Category: Fintech

This is usually the next question asked after: “what is Bitcoin?” or “what is Blockchain?” Ethereum (ETH) represents an ambitious blockchain project moving cryptocurrency into uncharted territory by decentralizing a wide range of products and services. 

If we think of Bitcoin as digital gold, storing value, then Ethereum clearly takes a different approach. It creates wrappers in which users place custom assets and add rules governing their operations and transfers.

Investors consider Bitcoin a precise tool for a specific job, while Ethereum is more like a Swiss army knife. It enables users to interact with it in novel ways and create new products. In this article, we will go further into the specifics of Ethereum and how it has become the second-largest crypto according to current market capitalization.   

Ethereum Basics

Ethereum performs two tasks. It:

1. Tracks changes on its blockchain (confirming transactions like Bitcoin)
2. Tracks potential changes called “State” (Bitcoin does not do this)

Ethereum contains multi-step functions called “smart contracts.” For example, “A” must do X first, and then “B” will automatically happen, like any basic logic function. State tracks if “A” has completed the relevant task.

Smart contracts are often linked together and stacked into larger structures which are called decentralized applications or Dapps.

Current Dapps are primitive, but Ethereum proponents believe that Dapps will eventually facilitate the creation of software replicating the services offered by the world’s largest tech companies and financial institutions, such as Amazon.

Let’s think of the Amazon Marketplace as a “state” service connecting buyers with sellers through an easy-to-use graphical interface providing a massive selection of constantly updated inventory. Amazon is just a middleman, a steward of the technology. It takes a (hefty) portion of the sale price for this role.   Ethereum is an early attempt of using blockchain to create a marketplace, circumventing these monopolistic services. 

To execute these ever-complex Dapps, the Ethereum team created a scripting language native to its own virtual machine, itself funded through the sale of “Ether” coin.

Ethereum’s Origin Story

The idea for Ethereum came from a 20-year-old Russian-Canadian named Vitalik Buterin. Buterin realized that it’s possible to more broadly apply Bitcoin’s design, to, according to Buterin, mitigate the “horrors centralized services can bring.”

Buterin’s famous example refers to the life-changing slight he suffered from a centralized service while playing the online game World of Warcraft. He discovered that the game’s developers could make arbitrary changes at any time, drastically affecting gameplay.

A Theil Fellowship was awarded to Buterin, allowing him to work on Ethereum full time and create a non-profit entity, The Ethereum Foundation. Its sole goal: launch the Ethereum project. In 2014, this project generated $18 million through an online crowd sale of 72 million ETH (roughly worth $255 billion USD in October, 2021).

Ethereum expanded to attract a passionate community of developers and users, who continue to forge its development today. Some of the most notable are:

• Jeff Wilke: creator of Ethereum’s first software implementation
• Gavin Wood: author of Ethereum’s yellow paper defining its virtual machine
• Joseph Lubin: Consensys Founder and Ethereum investment incubator

The Inner Workings of Ethereum

Two Ethereum networks always exist in tandem: the network being used at present and the new network which its developers are building.

Its team maintains an ongoing roadmap since Ethereum’s launch in 2015. Its mandate is to continue growing. This partly explain Ethereum’s many accomplishments since 2015, though several proposed features are still pending.

The Current Ethereum

The Ethereum blockchain from 2015 until today uses a proof-of-work (PoW) consensus mechanism in which “miners” (computers) verify orders and add them to the ongoing blockchain. Through PoW, miners use energy to compete in solving puzzles (find the correct string of numbers called a has) and earn the role of a creator of a new block.

The winning miners receive modest amounts of ETH as their prize. This process repeats every twelve seconds.

Smart contract developers use one of two programming languages: Solidity or Vyper. Being proprietary to Ethereum, they deploy code onto its blockchain. All nodes (the miners running Ethereum software) maintain respective copies of Ethereum’s Virtual Machine (EVM). The EVM is a compiler translating smart contracts written in Solidity or Vyper, and executes them upon the blockchain.

A group of miners who had rejected a proposed Ethereum code update chose to continue running the older code, and this resulted in a new cryptocurrency in 2016 called Ethereum Classic. The two should not be confused. 

ETH 2.0, Proof of Stake, and Shards

The original PoW structure of Ethereum is similar to Bitcoin’s blockchain. However, Ethereum is shifting its core operating system with Ethereum 2.0.

