04-12-2021, 09:08 PM
*** 13-Apr-21 World View -- Investing in Decentralized Finance (DeFi) and Smart Contracts
This morning's key headlines from GenerationalDynamics.com
****
**** Investing in Decentralized Finance (DeFi) and Smart Contracts
****
![[Image: g210412b.jpg]](http://Media.GenerationalDynamics.com/ww2010/g210412b.jpg)
How Smart Contracts Work (Deccan Herald)
I've been asked about investing in the crypto-currency (Bitcoin)
related technologies, Decentralized Finance (DeFi) and Smart
Contracts, which use the same internet-based blockchain technology as
Bitcoin.
For over a decade, crypto currencies have been the highly stylish,
fashionable rock star finance technology, but lately they've been
losing their glamor and lustre as compared to a newer technology,
"decentralized finance" (DeFi) and "smart contracts."
It was just a few years ago that people were saying that the world was
just a stone's throw away from having a universal currency (Bitcoin)
that was independent of any nation. Last week, I read one analyst
saying, "We are a stone’s throw away from the global financial
industry running on a common software infrastructure." Well, that
stone would have to land something like 20-30 or more years in the
future, and if humans haven't figured out how to do it by then, then
perhaps our computer overlords will do it for us.
What's happening now is that there's an explosion of financial
applications and services, normally provided by banks, brokers, and
other financial institution, that are now being provided on blockchain
platforms as "smart contracts." There are really an unlimited number
of possible apps and services -- insurance, lending, borrowing, asset
management, gaming, day trading, savings, payments, billing, and so
forth. Smart contracts are "self-executing," meaning that once a
particular smart contract is set up, any action that would normally be
taken by a human intermediary in a bank or financial institution would
now be executed automatically by the smart contract.
Another way of looking at it is to compare a smart contract to
workflow software that has been around since the 90s. The software is
set up with a set of workflow rules, and the appropriate conditions
specified by the rules are satisfied, then the workflow software sends
out e-mail messages to the appropriate people, telling them to take
the appropriate action.
DeFi applications are more powerful because typically they have
control of crypto assets, so when the right conditions are met, the
app does not send out an e-mail saying "buy a new car." Instead, it
automatically issues the paperwork to buy a new car.
There are several ways to invest in DeFi technology. You can set up a
financial relationship with someone else using a smart contract. Or
you could invest in companies that develop these apps or offer
services using this technology.
The following web site provides a pretty extensive list of companies
offering such apps and services at the current time: https://defipulse.com/defi-list/
****
**** Automated processing on IBM mainframes in the 1960s
****
Although Decentralized Finance and Smart Contracts are a brand-new,
shiny technology, there are problems and dangers that can be learned
from history. Let's look at some historical examples.
Back in the 1960s, accounting systems were developed for IBM mainframe
systems, and they were only a stone's throw from never needing human
accountants again, according to experts.
The transaction processing systems used magnetic tapes. A typical
processing run required three tapes -- an input tape of existing
account records, an input tape of new transaction records, and an
output tape of updated account records. The two input tapes are
pre-sorted by account number so that they can be processed
simultaneously in order of account. It's therefore possibe to update
the accounts with only one pass through the transaction tape, writing
the updated accounts to the output tape, which would be the existing
accounts input tape for the next day's run.
So let's take a look at some of the issues. The most obvious one is
that the mainframe might be down, so that the transaction processing
run could not take place. Another issue is that mag tapes are
somewhat fragile, and data could be lost.
Another possible problem is that the transaction processing software
could have a bug, since all software has bugs. So if the bug affects
several thousand accounts, then it's possible that a single run could
result in several thousand errors caused by the bug, and they wouldn't
be caught until much later.
That's when people started saying things like, "To err is human. To
really screw things up takes a computer."
****
**** Intentional sabotage in automated processing
****
Another problem was intentional sabotage. The mag tape transaction
processing that I described was subject to a very interesting form of
sabotage.
Some transactions involve division of two numbers, and result in an
amount with a fraction of a penny. The correct algorithm would round
to the nearest penny, and the resulting amount would be used in the
transaction. But one developer did something different. His software
contained secret code that deducted the fractional penny from the
amount, and credited it to his own account. Tens of thousands of
fractions of a penny adds up to real money. He made a lot of money
that way, but the consequences of what he had done were not discovered
until much later.
