EDITOR
Amaya Vega
Lecturer in Economics
Department of Enterprise & Technology
School of Business, Galway-Mayo Institute of Technology
Amaya.Vega@gmit.ie
ASSOCIATE EDITORS
Trevor Clohessy & Eamon Walsh
Department of Enterprise & Technology
School of Business, Galway-Mayo Institute of Technology
Trevor.Clohessy@gmit.ie & Eamon.Walsh@gmit.ie
CREATIVE DESIGN
Laura McTigue
School of Business, Galway-Mayo Institute of Technology
Laura.mctigue@gmit.ie
HEAD OF SCHOOL OF BUSINESS
Dr. George Onofrei
School of Business, Galway-Mayo Institute of Technology
Graham.heaslip@gmit.ie
Contents
EDITORIAL 3
ARTICLES 4
No More Tragedy for the Commons? 4
Colin Callinan
The Development of Blockchain as a Solution to the Reduction in 11
Transactions Cost of Customer Verification within the Financial
Service Industry
Tony Fitzpatrick
Blockchain Credentials in Education 18
Tayfun Karabagli
A Literature Review on the Applicability of Blockchain Technology 27
for use in Real Estate Transactions
Enda McDonnell
The Economic Design on Consensus Incentive Methods 38
Iarla Molloy
Preventive Health Behaviour – A Blockchain Economy Review 52
Mafalda Santos
Cyber Laundering and its Economic Impact of Money Launderers 59
Renata Tenório Sorrentino
Editorial
Welcome to the first edition of Economics of Blockchain Student Research Paper Series.
This is a collection of the best research papers by students undertaking the Certificate
in Blockchain for Business at Galway-Mayo Institute of Technology.
The purpose of the publication is to showcase excellence in the research carried out by
students, as part of the fulfilment of the examination requirements of the module
Economics of Blockchain.
In this research paper series, students explore the economic implications of distributed
ledger technologies and blockchain applied to industry and public policy. All papers
included in this volume have been independently reviewed by experts in digital
technologies and blockchain, in collaboration with the editorial team.
The research presented covers a wide range of applications including core concepts in
blockchain economics, such as the consensus protocol, governance issues, agency and
incentives, technology adoption, and the economics of trust. This edition demonstrates
the breadth of student research interests in this area, and the depth of their discussion
of key economic issues associated with distributed ledger technologies and blockchain.
Each paper presents a literature review in the context of the various economic
approaches and concepts covered during the Programme.
Congratulations to the students for the high-quality research presented in this volume.
My thanks to Dr Trevor Clohessy, Eamon Walsh, Kevin Derrane and Laura McTigue for
their support in compiling this first edition.
Dr Amaya Vega
Colin Callinan: No More Tragedy for the Commons
4
No More Tragedy for the Commons?
Colin Callinan
Abstract: Blockchain has emerged in recent times as a potentially
revolutionary technology. Its’ proponents would have us believe that it will
(amongst other things), democratise the financial industry from the
outside, solve the problem of firms profiting from the exploitation of
personal data, alter supply chains irrevocably and change traditional
professional professions such as accountancy and law forever. While
there has been some excellent research emanating from academia and
the private sector in the form of case studies that address these, there has
been a paucity of research questioning the wider philosophical question
of what exactly is a blockchain. This literature review attempts to bring
together a portion of the research attempting to address this and focuses
on the idea of a blockchain as a new overarching governance structure in
the mould of the ‘commons’.
Keywords: Blockchain, Technology, Economics, Commons,
Governance
Colin Callinan: No More Tragedy for the Commons
1. Introduction
5
The increased presence of technology in everyday life and its’ ubiquitous nature
offers great opportunities to reshape the landscape of how citizens interact with
the state through modes of governance (Mulgan, 2005; Toress, et. al., 2005).
Another view of its’ ubiquity is its embedded nature in everyday commerce. A
somewhat overlooked avenue is that of the potential creation of new governance
structures (Ostrom, 2010; Davidson et. al.). This literature review sets out to fill
this gap in a minor fashion. It will do so by reviewing the historical view of the
‘commons’ as a governance structure first espoused by Garett Hardin. Elinor
Ostrom’s work on theorising the ‘commons’ will be examined. Following that,
the evolution from ‘Commons 1.0’ to ‘Commons 2.0’ will be traced with key
features examined such as open source technology, peer production, open
science and open innovation. Finally, the idea blockchain as ‘Commons 3.0’ will
be theorised.
2. Theoretical Background
In the following sections the theoretical background forming the basis of this
literature review will be elaborated.
2.1. The ‘commons’ theorised
Inspired by the work of Adam Smith, Hardins’ original formulation of the
‘commons’, took the overconsumption view of natural resources (Hardin, 1998).
He posited that, essentially, in a shared resource system, (e.g. a field for farming),
with individual users acting in their own self-interest, they do not act in the
common good and deplete the shared resources through collective action (Hardin,
1998). Following Hardin, in one of her many seminal works, Elinor Ostrom
developed a number of scientific studies of groundwater basins to provide a
“broader theory of institutional arrangements related to the effective governance
and management of common-pool resources” (Ostrom, 1990, p. xiv). At the
beginning of the book she lays out three differing models often used to provide a
basis for recommending state or market solutions. She then goes on to suggest
“theoretical and empirical alternatives to these models to begin to illustrate the
diversity of solutions that go beyond states and markets” (Ostrom, 1990, p. 2). As
she points out later in the book, these models are not wrong; rather they “are
special models that utilize extreme assumptions rather than general theories.
These models can successfully predict strategies and outcomes in fixed situations
approximating the initial conditions of the models, but they cannot predict
outcomes outside that range” (Ostrom, 1990, p. 183). Hardin’s and Ostrom’s work
has been commonly deemed ‘Commons 1.0’. The umbrella term is misleading
however; Hardin’s view emanated from a negative view of human behaviour
Colin Callinan: No More Tragedy for the Commons
6
while Ostrom’s demonstrated humanity’s capacity for common rules and
cooperation.
2.2. Evolving perspectives on the ‘commons’
As alluded to above, ‘Commons 1.0’ addressed the analytical requirement to
explain the economic and governance aspects of natural resources. In recent
times, the idea of ‘Commons 2.0’ has entered the zeitgeist; ‘Commons 2.0 has
developed over the past two decades by extending analysis to information and
knowledge commons, particularly digital commons, e.g. open source software,
peer production, open science, open innovation’ (Davidson et. al., 2016, p. 13).
Of the four examples cited in the above quote, open source software has been the
greatest success as a democratising artefact. Furthermore, contrary to popular
belief outside the technology industry, open source software has been a key driver
of innovation and profitability within the private sector, e.g. ‘The Open Source
Initiative (OSI) was founded in 1998 to support the new focus on technology
rather than ideology. This more pragmatic nature of the movement downplayed
some of the most ideological parts of the value system, but also contributed to a
wider diffusion of free and open source software’ (Bergquist et. al., 2011, p. 201).
Following that initiative, governments started to take notice and engage in a
process of adoption. Open source software ‘became attractive to public
authorities due to new demands and needs dictated by changes in their own
organizations and in society. Economically it was a way to cut costs in the public
sector and get value for taxpayer money’ (Bergquist et. al., 2011, p. 202). From a
philosophical viewpoint, it was seen as democratising process within the public
sector, freeing itself from the proprietary demands of the private sector (Bergquist
et. al., 2011).
Commons based peer production has become increasingly popular for knowledge
based endeavours with Wikipedia offering the most well-known example;
‘Facilitated by the technical infrastructure of the Internet, the hallmark of this
socio-technical system is collaboration among large groups of individuals,
sometimes in the order of tens or even hundreds of thousands, who cooperate
effectively to provide information, knowledge or cultural goods without relying
on either market pricing or managerial hierarchies to coordinate their common
enterprise’ (Benkler and Nissenbaum, 2006, p.394).
Open science is a multi-faceted term that has come be known as ill defined.
Running the gamut from ‘the democratic right to access publicly funded
knowledge (e.g. Open Access to publications) or the demand for a better bridging
of the divide between research and society (e.g. citizen science) to the
development of freely available tools for collaboration (e.g. social media
platforms for scientists)’ (Fecher and Friesike, 2014, pp. 17-18). There tends to
be five core schools of thought involved in the idea of open science. The
infrastructure school attempts to create openly available tools, platforms and
services for scientists. The public school tries to make science accessible for
citizens. The measurement school looks to develop an alternative metric system
Colin Callinan: No More Tragedy for the Commons
7
for scientific impact. The democratic school is concerned with making knowledge
freely available for everyone. Finally, the pragmatic school wants to make the
process of knowledge creation more efficient and goal orientated. (Fecher and
Friesike, 2014).
Open innovation as a phenomenon has sought to challenge the underlying theory
and structures of traditional business strategy. Most traditional business strategies
have been characterised at defensive in nature. These strategies have acted as a
bulwark against the forces of competition that may threaten the power and
profitability of the firm. However, in recent times ‘firms and even whole
industries, such as the software industry, are experimenting with novel business
models based on harnessing collective creativity through open innovation
(Chesbrough and Appleyard, 2007, p. 57). Open innovation can be viewed as a
subdivision of a larger overarching structure. One perspective is the outside-in
process where the company’s own knowledge is enriched ‘through the integration
of suppliers, customers, and external knowledge sourcing’ (Enkel et. al., 2009, p.
312). The second perspective is that of the inside-out process whereby profits are
generated ‘by bringing ideas to market, selling IP, and multiplying technology by
transferring ideas to the outside environment’ (Enkel et. al., 2009, p. 312). The
final perspective is that of the coupled process enabling ‘co-creation with
(mainly) complementary partners through alliances, cooperation, and joint
ventures during which give and take are crucial for success’ (Enkel et. al., 2009,
p. 313).
2.3. Blockchain as ‘Commons 3.0’
The binary choice between market and state often presented by politicians,
economists and ideologues can be unhelpful when applied to new economic and
technological phenomena such as blockchain. The challenges of group
cooperation in joint production and/or shared resources has been examined
extensively as discussed above. Elinor Ostrom has previously written that the
people she has studied ‘have complex motivational structures and establish
diverse private-for-profit, governmental, and community institutional
arrangements that operate at multiple scales to generate productive and
innovative as well as destructive and perverse outcomes’ (Ostrom, 2010, p. 641).
How can we as a species square these competing circles? Is it possible to create
new governance structures that satisfies competing interests such as private-forprofit, group cooperation and production, democratic and just governance and
polycentricity? With blockchain, are we witnessing the next evolution of the
‘commons’? Davidson et. al., (2016) posits that this may be feasible stating that;
‘A blockchain is a trustless commons in which effective rules are embedded in
constitutional smart contracts that are cryptographically secure and cryptoeconomically implemented’ (Davidson et. al., 2016, p. 13). The decentralised
consensus mechanism inherent to the design of blockchains may prove to be the
defining factor in enabling the creation of a new commons. As Clohessy (2019)
makes clear, the elimination of a central authority/broker with innovative
consensus protocols can lead to disintermediation and the creation of new power
structures.
Colin Callinan: No More Tragedy for the Commons
3. Methodology
8
The fundamental problem facing researchers of widely used terminology such as
economics, commons, blockchain or technology is that of the vastness of the
literature on these subjects. To address this, the authors employed a systematic
literature review to cope with the unbounded and ever-growing number of papers
published in this area. Fortunately, there exists a number of seminal articles that
offer different guidelines and approaches on how to operationalize a systematic
literature review (Webster and Watson 2002; Boell and Cecez-Kecmanovic,
2015; Vom Brocke et al., 2015; Watson, 2015). The value of conducting a
systematic review is laid out clearly by Boell and Cecez-Kecmanovic (2015, p.
162); “The distinct feature of SLR is a protocol that prescribes how to identify,
select, assess and synthesize evidence from the literature. By adhering to such a
protocol, SLRs, it is claimed, provide a ‘standardized method’ for literature
reviews that is replicable, transparent, objective, unbiased and rigorous”. The
first step involves selecting keywords and search terms. For this review, I selected
the following keywords and strings: economics AND commons, blockchain AND
technology. Given the multidisciplinary nature of the topics under examination,
the keywords were entered into renowned academic database such as Web of
Science. The database was searched for citations from 1960 to present, while
limiting the search of the keywords to titles only. Unsurprisingly, given the
generic nature of the terminology the process resulted in the retrieval in a large
amount of citations numbering 1135. The titles were then analysed against predetermined inclusion and exclusion criteria resulting in 76 citations. Where there
was any ambiguity pertaining to the papers title, the abstract was examined to
determine the relevance of the study. Duplicate citations and book reviews were
further excluded. Further articles were excluded based on relevance and the scope
of this paper. At this point, the author would like to acknowledge the
methodological limitation of analysing only the titles. However, this approach
was pursued owing to the generic terminology producing an inordinate number
of results. Furthermore, others have followed this approach when dealing with a
massive amount of citations (Pittaway et al., 2004).