The consensus mechanism will change to “Proof-of-Stake” (PoS), swapping traditional miners for “stakers.” Users who have 32 ETH or more can lock their “stakes” and earn rewards for maintaining the blockchain, using less intensive software and hardware than the increasingly power-hungry miners of PoW.

The single (active) Ethereum blockchain will be divided into a group of separate sections called shards, ultimately linked by an overarching “beacon chain” dedicated to improving the entire system’s throughput.

ETH 2.0 upgrades will improve electricity usage and throughput speed, making the chain safer, and should be completed by mid-2022.

Why Does Ethereum Have Value?

The cryptocurrency behind Ethereum is called Ether. New coins of it are minted with every new block miners create. Ether has no supply limit.

Currently, two Ether are created every twelve seconds, though some coins do get burned, thereby limiting the supply.

Developers propose monetary policy changes, which must be agreed upon by nodes. Miners (or after ETH 2.0, stakers) receive fees for their processing work. These are referred to as “gas.” The more complex the smart contact, the more gas used. One of Ethereum’s goals is to constantly increase the utility of Ether and its platform, attracting more stakers despite the implicit ceiling on gas rates.

Why Choose Ethereum?

Ethereum aims to be more than a cryptocurrency, unlike many of the altcoins available, and has created several pillars for increasing demand.   

Private Blockchains

Major banks embraced Ethereum by taking advantage of its opensource code, creating proof of concept/R&D initiatives in 2015-16. These projects contained either copies of Ethereum’s code or were Ethereum-inspired, like R3’s Corda and Linux Foundation’s Hyperledger. They used the architecture but did not create a new cryptocurrency.

In 2017, these banking projects led to the Enterprise Ethereum Alliance, a non-profit backing Ethereum and bridging the gap between it and private blockchains.

The ICO Craze

Also in 2017, several entrepreneurial projects used Ethereum as a platform for fundraising. They created new cryptocurrencies and sold them to investors through initial coin offerings (ICOs). Through its ERC20 token standard, Ethereum holds the ability to facilitate new crypto assets without requiring additional, coin-specific blockchains. Chainlink, LiquidiFy, and VeChain are all Ethereum ERC20-based projects.

Decentralized Finance (DeFi)

Ethereum’s most recent innovations are in decentralized finance (DeFi), where Ethereum replicates legacy financial services. For example, MakerDao decentralized USD-pegged cryptocurrency management. Other DeFi projects automate lending and borrowing and represent the most recent use cases for Ethereum’s blockchain.

Security Tokens

The most exciting development for Ethereum is in the security token space, where financial assets are converted into digital equivalents. These security tokens are to be traded on decentralized markets, all on the Ethereum network and without expensive middlemen.

The essential requirement of security tokens is legal compliance. Are they complying to all relevant laws and regulations applying to where they are traded? Fortunately, several projects are building compliant tokens.

NFTs

A Bitcoin, a dollar, or an Ether, is “fungible.” One dollar is like any other and has the same value. Art, however, is nonfungible. There may be several copies of the Mona Lisa, but only one is the original. 

Nonfungible tokens or NFTs are one-of-a-kind digital assets. These new forms of digital value have become popular over the past year as we see headlines of people buying them for millions of dollars. 

Ethereum is well-suited to creating NFTs. The tokens and their respective proofs of ownership can be transferred with ease, while the transfer itself follows pre-defined rules with Ethereum’s smart contracts.

Always Upgrading

Ethereum’s rapid rise in market capitalization proves it to be the ideal choice for blockchain development. It has shifted over the years, though each update adds more functionality to its smart contract abilities. These increases give developers more tools to further expand Ethereum’s capabilities.

Summary

In a handful of years, Ethereum has changed the world of cryptocurrency. It continues to change this world each day. Smart contract functionality, coupled with decentralized management, represents a genius invention carrying ramifications yet to be felt. The future for Ethereum is nothing but bright.   

Disclaimer:  The author of this text, Jean Chalopin, is a global business leader with a background encompassing banking, biotech, and entertainment. Mr. Chalopin is Chairman of Deltec International Group, www.deltecbank.com.

The co-author of this text, Robin Trehan, has a bachelor’s degree in economics, a master’s in international business and finance, and an MBA in electronic business. Mr. Trehan is a Senior VP at Deltec International Group, www.deltecbank.com.

