Discussion Questions and Answers (Chapters 2–22)

Citation (2021), "Discussion Questions and Answers (Chapters 2–22)", Baker, H.K., Nikbakht, E. and Smith, S.S. (Ed.) The Emerald Handbook of Blockchain for Business, Emerald Publishing Limited, Bingley, pp. 383-415. https://doi.org/10.1108/978-1-83982-198-120211029 Publisher: Emerald Publishing Limited Copyright © 2021 by Emerald Publishing Limited Chapter 2 – History of Blockchain Define the three major characteristics of money that bitcoin possesses. Bitcoin has three major characteristics of money. First, bitcoin is divisible similar to how fiat currency units are divisible into smaller units of previously existing units. The division takes place digitally in the form of bitcoin and other cryptocurrencies, but the divisibility still exists. Second, any medium of exchange (money) must also be useful as a unit of account, which bitcoin partially fulfills. Despite prior price volatility and continued lower levels of volatility, bitcoin has a value in other forms of currency. In fact, after the 2017 price bubble, volatility decreased substantially. Third, any medium of exchange must be portable. That is, it must be able to be transferred across borders and boundaries. As a digital medium of exchange, bitcoin is easily portable and can be transferred across borders without fees. Describe five core components of blockchain technology. Blockchain technology has the following five core components that include but are not limited to the following. First, every blockchain has a tamper-resistant ledger, which is where the transactions and other information that have occurred on the blockchain network are stored. Second, this information stored on the ledger is approved, before posting on the network itself, via some sort of consensus methodology that enables network members to jointly confirm that data are presented correctly. Third, any blockchain is defined by the encryption protocols used to safeguard information, with the most famous iteration being the SHA-256 encryption protocol used by the bitcoin blockchain. Fourth, the management of this entire process (i.e., the way in which data are confirmed and added to the network itself) is generally managed by full nodes, playing an important role in maintaining the integrity of the blockchain network. Fifth, every blockchain is in some way defined by the peer-to-peer (P2P) nature of transactions that underpin the entire blockchain ecosystem, which greatly reduces the need for intermediaries and other third-party organizations. Define interoperability in the context of blockchain implementation. In the context of blockchain implementation, interoperability equates to how easily a blockchain network or application can transfer data among the blockchain platform and other technology applications. A blockchain is simply a record of transactions. For that information to be leveraged effectively, it must be able to be communicated effectively. Discuss how problems with scaling and interoperability affect wider blockchain utilization. Issues involving interoperability and scaling are two major obstacles to wider enterprise or commercial adoption of blockchain technology. If blockchain cannot meet the needs of commercial business, both in terms of transaction processing and network capacity, or the ease with which data can be transferred between the blockchain and other technologies, implementation efforts are likely to fail. As efforts and other iterations of blockchain emerge, scaling and interoperability continue to come to the forefront. Describe how blockchain is helpful for e-commerce. Blockchain and crypto assets, specifically stablecoins, can be helpful for e-commerce transactions. Such an arrangement mirrors many of the benefits and savings associated with other mobile and digital payment transactions. Venmo, PayPal, Square, and Zelle have capitalized on the growing need for digital and P2P payments, increasing demand for lower cost options and general dissatisfaction with traditional financial incumbents. Stablecoins and blockchain-based payment platforms are equally well positioned to take advantage of many of these market forces. Chapter 3 – Review of Blockchain and Emerging Applications Explain what constitutes a blockchain network, including a main property of that network. A blockchain network usually consists of specific agents with each transaction verified by an agreement among the majority of the agents. Unlike a traditional database, the data on the chain are permanently stored and cannot be erased once a transaction enters the system. To maintain a cumulatively added ledger in a blockchain network, cryptography is used to record transactions among the participating agents of the same network. List several differences between a public and a private blockchain. The identities of users are anonymous in a public blockchain platform and known in a private blockchain platform. Relative to a private blockchain system, the speed of transactions is usually relatively slower in a public blockchain platform due to scalability. Transactions can be created by any participant in a public blockchain, but participation is limited to the members of a private blockchain platform. Despite these expected differences, cases exist in which some of these properties are not always distinct between the two platforms. Identify two major benefits of using blockchain in supply chain management. If blockchain is properly implemented, the origin of a problem item, such as a specific food if exposed to a bacteria, can easily be traced, and a corrective action can be made in that specific region. Without a blockchain system, the entire inventory for the same food throughout the chain, regardless where the contamination occurred, might have to be destroyed. In the case of supply chains using blockchain-based technology, the technology tracks goods and materials to prevent counterfeit