4. Conclusion
What society is faced with is an interesting puzzle – is blockchain a new piece of
technology, an evolution of, or a radical departure from, governance structures, a
new form of economic organisation or all of the above? Clearly, much more
interdisciplinary research must be conducted. It is certainly interesting to ponder.
Most people, with some justification, will view blockchain as purely a
technological utility. That is to say, its core uses will be functional, i.e. tracking
food and pharmaceuticals along a global supply chain or programming smart
contracts for the purposes of house buying for example. Of course, this functional
utility is not something to be dismissed lightly, the revolutionary potential to
upend the financial system and change the nature of currency and international
payments is important. It must be stated though, that while these will drive
efficiencies and create new wealth, they do not offer the potential to change the
Colin Callinan: No More Tragedy for the Commons
9
way we live. Blockchain viewed as a new form of economic organisation or a
new way to govern has to potential to change the way we live, whether it be the
organisational relationship between the citizen and the state or how we
collectively manage shared diminishing resources.
References
Benkler, Y. and Nissenbaum, H., 2006. Commons-based peer production and
virtue. Journal of political philosophy, 14(4).
Bergquist, M., Ljungberg, J. and Rolandsson, B., 2011, October. A historical
account of the value of free and open source software: From software commune
to commercial commons. In IFIP International Conference on Open Source
Systems. Springer, Berlin, Heidelberg, pp.196-207.
Boell, S.K. and Cecez-Kecmanovic, D., 2015. On being ‘systematic’ in literature
reviews. In Formulating research methods for information systems (pp. 48-78).
Palgrave Macmillan, London.
Chesbrough, H.W. and Appleyard, M.M., 2007. Open innovation and
strategy. California management review, 50(1), pp.57-76.
Clohessy, T. 2019. Blockchain: The Business Perspective. NovoRay Publishers.
Davidson, S., de Filippi, P. and Potts, J., 2016, May. Economics of Blockchain.
In Public Choice Conference.
Dellarocas, C., 2006. Reputation mechanisms. Handbook on Economics and
Information Systems, pp.629-660.
Enkel, E., Gassmann, O. and Chesbrough, H., 2009. Open R&D and open
innovation: exploring the phenomenon. R&d Management, 39(4), pp.311-316.
Fecher, B. and Friesike, S., 2014. Open science: one term, five schools of thought.
In Opening science (pp. 17-47). Springer, Cham.
Hardin,
G.,
1998.
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tragedy
of
the
commons”. Science, 280(5364), pp.682-683.
Mulgan, G., 2005. Reshaping the State and its Relationship with Citizens: The
Short, Medium and Long-term Potential of ICT’s. The Network Society From
Knowledge to Policy, p.225.
Ostrom, E., 2005 Understanding Institutional
Diversity. Princeton: Princeton University Press.
Ostrom, E. (2010) ‘Beyond markets and states: polycentric governance of
complex economic systems.’ The American Economic Review, pp. 641–672.
Ostrom, E. and C. Hess., 2006. A Framework for Analyzing the Knowledge
Commons. In Understanding Knowledge as a Commons: from Theory to
Practice. eds. Hess, C. and E. Ostrom, Cheltenham: Edward Elgar, pp.41–82.
Ostrom, E., Walker, J., Gardner, R, 1992. ‘Covenants with and without a sword:
Self-Governance is possible’ American Political Science Review, 86(2), 40417.
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Ostrom, Elinor., 1990. Governing the Commons. The Evolution of Institutions
for Collective Action. New York: Cambridge University Press.
Pittaway, L., Robertson, M., Munir, K., Denyer, D. and Neely, A., 2004.
Networking and innovation: a systematic review of the evidence. International
journal of management reviews, 5(3‐4), pp.137-168.
Toress, L., Pina, V. and Acerete, B., 2005. e-Governance developments in EU
cities: reshaping government relationship with citizens.
Vom Brocke, J., Simons, A., Riemer, K., Niehaves, B., Plattfaut, R. and Cleven,
A., 2015. Standing on the shoulders of giants: Challenges and recommendations
of literature search in information systems research. Communications of the
association for information systems, 37(1), p.9.
Watson, R.T., 2015. Beyond being systematic in literature reviews in IS. Journal
of Information Technology, 30(2), pp.185-187.
Webster, J. and Watson, R.T., 2002. Analysing the past to prepare for the future:
Writing a literature review. MIS quarterly, pp. xiii-xxiii.
Yli-Huumo, J., Ko, D., Choi, S., Park, S. and Smolander, K., 2016. Where is
current research on blockchain technology? — a systematic review. PloS
one, 11(10), p.e0163477.
Tony Fitzpatrick: The Development of Blockchain as a Solution to the Reduction in Transactional Costs of
Customer Verification within the Financial Services Industry
11
The Development of Blockchain as a Solution to the Reduction in
Transaction Costs of Customer Verification within the Financial
Services Industry
Tony Fitzpatrick
Abstract: Blockchain has emerged as a credible solution to deliver a
universal store of digital identities that is accessible to all financial
institutions. The timeline of the development of this solution began with
the emergence of crypto currencies where regulators dismissed the
technology as a phase and unworthy of their consideration. Since those
early days the potential of a Blockchain solution to AML verification has
gained credibility and support from mainstream business and more
recently regulators. This literature Review looks at how Blockchain
emerged as a solution to reduce AML verification transaction costs and
the chronology of this development from establishing the scale of the
problem, proposed solutions, official support for Blockchain and finally
implementation.
Keywords:
Costs
Blockchain, Digital Identities, AML Verification, Transaction
Tony Fitzpatrick: The Development of Blockchain as a Solution to the Reduction in Transactional Costs of
Customer Verification within the Financial Services Industry
12
1. Introduction
Following the Global Financial Crisis of 2007/2008 and the growth of electronic
payments regulators have cracked down on financial institutions with
unprecedented force and lawmakers have introduced thousands of new
regulations around the globe. It is estimated that in 2015 alone 50,000 regulatory
updates were made.
According to International Banker (2018), banks spend $270 billion per year on
compliance. Some 10 percent or more of most bank operating costs can be
attributed to compliance, and some estimates have regulatory costs doubling by
2022.
Going forward, banks must develop strategies that cut costs and improve the
economics of compliance, but still allow them to maintain robust compliance
programs. To do this, they are increasingly turning to artificial intelligence, big
data, biometrics and analytics technologies to support the ongoing development
and deployment of their compliance programs.
2. Anti-Money Laundering, Client Onboarding and Fraud Prevention
To start with, Anti-Money Laundering (AML) and Know Your Customer (KYC)
regulations for client onboarding are the obvious choice when we talk about use
cases for blockchain application in RegTech. Numerous companies try to tackle
this area and the reason is simple: All financial institutions need to collect their
own data on potential clients before they can start doing business with them. In
addition, this data needs to be updated regularly for existing counterparties.
Needless to say, that this very time consuming and expensive with regard to both
human resources and money spent. The perfect solution would see a universal
ledger all banks could use to identify their customers and monitor transactions.
However, that is difficult to achieve given the international nature of financial
services which would necessitate a single global ledger with the verified identity
of every person on the planet that holds an account with a financial institution.
That would include banks but also transactions such as buying a sofa on credit
over three years. This is an obvious contender for a Blockchain solution.
3. The Scale of the Problem
While these issues have been around for some time it was only a few years ago
they began to gather momentum. Harrop (2017) found that based off Thomas
Reuters annual benchmarking survey carried out to assess the impact of AML
verification on financial institutions. This report effectively set out the scale of
the problem. Most notable was the fact that AML verification was by far the
biggest regulatory issue facing financial institutions. The larger financial
institutions spending €150m per year and employing 300 staff just to carry out
the AML verification process and deliver results that are barely compliant with
regulations (Harrop, 2017).
Tony Fitzpatrick: The Development of Blockchain as a Solution to the Reduction in Transactional Costs of
Customer Verification within the Financial Services Industry
13
Moser et al. (2018) examined the opportunities and limitations of anti-money
laundering (AML) in crypto currencies. While Moser looked at the overall issue
of fraud and its prevention within cryptocurrencies the issue, I was interested in
was how it could relate to today’s regulation, digital identity and addressing the
issues of AML verification.
Moser et al. (2018) conclusion on this point was that as Bitcoin and
cryptocurrency accounts have weak identities at best, but all transaction records
are public, for AML to be effective, it should blacklist transaction histories rather
than accounts or account holders. This means that it is OK for a known fraudster
to hold an account it’s just not OK for that fraudster to transact on that account.
This is a very different approach to regulation which traditionally tried to keep
fraudsters and criminals out of the financial system altogether. With such a radical
solution being proposed it is easy to see why regulators around the world were
not engaging in this space. They also had little understanding of the Blockchain
technology underpinning cryptocurrencies (Moser et al., 2018).
4. Proposed Solutions
In January 2020 things began to gain momentum with the publication by Kumar
et al. (2020) called “A Blockchain Based Approach For An Efficient Secure KYC
Process With Data Sovereignty”. Kumar et al. (2020) set out a fully worked
solution to digital identity which is central to AML verification. AML verification
being the task at the centre of the KYC process.
This paper proposed a blockchain based approach to decentralise the storage of
personal data and remove the need to trust a third party. Additionally, their
proposed solution focused on the problem of data ownership which they solved
by storing it in an encrypted format which can only be decrypted by the user. In
their implementation, the user has their PII (Personally Identifiable Information)
on a QR code in an encrypted format, ensuring two-layer security of data. The
banks only have access to the data when the customer explicitly gives it to them.
Consequently, implementing the proposed system along with the coordination
between the banks, the regulator and other stakeholders will ensure an enhanced
user experience and save costs for the service providers (Kumar at al., 2020).
Kumar at al. (2020) covered all the angles and addressed considerations of all
parties meaning for the first time Regulator and financial institutions had a
window into what could be possible. They have moved the discussion from
bonkers ideas to credible ones and made the whole idea of a digital solution a
serious business.
There were numerous other papers published either with the authors own digital
solutions or elaborating on the work of Kumar at al. (2020). One of these was by
Pachaiyappan and Kasturi (2018) that gave the requirements of a digital solution
but not a solution. This was in effect a template for others to work off in designing
their own digital solutions.
In 2018 the consultancy firm KPMG issued a research paper by Maguire and Chia
(2018) called: “Could blockchain truly be the key to a viable KYC utility, or is
Tony Fitzpatrick: The Development of Blockchain as a Solution to the Reduction in Transactional Costs of
Customer Verification within the Financial Services Industry
14
this a case of a technical solution in search of a problem?”
Here Maguire and Chia (2018) set out to consider the business case for a
blockchain-enabled AML utility for sharing information among the participating
financial institutions, while institutions continue to perform due diligence on
customer information obtained from the platform. KPMG in Singapore put
together a consortium of three banks and the Singaporean regulator to trial a
Blockchain prototype with the idea of demonstrating the effectiveness of the
utility’s functionality, security, and scalability. The result was an estimated cost
savings of 25–50 percent by reducing duplication and providing a clear audit trail
(Maguire and Chia, 2018).
KPMG backing the idea of Blockchain for AML was a huge step in altering the
acceptability of Blockchain as a credible AML solution. Up until now everything
about this solution was academic and theorical but KPMG moved the idea from
the world of academia to the business mainstream. This in turn opened up the
investor world to join the race to find a solution (Maguire and Chia, 2018).
5. Official approval towards a Blockchain solution
In 2019 the Bank for International Settlements which is owned by 60 central
banks, published a paper entitled “Embedded supervision: how to build regulation
into blockchain finance” (Auer, 2019). Here, Auer (2019) considers how current
financial market infrastructures might evolve to use distributed ledger
technology. And in turn, those distributed ledgers could enable automated
supervision. Focused mostly on the financial supervision of product transactions
the report suggested that the role of regulator may evolve to sanction a particular
Blockchain based financial product as acceptable where its embedded smart
contracts can act as a proxy for the regulator. In effect the regulator is delegating
supervision to the smart contract (Auer, 2019).
While this paper did not directly discuss a Blockchain solution to AML it laid
down a clear marker that the regulatory community was open to Blockchain as a
solution to many regulatory issues (Auer, 2019).