The views, thoughts, and opinions expressed in this text are solely the views of the authors, and do not necessarily reflect those of Deltec International Group, its subsidiaries, and/or its employees. This information should not be interpreted as an endorsement of cryptocurrency or any specific provider, service, or offering. It is not a recommendation to trade.

Taproot is groundbreaking because it’s the first upgrade to Bitcoin in four years.

It was approved by the cohort of Bitcoin miners in early June of 2021 and went into effect the following November. The upgrade means greater transaction privacy and efficiency, and most importantly, the potential for smart contracts. With this article, we’ll discuss what Taproot is and what its implications are for Bitcoin, its users, and investors. 

What Does Taproot Do for Bitcoin?

Finally, with Taproot, Bitcoin is compatible with basic smart contract functionality. This is due to two overarching back-end code changes. Specifically, a change in the network’s cryptography method and new support for Merkelized Alternative Syntax Tree (MAST) script execution (we will go deeper into this below).

Because of the complexity of these improvements, and with many investors lacking in-depth knowledge of blockchain, Bitcoin’s price will not readily take into account these upgrades. For all investors, it’s still vital to understand Taproot.

The Upgrades in Detail

Bitcoin’s blockchain network carries as its main function a direct peer-to-peer payments system for transferring value. Our cryptocurrency layering article discussed Layer 2 capabilities, like those offered with the Lightning Network.

However, due to a lack of functionality and scalability issues, Dapps and smart contracts cannot be built on the Bitcoin Layer 1 network. Taproot provides a workaround and eliminates Bitcoin’s code limits to increase real-world uses on the network.

Taproot gives app building, combined with increased scale, privacy, transparency, and fungibility. These changes should increase Bitcoin’s adoption worldwide and, with it, its price.   

Schnorr Signatures

The most fundamental change Taproot brings to Bitocin is a rehaul of its cryptography method. It previously used an Elliptic Curve Digital Signature Algorithm (ECDSA). Bitcoin’s creator, Satoshi Nakamoto, used ECDSA to produce a public key (i.e., a public ID) from a private key. Supposedly, he chose this method due to its lack of popularity.

ECDSA signatures are, however, vulnerable to exploits such as lattice attacks. Worse still, they cannot be compressed, slowing transaction processing speed and throughput. With Taproot, Bitcoin is shifting to Schnorr signatures.

These can be compressed. They will also improve the privacy of more complex smart contract transactions, while enabling simultaneous signature processing (batched validations).

Image courtesy of bitcoin.com

Merkelized Alternative Script Trees (MASTs)

The second change Taproot brings: MAST. These scripts feature a similar function to Schnorr signatures. They minimize on-chain data transfers.

MAST scripts compress transactional conditions into their simplest forms, called Merkle roots. Merkle trees are data structures used in computer science apps. In the case of Bitcoin, Merkle trees encode blockchain data efficiency and securely.

The MAST idea in a nutshell is that you have alternative scripts or script fragments stored as leaves in a single Merkle tree. Those leaves not used can be pruned away, saving space.

Merkle Tree Diagram

Image courtesy of Investopedia

Compare MAST to P2SH (Pay to Script Hash), where the entirescript must be hashed and then revealed on the blockchain when spent. This brings block space efficiency (and lower transfer costs) and numerous privacy benefits. 

With MAST, Bitcoin transactions of greater complexity, such as Bitcoin DeFi apps, are compressed into only one hash each. This minimizes memory usage and increases scalability. MAST enables Bitcoin developers to write more complex scripts requiring less gas (less usage for processing) .

Image courtesy of Stephen Tuttle

The Valuable Combination

Combing Schnorr signatures with MASTs is significant. Taproot means that Bitcoin now has a value beyond a simple Store-of-Value (SoV), like with gold. Bitcoin’s network now has the capability to develop an ecosystem of applications like Ethereum.

As Ethereum continues to grow and accommodate more complex apps, Bitcoins and its players understand the need to compete.

Bitcoin’s Possibilities

For an investor to feel secure with Bitcoin as a portfolio constituent, it’s crucial to understand the possibilities for development that will result from Taproot’s code changes. This understanding requires some technical knowledge, but this relatively simple understanding will still surpass that of the typical investor. 

Lightning Network’s Improvements

Our Bitcoin layers article introduced the Bitcoin Lightning Network, a Layer 2 solution that takes Layer 1 bundles and deals with them off-chain, providing Bitcoin with enhanced functionality. This is how Bitcoin has been able to have smart contract functionality in the past.