products and low-quality products. Explain the concept of humans, technology, and organizations in the context of smart cities. Blockchain systems encompass three interrelated factors of humans, technology, and organizations. The framework identifies the attributes of the sharing economy of a smart city. Thus, blockchain may influence and create value-added. Blockchain increases the accessibility and availability of technology, which makes people more willing to accept access over ownership and to trust organizations and technology. Identify some relatively news areas where blockchain might have applications. Blockchain is relatively well-known to the financial sector, supply chain management, and the fields of accounting and auditing. Smart cities, water distribution, and waste management sectors are relatively new to this emerging technology. As the world's population increases, living conditions are likely to become more challenging in such areas as communication and access to resources. This change has brought about the emergence of smart cities. A smart city relies on innovation and technology to have something unique to offer, such as introducing smart parking or blockchain and Artificial intelligence (AI) into city life. Chapter 4 – Technical Aspects of Blockchain Describe the concept of a block and its components. A block is a main component in blockchain architecture. It is a kind of data structure to record transactions during a specific period. Once a block is completed and validated, it is a permanent storage that cannot be altered or removed. Blocks are connected with each other by a hashing code as a chain. A block consists of a header and transaction data. A header is section in a block that serves as a summary of data. A header consists of several components such as version number, timestamp, difficulty target, nonce, previous hash, and Merkle root. Version number is the current version of the block structure. It is used for keeping track of changes and updating the block. Timestamp provides the time when the block is created. Difficulty target is a value used to show how hard is it to find a hash. It will be lower than the target defined by a system. Nonce is a random value that a miner is allowed to manipulate to get a block hash. Once it is discovered, then all transactions are added to the blockchain. Previous hash is the hash of the previous block. It is used for connecting with other block as a chain. Merkle root consists of all the hashes of all the transactions to form a single hash code. Identify two major properties of a blockchain network. Two major properties of a blockchain network are decentralization and immutability. Decentralization: Blockchain is a distributed ledger that provides a way for data to be recorded and shared by multiple nodes or users. No single authority can approve the transactions or set specific rules for the delivery of data. So, blockchain is a decentralized system. Immutability. Blockchain introduces cryptographic hashing for enabling security in a block during the process of data transmission. It provides integrity in that blockchain data are difficult to alter or modify due to every chain being different. This property helps to prevent unauthorized access of data because an attacker would have to manipulate every single piece of the blockchain present on the network. Define a Merkle hash tree, describe its role in blockchain, and explain the meaning of a Merkle root in the block header. A Merkle hash tree (MHT) is a hash-based data structure that efficiently organizes a large amount of data. It is a tree structure in which each leaf is a hash of a block and a root is the hash at the top. MHT is designed to verify the integrity of data stored in a node and transmitted between nodes in a P2P network. More specifically, MHT helps to ensure data remain in their original state without alterations or corrupted information. The Merkle root, which is the hash of all the hashes of all the transactions in the block, is a part of the block header. This scheme enables securely verifying that the network has accepted a transaction. Explain the meaning of a distributed ledger. A centralized ledger has multiple ledgers, but only a master ledger keeps the true records as a clearinghouse. Unlike the centralized ledger, a distributed ledger has a single ledger that is shared by all nodes. All nodes have some level of access to that ledger and determine the ledger's true state. A distributed ledger in blockchain is a database that is distributed across several computers or nodes. Although a blockchain network is physically located in different places, it has a single ledger that is shared by all nodes. A distributed ledger eliminates the need for a central authority or intermediary to process, validate, or authenticate transactions. Chapter 5 – Public Blockchains Describe a public blockchain and mention three current applications. A public blockchain is a permissionless blockchain, allowing universal access to read, write, and validate information stored in the network. Current applications of public blockchain are monetary and financial networks such as Bitcoin and Zcash, distributed computing and virtual machines such as Ethereum and EOSIO, and decentralized markets such as Sia. Explain how public blockchains ensure the adherence of transaction and block-writing rules. Public blockchains ensure the adherence of transaction and block-writing rules through the consensus protocol. The consensus process goes beyond the rules that are written in the blockchain code and involves incentive mechanisms to ensure proper functioning of the validator network. The code sets the limit on miner activities that can be written into the software, for instance adding an invalid transaction (i.e., a transaction with insufficient funds or an incomplete executable contract), switching input or output addresses, or modifying transaction