodically issue securities on the back of a cohort of these loans
to specialized investors with the aim to replenish their capital. These cohorts often
necessitate intensive manual work tying the life cycle of the loan to the actual
progress made on individual cases. A large cohort of maybe 5,000 loans can further
complicate matters. Lastly, one also needs to manually track individual cases in thecohort to determine which ones have been settled and calculate the amount ofprincipal owed back.
A three-way smart legal contract can be initiated between the lender, the legal
services provider, and the claimant. These can then be grouped into a special
purpose vehicle (SPV), that issues a debt instrument. Extensive amounts of data
can then be collected and structured to automate regular payments, making theprocess far more efficient and transparent. In my opinion, this type of transparency
would have avoided the 2008 sub-prime crisis as the rating agencies and investors
would have seen exactly what was being collateralized.
Q: What recourse mechanism is available when a smart legal contract goes
wrong? How do you handle bugs and errors in code?
Aaron: The quality of the code in a smart contract is of paramount value — it isyour first and last defense.
Smart contracts also need to have fatalistic execution. If you had a force majeurebutton on a smart contract for forward sales of cryptocurrency, it would be calamity
as there would be no repercussion for pressing it — as there is no legal significancein the smart contract.
But if a party to a smart legal contract claims force majeure and pauses its
execution inappropriately, they can expect to find themselves in court. In otherwords, having the legal system as the backstop for smart legal contracts allows thetechnology to offer ways to update an agreement or fix things that are going wrong.
During a dispute, should the parties agree, or the court mandate, the automation
can be turned off. We term this as rectification automation. Additionally, if bothparties mutually agree to make rectifications to the contract, they can amend thesmart legal contract in a very similar way as one would for a traditional agreement.

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Taking it a step further from conventional agreements, smart legal contracts allow
users to agree to incorporate, at the outset, potential resolution mechanisms for
anticipated breaches of terms. Most commonly, breaches either involve delay inpayment of an agreed sum of money or denial of payment altogether. The parties tothe agreement can agree on potential ways to address these breaches at the timeof initiating the smart legal contract itself. The smart legal contract can thenautomatically execute such actions if a breach occurs. Think of a secured bond that
automatically starts the liquidation of a pledged asset 45 days after a missed
repayment — investors don’t have to organize a costly litigation and the issuer
doesn’t have the opportunity to drag things out in court. This would reduce the timeneeded to recover capital from years to weeks and think of what that kind of changemeans to a model for pricing risk.

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Citi GPS: Global Perspectives & Solutions

Appendix 1: How Real-World Assets
Are Tokenized
In the real world, there are non-fungible assets, which are unique and irreplaceable,
and fungible assets, which may be interchanged for other assets of similar or
identical qualities and quantities. In most cases, the fungibility of the real-world
asset token corresponds with its underlying real-world asset. For example, when ashare of stock or gold is tokenized, it is typically minted as a fungible token, but apiece of land typically becomes a non-fungible token (NFT) as it has unique
attributes including but not limited to its acreage and geographic location.
Theoretically, any assets with monetary value in the real world can be tokenized,
and there are various ways to create real-world asset tokens.136 The process andcomplexity of tokenizing certain types of real-world assets may vary but could
generally be summarized by the following steps.
1.

Due Diligence
The owner of the real-world asset thoroughly reviews, audits, and appraises theasset value and relevant information that would be encoded on-chain.137 The
owner also conducts due diligence on the jurisdiction including regulations andlegal guidelines, different blockchain networks and types of token, custodians
for the underlying real-world assets, tokenization platforms, and marketplaces
or exchanges where the token will be listed, to ensure both the terms andconditions and the tokenization process are best suited for the real-world asset
and remain legally compliant. In more complex cases — such as tokenizing
real estate assets or private equity funds — additional factors, including theinvestment time horizon, fractionalization ratio, and ownership structure, also
go into consideration.138 There is now a growing number of platforms that offer“tokenization as a service” to help facilitate the process for asset owners.

2.

Digitization
As due diligence concludes and decisions are made on the various aspects oftokenization, the relevant information, the asset’s unique attributes, and theagreed terms and conditions can proceed to be digitized on-chain through themethods selected during the due diligence period and written into the smart
contract. These can either be embedded in the token or deployed on theblockchain to automate functions such as transferring ownership, distributing
dividends, or allowing the token to be exchanged for other cryptocurrencies or
fiat currencies.139

136 Ravi Chamria, “Comprehensive Guide on Tokenized Real-World Assets,” Zeeve,

November 23, 2022.
137 Ibid; Ben Plomion, “How to Tokenize an Asset: A Step-by-Step Guide to NFTs
Backed by Physical Assets,” Dibbs, accessed March 22, 2023.
138 Ravi Chamria, “Comprehensive Guide on Tokenized Real-World Assets,” Zeeve,
November 23, 2022.
139 Andrei Larion, “Real Estate Tokenization,” University of Florida, Warrington College ofBusiness, August 26, 2022.