The thing that makes this kind of sabotage possible is that managers
don't understand what the programmers are doing. There was a similar
problem with the financial crisis of the 2000s. The Gen-X financial
engineers got their Masters Degrees in the 1990s, and applied those
skills to create fraudulent synthetic securities based on subprime
mortgages. Their managers in the financial institutions had no idea
how they worked, except that they made lots of money, and the result
was the financial crisis. In the late 2000s I was working on a
government system where the lead programmer was sabotaging the code
(my code, in particular). I complained repeatedly to my boss, but he
refused to believe me. Eventually, the lead programmer screwed around
with someone else's code, someone really important, and my manager
apologized to me. This shows that the consequences of sabotage are
not usually discovered until much later.
Another example was the Obamacare website Healthcare.gov. President
Obama launched Obamacare on the afternoon of Oct 1, 2013, and he had
no idea that the web site wasn't even working. When he announced the
launch, he had no idea a disaster had unfolded several hours earlier.
As I wrote in my 2015 article, massive fraud had occurred among all
the consuting firms, and they propagated lies all the way up the
chain. The entire White House had no idea of the disaster until it
was too late. (See: "Healthcare.gov -- The greatest software development disaster in history")
So there was massive fraud in the development of Obamacare, which no
one cares about since caring about Obamacare fraud is politically
censored. Similarly, with tens of millions of mail-in ballots sent
out last year there was massive fraud in the 2020 election that no one
cares about, since caring about fraud in the 2020 election is
politically censored.
The reason for mentioning all this is that the DeFi technology will be
a huge target for sabotage and fraud, and the people benefiting from
the fraud may want it censored. This concern is being politically
censored because the major beneficiaries -- Silicon Valley, the
Chinese, the Democrats, hedge funds -- don't want it discussed.
****
**** Sabotage and fraud in DeFi and Smart Contracts
****
Blockchain technology has this magical, mystical reputation as being
incorruptible -- open source, "tamper-proof data," transparency,
permissionless access, etc. Obamacare had the same magical, mystical
reputation, and the amount of fraud was massive. The mainstream media
didn't want to see it, because it was censored. The housing bubble of
the early-mid 2000s was obvious (I was writing about it, Alan
Greenspan was talking about it), but mainstream media didn't want to
see it until 2009, when millions of people had lost their homes or
went bankrupt. The mainstream media don't want to see the massive
voter fraud in the 2020 election.
So there's no doubt that as DeFi grows, there will be lots of bugs and
plenty of fraud, sabotage and corruption. This will be done at
technical levels, and managers won't even know that it's going on
until there are severe consequences and it's too late. In particular,
it's absolutely certain that China's military is already developing
tools to hack into DeFi applications, to control them.
There's another issue that's analogous to the 1960s IBM mainframe
being unavailable, and this applies to all blockchain technologies:
There may be a crisis (flood, hurricane, Chinese sabotage, malware,
war), and the internet could become unavailable, or large numbers of
servers along the blockchain could be destroyed.
****
**** Due diligence in DeFi and Smart Contract investments
****
So you can invest in DeFi at any of several levels. You can invest in
companies developing core low-level technologies, or in companies
developing mid-level API platforms, or in companies developing the top
level apps that people and corporations actually use in their
business. Or, you could invest by using one of the apps for its
business relationships. The investment at any of these levels would
be subject to the same concerns that I've raised.
So how do you do due diligence on such an investment? I believe that
the biggest advantage of DeFi is also its biggest disadvantage and
biggest risk -- the "self-executing" feature of "smart contracts."
Here's the investopedia definition of Smart Contracts:
<QUOTE>A smart contract is a self-executing contract with the
terms of the agreement between buyer and seller being directly
written into lines of code. The code and the agreements contained
therein exist across a distributed, decentralized blockchain
network. The code controls the execution, and transactions are
trackable and irreversible.
Smart contracts permit trusted transactions and agreements to be
carried out among disparate, anonymous parties without the need
for a central authority, legal system, or external enforcement
mechanism.<END QUOTE>
In other words, a "smart contract" is just a software program. It will
also certainly contain bugs -- because all software programs contain
bugs -- and it will be subjected to sabotage, malware and hacking.
And since the whole point of smart contracts is that they're
"self-executing," without human involvement, and since management
won't understand what's going on anyway, the bugs and sabotage won't
be detected until a disaster has occurred.