amounts. However, the code excludes all potential misbehavior such as rewriting a block already included on the blockchain, purposefully not including a transaction or writing empty blocks (“selfish mining”). These actions are regulated by explicit and implicit incentive mechanisms. An example of an explicit mechanism is the reward mechanism in Bitcoin, motivating but not imposing miners to write blocks following the most recently added block, as opposed to choosing a previous one. An example of an implicit mechanism is an agreement by miners not to mine on top of empty blocks, discouraging but not prohibiting adversarial miners from selfish mining. Discuss the need for predefined mechanisms and rules to modify a public blockchain's protocols. Besides the straightforward need to fix errors in the code, blockchain protocols need to adapt to the evolving use cases, applications, technology, and overall characteristics of the blockchain ecosystem. Given the decentralized nature of public blockchains, no central authority is available to determine the need and to approve and implement changes in the protocol. These decisions are vested to the blockchain's community. However, the interests of different blockchain stakeholders might diverge, hence leading to potential conflicts. Predefined mechanisms and rules would allow potential users to make informed decisions and participate in the network knowing beforehand the risks of future protocol changes. However, the permissionless nature of public blockchains also allows any user to replicate the blockchain and its protocols, modify them according to its own preference, and to launch an alternative blockchain, partly rendering the mechanisms and rules useless. Therefore, the existence of such mechanisms and rules is not a necessary condition for a public blockchain because even if present, it could be annulled by a hard fork on the blockchain. Proof of Work (PoW) consensus protocols have been criticized due to their high and continuously increasing mining cost. Discuss how mining cost affects the tamper resistance attribute of public blockchains. In PoW consensus protocols, block-writing rights are pseudo-randomly assigned according to amount of resources such as energy, memory space, and elapsed processing time that a validator has contributed to the network. If an adversarial miner wanted to tamper with the blockchain by blocking transactions or deleting transactions, the miner would have to dedicate a substantial amount of resources to attain probabilistic control of the block-writing process (51 percent attack). Therefore, as the mining cost of a blockchain increases, the cost of attacking the blockchain also increases, hence reinforcing the blockchain's tamper resistance attribute. Discuss whether a public blockchain requires issuing its own native cryptocurrency to provide incentives to its validator network. By creating its own native cryptocurrency, the blockchain network can reward validators for their contribution by issuing block rewards and transaction fees payable on such cryptocurrency. If this was not the case, validator's compensation would be limited to transaction fees paid by users through two alternative mechanisms, each with burdensome implications: (1) compensating validators through a nonblockchain (“off-chain”) system or (2) compensating validators through a blockchain compatible external cryptocurrency (crosschain atomic swaps). In both alternatives, blockchain users would require accepting some features present on the payment system or external blockchain, as well as losing noncompatible attributes. For example, both options would constrain blockchain transactions speeds to the transaction speed of the off-chain payment system or external blockchain. It would restrict the universe of potential users and validators to those individuals and institutions with access to the selected payment system. For the case of payments through traditional financial networks, it would most likely require eliminating the blockchain's anonymity and pseudonymity attributes since validators would need to be identifiable to receive payments. Describe the process of PoW. PoW is the original consensus algorithm in the blockchain network. It is used to confirm transactions and create new blocks. It requires expensive computing power to solve a complex mathematical puzzle known as a PoW problem. The process of PoW is as follows. New transactions are broadcasted to miners in the blockchain network. With PoW, miners compete against each other to complete transactions on the network and get rewarded by solving a complex mathematical puzzle using a hashing algorithm. The first miner publishes the verified PoW with a fixed length input string to all other miners. Other miners apply it to the same hash formula to see if the outcome is the same. The validated transaction is requested to enter into a block. All participants in the blockchain network attempt to approve this validated transaction using a consensus algorithm. If a majority of the participants (i.e., 51 percent rule in bitcoin) agree, then validation of this transaction occurs. After a set of approved transactions is bundled in a block, this block is sent to all the participants (nodes) in the blockchain network. Chapter 6 – Private and Hybrid Blockchains and Applications Differentiate between a public/permissionless and a private/permissioned blockchain. Several core differences exist between a permissionless and permissioned blockchain. First, a permissionless blockchain generally has few, if any, barriers or restrictions as to what kind of individual can be a part of the network itself. Second, a permissioned blockchain may operate in a similar manner as a traditional enterprise database management system depending on the levels of restrictions and barriers to entry. Third, a blockchain's internal controls are simpler to establish in a manner conducive to enterprise