In March 2020 the Financial Action Task Force which is the global body who sets
the AML rules that all financial institutions must follow, issued a report on digital
identity (FATF, 2020). In this lengthy study it set out guidance as to technology
used to establish digital IDs. Top of the list was Distributed Ledgers. The report
also listed digital credentials, biometrics such as fingerprints, face and voice
recognition as technologies that would be acceptable for developers to include
(FATF, 2020).
This official guidance gave the RegTech industry something to aim at rather than
developing AML process in the dark that they hoped would make the grade. For
example, Revolut’s AML identification process used during new account opening
process is under challenge for its use of selfie photo used to compare with the
customers passport photo (FATF, 2020).
Tony Fitzpatrick: The Development of Blockchain as a Solution to the Reduction in Transactional Costs of
Customer Verification within the Financial Services Industry
15
Cunliffe and Cœuré (2020) from the Bank for International Settlements published
a report laying out some key requirements for central bank digital currencies, or
CBDCs.
Their report was supported by all the major global central banks and marked a
step up in the global central banks position on Blockchain and digital currencies.
It is now clear that the Central banks intend to take the lead in setting out the
ground rules for how new technologies will impact their industry rather than their
earlier elitist approach of dismissing the new technologies as a passing phase
(Cunliffe and Cœuré, 2020). Within the world of central banks, it is the Bank of
International Settlement and Financial Action Task Force that are driving this
momentum by setting out the framework, guidance and rules within which AML,
digital identity and digital currencies will develop.
Regtech companies now have a very clear framework within which to develop
their blockchain solutions and venture capitalist also can back developments for
which there will be a market (Cunliffe and Cœuré, 2020).
6. Implementation
In July 2020, the Central Bank of Sri Lanka announced that they were beginning
development a blockchain KYC platform to include AML (CoinDesk, 2020). The
blockchain based platform is planned to allow the sharing and updating of bank
customer data in real time. The key advantage comes from allowing banks to
onboard new customers without delays for manual processing, as well as save
costs associated with traditional paper-based methods of verifying documents.
This is a real-world solution of what Pachaiyappan and Kasturi (2018) set out in
their paper.
The Central bank of Sri Lanka finds itself in a unique position having been
blacklisted by the Financial Action Task Force in 2017 for AML deficiencies.
Since then, it has been taking steps to improve its financial sector and meet
international standards and was removed from the blacklist in 2019 (CoinDesk,
2020). Delivering a fully compliant blockchain based AML platform would
restore credibility to Sir Lanks’s financial sector so they will make every effort to
get it right (CoinDesk, 2020).
7. Conclusion
The financial industry has now come full circle in its pursuit of a solution to the
labour intensive, inefficient and costly AML process. The interesting thing to
observe was the change in attitudes towards blockchain as an obvious solution.
Initially the vested interests who had controlled the financial services industry for
centuries felt safe in their ivory towers until the speed of developments dawned
on them and they decided to take a leading role.
The speed of developments was also dramatic. Given the prize at stake it’s
probably not surprising. However, from Pachaiyappan and Kasturi (2018)
theoretical solution to Kumar et al. (2020) fully worked out blueprint followed
Tony Fitzpatrick: The Development of Blockchain as a Solution to the Reduction in Transactional Costs of
Customer Verification within the Financial Services Industry
16
quickly by a framework from the Bank of International Settlement setting out
acceptable technologies and guidance from the Financial Action Task Force of
what they would accept to replace a passport and utility bill all parties are very
much on board and all are driving development forward. Time will tell how
successful the Central Bank of Sri Lanka’s AML Platform will be, but all the
elements are now in place for a comprehensive blockchain solution to AML to
emerge.
References
Auer, R., 2019. Embedded Supervision: How to Build Regulation into
Blockchain Finance. Federal Reserve Bank of Dallas, Globalization Institute
Working Papers, 2019(371).
CoinDesk. 2020. Sri Lanka's Blockchain Bank KYC Platform to Enter
Development 'Shortly': Central Bank - CoinDesk. [online] Available at:
https://www.coindesk.com/sri-lankas-blockchain-bank-kyc-platform-to-enterdevelopment-shortly-central-bank [Accessed 30 October 2020].
Cunliffe, J. and Cœuré, B., 2019. Central bank digital currencies: foundational
principles and core features. [online] BIS. Available at:
https://www.bis.org/publ/othp33_summary.pdf [Accessed 2 November 2020].
FATF. 2020. Digital Identity. [online] Available at: https://www.fatfgafi.org/media/fatf/documents/recommendations/Guidance-on-DigitalIdentity.pdf [Accessed 1 November 2020].
Harrop, M., 2017. Thomson Reuters Global KYC Surveys Attest to Even
Greater Compliance Pain Points. [online] Thomsonreuters.com. Available at:
https://www.thomsonreuters.com/en/press-releases/2017/october/thomsonreuters-2017-global-kyc-surveys-attest-to-even-greater-compliance-painpoints.html [Accessed 30 Oct 2020].
International Banker. 2018. The Cost of Compliance. [online] Available at:
https://internationalbanker.com/technology/the-cost-of-compliance/ [Accessed
30 Oct 2020].
Pachaiyappan, V. and Kasturi, R., 2020. Block Chain Technology (DLT
Technique) for KYC in FinTech. International Journal of Pure and Applied
Mathematics, 119(10).
Tony Fitzpatrick: The Development of Blockchain as a Solution to the Reduction in Transactional Costs of
Customer Verification within the Financial Services Industry
17
Kumar, Manoj & Yadav, Nikhil., 2020. A Blockchain Based Approach For An
Efficient Secure KYC Process With Data Sovereignty.
Maguire, E. and Chia, T., 2018. Could blockchain be the foundation of a viable
KYC utility?. [online] KPMG. Available at:
<https://assets.kpmg/content/dam/kpmg/xx/pdf/2018/03/kpmg-blockchain-kycutility.pdf> [Accessed 04 Nov 2020].
Moser, M., Bohme, R. and Breuker, D., 2013. An inquiry into money
laundering tools in the Bitcoin ecosystem. 2013 APWG eCrime Researchers
Summit.
Tayfun Karabagli: Blockchain Credentials in Education
18
Blockchain Credentials in Education
Tayfun Karabagli
Abstract: Blockchain technology gives unique possibilities to educational
institutions to issue certificates and badges. These certificates are tamper
free, authentic, verifiable and accessible from everywhere. These have
been in paper format in the past and were costly. In the recent years there
are several organisations which gives the educational institutions and
companies the possibility to issue the certifications and badges in digital
form on a central databases. Digital certifications on these platforms help
the issuers reduce the costs. However, these digital certifications are
flawed. Blockchain certifications are tamper resistant, secure, immutable
and provides the institutions and organisations with a robust long term
solution. This literature review gives detailed information regarding
blockchain certifications, it outlines experts viewpoints and points out
further research to be done.
Keywords: Blockchain, Credentials, Badges, Certification, Education
Tayfun Karabagli: Blockchain Credentials in Education
19
1. Introduction
For centuries certifications, diplomas or other merit based documents were
issued in paper. With the advent of the Internet a wave of digital transformation
commenced. Companies and organisations adapted their business models and
became more active on this technology medium. In recent years the universities
and educational organizations gradually started to offer part of their curriculum
online under the name distance learning.
Distance learning has triggered the issuing of online certification or digital
credentials. Mozilla Foundation started in 2011 the initiative “Open Badges”
standard to give a specification to the digital credentials. Online organizations
like Credly.com, YourAcclaim.com, Badgr.com and Credential.com started to
assist educational organizations to issue certifications on their digital platforms.
These platforms ran on central databases with CRUD based systems. Ownership
and control of credentials were in the hands of these online organizations.
Blockchain technology is a distributed ledger technology and the information
changes are recorded on blocks by nodes. This information is across the network
and every participant has a copy of the ledger. When issuing a certification in
blockchain it provides several advantages to the issuer and holder. It is secure,
digital, tamper-free and accessible everywhere at any time.
This literature review pays attention to the “Digital Credentials”. The reader
will find information about digital and blockchain credentials platforms. This is
followed by a selected literature about blockchain credentials and a brief
summary about each research project is outlined. In the third section, the
research papers will be compared and the similarities/ differences will become
clear. The fourth section is dedicated to research gaps followed by the
conclusion.
2. Digital Credentials
Paper diplomas and certifications are the oldest form of validated papers. This
custom started with the advent of the first universities and schools. A diploma
or certificate is so called a value document. Paper diplomas has some protection
against counterfeit practices. Most of the paper diplomas has micro text, a logo
of the issuing organization, a silver foil strip, a cut-out monogram and a
protected watermark. On a paper diploma there is a unique paper number in
laser perforation. These measures are taken to improve the authenticity (Fontys,
2020). However, that does not prevent third parties such as large number of
universities FROM issuing fake diplomas. Fake diplomas has a damaging effect
on institutions, employers and society (Ezell and Bear, 2012).
Digital badges are a web-enabled version of certifications. These can be
obtained as a learning outcome and it can be verified in real time on a public
Tayfun Karabagli: Blockchain Credentials in Education
20
accessible website. Digital badges and certifications confirm professional skill
achievement through completed learning projects. Digital credentials are also
referred to as digital badges and it contains a small image or logo. The holder
of the badge could share this online through social media platforms such as
LinkedIn. If a person clicks on this image, they will be directed to the platform
where the badge is issued. On the page of the badge the necessary skills can be
viewed that need to be achieved (‘Digital Credential & Badge FAQs |
VDCI.edu’, n.d.). The popular digital badge platforms are credly.com,
youracclaim.com, credential.net and badgr.com
Open badges is the leading format for the digital badges and certifications. This
standard determines the type of digital badges that are issued to the holder. Open
badges must contain certain digital packaging information about the
accomplishment: portable image file of the badge, resources for web validation
and verification, issuer, holder, the criteria to earn the badge, and relevant skills.
Current Open Badge protocol is now 2.1. The current version has endorsement
features, multi-lingual capabilities, JSON-LD and API connection features
(IMS Global, 2020). Among the providers of certified products with Open
Badge protocol are Moodle, Hyland Credentials, Badgr, BC Diploma and Open
Badge factory (IMS Global, 2019).
Blockchain based credentials is a new type of digital credentials and are issued
as follows. The issuer creates the cryptographic hash of the document which
contains the student’s name, degree name, issuer name and issue date. The
institution signs it with its private key and the signature is appended to the
certificate. The private key is used again to create a record on the blockchain.
When the blockchain transfer is completed, the certification is registered and
shared among all the nodes in the network. It is digitally accessible from the
public blockchain and it cannot be tampered with. University of Nicosia’s
project Block.co is one of the first blockchain certification providers in the
world (UNIC, 2020). Another blockchain certification issuer is Hyland
Credentials. It uses open standard from MIT Media Lab for blockchain
certificates (Blockcerts, 2020.
3. Literature Analysis
Blockchain technology can provide a solution for the educational institutions,
companies and individual which are exposed to credential fraud. In this section
selected papers are analyzed, briefly summarized, synthesized and the main
thoughts presented.
Saleh et al. (2020) review the types of fake certifications and find that fraud
happens at alarming proportions. Blockchain technology is the solution that
appears in the paper that can prevent the falsification of certifications. The
authors believe that security is a very important theme for certifications in
education. Authentication, authorization, confidentiality, ownership and privacy
Tayfun Karabagli: Blockchain Credentials in Education
21
must be part of the system when issuing certifications on blockchain. In the
same paper the authors analyze in depth the existing blockchain certification
platforms (UNIC, MIT Labs, Blockcerts, Smartcerts or RecordKeeper) and
stipulate their vulnerabilities or limited functionality. The paper proposes an
alternative solution to fill this gap on a permissioned blockchain. This shows
that the current blockchain solutions for certifications according the authors are
still in infancy (Saleh et al., 2020).
Arenas and Fernandes (2018) provide examples of falsified diplomas and show
how individuals are able to fulfil important positions under false pretenses. The
authors see a big opportunity for blockchain as it can be implemented as a
transparent and trusted system which can be used for sharing, securing and
verifying educational credentials. In addition to this, the blockchain platform
gives the employers the possibility to complete diploma verification. The paper
compares paper based records vs digital academic records, central databases vs
blockchain and permissionless vs permissioned blockchains. The authors
believe that the existing solutions (Blockcerts, OpenCertificate, Gradbase,
Stampery and Credence) are challenged by issues around storage, open to
everyone, scalability and has a longer chain. The alternative solution is an
opensource permissioned blockchain (Arenas and Fernandez, 2018).
Gresch et al. (2019) sees that the current systems on issuing diplomas are not
effective and unable to meet the expectation demanded by the labor market.
