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by Yap Heng Kiong
A blockchain is a cryptographically secure distributed ledger. Transactions (either money or records) are validated by complex computer algorithms. Verified transactions are “Chained” together in “Blocks” using cryptography. (that’s why the name Blockchain). In Blockchain, the ledger is not stored in any centralised server; but distributed via a network of computers. Each node sees the same set of data (transactions). Data is stored in ledgers across all nodes (hence distributed) in the Blockchain network. Ledgers are updated when there are new validated transactions. Additions to the Blockchain can only be made after validation using a Consensus Mechanism. The two most popular ones being Proof-Of-Work (PoW) and Proof-Of-State (PoS). This makes it extremely difficult for anyone to tamper with the data. Can Data Stored on a Blockchain Be Erased?Each node on a Blockchain network has a verified, up-to-date and immutable history of all transactions. Once validated, transactions cannot be altered and cannot be tampered with. Data is reversible only by a subsequent transaction. What is the difference between a distributed database and a centralised database?A centralised database can be explained using the analogy of a document being shared among users via emails. All owners update records on the same Master copy. All parties involved would need to wait until receiving a return copy before one can see or make other changes. On the other hand, a decentralised database is like when multiple parties work on a shared document in the cloud, changes made at any nodes are synchronised. Blockchain uses decentralised database system (or distributed ledger), records are not stored in any single location. Once a record or transaction is stored on a Blockchain, it is extremely difficult to amend. I am creating a multi-part guide on the fundamentals of Blockchain. Part 1 and 2 have been released and can be found at below link.
Click here to access the guide Part 1 - What is Blockchain? Part 2 - Centralised vs Decentralised Database
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This post discusses the Public/Private Key encryption and cryptography technique used in Bitcoin and Blockchain. Follow my other articles to find out more about Blockchain and how it works.
Issues with Symmetric Key System
This is how the One-key (or symmetric) encryption system works. A Sender encrypts the message to be sent using a private key. The private key is then used by the Receiver to decrypt in order to receive the message. The risk of such a system is that anyone else could potentially obtain the private key and able to receive the message though not authorised.
Symmetric key algorithms are algorithms for cryptography that use the same key for both encryption and decryption.
Plaintext is the unencrypted message whereas Ciphertext is the encrypted message. The issues are:
Encryption Used in Blockchains - Asymmetric Key Algorithms
Blockchain and bitcoin use Asymmetric key algorithms to protect transaction messages across the network.
James Henry Ellis (25 September 1924 – 25 November 1997) was a British engineer and cryptographer. In 1970, while working at the Government Communications Headquarters (GCHQ) in Cheltenham he conceived of the possibility of "non-secret encryption", more commonly termed public-key cryptography. (Wikipedia https://en.wikipedia.org/wiki/James_H._Ellis)
Instead of sharing a private key, A makes available publicly the lock (public key) which only his private key can be used to open. A then sends the lock to B. B uses the lock to secure and send the message to A. Since the key is private to A, the encrypted message (locked message) will not be subjected to any eavesdropping, e.g. E. Blockchain and bitcoin encrypt transaction messages makes use of public-key cryptography. How Public/Private Cryptography works?
Clifford Christopher Cocks CB FRS is a British mathematician and cryptographer. Cocks, with his background in number-theory, developed the idea of using prime factorisation to implement Public/Private Key Cryptography, which later became known as the RSA encryption algorithm.
What is prime factorisation? In number theory, the fundamental theorem of arithmetic, also called the unique factorization theorem or the unique-prime-factorization theorem, states that every integer greater than 1 either is prime itself or is the product of prime numbers. (Wikipedia - https://en.wikipedia.org/wiki/Fundamental_theorem_of_arithmetic). For example, 30 = 5 X 3 X 2 589 = 31 X 19 437231 = 859 X 509 The Euler totient function ϕ Based on another theory proposed by Leonhard Euler in 1760, we introduce Euler phi function, written ϕ(n), ϕ(n) is the number of non-negative integers less than n that are relatively prime to n. In other words, if n>1 then ϕ(n) is the number of elements in Un, and ϕ(1)=1. Hence, ϕ(6) = 2 [1,2,3,4,5,6] ϕ(7) = 6 [1,2,3,4,5,6,7] - 7 is a Prime number ϕ(8) = 4 [1,2,3,4,5,6,7,8] ϕ(13) = 12 [1,2,3,4,5,6,7,8,9,10,11,12,13] - 13 is a Prime number There is an interesting pattern we can observe from the Euler totient theory above, i.e. ϕ(n) = n-1 (if n is a prime number).