With Taproot, Lightning Network nodes which minimize memory usage and gas fees of Bitcoin payments by computing the transactions off-chain, shall gain scalability and privacy improvements. The two technical reasons for these improvements are due to Schnorr signatures:

1. Switching to point-locked contracts
2. Batched validation

These improvements should make Lightning Networks more intuitive and cost-effective for their users.

Lightning Network Applications

With Taproot’s upgrade increasing the efficiency of the Lightning Network, it will also provide for additional development of applications on the Lightning Network. This is an ecosystem of dApps intend to expand the uses for Bitcoin. 

Besides Blockchain developers, few people are aware of Bitcoin’s improved functionality. The primary source network of smart contracts and DApps has been Ethereum.

With “Layers,” we learned that Bitcoin’s Base Layer uses its Proof-of-Work consensus mechanism, Lightning is the Layer 2 of Bitcoin, and to it, we can add Layer 3 DeFi (Decentralized Finance) and dApps.

Taproot Risks

There are risks involved when a blockchain of any kind upgrades. Bitcoin, being the world’s most valuable decentralized network, certainly has many eyes on them. Yet this attention is a double-edged sword. It brings both expert hackers wanted to exploit protocol vulnerabilities, as well as brilliant computer scientists working against them.

Though Taproot should make Bitcoin more secure, there are always potential unforeseen errors, whether during or after Taproot’s implementation. The amount one chooses to invest should mirror their confidence in the upgrade.

Bitcoin’s New Core Function

Before Taproot was released, there was a September 13^th Bitcoin Core 22 release hat helped prepare the Bitcoin Core for Taproot. A Bitcoin Core decides which blockchain contains the valid transactions. One of the key upgrades to the Core was Multisig, or coins that require signatures from multiple private keys in order to be spent.

Multisig is used for several purposes. For example, it’s used to secure funds from several devices. Even if one device becomes compromised or lost, the coins remain safe and accessible.

Multisig can also share control over funds between several users but requires cooperation (multiple signatures) to spend the coins.

Summary

The list of technical improvements coming to Bitcoin with Taproot is too long for a single article. Beyond Schnorr signatures and MAST scripts, there are discrete log contracts, script-less scripts, ring signature functionality, and other privacy increases.

The important takeaway, however, is that continued development is coming to Bitcoin. Taproot expands on its single use as a SOV and becomes a platform for dApps and DeFi. This change alone completely reimagines Bitcoin by linking it to Layer 2 and 3 solutions, and the future itself.

Disclaimer:  The author of this text, Jean Chalopin, is a global business leader with a background encompassing banking, biotech, and entertainment. Mr. Chalopin is Chairman of Deltec International Group, www.deltecbank.com.

The co-author of this text, Robin Trehan, has a bachelor’s degree in economics, a master’s in international business and finance, and an MBA in electronic business. Mr. Trehan is a Senior VP at Deltec International Group, www.deltecbank.com.

The views, thoughts, and opinions expressed in this text are solely the views of the authors, and do not necessarily reflect those of Deltec International Group, its subsidiaries, and/or its employees.

The adoption of blockchain technologies and distributed ledgers is still in its infancy for capital markets, and it’s continuing to find new use cases. One of these broad cases is the tokenization of assets whereby the token is a digital representation of either an asset that only exists on a blockchain, a noncertified security, or an asset that exists off the blockchain.  

The tokenization of assets from the “real world” continues to grow in popularity, and investments in this space are cropping up across finance.

Tokenization, Short and Sweet

Tokenization is not a new concept for the blockchain space, but the finance industry’s attention is on the tokenization of real-world assets. At its core, tokenization is the conversion of a full right, or at least a portion of ownership, to a digital form (a token) that is stored on a blockchain. Regulated financial instruments, like equities and bonds, futures contracts, precious metals, real estate, and even intellectual property rights for patents, writing, and music could be tokenized.  

Graphic courtesy of smart chainers

The benefits of tokenization are apparent for assets that do not currently trade electronically. Items that need increased transparency and basic liquidity stand to benefit greatly, such as artworks and other collectibles.  

Tokenization, Fractional Ownership, and Securitization

Through timestamps and encryption, asset tokenization brings improved information security. The terms tokenization, fractional ownership, and securitization are interrelated and easy to confuse but have some considerable differences. 