Fake diplomas issued by Degree Mills is a huge challenge that needs to be
overcome and the educational organisations are still attracted by paper based
degree as it is very lucrative. Authors argue that digital certifications are stored
in central databases and these databases have many drawbacks. Blockchain
technology is the proposed solution, because it provides a tamper-resistant
option for degrees. Authors mention the digital platforms Badgr, Mozilla Open
Badges and grouped them as a non-blockchain solution. Blockchain based
platforms such as BcDiploma, MIT labs, Blockcerts, EduCTX and UNIC are
from a cost perspective not ideal, with no automation functionality, accessible
to everyone and private key retrieval is a big issue. The authors come with a
smart contract solution on public blockchain where documents can be stored
(Gresch et al., 2019).
Brunner at al. (2019) is critical about the current certification systems. Most of
the systems which issues certifications are paper based credentials. The authors
find some issues with paper certifications. They argue that paper documents
could be falsified, difficult to verify and there is a risk of being lost. If it needs
to be reissued or verified by the employers, it is an intensive and time consuming
job. The papers see the centralized system where digital credentials are issued,
is problematic and unreliable. In those systems the verification procedure is not
easy and when documents are lost, the recovery might be a problem. The authors
argue for blockchain as a solution, analyses the existing blockchain solutions
for digital credentials (MIT Media Labs, UNIC, Blockcerts and Life Long
Learning Platform) and find limitations in functionality such as completeness
Tayfun Karabagli: Blockchain Credentials in Education
22
(no linked courses to the digital certification or verification in bulk. The
alternative solution from the authors is a public blockchain based solution with
verified issuer identity (Brunner et al., 2019).
Tariq et al. (2019) acknowledge that falsification and fraud in educational
credentials is widespread in the education sector and it is a big market. The
practices in this field damage the reputation, credibility of education and
reputation of educational institutions. The authors argue that falsification
happens in the following forms: intuitional fraud, Diploma Mills, accreditation
fraud and document fraud. The existing credentials verification solutions
according to the authors does not prevent the falsification because it is not
transparent, time consuming and very costly. Blockchain technology is seen as
a solution which can fulfil this gap and can be an extension to paper-based
diplomas. In the paper, the blockchain certification systems (UNIC, Blockcerts,
Hypercerts, Echo, UZHBC, EduCtx and Blockchain for Education) are
compared. The authors note that these solutions are missing the features such as
revocation, scalability, accreditation and selective disclosure of information.
The paper proposes a new solution including smart contracts on private
permissioned blockchain with different consensus model to fill those gaps
(Tariq et al., 2019).
4. Literature Comparison
All the research papers selected for the review has similarities and differences.
These similarities vary from fraud in the industry, opinion about the existing
credentials systems, blockchain as a solution, limitation of current blockchain
solution and alternatives.
All authors in their research papers mention diploma fraud in the education
sector. Falsification of diplomas or certifications are seen as a phenomena which
was always there. Individuals and organizations are alternating between victim
and perpetuator. The falsification of paper-based diplomas take place in the
recognized institutions, in degree mills or by individuals. These practices have
huge (social and financial) negative effect on the institutions, education and also
on individuals. This is similar in all papers.
The existing centralized system for digital credentials is another topic that the
majority of the authors highlight. While Saleh et al. (2020) and Tariq et al.
(2019) do not mention any information about this topic, all the other authors
have an opinion that these systems do not prevent the issues around falsification
of diplomas. The majority of the authors believe that the centralized systems are
weak and cannot respond the threats from outside. These weaknesses are
characterized as having drawbacks, single point of failure, security reliance on
existing (traditional) protocols, vulnerable to hackers, unreliable, verification
process is not easy, recovery of document could be a big issue. This is a
concerning fact.
Tayfun Karabagli: Blockchain Credentials in Education
23
Analyzed papers show that all of the authors believe that blockchain technology
has huge potential and it can resolve the challenge of counterfeit academic
credentials. Gresch et al. (2019) and Brunner et al. (2019) do not go into depth
on the characteristics and working mechanism of blockchain technology. Tariq
et al. (2019) briefly describes how the technology in general works. Other
authors characterize the blockchain technology as decentralized, immutable,
open source, cryptographic, secure, consensus based and above all that there is
an automation feature called smart contracts. In short, blockchain technology
comes forward as an advanced technology system with many features which
might be used in the education sector.
The current blockchain solution for educational credentials is another topic the
authors discuss. There is a big variety of institutions and organizations which
operate in this field, however those initiatives are criticized heavily. The critics
from the majority of authors focus on weakness and dysfunctionality of the
offered services. Saleh et al. (2020) find private data disclosed on the public
blockchain and no protection for privacy and ownership. There is no registration
feature and the security on these blockchain solutions are weak. Arenas and
Fernandes (2018) mention that these solutions are using cryptocurrencies. When
the solutions are running on public blockchains, storage costs, longer chain,
scalability and open access are issues. Gresch et al. (2019) find that these
systems are not easy to integrate into a structure of a university, digital
signatures can be bypassed and cost is an issue. Bruner et al. (2019) criticize
these systems on the following points: no issuer verification and verification of
all documents related to a certification are not included. Tariq et al. (2019)
compares these solutions and sees them as not scalable, limited user experience,
revocation not available, weak counterfeit protection and there are no features
for selective disclosure of information
The majority of authors propose a solution to resolve the existing challenges.
There are differences in their proposed solution. Saleh et al. (2020) thinks that
the challenge can be resolved by a private permissioned blockchain
(Hyperledger Fabric) with chain code and predefined participants. Arenas and
Fernandes (2018) proposes permissioned blockchain by using open source
Multichain as a solution. This project will use streams as abstraction of database
for Multichain. Gresch et al. (2019) has a solution which stores hashed PDF
documents on the public blockchain Ethereum with smart contracts. Brunner et
al. (2019) advocates for Ethereum or Bitcoin blockchain with IPFS and Swarm
data storage. His proposal uses off-chain protocol with own consensus SPROOF
protocol. Tariq et al. (2019) proposes a Ethereum based solution running on
Parity with smart contracts and Proof of Authority protocol.
5. Further Study
In the selected papers several topics are missing. Single blockchain solution,
localization, interoperability, ownership, GDPR and international standards.
Tayfun Karabagli: Blockchain Credentials in Education
24
These topics are very important for the further study of blockchain credentials
platforms.
There is no single blockchain solution for issuing certification and credentials.
The authors select existing private or public blockchains, but those solutions
have strong features but, in the meantime, contains weaknesses. Educational
institutions and companies need a compact and robust solution which can meet
the demand of all participants of the educational sector. That can be done by
further study instead of doing trial and errors with existing methods. This is a
gap that needs to be addressed.
Another gap that is not addressed in the papers and that should be highlighted
is international standards and localization. Meeting international standards for
certifications will give more recognition to the diplomas and certificates. Realtime translation the certifications to local languages without doing damage to
authenticity of the certifications or diplomas. The proposals or compared
solutions focus on English speakers and are not internationally oriented. If the
certifications are requested for verification by non-English speakers, how is this
challenge overcome. A proposed solution must have a multilanguage feature.
This is another gap that needs to be filled.
Interoperability is a very important point that is missing in the papers and not
mentioned by the authors. In the blockchain sector, the interoperability between
different blockchain platforms is an important theme. In the research papers the
solutions provide no space for interoperability between the blockchain
platforms. There is no mention of how to operate with national and international
educational systems. The main goal of the proposed solution is onboarding the
educational institutions on their platform, rather than providing the mobility to
be connected between different platforms. Interoperability is very important gap
that needs further research.
The last gap finds itself in the ownership and GDPR. The existing and proposed
solutions focusing on storing data on the blockchain rather than giving the
ownership of the certification or diploma as digital assets platforms provides to
its users. Apart from this, GDPR is an issue that rarely mentioned by authors.
How do we provide solutions to the issuers and users without compromising the
privacy, GDPR and other regulations on these platforms. This is an import topic
for the further study.
6. Conclusion
Traditional diplomas and certifications are paper based for centuries. Paper
credentials have some limitations and weaknesses. They can be easily falsified,
copied or duplicated. The falsification can take place everywhere, in
universities, educational institutions, companies and executed by authorities or
individuals. This effects the educational industry, society, individuals and
Tayfun Karabagli: Blockchain Credentials in Education
25
education in a negative way. Educational institutions need robust systems to
prevent this, but they are failing.
There are alternatives such as digital credentials and badges platforms. These
platforms give companies or educational institutions the option to issue digital
credentials. The badges or credentials are stored on the central databases. These
platforms are weak from the point of failure and security because these
platforms could be hacked, down or erased. The certification owner and the
issuer using these platforms has a challenge with the privacy and authenticity
of certifications. These platforms do not meet the current standards and respond
to the challenges of the education sector.
Blockchain is seen as a solution by the authors to overcome the challenge of the
falsification of diplomas. The existing blockchain solutions for educational
credentials are seen by the authors as weak, missing security or have limited
features to help the educational institutions overcome this challenge. Every
author has its own proposal which aims to resolve the falsification of
educational credentials.
Proposed solutions might be the answer on some of the challenges, however
there are gaps that need to be further studied instead of executing trial and
errors. These gaps are localization, interoperability, single blockchain solution
for educational credentials, ownership and GDPR.
References
Arenas, R. and Fernandez, P., 2018. Credence Ledger: A Permissioned
Blockchain for Verifiable Academic Credentials. 2018 IEEE International
Conference on Engineering, Technology and Innovation (ICE/ITMC). pp. 1–6.
Blockcerts., 2020. Blockchain Credentials [online]. Available
https://www.blockcerts.org/about.html [Accessed 30 November 2020].
from:
Brunner, C., Knirsch, F. and Engel, D., 2019. SPROOF: A Platform for Issuing
and Verifying Documents in a Public Blockchain. Proceedings of the 5th
International Conference on Information Systems Security and Privacy. pp. 15–
25.
Ezell, A. and Bear, J., 2012. Degree Mills: The Billion-Dollar Industry That Has
Sold Over a Million Fake Diplomas. 1st ed. Amherst, N.Y.: Prometheus Books.
Fontys., 2020. Degree Certificate Higher Education & Diploma Supplement
[online].
Available
from:
https://fontys.edu/Study-at-Fontys/Practical-
Tayfun Karabagli: Blockchain Credentials in Education
26
information-1/Degree-Certificate-Higher-Education-Diploma-Supplement.htm
[Accessed 26 November 2020].
Gresch, J., Rodrigues, B., Scheid, E., Kanhere, S. and Stiller, B., 2019. The
Proposal of a Blockchain-Based Architecture for Transparent Certificate
Handling. Business Information Systems Workshops, pp.185-196.
IMS Global., 2020. Digital Badges | IMS Global Learning
Consortium.
[online]. Available from: https://www.imsglobal.org/activity/digital-badges
[Accessed 30 November 2020].
IMS Global., 2019. Product Certifications [online]. Available from:
https://site.imsglobal.org/certifications?refinementList%5Bstandards_lvlx%5D
%5B0%5D=Open%20Badges [Accessed 30 November 2020].
Saleh, O. S. et al. (2020) Blockchain based framework for educational certificates
verification. Journal of critical reviews. 7 (3),
79–84.
Tariq, Aamna & Binte Haq, Hina & Ali, Syed. (2019). Cerberus: A BlockchainBased Accreditation and Degree Verification System.
UNIC., 2020. Blockchain Certificates [online]. Available from:
https://www.unic.ac.cy/iff/blockchain certificates/ [Accessed 28 November
2020].
VDCI., 2020. Digital Credential & Badge FAQs | VDCI.edu [online]. Available
from: https://www.vdci.edu/digital-badge-faq [Accessed 25 November 2020].
Enda McDonnell: A Literature Review on the Applicability of Blockchain Technology for use in Real
Estate Transactions
27
A Literature Review on the Applicability of Blockchain Technology
for use in Real Estate Transactions
Enda McDonnell
Abstract: This paper presents the result of an examination of published
material relating to the applicability of blockchain technology in the field of
real estate transactions. It does not examine tokenization, but whether
and how Blockchain could aid with property transactions and title transfer.
Keywords: Blockchain, Real Estate, Property
Enda McDonnell: A Literature Review on the Applicability of Blockchain Technology for use in Real
Estate Transactions
1. Introduction
28
Real estate has become the largest asset class of the global stock market next to
equities and bonds (Andonov et al., 2014), yet it is characterised by high
transaction costs, long term commitment and information asymmetry (Xie,
2017).
Problems associated with real estate transactions such as the lack of
transparency, high transaction costs and disparate title recording systems could
be significantly altered by blockchain. There is a broad range of material in
this area, though much of the examination is quite light given Blockchain’s
relative infancy as a technology.