Blockchain uses the RSA algorithm to send and sign an encrypted message without a separate exchange of a symmetric key,
To see the implementation of Public/Private Key in action, STEP 1 choose two distinct primes P=11 Q=7 STEP 2 Find N; where N is the product of P and Q. N=PXQ=11X7=77 STEP 3 From above Euler totient theory, we know that ϕ(N)=N-1 and since ϕ(PXQ)=(P-1)X(Q-1); we can determine ϕ(N) In number theory, Euler's totient function counts the positive integers up to a given integer n that are relatively prime to n. ... Euler's totient function is a multiplicative function, meaning that if two numbers m and n are relatively prime, then φ(mn) = φ(m)φ(n). (Wikipedia - https://en.wikipedia.org/wiki/Euler%27s_totient_function)
Therefore
ϕ(N)=ϕ(77)=(P-1)X(Q-1)=(11-1)X(7-1)=10X6=60 (Since P & Q are prime numbers) STEP 4 Next, we choose an Encryption Key (e) or the lock(also known as the public key) as illustrated above. e should be a prime number greater than 1 but less than ϕ(N), and the greatest common divisor, gcd(e, ϕ(N) ) = 1 this means e should be coprime to φ(N). In number theory, two integers a and b are said to be relatively prime, mutually prime, or coprime (also written co-prime) if the only positive integer (factor) that divides both of them is 1. ... This is equivalent to their greatest common divisor being 1. (Wikipedia - https://en.wikipedia.org/wiki/Coprime_integers)
The following numbers satisfy the condition 1 < e < ϕ(N) or 1 < e < 60, where e is a prime number.
2, 3, 5, 7, 11, 13, 17, 19, 23, 29, 31, 37, 41, 43, 47, 53, 59. In this case, let's choose 37 as e. Click on link below to use a tool to find out if gcd(e,ϕ(N)) or gcd(37,60)=1
Alternative, here's how to determine gcd
60 = 2 x 2 x 3 x 5 i.e. GCF(37,60) = 1 since there are no common prime factors. In another example 4 = 2 x 2 40 = 2 X 2 X 2 X 5 i.e. GCF(4,40) = 4 (2X2) Therefore the Encryption key (or the lock) is (37, 60). A hides P, Q and ϕ(N); and sends only (e, N) or (37, 60) to B. B has a message to send to A. B uses the Encryption key (or public key) to protect the message (Plaintext) to send to A. A uses a private key (Decryption key) to decrypt the Ciphertext back to Plaintext. The next step shows how the Decryption key is being derived. The Decryption key (d) is derived from and hence is related to the Encryption key (e)
STEP 5
Next, determine d, the Decryption key from the Encryption key (e), which is private to A. (Source - https://www.youtube.com/watch?v=fz1vxq5ts5I)
Since d X e ≅ 1 (mod N)
d X 37 ≅ 1 (mod 60) d ≅ 37^-1 (mod 60) 37^-1 (mod 60) = ??
First write down
LHS=60 and RHS=37; Determine the remainder to make LHS=RHS. Hence, 60 = 37 X 1 + 23 Bring 37 and 23 to the left; and repeat the same process above, until you get remainder =1 as shown below.
Once completed, move the numbers around for each line, until you get the following on the right.
Remember we started with:
d ≅ 37^1 (mod 60) 37^1 (mod 60) = ?? Therefore d = 8X60/37=13 Therefore the Encryption key (or the lock) is (37, 60). the Decryption key (or the private key) is (13, 60). Encryption and Decryption of the Message
Step 6
To summarise, we have the following: P=11 Q=7 N=11X7=77 ϕ(N)=ϕ(77)=60 e=37 d=13 Assume that B has a message to send to A. The Message, M=15 A sends B the lock (Encryption key): e=37, N=77; B performs the encryption using the following: M^e MOD N = C How MOD works?
Step 7
A receives C=71 from B. A performs the decryption using the following: C^e MOD N and get M=15
In actual Blockchain and Bitcoin implementation, P and Q are chosen to be very large numbers.
Resources
https://www.youtube.com/watch?v=O-4_oS3G7MI&t=271s&list=PLoNXVEI2Gdc8CnLo4ceaArsXVoLwWcbj0&index=3
Behold!