adoption as a result of the increased permissions. List three advantages of a private/permissioned blockchain relative to a public/permissionless blockchain for enterprise usage. Three advantages of a permissioned blockchain for enterprise usage are: Increased ease with which internal controls and access protocols can be constructed to safeguard the information and data stored and shared within this blockchain. Increased processing speed due to the fact that the consensus methodologies used at a permissioned blockchain need not be as complex or time consuming as those used at a permissionless blockchain. Enhanced opportunities for P2P activity because different network members can be granted different levels of access, custody, or control over the network information. Differentiate between stablecoins and decentralized cryptocurrencies. Stablecoins differ from decentralized cryptocurrencies in several ways. A stablecoin is pegged, tethered, or otherwise connected to an external asset such as oil, gold, or other fiat currency. A single entity or small number of organizations generally issue and govern stablecoins. Although a firm limit might exist on the number of decentralized cryptocurrencies that can be issued, not every stablecoin operates in this manner. Discuss how CBDCs differ from other stablecoins. A CBDC is a type of crypto asset that is governed and issued by a central bank or other type of quasi-governmental agency. The main difference between a CBDC and other stablecoins is that a governmental entity complete with the full backstopping of that governmental agency or count issues a CBDC instead a private sector organization. A CBDC may also not be based on any blockchain technology. Explain how consumer privacy is relevant to CBDCs. A CBDC could allow a government to keep track of all transactions in which a user engages. As a result, a government could block anything it deems an undesirable purchase. A CBDC could also reduce tax evasion because users have minimal privacy. Additional factors related to consumer and institutional privacy are more closely connected to the potential for governments or governmental actors to potentially leverage CBDCs for surveillance purposes. Specifically, those involved in the CBDC development process need to guard against the potential for abuse, tracking, and targeting or certain individuals, institutions, or purchase types. Chapter 7 – Consensus Mechanisms and Related Issues Discuss how Global Bling could adjust the amount of bitcoin that Vantage Mines paid for the diamond in Transaction #2 and whether it would belong to the same chain. Any accounting correction, whether it be an adjustment (adding the difference as a new block) or deleting the transaction in a new block and subsequently rebilling it in yet another block (two new blocks), should be an additional transaction added to the same chain. A transaction that occurred earlier cannot be changed in that block, but amounts can be altered in subsequent blocks. This approach differs from traditional accounting systems where previous entries and financial reports can be adjusted. Explain whether the electrical energy and equipment costs required by PoW are justified. The answer depends on the relation between the costs of PoW (e.g., energy, environment, equipment, and transaction latency) and its benefits (e.g., security, immutability, and protection due to its complexity). Using PoW cannot be determined on a “one-size-fits-all” basis. In some cases, where immutability and security are quite important, the costs of PoW may be worth it. This situation could occur in real estate transactions, which do not occur often and where immutability of records is required. In other cases, such as many everyday retail transactions, PoW might be “too much” and not worth its costs in energy and equipment, given that thousands of transactions occur every minute. Banks most likely would prefer using a less robust mechanism for processing these types of payments, given that PoW can only handle a few transactions at any one time and each batch of transactions takes 10 minutes to process. However, since the network controls this 10 minute processing time, possibly this restriction could be modified. In summary, cost justification for using PoW is unique for each situation or context. Explain what is likely to happen to the PoW mining industry after the most recent halving of bitcoin. Because mining is a business, any mining concern would need to examine its costs of operation and expected profit. With the block reward being halved in May 2020, a mining operation should be assessing whether its equipment is working efficiently and whether its power source is too expensive. Miners might cease mining if the equipment and energy costs are too high, given the current reduced payment. What was profitable yesterday might not be profitable today. Some expect a reduction in the number of miners as those who cannot remain profitable with the new pricing scheme are likely to quit. Ultimately, fewer miners could lead to a reduced hash rate and subsequently reduced energy requirements. Yet, having fewer independent miners could also lead to a greater centralization by a few mining pools. Discuss whether business owners are likely to be comfortable with a Proof-of-Stake (PoS) blockchain. Since PoS is a mechanism of trust, where participants assume that the validator's own best interest is that of maintaining the chain and not conducting an attack, many businesses might be uncomfortable with this arrangement. What is interesting is that Ethereum, which sponsors many smart contracts, is considering PoS as its mechanism in the future, but has yet to do so. As was seen with some of the potential attacks of PoS, attacks could occur if the attack or fork seems to be more profitable for the validator. Businesses are rightfully concerned by this naiveté of trust in PoS that could expose it to these types