2. Research Needed
Banking and mortgage lenders are typically risk averse and not associated with
fast adoption of new technology. They could potentially push back on the new
technology because it is foreign to them (Spielman, 2016). For this reason, it is
important to have backup data to argue the benefit of new technologies. There is
consensus that research is needed to determine the applicability of Blockchain to
property transactions.
Wouda and Opdenakker (2019) cite studies by Dijkstra (2017) and Veuger (2017)
as stating that Blockchain technology could lead to improvements in efficiency,
transparency and therefore trust, but continue that specifics and applications
remain unclear. One of their central questions was to identify how blockchain
technology could improve a real estate transaction of an office building.
The technique employed to conduct the research is through interview with five
real estate transaction experts. Stakeholder pain points are identified through
Grounded Theory analysis – an approach that can be used to extract research
data from interviews. The authors interview just 5 candidates spanning the
property transaction stakeholders, which is at the lower end of validity for
Grounded Theory analysis.
Nijland and Veuger (2019) argue that research is needed to understand how
greater transparency could impact the different stakeholders in the process.
•
•
They identify that the buyer benefits from uncertainty – how unknown
problems and changes in the asset that may arise are compensated for with
reductions in price.
On the other hand, the resulting lack of trust between buyer and seller are
not in the buyer’s interest, and changes are not good as they deviate from
what is likely to have been a planned strategy on behalf of the buyer.
Enda McDonnell: A Literature Review on the Applicability of Blockchain Technology for use in Real
Estate Transactions
29
Separately, Veuger (2017) indicates from his study that little research had been
done on the impact of Blockchain on the buying process for real estate 1.
3. Issues with Current Process
McNamara (1998) identifies four factors that can significantly delay the due
diligence process in property transactions.
•
Previously unknown or ignored inherent problems
•
Changes in the asset e.g. tenant default
•
Change in market conditions
•
Changes in the circumstances of the purchaser, for example
o Difficulty of funding. Increasing use of debt was said to sometimes
result in an additional due diligence process which could cause delay
o Re-assessment of offer price
Graglia and Mellon (2018) argue that transaction costs are deemed to be high for
property transactions. For the median house sold in the US, transaction costs can
account for 10% of the transaction price. They quote Goldman Sachs as
estimating that $2-$4billion could be saved in efficiencies in property title
insurance alone.
Such costs result in fewer transactions and have a negative impact on society
welfare.
•
Transaction costs reduce mobility. Venti & Wise (1989) 2 suggest that
mobility among the elderly is generally low – which they put down to
transaction costs. They argue that the significant jump in mobility when
necessary (such as with a change in marital status, or children moving out
of family home) points to the fact that moves would be more frequent if
transaction
costs
were
not
a
barrier.
•
Furthermore, the negative welfare effects of such transaction costs if they
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Enda McDonnell: A Literature Review on the Applicability of Blockchain Technology for use in Real
Estate Transactions
30
reduce mobility are significant. Oswald (1996) 3 relates a 2% increase in
unemployment with a 10% increase in home ownership. He identifies
renters as having more mobility and thus can exit unemployment faster.
•
•
Oswald continues to point out that regions with higher proportion of renters
have lower rates of unemployment.
As shown in Figure 1
Figure 1. Oswald's alignment of Unemployment to
Proportion of Private Renters. Oswald (1996).
4. The Buying Process
Given the issues with the current process and the need for further research,
Nijland and Veuger (2019) tackle the central research question:
‘In which stage of the buying process of commercial real estate can Blockchain
provide added value for the stakeholders involved?’
Firstly, the authors interviewed Blockchain experts to understand its demands and
possibilities. A second phase saw them interview experts of the real-estate buying
process (managers, commercial advisors, notaries, and legal/fiscal professionals).
The goal was to learn which stage of the buying process would be most suitable
for the implementation of Blockchain.
Enda McDonnell: A Literature Review on the Applicability of Blockchain Technology for use in Real
Estate Transactions
31
Though deductive approaches were used to extract qualitative analysis from the
semi-structured interviews, the data gleaned from both cohorts is funneled
through the authors, which limits potential outcomes by the authors’
understanding of each field. Perhaps a better approach would be to bring these
groups together in a working group, where problems and potential solutions could
be explored unfiltered.
Additionally, the process assumes incremental improvement is appropriate for
Blockchain implementation. Stakeholders where asked about obstacles with
current process. However, blockchain has the potential to radically alter the
process. If it were to remove intermediaries, for instance, it is not likely that the
affected intermediaries would cite themselves as an obstacle.
A smart aspect of the field research describes how the interviews would be
transcribed to facilitate later additional analysis if deemed worthy.
4.1 Findings
Nijland and Veuger (2019) do not make grand claims for blockchain. They
determine that the positive characteristics of Blockchain are mainly focused on
safety/security aspects of data. Due to the early nature of blockchain, large
adoption by the majority is not forthcoming. Controlling, and sharing real estate
documents could become more efficient using a Blockchain, which would have a
positive effect on the duration of the process and therefore on the costs.
Interestingly, they specifically call out that contrary to the expectation that
blockchains will disintermediate, the total disappearance of these parties in real
estate transactions will not be the case due to their special knowledge in a part of
the process.
5. A Proposed Infrastructure
Through their interview analysis, Wouda and Opdenakker (2019) identify
reliability, transparency, and security of data to be the main challenges for actors
in the real estate transaction. They “propose an infrastructure for a blockchainbased application to enhance the current way real estate is transacted by
introducing a more comprehensive, better quality and more complete asset
information overview.” They propose storing original legal and contractual
documents on the servers of the involved parties and maintaining an audit trail of
amendments to the original documents on the blockchain.
Wouda and Opdenakker (2019) point out that the immaturity of the technology, a
lack of standardization and limited examples of successful applications present
Enda McDonnell: A Literature Review on the Applicability of Blockchain Technology for use in Real
Estate Transactions
32
challenges for using blockchain as a solution. They continue to argue that
property reports and inspection information must be standardised, which could
enhance verification through the use of APIs.
They quizzed the five interviewees again to assess the utility of their architecture
and heard the following benefits mentioned
•
Storing and sharing data avoids need for party interaction
•
Information validated in the network is more reliable
•
Information shared between parties is the same
•
Structured and standardised data facilitates more efficient workflows and
analysis
Importantly, parties identified the need for all stakeholders to sign-up to create
sufficient incentive to develop the blockchain infrastructure.
6. A Deeper Examination
Blockchain and Property in 2018 is a more considered examination (Graglia &
Mellon, 2018). They take a broader, more philosophical approach, concerning
themselves with the degree to which society will embrace decentralised
governance, and how inherently political Blockchain is, compared to other
technologies. They point out that the power we have placed in the hands of a few
tech giants must be redressed and that, of technologies currently available, only
blockchain has the power to do this.
Graglia and Mellon (2018) state that transaction costs for the median house sold
in the US can account for 10% of the transaction price, and that entire industries
exist with the sole purpose of capitalising on the inefficiencies of property
transfers. They quote Goldman Sachs as estimating that $2-$4 billion could be
saved in efficiencies in property title insurance alone. They reckon this saving
could be achieved in the short term by sharing contracts and approvals on a
blockchain, which is also the approach recommended by Wouda and Opdenakker
(2019).
In addition to this short term saving, Graglia and Mellon (2019) look further into
the future to imagine a peer-to-peer property transfer market where transaction
times drop from months to minutes and costs drop from thousands to small
service fees. They consider a time where unbundling permits shares in property
to be sold, and blockchain facilitates real estate investment not limited by
geography. However, they admit it is difficult to envision a genuine peer-to-peer
Enda McDonnell: A Literature Review on the Applicability of Blockchain Technology for use in Real
Estate Transactions
transactions without intermediaries.
33
•
This will come as good news to the real estate agents who partook in a
study on the impact of Blockchain on the Real Estate sector in Pakistan
(Uzair et al., 2018). Their conclusion was that “the real estate brokers
would rather not have this technology implemented […] as it would enable
any new or old buyer or seller to see the prices at which these properties
are being traded, which would cut into their profits as well as eventually
make
them
redundant.”
•
However, a perhaps wiser view came from intermediating notaries in
Georgia. Nijland and Veuger (2019) quote Straub (2018) as pointing out
how ‘Notaries in Georgia have contributed to the switch to Blockchain.
Because the system eliminated exactly the work that required little
intellectual effort, allowing the notaries to focus on the more interesting
and challenging tasks. We might lose some revenue due to the
implementation of Blockchain, but we could earn more money due to the
better focus on more complex dossiers.’
Graglia and Mellon (2019) outline the benefits of blockchain and, assuming it can
achieve societal acceptance, list prerequisites for any solution for the real estate
sector. These include an identity mechanism, a method to require more than one
person’s authorisation for transactions to proceed, and training, among others.
Graglia and Mellon (2019) examined how a blockchain-based registry might
evolve and, uniquely in the literature, list eight maturity levels
1. No Blockchain Integration (this is the status quo)
2. Blockchain Recording: important documents are stored on the blockchain
such that they can be independently verified. Though feared by some
surveyors and notaries, the authors believe this will continue.
3. Smart Workflow: Efficiencies are gained by publishing steps of a
transaction to the chain and avoiding the current process of physically
sending proof between parties.
4. Smart Escrow: Buyers, sellers and banks interact and transfer funds via
smart contracts. The authors raise concerns here about the vulnerability of
smart contracts and the potential for legal issues if they do not behave
correctly
5. Blockchain Registry: Central datastore of property titles moves to a
decentralised blockchain. Detailed transaction data would be stored on a
private, permissioned blockchain, while the public aspects of a land registry
would be stored on a public chain.
Enda McDonnell: A Literature Review on the Applicability of Blockchain Technology for use in Real
Estate Transactions
6. Disaggregated Rights.
34
7. Fractional Rights.
8. Peer to Peer Transactions: all previous levels must be realised first. The
authors find it difficult to envision genuine P2P without intermediaries.
9. Interoperability: global interoperability between blockchain registries in
different jurisdictions – the holy grail as they call it.
Theirs is an excellent, considered piece that delves deeper than other papers.
They conclude with a series of thought-provoking questions about the future of
Blockchain for Real Estate, the highlights of which suggest…
•
Premiums for title insurance may drop by 30% in the US if titles are stored
on a blockchain.
•
The authors make the point that addressing problems like corruption is a
greater incentive for blockchain adoption than the desire to upgrade an
already functional system.
•
Efficient access to foreign property markets is more significant for
emerging economies than for developed ones.
•
Accurate data helps all participants. The authors argue that blockchain can
help in encouraging accuracy and point to a Ghanaian test where users are
rewarded for adding accurate data and penalised for adding erroneous
information.
•
The authors argue that governments must regulate the economy and enforce
the law, and as blockchains become integrated into registries at higher
levels, national laws, taxes, fees, and regulations will have to be integrated
into smart contracts.
7. An Examination of Costs
Hermansson (2020) determined that a real estate smart contract would be simpler
than CryptoKitties contract and therefore cost less to deploy. However,
documents needed to support a real estate transaction would be prohibitively
expensive to store on the blockchain. For example, storing a 10KB document on
the Ethereum network was estimated to cost roughly $10 in Dec 2019. Thus, real
estate transaction documents would need to be stored on IPFS, with the hashed
representation going on the blockchain. Hermansson (2020) also expresses
concerns about price volatility on blockchains – that changes in the value of
Enda McDonnell: A Literature Review on the Applicability of Blockchain Technology for use in Real
Estate Transactions
35
Ethereum would alter the value of the down payment may alter. It is argued that
stable coins would solve this challenge.
8. Practical Experiment - Sweden
A Swedish project by Lantmäteriet (The Swedish Mapping, Cadastre and Land
Registration Authority) along with several private corporations compared 33
steps needed today for private persons to purchase small properties via agents,
with how that could occur using blockchain. They identified several
improvements in accordance with the literature (Lantmäteriet (The Swedish land
registration authority), 2016).
•
Time reduced from 4 months to a few days (and could become real-time).
•
Information needed for bill of sale is shared, so can be signed by buyer
and seller upon taking up occupation.
•
The risk of title not transferring is much reduced because legal
prerequisites can be ensured prior to signing.
•
Digital signatures provide higher levels of security, which increases
confidence in the system for multiple signatories.
9. Conclusion
The main papers agree that blockchain is a potential game changer for real estate
transactions. However, they also all agree that blockchain is in its infancy and
that more research is needed. Wouda and Opdenakker (2019) argue that specifics
and applications of blockchain remain unclear. Nijland and Veuger (2019) call
for research to understand how transparency could impact stakeholders in the
process. Verger (2017) says how little research has been done in this area.