Mathematical literacy is not the most important skillsets to work in a bank these days. Thanks to technology and advancements in Fintech solutions that are disruptive to existing jobs and business models.
In an article by Anouk Vleugels dated 18 Sep 2017, "Robots will soon do your taxes and your bookkeeper is cool with that", the author presented four examples of solutions that could potentially replace jobs that are susceptible to automation. Occupations like bookkeepers, accounting and auditing clerks could be the most possible ones that are easily replaced.
These solutions include the use of artificial intelligence to either answer questions about possible tax deductions, automate manual and repetive tasks such as streamlining management processes or letting robots review a company’s expense reports.
In another article, "Future of Work: Death of the Accountant and Auditor" the author, Cesar Bacani presented an examination by University of Oxford academics Carl Benedikt Frey and Michael A. Osborne with regard to 702 occupations that are susceptible to computerisation. "The jobs that are at low risk of being replaced by automation include management analysts, compliance officers, marketing managers, sales managers and CEOs." Does the rise of Fintech firms in Asia have the potential to put an increasing number of banking professionals out of work leading to more job losses? After all, Fintech is about making financial services more efficient by increasing its reliance on technology and reducing its reliance on humans. Or will Fintech be actually creating jobs for the banking industry with better prospects? ‘Banks could lose up to 60pc of their retail profits to fintech firms’ Certain jobs being made redundant while new ones are being created
Despite the slowdown in financial sector growth to 0.7% from 5.7% in 2015, The Monetary Authority of Singapore (MAS) noted a net increase of 2,800 financial sector jobs in 2016 in its annual report last week.
The demand for professionals in the areas of finance include compliance, risk management, insurance underwriting, and asset and wealth management. As financial services industry continues to increasingly turn to cyber security, data analytics, network architecture, artificial intelligence, and machine learning to meet the needs in the new digital economy, there continues to be strong demand for expertise in these fields. More banks are pushing new frontiers by embracing and harnessing technology amid the digitisation wave and rise of FinTech, many new jobs, e.g. UX/UI designers, digital data analysts and app developers will be in high demand. Markus Gnirck, co-founder and global COO of Startupbootcamp. “First, jobs which focus on data and information and are mainly done by humans now; and second, jobs involving a lot of repetitive processes.” Embrace change or be engulfed
As Fintechs continue to strive to come up with solutions to poach banking customers and market share, banks are also preparing for the challenges that Fintech poses.
In a highly unpredictable, competitive and dynamic business environment today , workers need to continually upgrade skills to remain relevant. The need for continuous learning and adaptability have never been greater than it is now. Perhaps, no one sums it up better than Jack Ma in this interview with CNBC about Artificial Intelligence vs Human.
Resources
http://www.straitstimes.com/business/banking/singapore-finance-sector-sees-boom-in-tech-jobs-even-as-industry-growth-slows http://www.mas.gov.sg/News-and-Publications/Speeches-and-Monetary-Policy-Statements/Speeches/2017/MAS-Annual-Report-201617.aspx Impact of Fintech to the Banking Industry
The Fintech revolution is fast transforming the way how customers access financial products and services. With the increased use of smart phones and the development of mobile apps, Fintech managed to penetrate the market at an accelerating pace. New products and solutions offered by these Fintech firms have caused the financial sector to experience a good degree of change in recent years.
Just like how Amazon is disrupting the retail industry and Uber to the transportation equivalent, FinTech is gaining significant presence and causing disruption to the traditional banking industry. An April 2016 article "Fintech is Shaking up the Banking and Financial Services Industry in Singapore", listed the key Fintech ecosystems and their impact on traditional banks and financial services.
Leveraging on technology, Fintech solutions promise easy to use and provide new services at lower cost which banks cannot yet rival.
While banks are counteracting by investing heavily to compete in order to narrow the gap, many Fintech startups are simply willing to operate at a loss in order to gain market share. Challenges which Fintech Companies Face
Many Fintech companies are struggling to justify their high costs of existence. Apart from the cost of people, the relatively high cost of solution development and customer services are pushing Fintech firms to work on tighter budgets.
Besides focusing effort to develop core services and build products to improve the customer experience for financial services, more Fintech startups are struggling to stay on top of their operational costs
No matter how great an innovation is, it will not sell itself. As VC investment into Fintech slowed down, things are becoming tougher for Fintech startups.