Perhaps a good solution is to require "human oversight" of any smart
contract. That is, if a self-executing smart contrast tells you "kill
your mother or pay a large fine" (and this isn't as far-fetched as it
might seem, given my experience with software developers in the last
20 years), then there has to be a way for a human being on each side
of the smart contract to review the self-executing action, and
override it under the right circumstances.
This means that every party to a "smart contract" should have, as a
backup, a printout or a pdf of a written contract that can be
referenced if the internet goes down, or if there's a failure in or
sabotage of the smart contract.
Unfortunately, this will only work at a small scale. DeFi
applications are going to become larger and more complex, with a
single app consisting of hundreds or thousands of interlocking smart
contracts, and these will really be a disaster waiting to happen. But
they're coming anyway. Watch for the buzzword: DAO (distributed
autonomous organization), an entire business which is just a
collection of smart contracts.
Sources:
Related Articles:
KEYS: Generational Dynamics, Decentralized Finance, Defi, Smart Contracts,
blockchain, crypto-currency, bitcoin,
Obamacare, Healthcare.gov, distributed autonomous organization, DAO
Permanent web link to this article
Receive daily World View columns by e-mail
Contribute to Generational Dynamics via PayPal
John J. Xenakis
100 Memorial Drive Apt 8-13A
Cambridge, MA 02142
Phone: 617-864-0010
E-mail: john@GenerationalDynamics.com
Web site: http://www.GenerationalDynamics.com
Forum: http://www.gdxforum.com/forum
Subscribe to World View: http://generationaldynamics.com/subscribe
This morning's key headlines from GenerationalDynamics.com
- Investing in Decentralized Finance (DeFi) and Smart Contracts
- Automated processing on IBM mainframes in the 1960s
- Intentional sabotage in automated processing
- Sabotage and fraud in DeFi and Smart Contracts
- Due diligence in DeFi and Smart Contract investments
****
**** Investing in Decentralized Finance (DeFi) and Smart Contracts
****
How Smart Contracts Work (Deccan Herald)
I've been asked about investing in the crypto-currency (Bitcoin)
related technologies, Decentralized Finance (DeFi) and Smart
Contracts, which use the same internet-based blockchain technology as
Bitcoin.
For over a decade, crypto currencies have been the highly stylish,
fashionable rock star finance technology, but lately they've been
losing their glamor and lustre as compared to a newer technology,
"decentralized finance" (DeFi) and "smart contracts."
It was just a few years ago that people were saying that the world was
just a stone's throw away from having a universal currency (Bitcoin)
that was independent of any nation. Last week, I read one analyst
saying, "We are a stone’s throw away from the global financial
industry running on a common software infrastructure." Well, that
stone would have to land something like 20-30 or more years in the
future, and if humans haven't figured out how to do it by then, then
perhaps our computer overlords will do it for us.
What's happening now is that there's an explosion of financial
applications and services, normally provided by banks, brokers, and
other financial institution, that are now being provided on blockchain
platforms as "smart contracts." There are really an unlimited number
of possible apps and services -- insurance, lending, borrowing, asset
management, gaming, day trading, savings, payments, billing, and so
forth. Smart contracts are "self-executing," meaning that once a
particular smart contract is set up, any action that would normally be
taken by a human intermediary in a bank or financial institution would
now be executed automatically by the smart contract.
Another way of looking at it is to compare a smart contract to
workflow software that has been around since the 90s. The software is
set up with a set of workflow rules, and the appropriate conditions
specified by the rules are satisfied, then the workflow software sends
out e-mail messages to the appropriate people, telling them to take
the appropriate action.
DeFi applications are more powerful because typically they have
control of crypto assets, so when the right conditions are met, the
app does not send out an e-mail saying "buy a new car." Instead, it
automatically issues the paperwork to buy a new car.
There are several ways to invest in DeFi technology. You can set up a
financial relationship with someone else using a smart contract. Or
you could invest in companies that develop these apps or offer
services using this technology.
The following web site provides a pretty extensive list of companies
offering such apps and services at the current time: https://defipulse.com/defi-list/
****
**** Automated processing on IBM mainframes in the 1960s
****
Although Decentralized Finance and Smart Contracts are a brand-new,
shiny technology, there are problems and dangers that can be learned
from history. Let's look at some historical examples.
Back in the 1960s, accounting systems were developed for IBM mainframe
systems, and they were only a stone's throw from never needing human
accountants again, according to experts.