In discussing the current status, McNamara (1998) identifies significant delays in
property transactions. Graglia and Mellon (2019) argue that transaction costs are
extremely high, putting forward figures that they believe Blockchain could
reduce. Venti & Wise (1989) point to the impact on welfare caused by lower
mobility due to high property transaction costs. Oswald relates reduced mobility
to increased unemployment, pointing out how renters can exit unemployment
faster due to their more favourable mobility.
Nijland and Veuger (2019) set out to determine which stage of the buying process
of commercial real estate could Blockchain provide added value. They conclude
that controlling and sharing real estate documents could become more efficient
using a Blockchain and reduce the process duration. They also point out that
Enda McDonnell: A Literature Review on the Applicability of Blockchain Technology for use in Real
Estate Transactions
36
blockchain is not likely to completely disintermediate agents due to their special
knowledge in a part of the process.
Wouda and Opdenakker (2019) also identify reliability, transparency, and security
of data to be the main challenges for actors in the real estate transaction. They
propose an infrastructure for a blockchain-based application to enhance real
estate transactions. They suggest that standards in real estate documents would
enhance blockchain’s benefit by permitting automated API verification. They
also make the point that all stakeholders would need to sign up to use the solution
before there would be sufficient incentive to develop the blockchain
infrastructure.
Graglia and Mellon (2018) provide a deeper analysis of what groundwork is
needed to lay the foundation for a blockchain solution. They provide a vision of
how such a framework might evolve through eight levels. They provide some
forward-looking statements of how blockchain could impact the industry with a
drop in insurance premia for instance. They also point out that regions with
corruption have more to gain from blockchain and how blockchain has the
potential to improve data accuracy through built-in rewards.
From a practical point of view, Hermansson (2019) provided light examination
of the costs of running a property system on Ethereum. A Swedish industry
project to examine the use of blockchain for the land registry there also drew
conclusions that matched the literature.
References
Andonov, A., Eichholtz, P. and Kok, N., 2014. Intermediated investment
management in private markets: Evidence from pension fund investments in
real estate.
Graglia, M. J., & Mellon, C., 2018. Blockchain and Property in 2018. MIT
Press Journals. 12(1/2), pp.90-116.
Hermansson M., 2020. Real Estate Transactions using Blockchain Technology.
Dissertation, Umeå University.
Lantmäteriet (The Swedish land registration authority)., 2016. The Land
Registry in the blockchain. [ebook]. Available at: http://icait.org/pdf/Blockchain_Landregistry_Report.pdf [Accessed 6 November 2020].
Enda McDonnell: A Literature Review on the Applicability of Blockchain Technology for use in Real
Estate Transactions
37
McNamara, P., 1998. Exploring liquidity: Recent Survey Findings. Brighton:
Paper to the 7th Investment Property Databank Conference.
Nijland, M., & Veuger, J., 2019. Influence of Blockchain in the Real Estate
Sector. International Journal of Applied Science, 2(2).
Spielman, A., 2016. Blockchain: digitally rebuilding the real estate industry.
Doctoral Dissertation, MIT.
Uzair, M., Karim, E., Prof. Dr. Shair, & Ahmed, S., 2018. The Impact of
Blockchain Technology on the Real Estate Sector Using Smart Contracts.
MPRA.
Wouda, H. P., & Opdenakker, R. (2019). Blockchain technology in commercial
real estate transactions. Journal of Property Investment & Finance, 37(6), 570579.
Xie, J., 2017. Who Is “Misleading” Whom in Real Estate Transactions?. Real
Estate Economics, 46(3), pp.527-558.
Iarla Molloy: The Economic Design of Consensus Incentive Methods
38
The Economic Design of Consensus Incentive Methods
Iarla Molloy
Abstract: Incentives play a key role in the success and sustainability of
blockchain solutions. Their effect and impact range the whole spectrum
from miner rewards, staking rewards, transactions-fee and play a role in
the critical design of the blockchain. In this paper, we explore the
economic impacts of consensus design decisions and design a framework
to capture the economic consequences of specific incentive intents. A
consensus method e.g. (Proof of Work, Proof of Stake) is the mechanism
use by distributed systems achieve an agreement on state of the
blockchain in turn maintaining the blockchain integrity. Each of these
mechanisms are designed to reward actors; a summary of the
mechanisms is explored in this paper with their design goals.
Keywords: Blockchain, Incentives, Economics, Consensus, PoW, PoS
Iarla Molloy: The Economic Design of Consensus Incentive Methods
1. Introduction
39
Incentives are the pillar of successful permissionless blockchains. We explore
the economic objectives behind the Proof of Work (PoW) and Proof of Stake
(PoS) consensus designs. We introduce a simplified model called Blockchain
Incentive Rewards (BIR) to capture the scope of the different consensus types.
2. Literature Review
This section provides a review of existing literature in the areas of the blockchain
incentive schemes, PoW and PoS systems. It finishes up with a brief look at the
verifiers dilemma.
2.1. Survey of blockchain incentive schemes
Catalini and Gans (2020) point to incentives being created through organic
growth of blockchain where early adopters benefit from early engagement. They
categorize incentives into two classes; adoption phase and incentives phase to
support continuous contribution. The first phase can include the issuing of the
tokens through an Initial Coin Offering (ICO) scheme, while the second phase
incentives are created through consensus mechanisms. Groups incentive
strategies into two primary groups; issuing a token in response to what a network
node deserves and based on the allocation of the tokens (Huang et al. 2019). In
the issuing mechanism for example Bitcoin, nodes win invoicing rights under
PoW consensus algorithms and Bitcoin rewards the miners. The second method
manages the distribution of existing tokens in the system through evaluating the
nodes contributing to the network, the contribution of each node and the random
factors that guarantee fairness. In the original allocation model proposed by
Nakamoto (2008), the first miner that succeeds can get a bitcoin while the rest all
fail and can only expect the next turn although they paid the computing power to
go through mining pools.
2.2. Incentives and Proof of Work systems
In a PoW consensus, solution miners have separate functions; creating
blockchains and checking the validity of each blocks. Luu et al. (2015) discuss
the concept of verifiers dilemma (resulting as consequence of lack of incentives
in the PoW protocol). The miners get paid for the work done and use the rewards
system as financial incentives. In the original bitcoin paper by Nakamoto (2008),
the first transaction in a block starts a new coin. Blocks can only be added by
Iarla Molloy: The Economic Design of Consensus Incentive Methods
40
solving a complex hash function. The hashing power for the PoW system can be
provided by individual miners or mining pools. The mining pool combine
resources and shared rewards using schemes such as Pay-Per-Share (PPS) and
Full Pay-Per-Share amongst others (Bitcoin, 2020).
2.3. Incentives and mining pools
Wang et al. (2020) point out several limitations associated within the mining
pools that can influence the motivational effects of mining pool. One of these
limitations is the security of the hardware and selection of mining pools (in 2018
– the top 5 mining pools had over 60% of the hashing power). They also outline
dishonest actor strategies such as self-mining attacks (an attack where a miner
does not release a block and creates a private fork) which can bias a mining pool.
The existence of mining pools shifts the blockchain principle from a decentralized
metaphor towards semi-centralized command and control metaphor. There are
many reward types associated with each of the mining pools (Bitcoin, 2020).
2.4. Incentives and governance
Blockchain governance is explored by Beck et al. (2018) under three dimensions;
decision rights, accountability and incentives. They point out that there are
several target areas for the incentives such as incentives for users, systems
development, token holders and technical consensus. In platforms such as
Polkadot, they have inbuilt governance mechanism e.g. ‘Dot’ holders can create
governance proposals and voting rights as shown in Figure 1 (Petrowski, 2020).
Figure 1. Polkadot Governance. Petrowski (2020).
Iarla Molloy: The Economic Design of Consensus Incentive Methods
41
The governance on a blockchain impacts the reputation of the blockchain and
how the market behaves on the blockchain.
2.5. Reputation based incentives
In Wang et al. (2020), a reputation-based incentive scheme is proposed in the
consensus process. Reputation networks have their origins in the early P2P
networks, but a model proposed by the Gupta at al. (2003) model trust and
reputation in decentralized multi-agent systems. Their model is built off the
Entropy model which captures the exchange of the trust in the business
environment. The Proof-of-Reputation is a proposed mechanism that can be
integrated into the consensus protocols. They propose a new set of rules in the
mining process in that it is the reputation decline if nodes fail to produce blocks
within a period.
2.6. Incentives and Proof of Stake systems
PoS addresses issues with PoW systems by providing a consensus mechanism
that is not impacted by computation cost and consensus time delays. The main
idea of a PoS consensus mechanism is that the proportion of users’ stake in the
system is inversely proportional to the difficulty of block generation. The larger
the stake held by nodes in the system, the easier the holder windows wins. In a
preliminary paper by Fanti at al. (2019), economic rewards in PoS systems can
be manifested in two ways; block rewards which are given to the proposer of the
longest chain and transaction fees paid by the sender for transferring the amount
which is split between a set of validators and the block proposer.
2.7. Incentives blockchain architectural layer
Huang et al. (2018) have categorized incentives into two primary areas; issuance
and allocation. Issuance, which is typically associated with the public blockchain
provides rewards to miners who contribute resources such as CPU/network or
storage to the upkeep of the network. The allocation incentives are designed to
ensure that there are incentives for the continuous processing and forwarding of
data on the network. Li et al. (2020) divide the architecture into multiple layers
as shown in Figure 2 below. The combination of the incentive and consensus
layers are a key fabric of the blockchain. In the architecture, the incentive layer
plays a key role in the blockchain solutions. We extend this work by making the
incentive layer orthogonal to all the other architecture layer and we include a new
governance layer.
Iarla Molloy: The Economic Design of Consensus Incentive Methods
42
Figure 2. Blockchain layers. Li et al. (2020).
2.8. & Incentive compatibility
Luu et al. (2015) describes the verifiers dilemma as a situation in which rational
miners are incentivized to accept invalid blockchains or decide to skip the
verification of expensive transactions. They cite two potential attack resource
exhaustions (using the Ethereum gas to include resource-intensive transaction in
new blocks) or incorrect transaction attacks (skipping part of the attacks that are
compute intensive). Incentive compatibility occurs when the incentives that
motivate the actions of individual participants are consistent with following the
guidelines established by the group for the common good. Chiu and Koeppl
(2019) describe modelling incentives as the No-Double-Spending constraint
(NoDS) which outlines how reward and confirmation lags play a critical role in
the design incentives to prevent users from double sending.
3. PoW Economics and Incentives
PoW miners have separate functions in consensus; checking that it is that blocks
are correctly constructed and checking the validity of each blocks. The
contribution of the work by Luu et al. (2015) includes the introduction of the
verifier’s dilemma. The miners get paid for the work done and use the rewards
system as financial incentives. The work originates in the original bitcoin
implementation.
3.1. Individual miner economics
Individual miner can earn revenue from the mining the blockchain but need to
buy hardware and pay energy costs. Once a complex puzzle is solved and a block
Iarla Molloy: The Economic Design of Consensus Incentive Methods
43
is created, the miners are given rewards. A lot of energy is expended when solving
the puzzle which make the expense quiet intimidating thus the need for pools.
3.2. Mining pool monopolies
In a study by Silva et al. (2020) on the Ethereum network, they identified selfish
behavior within the pools and the prevalence that these power mining pools have
impacted the blocked delays. Their analysis looked at fifteen mining pools that
created most of the blocks, with Sparkpool and F2Pool2 holding approximately
61% of the hash power. A study by Miller et al. (2015) concluded that 2% of
nodes accounted for 75% of mining power. These monopolies can act as a
disincentive for new miners to engage in the consensus.
3.3. ASIC economics and mining pools
In order to mine a cryptocurrency, a miner will need an upfront investment in the
ASICs. The cost prices that are based ASIC hardware is typically based on the
expected returns from the hardware. Yaish and Zohar (2020) argue the contrary
by showing that the underlying hardware can be considered as financial options.
Their analysis also showed that a reduction in Bitcoin volatility negatively
impacts the value of the hardware and thus becomes a financial disincentive. The
energy cost of running the equipment is important from an individual’s
mining/pooling perspective. Initial estimates from De Vries (2020) calculated
that in 2018, the total consumption of the bitcoin network equalled the
consumption of energy in Ireland.
4. PoS Economics and Incentives
PoS protocols were developed as energy saving alternatives to PoW. Instead of
computational power resources, leaders are selected based on their stakes,
i.e., contributions to the blockchain network.