As Fintech startups see a pullback in VC fundings, it is becoming more difficult for them to secure new fundings. As mentioned in my previous post, Can Fintech Startups Stay Profitable Without VCs, it is questionable whether Fintech firms are actually profitable. On top of that, most Fintech companies usually provide service-based financial solutions with arguably intangible offerings. Describing their potentials with a clear value proposition and little obfuscation then becomes even more difficult.
The Future of Fintech
So much has been mentioned about the death of banks as consumers are swarming towards Fintech products and services. Banking is transforming itself because of Fintech. The disruption is real. But to claim that banks are dying could just be an overstatement.
In all likelihood, every month you would see a new Fintech startup receiving huge fundings. For every successful one, there are even more Fintech startups struggling everyday just to stay in business. On the other hand, banks are trying their best to win back customer trust. To enable them to stay ahead of their immediate competition and thrive in this period of change, there is plenty of opportunity for traditional banks and Fintech to co-exist. Collaboration between Banks and Fintechs could well be the best way for banks and Fintech start-ups to succeed in this journey.
References
http://www.fintechbd.com/the-challenges-ahead/ https://www.seedrs.com/learn/blog/entrepreneurs/five-challenges-facing-fintech-startups-that-could-provide-big-opportunity https://www.bba.org.uk/news/bba-voice/what-is-the-long-term-impact-of-fintech-on-banking/#.Wb5llEqCzVp http://www.us.confirmation.com/blog/fintech-and-banking http://www.whitlockco.com/fintech-and-your-bank/ https://www.cio.com/article/3148756/leadership-management/the-fintech-effect-and-the-disruption-of-financial-services.html https://www.forbes.com/sites/nikolaikuznetsov/2017/04/07/collaboration-is-the-way-forward-for-banks-and-fintech/#68ecf6a26fdb
According to the EY FinTech adoption index – Germany Key findings, of the 623 responses, globally, only 1.8% cited trust as the key reason to choose FinTech services over a traditional institution.
Many Fintech solutions such as those based upon Blockchains infrastructure and Bitcoin payments have changed how customers access financial services and products. Consumers are being moved away from highly regulated financial services towards more decentralised systems. So does adopting this new Fintech ecosystem really poses no trust and security issues? Or consumers are just so bedazzled by the other aspects of Fintech such as ease of use and more attractive rates that trust and security issues are being neglected? Just this year, I received a SMS alert notice from a local bank informing me of a suspicious transaction of one my credit cards making a purchase online. The transaction, however, did not go through due to the missing credit card verification value. Can such frauds be similarly prevented in Fintech solutions such as Blockchain? Blockchain is the public ledger network which keeps track of the balances for all users and updates them as Bitcoins changes hands. In a decentralised system, consumers need to understand the importance of having greater control over security as no single entity is trusted to verify any form of transactions. This can be seen from the fall of the largest Bitcoin Exchange, Mt. Gox in 2014, which caused the lost of over 460 million dollars worth of Bitcoins, reportedly stolen by hackers. How safe then are Fintech solutions? Since the arrival of social media networking, you begin to realise that every time you engage in an online activity telling people where you are, or asking for recommendations around you, you give up some of your privacy such as your location. Similarly almost all Fintech solutions involve obtaining customer’s private data to generate useful financial insights. Customer's private data are also collected to better predict customers' needs and to provide better user experience. Can Fintech companies provide better customer experience and yet able to protect their customers against cyber threats? Fintech companies are increasingly gaining more control over their customers' financial information and data through the use of technology. To help Fintech companies better protect their stakeholders, more are adopting higher protection such as multi-factor authentication and One-Time-Passwords to minimise the overall risk.
With fast growing popularity of Fintech solutions, the financial services industries are well becoming a major target for cyber crimes. The challenge facing most fintech companies just like the other financial institution is how to keep the customer’s data secure. Fintech solution providers should focus more on risk management and making sure that Fintech business is secured enough to ensure safe banking and financial services are delivered.
Resources:
http://www.techbullion.com/safe-fintech-ecosystem-infrastructure-money-markets/ https://www.wired.com/2014/03/bitcoin-exchange/
In June 2016, Number26 (N26) issued standard account cancellation notices to several hundred customers based on what is known as a Fair-Use Policy. N26 is a Digital-only bank with a full banking license to operate in Europe.