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3.

March 2023

Custody
To add a layer of security for token holders, a third-party typically provides
custody of the token’s underlying real-world asset to make sure the asset issafely stored and appropriately maintained. For example, luxury wine needs tobe stored in a temperature-controlled cellar, and gold needs to be stored in avault.
Furthermore, real-world assets are subject to entropy, meaning that all objects
that physically exist will eventually degrade and perish. However, tokens (i.e.,the digital representation of the real-world assets) are not subject to suchphysical law. As the physical status of the underlying real-world asset continues
to evolve, it is important that the custodian or another party reflects thechanges on-chain to ensure transparency and ease of valuation and auditing.
Various start-ups are developing technology using the Internet of Things (IoT)
and Oracle networks to convey real-time data of the tokenized real-world asset,
such as gold purity, soil acidity, or foot traffic, which can be applied to measure
and convey the status of the asset.140
Proof-of-reserve has also become an increasingly crucial component ofcustody since the series of bankruptcies and scams negatively affected thecrypto world in the second half of 2022. Investors now often demand
exchanges to prove that the digital assets they hold in custody on behalf of
their customers are backed 1:1. Similarly, investors may also demand proof
their real-world asset tokens are backed 1:1 by the real-world assets stored
under custody.
Notably, the custody of the underlying real-world assets is differentiated from
custody of the token. Token holders are usually free to choose where to keep
their private key, whether in a hot wallet (connected online) or a cold wallet(data stored offline) to prevent loss and theft.

4.

Distribution
The last step is to issue the tokens, which will be transferred to new investors
for the first time, and to list the tokens on selected marketplaces or exchanges
so there is a secondary market, and their holders have access to liquidity.141
Marketing is another component during this process and is particularly
important for projects that aim to raise capital or sell assets not yet widely
recognized in traditional finance.

140 Chainlink, “Tokenizing Real-World Assets On-Chain,” Chainlink Tech Talk #10,

YouTube, December 26, 2022; Menghua Wong, Xuedong Liang, and Zhi Li, “Researchon the Evaluation Index System of the Soil Remediation Effect Based on Blockchain,”Land, Vol. 10, No. 11, November 2021.
141 Ravi Chamria, “Comprehensive Guide on Tokenized Real-World Assets,” Zeeve,
November 23, 2022; Ben Plomion, “How to Tokenize an Asset: A Step-by-Step Guide to
NFTs Backed by Physical Assets,” Dibbs, accessed March 22, 2023.

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Citi GPS: Global Perspectives & Solutions

Appendix 2: Digital FMIs Scaling
Infrastructure
New Digital Disruptors

As distributed ledgers are creating new opportunities across the value chain for
financial securities, we are seeing a wave of new digital market infrastructures
entering the market by either introducing new functionality or disrupting traditional
operating structures. These include: Digital Securities Trading and Settlement Market Infrastructures: Built onDistributed Ledger Technology (DLT) or with significant parts of theirinfrastructure utilizing tokenized, smart contract-driven flows, these seek to either
target new emerging asset models (fractional, tokenized) or offer cheaper
clearing and settlement functionality for traditional assets. Examples include
BondEvalue in Singapore, Archax in the UK, and Paxos in the U.S.

 Tokenization Agents: These focus on the issuance/origination of securities on

DLT, either as a digital-native token or a tokenized outstanding security.
Examples include agents such as Tokeny, Securitize, and Securrency.

 Documentation and Workflow Infrastructures: These offer the option tocentralize the whole documentation process pre-issuance by facilitating theexchanges between all the involved parties and automating some of these parts.
Examples include Agora, Origin, NowCM and previously Nivaura (recently
acquired by NowCM).

 Marketplaces and Tokens Distribution Platforms: These provide access to abroader investor base, expanded to all accredited investors that can directly
access the digital token through an online platform offering features for an easier
investment process (e.g., 24/7 access, fractionalization, and instant settlement).

 Wallet Providers and Digital Custodians: These enable custody of digital

securities on DLT-based wallets.

 Digital Collateral Infrastructures: Focused on digitizing collateral flows in orderto make them smoother, cheaper and seamless globally, examples of digitalcollateral infrastructures include HQLAX (which is building a digital collateral
network initially in Europe), JPMorgan’s Onyx repo platform, and Broadridge’s
DLT Repo.