The algorithms use a Follow-the-Satoshi (FTS) algorithm that have been adopted
in PoS based blockchain networks such as Cardano, Sp8de, and Tezos. The
staking rewards are created through inflation and the reward scheme is designed
to incentive consensus participation by rewarding block creators and validators
while at the same time penalizing poor behaviors’ and prevent attacks. Table 1
below shows these consensus protocols
Iarla Molloy: The Economic Design of Consensus Incentive Methods
Table 1. Consensus Protocols
Protocol
Casper
Algorand
Tendermint
44
Incentive scheme
Deposit confiscated for poor validator behaviors
Pure POS (every node can particulate in the
network)
Rewards divided between validators and
deposit confiscated for mis-behaviors
4.1. Ethereum transition to POS
Ethereum (2020) is transitioning away from a PoW system towards a PoS system
in which validators will be paid to perform tasks to ensure the network is healthy.
The incentive stakes influence the number of validators on the network and cost
of the network. There are several factors that a validator must consider before
taking up an incentive; computing costs, capital acquisition cost (deposit of 32
ETH), cost risk and general uptime of a maintenance cost and security risk.
Polkadot is a multi-chain network that connects blockchain and uses a NPoS
protocol as its consensus mechanism in which it nominates a subset of validators
that can perform the consensus. There is a limited number of validators that get
equal powers and equal rewards.
4.2 DeFi as a dis-incentive for PoS
Incentives from the PoS have competition from new offerings in the DeFi space.
The PoS requires validators to commit their assets to earn rewards while
decentralized financial application such as Compound and maker provide ways
in which the user and validators can lock-up Ethereum from the blockchain. The
white papers on the asset protocol from Park et al. (2020) outlines these problems
in detail:
•
•
•
Staking can damage the ecosystem as the new DeFi lending offers higher
rates.
Tokens that are DeFi staked cannot contribute to network security.
Staked tokens cannot be traded as their true value cannot be reflected on
the market.
4.2.1 Voting mechanism for disincentives
The nature of staking can lend itself to monopolies. EOS is a
blockchain similar to Ethereum but in EOS there is an option to buy votes which
slew the democracy of the blockchain producers. EOS however only runs 21
Iarla Molloy: The Economic Design of Consensus Incentive Methods
45
miners. Significant development has occurred in the PoS consensus mechanism
over the last few years.
5. Design of the Model
In this section we will test the consensus models against a reference model that
captures the economics decisions that influence the design mechanism used in the
blockchain. We refer to this as the Blockchain Incentive Reward (BIR) model.
5.1 BIR Model
The model is captured below in Figure 3. The model is derived from Rakoff’s
Gameplay Model game playing model is assessed on co-operating, competition,
immersion and achievement Albertarelli et al. (2018). The framework is
composed of three tiers; external factors, game playing framework and
blockchain mechansim stacks. These are decribed below in Figure 3.
Figure 3. BIR Model. Albertarelli et al. (2018)
5.1.1 External Factors
This tier captures the external factors such as PESTEL and the rewards and
state of the dependent markets that might influence an agent’s decision to engage
in the consensus mechanism.
Iarla Molloy: The Economic Design of Consensus Incentive Methods
46
The PESTEL factors can be a co-operating (political beliefs) and a competitive
factor to the blockchain e.g. cost of energy. The incentives can be allocations or
issuance orientated.
5.1.2 Game Playing Framework
This tier will capture the agents state and motivations to engage in blockchain
incentives. These states can be co-operating, competition and achievement
orientated of immersive factors.
Defi monopolies are competitive factors to incentives while staking is seen as
positive incentive factor.
Figure 5. Game Playing Framework. Albertarelli et al. (2018)
Figure 4. Blockchain Mechanism Stack. Albertarelli et al.
(2018).
Iarla Molloy: The Economic Design of Consensus Incentive Methods
47
5.1.3 Blockchain Mechanism Stack
In this tier the incentives can be applied several levels within the blockchain.
The incentives can be applied at multiple technical layers within the technology
stacks. Sometimes an
incentive
might
span
multiple layers in a stack.
5.2 Testing the model
This section outlines how
each consensus can be
mapped
into
the
framework.
5.2.1 Analyzing Proof of work
The are some notes from this model, in order to co-operate into the network you
need to invest while energy costs and mining pools could be a competition factor.
Figure 5. PoW consensus. Albertarelli et al. (2018).
5.2.3 Analyzing Proof of Stake
The investment is the PoS stake while the competition factor is DeFi.
Iarla Molloy: The Economic Design of Consensus Incentive Methods
If we look at the nPOS model the governance layer is activated.
48
6. Conclusions and future directions
We captured academic research into incentives behind the consensus mechanism.
As part of the exploration there are number of key observations:
•
•
•
•
•
The PoW mechanisms will be superseded by more advanced forms of
PoS.
The DeFi investment options can have a negative impact on the returns
PoS systems.
The governance and voting the model when considering investing option.
The Data/Network layer outline in the document can be converged into a
verifier layer.
The BIR external model needs to be refined and the layers coding to create
a simulation tools for incentives
References
Albertarelli, S., Fraternali, P., Herrera, S., Melenhorst, M., Novak, J., Pasini, C.,
Rizzoli, A. and Rottondi, C., 2018. A Survey on the Design of Gamified
Systems for Energy and Water Sustainability. Games, 9(3), p.38.
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49
Beck, R., Müller-Bloch, C. and King, J., 2018. Governance in the Blockchain
Economy: A Framework and Research Agenda. Journal of the Association for
Information Systems, pp.1020-1034.
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2020].
Catalini, C., Gans, J., 2020. Some simple economics of the
blockchain. Communications of the ACM, 63(7), pp.80-90.
Chiu, J. and Koeppl, T., 2019. Incentive Compatibility on the
Blockchain. Studies in Economic Design, pp.323-335.
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https://docs.ethhub.io/ethereum-roadmap/ethereum-2.0/eth-2.0-economics/.
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networks, Proceedings of the 13th International Workshop on Network and
Operating Systems Support for Digital Audio and Video, ACM (2003), pp. 144152
Huang, J., Lei, K., Du, M., Zhao, H., Liu, H., Liu, J. and Qi, Z., 2019. Survey
on Blockchain Incentive Mechanism. Communications in Computer and
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Li, A., Wei, X. and He, Z., 2020. Robust Proof of Stake: A New Consensus
Protocol for Sustainable Blockchain Systems. Sustainability, 12(7), p.2824.
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in the Consensus Computer. Proceedings of the 22nd ACM SIGSAC Conference
on Computer and Communications Security, pp.706-719.
Miller A., Litton J., Pachulski A., Gupta N., Levin D., Spring N. and
Bhattacharjee B., 2015. Discovering bitcoins public topology and influential
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Nakamoto, S., 2008. Bitcoin: A Peer-to-Peer Electronic Cash System. SSRN
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Protocol for Sustainable Blockchain Systems. Sustainability, 12(7), p.2824.
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https://anchorprotocol.com/docs/The_bAsset_Protocol.pdf. [online]. Available
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https://polkadot.network/polkadot-governance/ [Accessed 2 April 2020].
Silva, P., Vavřička D., Barreto J. and Matos M., 2020. Impact of GeoDistribution and Mining Pools on Blockchains: A Study of Ethereum - Practical
Experience Report and Ongoing PhD Work. 2020 50th Annual IEEE-IFIP
International Conference on Dependable Systems and Networks-Supplemental
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de Vries, A., 2020. Bitcoin’s energy consumption is underestimated: A market
dynamics approach. Energy Research & Social Science, 70, p.101721.
Wang, E., Liang, Z., Chen, C., Kumari, S. and Khan, M., 2020. PoRX: A
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Yaish, Aviv & Zohar, Aviv., 2020. Pricing ASICs for Cryptocurrency Mining
Mafalda Santos: Preventive Health Behaviour – A Blockchain Economy Review
Preventive Health Behavior – A Blockchain Economy Review
51
Mafalda Santos
Abstract: Current healthcare focuses on treating and medicating people
to treat ailments, which is costly on governments as well as on people’s
lives and quality of life, people are used to react to their health as opposed
to be active about their health and adopt preventive behaviors. By
instigating people’s decisions making towards a preventive health
behavior, people can avoid developing certain preventive diseases and
related deaths, improving their health and have better quality of life.
Traditional economics postulates that people are rational, take the best
decisions to maximize their utility and cannot be influenced however, this
is not how humans behave. That’s why people take healthy risks such as
smoking, have unhealthy diets and don’t exercise, these risky behaviors
underline many of the preventive diseases. Behavior economics
developed several theories to explain how humans make decisions do
way they do and why they’re not always rational about their decisions,
making decisions that aren’t on their best interest.
Behavioral economics, neuroeconomics and health psychology together
make strong theories and studies about the decision process.
Neuroimaging is a powerful tool to understand where in the brain
computations happen in different decision context however, lots of data
being collected in these studies are based on peoples’ perceptions and
there’s lack of uniformity in definitions. Information isn’t readily available,
and it is difficult to understand pertinent information from different fields.
Blockchain technology is a great tool that can support storing and sharing
data across different fields of investigation. It can also be used to develop
applications to instigate people adopting health behaviors while
preserving personal and health data security and anonymity.
Keywords: Health behavior,
neuroeconomics, blockchain, AI
behavioral
economics,
incentives,
Mafalda Santos: Preventive Health Behaviour – A Blockchain Economy Review
1. Introduction
52
Most problems in healthcare are neither medical nor scientific, they’re behavioral
and in many cases preventable by improving people’s decisions making.
Individual decisions of healthy habits lead to a better health, prevent diseases and
related deaths however, humans don’t always take the best decisions about their
health, which is in contradiction to traditional economics that states that humans
are rational, always maximize their utility, seek for all the information required,
can handled several amounts of data and are not influenced. With the limitations
of traditional economics, behavioral economics has emerged and developed
better tools to understand human’s decisions and how people make choices the
way they do even if it’s advised not to in their own best interest.
The consilience of behavioral economics, neuroeconomics and health psychology
provides a better set of tools to understand the mechanics of decision making and
how to incentive healthy decisions to prevent diseases and related deaths.
In this paper it will be reviewed the process of decision making in the health
context and the challenges this area is facing. Then it will be reviewed the
potential of blockchain in health care and finally the directions for future research.
2. Decision making process
2.1. behavioral economics and health psychology
Rice (2017) centers his paper around the concepts of maximizing and sufficing,
where maximizing the utility (maximizing the satisfaction gained from an option)
is opposed to sufficing (settling for an ok option). According to Rice (2017), these
concepts are the basis for the emergence of behavioral economics which states
that people do not behave rationally, they don’t seek all the information required,
do not use it in the best way, don’t always take the best decisions and individuals
put present’s rewards ahead of future wellbeing. Behavioral economics theories
therefore refute traditional economics’ postulates that people are perceived as
having perfect information and if markets are not inflated by monopolistic firms,
they’re rational, use information to maximize their utility, they can handle huge
amounts of information and cannot be manipulated. Traditional economics’ focus
is on the outcome of human decisions as opposed to behavioral economics that
focuses on the process of decision making.
An underlying postulation of health psychology is that a myriad of modern
diseases is preventable by the adoption of health behaviors. Health risking
behaviors such as smoking, unhealthy diet and sedentarism underpin many of the
preventable diseases and related deaths. Health decisions are multiply determined
and the combination of neuroeconomics and health psychology provides
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foundation for the study of decision making as follows: “(a) Coherence of the
field around a set of biologically rooted constructs described in a common
language across fields; (b) concept parameterization, which helps make theories
more measurable, falsified and parsimonious; and (c) confirmatory evidence of
existing models” (DeStasio et al., 2019). Neuroeconomics theories and tools such
as incentivized elicitation of value, and neuroimaging methods to identify which
parts of the brain are involved in different decision making computations are a
great addition to understand the process of decision making and to stimulate
health behavior decisions (DeStasio et al., 2019).
An important aspect to take into consideration when studying decision making in
the health context, is that people making health decisions face information
asymmetry, too much information, too many unknown risks, time pressure and
other constraints (DeStasio et al., 2019). From a behavioral economics
perspective, too much choice overwhelms, demotivates and brings higher levels
of unsatisfaction to people, particularly to those who strive to maximize. Decision
fatigue is another important component, after making several decisions the brain
gets tired and starts making poor decisions, leading to people when in the same
circumstances not always making the same decision (Rice, 2017).
2.2. Health decisions
The decision making in the health psychology context is composed of
multiattribute models and bounded accumulation models. For example, in the
scenario of the flu vaccine, the multiattribute model states that people weight the
rewards (protection against the flu) and punishments (the pain of the shot) as such,
the individuals who highly value their health add greater value to the vaccine than
those who undervalue their health (DeStasio, 2019). According to the bounded
accumulation model, in the same flu vaccination context, an individual passing a
sign reminding them to take the vaccine, if the individual already has the record
of taking the vaccine might influence them to take the vaccine however, by
analyzing the costs of fitting the vaccination in their busy schedule might
demotivate them from taking the vaccine. However, if passing a sign that the
vaccine is administered in the moment, might make the individual to change the
decision to yes, to take the vaccine due to the cost reduction (DeStasio et al.,
2019).