The transaction processing systems used magnetic tapes. A typical
processing run required three tapes -- an input tape of existing
account records, an input tape of new transaction records, and an
output tape of updated account records. The two input tapes are
pre-sorted by account number so that they can be processed
simultaneously in order of account. It's therefore possibe to update
the accounts with only one pass through the transaction tape, writing
the updated accounts to the output tape, which would be the existing
accounts input tape for the next day's run.
So let's take a look at some of the issues. The most obvious one is
that the mainframe might be down, so that the transaction processing
run could not take place. Another issue is that mag tapes are
somewhat fragile, and data could be lost.
Another possible problem is that the transaction processing software
could have a bug, since all software has bugs. So if the bug affects
several thousand accounts, then it's possible that a single run could
result in several thousand errors caused by the bug, and they wouldn't
be caught until much later.
That's when people started saying things like, "To err is human. To
really screw things up takes a computer."
****
**** Intentional sabotage in automated processing
****
Another problem was intentional sabotage. The mag tape transaction
processing that I described was subject to a very interesting form of
sabotage.
Some transactions involve division of two numbers, and result in an
amount with a fraction of a penny. The correct algorithm would round
to the nearest penny, and the resulting amount would be used in the
transaction. But one developer did something different. His software
contained secret code that deducted the fractional penny from the
amount, and credited it to his own account. Tens of thousands of
fractions of a penny adds up to real money. He made a lot of money
that way, but the consequences of what he had done were not discovered
until much later.
The thing that makes this kind of sabotage possible is that managers
don't understand what the programmers are doing. There was a similar
problem with the financial crisis of the 2000s. The Gen-X financial
engineers got their Masters Degrees in the 1990s, and applied those
skills to create fraudulent synthetic securities based on subprime
mortgages. Their managers in the financial institutions had no idea
how they worked, except that they made lots of money, and the result
was the financial crisis. In the late 2000s I was working on a
government system where the lead programmer was sabotaging the code
(my code, in particular). I complained repeatedly to my boss, but he
refused to believe me. Eventually, the lead programmer screwed around
with someone else's code, someone really important, and my manager
apologized to me. This shows that the consequences of sabotage are
not usually discovered until much later.
Another example was the Obamacare website Healthcare.gov. President
Obama launched Obamacare on the afternoon of Oct 1, 2013, and he had
no idea that the web site wasn't even working. When he announced the
launch, he had no idea a disaster had unfolded several hours earlier.
As I wrote in my 2015 article, massive fraud had occurred among all
the consuting firms, and they propagated lies all the way up the
chain. The entire White House had no idea of the disaster until it
was too late. (See: "Healthcare.gov -- The greatest software development disaster in history")
So there was massive fraud in the development of Obamacare, which no
one cares about since caring about Obamacare fraud is politically
censored. Similarly, with tens of millions of mail-in ballots sent
out last year there was massive fraud in the 2020 election that no one
cares about, since caring about fraud in the 2020 election is
politically censored.
The reason for mentioning all this is that the DeFi technology will be
a huge target for sabotage and fraud, and the people benefiting from
the fraud may want it censored. This concern is being politically
censored because the major beneficiaries -- Silicon Valley, the
Chinese, the Democrats, hedge funds -- don't want it discussed.
****
**** Sabotage and fraud in DeFi and Smart Contracts
****
Blockchain technology has this magical, mystical reputation as being
incorruptible -- open source, "tamper-proof data," transparency,
permissionless access, etc. Obamacare had the same magical, mystical
reputation, and the amount of fraud was massive. The mainstream media
didn't want to see it, because it was censored. The housing bubble of
the early-mid 2000s was obvious (I was writing about it, Alan
Greenspan was talking about it), but mainstream media didn't want to
see it until 2009, when millions of people had lost their homes or
went bankrupt. The mainstream media don't want to see the massive
voter fraud in the 2020 election.
So there's no doubt that as DeFi grows, there will be lots of bugs and
plenty of fraud, sabotage and corruption. This will be done at
technical levels, and managers won't even know that it's going on
until there are severe consequences and it's too late. In particular,
it's absolutely certain that China's military is already developing
tools to hack into DeFi applications, to control them.
There's another issue that's analogous to the 1960s IBM mainframe
being unavailable, and this applies to all blockchain technologies:
There may be a crisis (flood, hurricane, Chinese sabotage, malware,
war), and the internet could become unavailable, or large numbers of
servers along the blockchain could be destroyed.