In the email notices sent to their customers, N26 cited, amongst justifications such as suspicious activities, customers using their services too much as being the reason for their account closures.
In another article, "Here's the huge question facing fintech startups - can they make any money?", the author questions the profitability of these Fintech startups. Many startups charge low transaction fees or zero commission in their attempts to capture market size and increase revenue. Have Fintech companies such as N26 reached a point where the highly subsidised service fees can no longer sustain their business?
The business models of most Fintech startups are in collecting transaction and service fees, through payments, lending and investments, and/or commissions by referring customers to business partners.
Most Fintech startups, though offering new products and services over newer platforms such as the Internet and mobile apps, still incur transfer and debit costs just like the traditional financial services. Hence, if even bigger Fintech startups aren't making real profits, what can the other Fintech startups do to overcome challenges to stay profitable? Are these Fintech startups trying to grow as big as they can, and then later try to make money from the customers they have captured? Benoit Legrand, fintech head of Dutch bank ING, told BI earlier this year: "They’re flourishing everywhere but we’re still waiting for the business model to show up. Where is the money? Where is the return?"
In a heavily regulated banking industry, are Fintech startups able to lower costs and maintain profitability and growth? Otherwise, is it only VC money that's keeping some of the fundamentally flawed business models to carry on business as usual?
Most Fintech startups don't make real money. However, we need to ask ourselves, is profitability the sole purpose of all Fintech businesses? There are thousands of Fintech startups at various stages out there. So what do VCs look for in a Fintech startup company when it comes to potential investment? Some VCs only seek for startups with promised 100X returns, while others may look at startups with potential for significant growths. To stay profitable even without VC fundings, Fintech startups need the right business model. The million dollar question everyone is asking, is, "What is a right business model?" There is no doubt that the Fintech ecosystem will still continue to grow and cause disruption to the traditional banking and financial services. This disruption will be meaningful if it is able to make positive impacts, such as by bringing financial services to the un-bankables or delivering banking convenience to the communities that would otherwise be left out. However, when the reality of profitability sets in, the sustainability of such Fintech startups remains a question for all.
References:
http://uk.businessinsider.com/how-can-fintech-make-a-profit-number26-monese-2016-6/?IR=T http://www.businessinsider.com/fintech-profitability-report-2017-5/?IR=T https://techcrunch.com/2016/07/21/number26-is-now-a-true-bank-as-it-now-has-a-full-banking-license/ Blockchain is known to be one of the transformative technologies which has contributed towards the rise of FinTech in recent years. It is the underlying technology upon which the digital currency, Bitcoin, is based upon. Many have said that Blockchain is a disruptive technology and will define how money and payment operate in the new financial world. Numerous Fintech startups have built solutions based on Bitcoin in the area of peer-to-peer funding and mobile payments. Blockchain is more than just an enabler for new businesses and payment concepts; the true value and real opportunity lie in the data that can be extracted from the business transactions. Besides shaping the future in the financial services, it is perhaps worthy to look at how the blockchain technology, coupled with Data Analytics and Internet of Things (IOT), can help towards building Smarter Cities of tomorrow. For example, Smart Vending Machines could be installed with sensors to continuously monitor stock shortages. Once the stock level hits the minimum order quantity, the Smart Vending Machine triggers an order to the supplier using Smart Contract based on a Blockchain platform and automatically makes payment to the supplier via the digital wallet. Smart contracts enables us to create a binding legal agreement instantly, when a supplier meets the obligations at our pre-defined level of requirements. In addition, companies could use Blockchain technology to track the assets of the Vending Machines and the stocks they carry. Data analytics could be used to monitor the transactions to streamline marketing strategies. Suppliers could achieve great time savings by being able to reduce the number of trips made to every vending machine. Replenishment of stocks is required only when suppliers receives a “low-stock” notice directly from the Smart Vending Machines. Suppliers could benefit from Smart Vending Machines capable of making payment for the delivery of new items automatically using Smart Contracts and Bitcoins. Fully integrated data analytics solution could also be used to monitor the transactions. This will allow suppliers to extract insights at speed to dynamically understand real time supply and needs. Blockchain technology and Bitcoin affect not only the financial industry. It is up to the imagination of application developers to take the full advantage of the secured, peer-to-peer public ledger features of the blockchain technology, IoT and other technologies to make cities even smarter. What other case examples can you think of? Feel free to share your additions in the comments section below. Source
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