of attacks. On the other hand, PoS does not carry the high energy and equipment requirements of PoW, and blocks are validated more quickly. Similar to the analysis of PoW, in the end the choice to use PoS is context- and use-specific. In short, no single, definitive answer is available. Discuss whether the SHA-256 hash is appropriate for most blockchains. SHA256 hashing is the fundamental technology proposed by Nakamoto. The complexity of hashing imparts the features of security, immutability, and tamper resistance to bitcoin and other blockchains using PoW. However, these beneficial features come with a huge cost of equipment, substantial demands of energy, slow transaction processing, and concerns about mining centralization. The blockchain envisioned by Nakamoto and which currently exists as bitcoin seems to be irrelevant for today's potential uses. Businesses should be concerned about the financial viability of SHA256 hash based blockchains. Conversely, the blockchain might not be so secure or tamper resistant without hashing. Also, whether the chain could still be called a blockchain without SHA256 is unclear. At least, it would not be the bitcoin ledger that Nakamoto proposed. Clearly, the appropriateness of hashing as the proper consensus mechanism for a blockchain is context-specific and where the business carefully identifies the most important features for its blockchain transactions. Chapter 8 – Token Economies Define a cryptographic token. A cryptographic token is blockchain-native asset that facilitates new value creation and exchange models. It can represent a wide range of programmable assets or access rights managed by a smart contract and an underlying blockchain. Characterize Web 3.0 and identify the attributes that differentiate it from Web 2.0. Web 3.0 is the decentralized web underpinned by public blockchain networks that eliminate the need for trusted third parties and proprietary protocols. At its core, Web 3.0 disintermediates economic transactions and enables users to assume self-sovereignty over their data and digital identity. With the introduction of a universal state layer, Web 3.0 is a major step evolution over Web 2.0. This state layer gives users a way to hold state (economic value) in a digitally native way and transfer it to anyone on the network, enabling truly P2P transactions without intermediaries. Web 3.0 is considered the internet of value. Define a utility token and indicate how it differs from a SoV/MoE token. A utility token provides holders with access to a digital product or service and derive its value from this underlying right. It represents crypto asset that is intrinsic to the blockchain and inherently consumptive in nature. A utility token is designed to be used or consumed in the process. Although utility tokens can be traded among ecosystem participants, unlike SoV/MoE tokens, utility tokens are not typically used as a store of value (e.g., digital gold) or medium of exchange (e.g., for payments). They are typically developed for use within a decentralized application (dApp) that resides on top of an existing public blockchain network like Ethereum. Several types of utility tokens exist including governance, discount, work, and burn-and-mint tokens. Explain the difference between fungible and nonfungible tokens and identify the appropriate Ethereum token standards for each. Fungible tokens are identical in value, and they are interchangeable. The most common technical standard used for creating Ethereum-based fungible tokens is the ERC-20 (Ethereum Request for Comment 20) token standard. Nonfungible tokens (NFTs) represent something unique, can differ in value, and are noninterchangeable due to their individual distinct attributes. A common technical standard used for creating unique Ethereum-based NFTs is the ERC-721 token standard. The ERC-721 standard further extends the possibilities of fungible ERC-20 tokens with a higher degree of functionality, particularly around token creation and ownership. Crypto collectibles are typically created using ERC-721 NFTs. Explain why mechanism design is a critical component of cryptoeconomic systems. Cryptoeconomic systems rely on incentive mechanisms to drive user behaviors in a way that creates a self-sustaining system. Token economies (i.e., complex token systems) are cryptoeconomic systems where individual actions that advance a collective goal are incentivized through the token. The incentive mechanism driving the interactions (i.e., token transactions) among actors (i.e., humans or autonomous agents) is an integral cryptoeconomic component of the token system. Mechanism design focuses on the development of effective cryptoeconomic incentives such that if actors pursue their own self-interests, they are simultaneously incentivized to reach the collective system-level goal – a win-win outcome. The cryptoeconomic incentive mechanisms can be engineered to encourage only those behaviors that contribute to the overarching goals of the token system as a whole, while disincentivizing destructive behaviors. Discuss how system dynamics modeling is useful to token engineering. A general goal of all token systems is to create a coordinated outcome that satisfies system-level (i.e., global) goals. In reality, they can produce predictable (deterministic) but also unpredictable (stochastic) outcomes. Stochastic outcomes are often linked to human actors that do not always act in rational ways; they may be influenced by externalities that cause them to prefer actions other than those a model assumes. System dynamics modeling may help to demonstrate how a complex system behaves as a whole given varying assumptions about actor/agent behaviors. It can be a powerful tool to model the architecture of a token system visually using, for example, stock-and-flow diagrams. System dynamics models can help in exploring possible futures by asking “what-if” questions and simulating interact