****
**** Due diligence in DeFi and Smart Contract investments
****
So you can invest in DeFi at any of several levels. You can invest in
companies developing core low-level technologies, or in companies
developing mid-level API platforms, or in companies developing the top
level apps that people and corporations actually use in their
business. Or, you could invest by using one of the apps for its
business relationships. The investment at any of these levels would
be subject to the same concerns that I've raised.
So how do you do due diligence on such an investment? I believe that
the biggest advantage of DeFi is also its biggest disadvantage and
biggest risk -- the "self-executing" feature of "smart contracts."
Here's the investopedia definition of Smart Contracts:
<QUOTE>A smart contract is a self-executing contract with the
terms of the agreement between buyer and seller being directly
written into lines of code. The code and the agreements contained
therein exist across a distributed, decentralized blockchain
network. The code controls the execution, and transactions are
trackable and irreversible.
Smart contracts permit trusted transactions and agreements to be
carried out among disparate, anonymous parties without the need
for a central authority, legal system, or external enforcement
mechanism.<END QUOTE>
In other words, a "smart contract" is just a software program. It will
also certainly contain bugs -- because all software programs contain
bugs -- and it will be subjected to sabotage, malware and hacking.
And since the whole point of smart contracts is that they're
"self-executing," without human involvement, and since management
won't understand what's going on anyway, the bugs and sabotage won't
be detected until a disaster has occurred.
Perhaps a good solution is to require "human oversight" of any smart
contract. That is, if a self-executing smart contrast tells you "kill
your mother or pay a large fine" (and this isn't as far-fetched as it
might seem, given my experience with software developers in the last
20 years), then there has to be a way for a human being on each side
of the smart contract to review the self-executing action, and
override it under the right circumstances.
This means that every party to a "smart contract" should have, as a
backup, a printout or a pdf of a written contract that can be
referenced if the internet goes down, or if there's a failure in or
sabotage of the smart contract.
Unfortunately, this will only work at a small scale. DeFi
applications are going to become larger and more complex, with a
single app consisting of hundreds or thousands of interlocking smart
contracts, and these will really be a disaster waiting to happen. But
they're coming anyway. Watch for the buzzword: DAO (distributed
autonomous organization), an entire business which is just a
collection of smart contracts.
Sources:
- Smart Contracts (Investopedia, 25-Mar-2021)
- What is DeFi and why is it the hottest ticket in cryptocurrencies? (The Conversation, 26-Aug-2020)
- How to (not) make thousands of dollars with DeFi? (Alfa.Cash, 9-Sep-2020)
- Are Blockchain smart contracts all they touted to be? (Deccan Herald, 23-Oct-2019)
- What’s The Big Deal About DeFi And How Do You Invest In It? (Forbes, 21-Mar-2021)
- DeFi Update - The Future Of The Platform (Seeking Alpha, 4-Apr-2021)
- Compound Hits $15 Billion In Total Lending Value as DeFi Boom Continues (Decrypt.co, 6-Apr-2021)
- Blockchain for Decentralized Finance (DeFi) (Consensys)
- The DeFi List [1]The DeFi List Application (DefiPulse, 6-Apr-2021)
- App: Compound (DefiPulse/Compound, 6-Apr-2021)
- What are smart contracts on the blockchain? (Tallyfy, 10-Dec-2019)
Related Articles:
- Financial Crisis Inquiry hearings provide 'smoking gun' evidence of widespread criminal fraud (14-Apr-2010)
- How Priceline, Orbitz, FTD, 1-800-Flowers, Pizza Hut, and Continental Airlines are scamming you online (24-Nov-2009)
- Fraud and subversion in Healthcare.gov - the greatest IT disaster in history (23-Aug-2015)
- Healthcare.gov -- The greatest software development disaster in history (23-Aug-2015)
- For academics: Dysfunction, subversion, sabotage and fraud in software development projects (23-Aug-2015)
KEYS: Generational Dynamics, Decentralized Finance, Defi, Smart Contracts,
blockchain, crypto-currency, bitcoin,
Obamacare, Healthcare.gov, distributed autonomous organization, DAO
Permanent web link to this article
Receive daily World View columns by e-mail
Contribute to Generational Dynamics via PayPal
John J. Xenakis
100 Memorial Drive Apt 8-13A
Cambridge, MA 02142
Phone: 617-864-0010
E-mail: john@GenerationalDynamics.com
Web site: http://www.GenerationalDynamics.com
Forum: http://www.gdxforum.com/forum
Subscribe to World View: http://generationaldynamics.com/subscribe