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Figure 42. Selected New Digital FMIs and Platrofmrs Disrupting Traditional Capital Markets
Company
Trading and
Settlement
MarketInfrastructures

Tokenization
AgentsOverview
Singapore-based Fintech focused on
digitizing the bond market and allowing for
fractionalized trading of bonds

BondEvalue
ArchaxLondon-based digital securities exchange

Paxos Trust Company

Blockchain infrastructure provider providing
trading and settlement solutions

TokenyLuxembourg-based institutional grade
platform allowing for the issuance, transfer,and management of digital securities

Securitize

Platform for digital securities issuance andlive trading of security tokens
Platform for digital securities issuance andmarketplaces
Blockchain-based voting ecosystem

Securrency
Documentationand Workflow
Infrastructures

DigitalCollateral
Infrastructures
Source: Citi GPS

Agora

NowDocs automates the documentation
process for issuances

NowCm

HQLAx

Onyx by J.P. Morgan

Distributed ledger for securities finance andrepo transaction to improve collateralmobility
Blockchain-based platform for payments
transactions, tokenization, and exchange ofdigital assets

Key Partnerships
 Citi: Investor and Custodian Northern Trust: Asset Servicing
 Ownera, Tokeny, Securitize,
Securrency (among others) Bank of America, Credit Suisse,Interactive Brokers, Binance:
Clients
 Euronext-backed
 Morgan Stanley, Nomura,
Coinbase Ventures: Investors KKR: client for a fund tokenisation
 WisdomTree, Money Group,
Ownera, State Street, US Bank Binance and Synaps
 Natixis, BNP Paribas, Credit
Agricole: Clients
 Societe Generale, Amundi,
Banque de France: Investors
 Citi, Goldman Sachs, BNY Mellon,
Deutsche Börse
 J.P. Morgan

Traditional FMIs Upscaling
Faced with a direct disintermediation threat, traditional FMIs have been working on
upgrading their infrastructures and data models: Central Securities Depositories (CSDs): As we have seen in the EIB digitalpilot bond, the need for a CSD was successfully tested for in the initial pilots, andCSDs may be needed for a potential future market environment.

 In 2021, Deutsche Börse and Clearstream (an international CSD that is part ofDeutsche Börse Group) developed D7, a platform that operates within German
and European regulatory frameworks and offers and supports same-day
issuances for digital securities, automated straight-through processing, anddecentralized and atomic settlement and custody systems. LBBW (Landesbank
Baden-Württemberg) and Vontobel performed automated issuances on theplatform as well as KfW (a €20 million digital bond with a two-year duration and acoupon of 2.381%).

 In the U.S., the Depository Trust & Clearing Corporation (DTCC) announced its

Project Ion platform, which leverages DLT to improve settlement processes. A
primary goal of the platform is to support T+0 settlement, on top of T+1 and T+2
settlement cycles, in a regulatory-compliant manner. The platform, which isprivate and permissioned, went live in pilot form in parallel with existing
settlement infrastructure.

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 Stock Exchanges and Trading Venues: With increasing number of new digitalexchanges and marketplaces, traditional venues have been upscaling theirvalue-add to cater to digital securities leveraging local regulations when possible.
Switzerland’s SIX Digital Exchange (SDX) is the digital exchange arm of the SIX
Swiss Exchange, leveraging the flexibility offered by Swiss regulation for theissuance and secondary trading of digital securities. SDX has performed a few
pilots where a digital bond was issued on DLT, listed both on the traditional anddigital exchange at the same time, and available for trading on both.

 Custodians: With the growing need for custody for digital securities and thetemptation of self-custody, select major custodians have been setting up digital
custody capabilities.
Traditional custodians have the additional experience and capability to upscale
their role and manage the private keys of the DLT instruments and assets forholding and transfers. They also provide connectivity to the relevant networks
and protocols as well as the balance sheet backing in case of any issue.

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Appendix 3: DAOs as a Foundation
for Web3
DAOs have the potential to drive blockchain adoption by providing new, innovative
ways for communities to govern and manage themselves. The decentralized anddemocratic economic model of DAOs helps grant individuals flexibility to rent theirtalent or time to specific projects in order to earn rewards by leveraging fractional
ownership in a community-governed ecosystem.
DAOs can facilitate inclusive access, providing small investors and contributors withaccess to the DAO’s content and a voice in organizational decisions. They can also
potentially help unlock access to private investment opportunities previously
available only to wealthy investors.
DAOs could also play a crucial role in the Open Metaverse (i.e., a Web3-based
version of the Metaverse). Using DAOs, content creators can own and monetize
their original creations, and the value can be manifested as NFTs (non-fungible
tokens) or tokens.
 More Autonomy, Better Monetization: Increased lifestyle flexibility and control