Tokenization is the transformation of real-world assets into digital tokens, increasing their liquidity. However, securitization is the conversion of assets with low liquidity into instruments with higher liquidity.  “Security tokens” enable liquid trading with financial exchanges, as well as in over-the-counter (OTC) markets. Blockchain tokenization differs from fractional ownership as the latter refers to shared digital ownership of an asset.   

Token Types

Tangible tokens represent assets with specific monetary values and ultimately are in the physical form. 

Fungible tokens represent those digital assets which are all equal in value—similar to fiat currency. One bitcoin in your wallet is equal to one bitcoin in someone else’s wallet. 

Non-fungible tokens represent digital or real-world assets having unique traits and are not interchangeable, like art. 

Tokenization’s Benefits

When physical assets are tokenized, market participants gain several new benefits.   

Increased Geographic Reach

By their nature, public blockchains have no barriers. In legacy (developed) markets, extensive Know Your Customer (KYC), and Anti-Money Laundering (AML) regulations must be followed. These requirements have slowed the wider adoption of public blockchains.  

Nevertheless, there are now public blockchains performing KYC and AML tasks, building overall trust, and increasing the reach of tokenized assets. This important segment of “Permissioned Blockchains” is evolving, allowing the interest of the all-important institutional investor to grow.  

A Growing Investor Base

While institutional investors comprise much of finance, retail investors are also important. 

For most real-world assets, there is limited fractionalizations. For example, trading fractions of shares has now grown into a massive market with online brokers. 

Selling 1/20^th of an apartment or 1/100^th of a painting is possible with tokenization. This means a much broader investment base can access and participate in restricted investments such as fine art, which have traditionally only been available to the very wealthy. 

24/7 Trading

The tokenization of assets also means 24/7 market liquidity. 

These assets sit on the blockchain in smart contract form, available for instantaneous trading so long as the smart contract’s parameters are filled—and these parameters can change throughout the token’s lifecycle. This digitization streamlines trading by removing classical intermediaries. 

Counterparty risk is also reduced with blockchain transactions, as is the possibility of trade breaks.  

Reduced Administrative Costs

Blockchains are immutable, distributed digital ledgers. Asset recordkeeping is always ongoing, and those records are easily accessible. 

Administrative tasks like profit sharing, buybacks, voting rights, dividends, and stock splits are much more efficient with tokenization and distributed ledger technology. As the world’s markets slowly accept the distributed ledger as golden, the need for reconciliation could potentially be eliminated, with users just accepting the ledger as is.

Upgraded Infrastructure

Many asset classes are slow and labor-intensive, like real estate or private equity. They require the exchange of traditional paper-based documentation. 

With the digitization of such assets on distributed ledgers, the efficiency of these markets can be greatly improved. The possibilities for other segments currently having limited infrastructure become apparent as well.  

Improved Regulation

Regulators are slowly moving into preestablished markets and laying the foundation of a regulatory framework for digital asset exchanges. The real-time immutable data contained in a digital ledger enhances the protection of investors. 

Asset Collateralization

With the fractionalization of novel asset classes, tokenization expands the range of collateral to beyond traditional assets. 

This significantly increases market activity by providing a new universe of acceptable noncash holdings to be staked as collateral. Through blockchain technology, collateral management can be effectual, transparent, and available to new asset classes.  

The Future of Tokenization

Large financial institutions already understand the opportunities that the tokenization of financial assets brings. 

The transition of legacy assets like corporate securities into digital markets is tempting. We are already seeing American and European exchanges take steps in the development of tokenized offerings. In addition, the enhanced liquidity purports new fiduciary duties for financial services providers. 

We are still in the embryonic stage of security tokens, yet these have the potential to change the entire financial services industry–making markets more dynamic, bringing in new investors, and fractionalizing investments. The sky is the limit.  

Disclaimer: The author of this text, Jean Chalopin, is a global business leader with a background encompassing banking, biotech, and entertainment. Mr. Chalopin is Chairman of Deltec International Group, www.deltecbank.com.

The co-author of this text, Robin Trehan, has a bachelor’s degree in economics, a master’s in international business and finance, and an MBA in electronic business. Mr. Trehan is a Senior VP at Deltec International Group, www.deltecbank.com.

The views, thoughts, and opinions expressed in this text are solely the views of the authors, and do not necessarily reflect those of Deltec International Group, its subsidiaries, and/or its employees.