have enabled today’s creator economy of artists, vloggers, podcasters, and thelike to flourish through short-term contracts. As DAOs proliferate, instead of
having one employer and a defined working week, individuals may be able tocontribute several hours a week to multiple DAOs, resulting in more autonomy in
the monetization and scheduling of work hours.
DAOs are likely to attract self-motivated individuals who share an organization’s
specific vision. Thus, DAOs are well-suited to strengthen workers’ engagement
by rewarding them with ownership in projects, mitigating the principal-agent
dilemma, where there is a conflict of interest or priorities between employers (i.e.,
the principals in this example) and their employees (i.e., agents). DAOs could
grant more autonomy over where, when, and how an employee works.

 Freedom to Pursue More Fulfilling Work: According to a report by Gallup, only

21% of the global workforce today is engaged at work.142 DAOs could offer
employees freedom to choose projects where: (1) they share the company’s
mission or vision, (2) the role aligns with their core competences, and (3) talented
and like-minded co-workers are present. The technology-centric nature of DAOs
may also help automate trivial tasks using smart contracts that could further free
up employee time for more critical and creative work.

 Different Compensation Streams and Structures: DAOs could enableownership and governance in an Open Metaverse, driving newer monetization
methods for contributors. For instance, a DAO employee can contribute tocontent moderation of the virtual world where kids play, learn, socialize, and earnnative DAO or Metaverse tokens, thereby making the employee the owner andaligning their interests with that of the DAO and the Metaverse.

142 Gallup, State of the Global Workplace: 2022 Report, June 2022.

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As Web3 infrastructure proliferates and offers the possibility of redefining traditional
paradigms of gaming, social media, money, and finance over the next five to 10
years, we are likely to see more of these communities being governed by DAOs. In
the coming years, DAOs could challenge the way we think about organizations by
putting emphasis on self-governing businesses. And even if existing corporate
structures do not wither away, DAOs represent a mindset and an ethos that may
influence existing structures to become more participatory.

© 2023 Citigroup157

As our premier thought leadership product, Citi Global Perspectives &Solutions (Citi GPS) is designed to help readers navigate the most demanding
challenges and greatest opportunities of the 21st century. We access the bestelements of our global conversation with senior Citi professionals, academics, andcorporate leaders to anticipate themes and trends in today’s fast-changing andinterconnected world.
All Citi GPS reports are available on our website www.citi.com/citigps
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Education: Learning for Life
Why L&D Is the Next Frontierin Global Education
November 2021

Home of the Future
Building for Net Zero

Global Carbon Markets
Solving the Emissions Crisis
Before Time Runs Out
October 2021

Disruptive Innovations VIII
Ten More Things to Stop andThink About
October 2021

Holistic Digital Policy
Nation States Must Lead in
Building Equitable HumanCentric Digital Economies
October 2021

Biodiversity
The Ecosystem at the Heart ofBusiness
July 2021

Natural Gas
Powering Up the Energy
Transition
July 2021

Technology at Work v6.0
The Coming of the PostProduction Society
June 2021

Hard to Abate Sectors &Emissions
The Toughest Nuts to CrackMay 2021

Future of Money
Crypto, CBDCs and 21stCentury Cash
April 2021

Systemic Risk
Systemic Solutions for an
Interconnected World
April 2021

The Global Art Market and
COVID-19
Innovating and Adapting
December 2020

October 2021

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March 2023

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Citi GPS: Global Perspectives & Solutions

NOW / NEXT
Key Insights regarding the future of Blockchain
CURRENCY

Out of the 100+ central banks involved in central bank digital currency (CBDC)
research, development, and pilot, only three central banks have officially launched
its CBDC — Nigeria, the Bahamas, and Jamaica. / Major central banks, including
India, the UK, China, and the European Union are planning to launch a CBDC during
the 2020s.

Click Here to Add Graphic

INFRASTRUCTURE

Today, different parts of the financial market infrastructure run on different rails.
For example, payments run on a different tech stack than asset discovery, pre-trade
matching, clearing, and settlement. / The end state is a vision of a digitally native
financial asset infrastructure with smart contract and DLT-enabled capabilities. And
potentially using a shared “golden-source” infrastructure.

REGULATION

Smart legal contracts are not yet widely adopted but work is starting — with the UK
leading the way —on analyzing any regulatory barriers to innovation. / The creationof regulatory sandboxes to test out application of technologies under the eye of
regulators could help smart legal contracts gain mass adoption.

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