The scenario described above is supported by behavioral economics, according
to Herbert Simon, people have limited cognitive functions which is the base of
the bounded rationality theory he developed. People have limitations in the
amount of information they can process and how much they can remember, as
such people make shortcuts or heuristics decisions rather than the classical utility
maximization behavior, therefore people satisfice when making choices to
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mitigate the overwhelming of constantly looking for information and maximizing
utility due to their cognitive limitations (Rice, 2017).
Prospect theory was developed by Kahneman and Tversky in the individual
economic risk-taking behavior. This theory states that people evaluate risks not
based on the utility, but rather based on the gains and losses of the outcomes and
that people are risk averse. Another interesting factor is that people show a
phenomenon called loss aversion, they try to avoid loss even if that requires them
to engage in risky behaviors, loss is perceived to weight twice as much as gain,
the decision is influenced on how the choice is formulated if in terms of losses or
gains (Rice, 2017). Another related phenomenon is overly discounting the future,
where decisions about the present’s rewards are much more weighted with
regards to decisions about the future’s rewards.
Prospect theory and overly discounting the future are very relevant in the context
of health decisions with distinct emphasis on painful preventive health behaviors
such “invasive cancer screenings for which the risk of the immediate outcome
(e.g. pain) feels more certain and salient than do that of the potential long-term
outcome if the behavior is not enacted (e.g. illness severity)” (DeStasio et al.,
2019). Another contribution of the prospect theory, is the fact of phrasing
preventive behaviors in terms of gains rather than losses, “for example, when the
human papillomavirus vaccine is described as 100% effective against 70% of
cervical cancers, people are more likely to express vaccination intentions than are
they when the same vaccine is described as 70% effective against 100% of
cervical cancers” (DeStasio et al., 2019).
Nudge is a term coined by Richard Thaler and Cass Sunstein that supports the
idea of ‘libertarian paternalism’, in the libertarian view, people should be given
choices whereby the decision-making process should be guided by experts, hence
the paternalistic view.
The endowment effect explains the fact that when a person comes into possession
of something, they feel they own it and want to keep it, even it is in their own best
interest not to keep it. A similar concept is the status quo bias, whereby people
prefer the current state of affairs as an example people usually choose the
predefined option and usually do not choose the opt-in (or opt-out) options even
if it is in their own best interest. For example, in countries where there are
programs to support the cost of prescription drugs, have faced problems of
enrolment due to too much choice available making it difficult for people to
choose the most cost-effective plan for the drugs they’re prescribed. Every year
people are allowed to change plan however, rarely people do so, which is in
agreement with the status quo bias problem.
Another pertaining occurrence is the low enrolment in government sponsored
health insurance programs when people are eligible for it, from a behavioral
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55
economics’ point of view this situation could arise due to people not
understanding the costs and benefits of the several options, having too much
choice, discounting the future over the present, not understanding the risks of not
having health insurance or how people interpret the problems in their own mind.
With regards to the smoking problem, behavioral economists have found that
having people signing contracts to quit smoking and being rewarded financially
was very successful it has been studied that people respond well to financial
rewards. Another approach is the behavioral idea is that it is easier to get people
to engage in a related activity as opposed to eradicating it completely and as such
it would be easier to switch to electronic cigarettes instead of quitting smoking.
According to OECD, over the past 30 years the obesity rates have doubled in the
OECD countries. As per Zimmer, obesity is not a rational choice and as such is
not a result of people maximizing the utility from their food preferences, instead,
it is a result of how food-producing companies try to change people’s taste to a
fatty and high calorie content foods. To counteract these effects, people buy more
healthy food when their placed in strategic places, when fresh fruit and vegetables
are placed at the checkout instead of sweets and also when people are financially
rewarded for losing weight, they also engage more at losing weight.
3. Health behavior challenges
It is necessary a more precise and mechanistic approach in order to better
understand the process of health decisions (DeStasio et al., 2019).
Conner and Norman (2017) make a review of four health behaviors, smoking,
binge drinking, healthy diet and physical activity. According to Conner and
Norman, health behaviors include ‘behavioral patterns, actions and habits that
relate to health maintenance, to health restoration and to health improvement.”
In order to understand what health behavior is, it is necessary to first define what
behavior is. Majority of reviews are based on self-report measures of behavior,
which poses problems with reliability due to the low correlation between selfreported and objectively measured physical activity. According to the authors,
“definitions of physical activity vary along the dimensions of frequency,
intensity, time or duration and type.”
Another problem faced is the relation between the definition of health behaviors
and the several possible health outcomes. For example, according to Conner and
Norman (2017), a healthy diet represents a very complex situation due to “the
mixed evidence about which components of diet (e.g. fat content) are important
to which health outcome”.
The third issue pointed out on this publication is the link between health behaviors
and to the estimates of prevalence. There are problems of consistency of how
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56
health behaviors and related outcomes vary across different segments of
population, across countries.
It is important to have standard definitions and measures across countries to better
understand and correlate health behaviors with desired health outcomes. Another
crucial factor is how is data collected and published across countries. The study
of health behavior would greatly benefit if there were consistent definitions for
each health behavior, the data collected would have the same standards for
collection and stored in a single publicly available to anyone.
The interventions reported to change health behaviors always produced smallsize effects on target health behaviors, which “highlights the need for systematic
programmes of research to develop more effective interventions” also it “might
suggest the presence of potential moderators of intervention effectiveness”. “Four
potential moderators worthy of further investigation are: the use of theory,
behavior change techniques, modes of delivery and level/type of intervention”
(Conner and Norman, 2017).
4. The potential of blockchain in healthcare
Blockchain is changing healthcare and medicine to more reliable practices,
effective diagnosis and treatments due to the ability of being a secure vault for
storing and sharing data securely, in order to exchange sensitive clinical data, it
is required trustworthy and collaboration between the parties involved. “In the
healthcare field and clinical settings, safe, secure, and scalable (SSS) data-sharing
are highly imperative for diagnosis, as well as combined clinical decision
making.” (Siyal et al., 2019). According to Siyal et al. (2019) the biggest
constraints to safely exchanging clinical data are the sensitivity, data sharing
agreements, procedures, complex patient matching algorithms, ethical policies,
and governing rules.
Blockchain technology is a decentralized, peer-to-peer, ledger that uses
cryptography and distributed consensus algorithms to add transactions to the
network. Syial et al. (2019) defines the blockchain network as having the
following 6 characteristics: Decentralized, Transparent, Immutable, Autonomy,
Open source and Anonymity.
Several studies have been made to use blockchain in several domains of
healthcare such as neuroscience, genomics medicine, clinical, pharmaceuticals,
biomedical and HER medical. The Healthcare Data Gateway is a centralized
private network which allows patients to have freedom to access, monitor and
manage their clinical data. Another study based on the Ethereum protocol, allows
for safe usage of sensor monitors enabling practitioners to track the healthcare
status of their patients remotely. Blockchain can also play an important role in
biomedical research and clinical areas as the blockchain can be used to store all
Mafalda Santos: Preventive Health Behaviour – A Blockchain Economy Review
57
the consents, protocols, plans and smart contracts can be used in each step.
Blockchain based technologies can be used for telemedicine, remote operations,
support an active living of aging people and many more health applications.
Medical drug supply chain is prone to fraud as there’s several intermediaries
along the chain, a blockchain platform would introduce transparency and
traceability across all the chain. Developments in neuroscience could benefit from
blockchain technologies to store electric brain activity, brain activity is then
translated into commands to control external electronic devices. An example is
the company Neurogress that uses machine learning to improve brain activity
reading accuracy. “Blockchains are a form of information technology with
several important future applications, capable of supporting brain augmentation,
stimulation of the brain, brain thinking and digitize a brain” (Syial et al., 2019).
These technologies can be used to record sensory experiences, improve decision
making, and leaning.
After the text edit has been completed, the paper is ready for the template.
5. Directions for future research
By understanding that people have bounded rationality and don’t always make
decisions in their own best interest and that increasing taxes and providing more
information isn’t always the solution to help people making better decisions, with
the use of behavioral economics, blockchain and artificial intelligent algorithms,
it would be interesting to understand how ones decisions can be changed, how to
incentive people to adopt health behaviors by building blockchain applications
that support decision making. With the usage of nudges by reducing the amount
of choice and information available and as such reducing the cost and cognitive
effort and decision fatigue and reducing heuristic decisions. To promote people’s
welfare by supporting them to make healthy decisions.
6. Conclusion
Neuroeconomics and behavioral economics developed important theories about
the decision-making process and where in the brain those decisions take place.
Understanding how people make decisions, what motivates/demotivates them in
decision making can lead the way to develop strategies to incentive preventive
health behaviors and consequently prevent certain diseases and related deaths.
The core nature of blockchain of being transparent and immutable can help
resolve many of the issues health behavior studies are facing. Also, blockchain
applications can be used to support people making better health decisions,
adopting health behaviors and eschew preventable diseases.
Mafalda Santos: Preventive Health Behaviour – A Blockchain Economy Review
58
References
Rice, T. (2013). The Behavioral Economics of Health and Health Care. Annual
Review of Public Health, 34(1), pp.431-447.
Conner, M. and Norman, P. (2017). Health Behaviour: Current issues and
challenges. Psychology and Health, 32(8), 895-906.
DeStasio, K. and Clithero, J. and Berkman, E. (2019). Neuroeconomics, health
psychology, and the interdisciplinary study of preventive health behaviour. Social
and Personality Psychology Compass, 13(10).
Siyal, A., Junejo, A., Zawish, M., Ahmed, K., Khalil, A. and Soursou, G., 2019.
Applications of Blockchain Technology in Medicine and Healthcare: Challenges
and Future Perspectives. Cryptography, 3(1), p.3.
Renta Tenório Sorrentino: Cyber Laundering and its Economic Impact on Money Launderers
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Cyber Laundering and its Economic Impact on Money Launderers
Renata Tenório Sorrentino
Abstract: Money Laundering has been a critical issue in society for
years. It plays a role in the financial and non-financial sectors as it
interferes indirectly on the costs that are applied to the users of these
services due to the Anti-Money Laundering controls that some business
sectors are obliged to implement. However, Anti Money-Laundering
(AML) controls are increasingly making money launderers’ lives more
and more difficult due to the advance of technology and stronger
regulations. Such controls are forcing launderers to search for new
methods to cleanse their dirty money without raising suspicion or to
avoid being prosecuted, causing a higher cost in the money laundering
process. Through the revolutionary creation of Blockchain technology,
Satoshi Nakamoto introduced cryptocurrency to the world. An invention
that would help many unbanked people to have access to the financial
system, to give people autonomy on their money without any
governmental or third-party intervention, and to reduce the instance of
payment fraud. Unfortunately, when a new opportunity arises, criminals
and money launderers seek to take advantage of these new
opportunities. After exploring many relevant works in this research
topic, the Literature Review aims to expose the vulnerabilities of the
cryptocurrencies' features while analysing the economic incentives of
them for the money launderers to increase their revenue and it makes
a comparison between the traditional Money Laundering and Cyber
Laundering.
Keywords: Anti-Money Laundering; Money Laundering; Cyber
Laundering; Cryptocurrency; Blockchain
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60
1. Introduction
Markets in development that are implementing new transaction methods such
as digital currencies can transform communities and economies around the
world. However, with these new technologies, new risks to effective and
operational economies, societies, and everything that is involved with them are
emerging. Still, anti-Money Laundering controls are lacking in regulations,
legislation, and governmental rules concerning the risks that the blockchain
derivatives may bring to societies (Kosobutskaya & Rudakova, 2018).
Cryptocurrency instruments are vulnerable to criminal actions. How fast new
cryptocurrencies can be created and how fast the transactions through it can be
completed are challenging law enforcement and the sectors that are obliged to
follow AML controls (Holman & Stettner, 2018). “Many of these risks
materialize not on the blockchain itself, but in the surrounding ecosystem of
issuers, VCEs, and wallets that support consumer access to DLT” (Holman &
Stettner, 2018).
In 2017, $266 million was laundered and in only the first half of 2018, $ 761
million was laundered by money launderers using cryptocurrencies. It was
estimated that in 2019, more than $ 1,5 billion would be laundered. In Europe
alone, Europol estimates that criminals have laundered from $4.1 to $ 5.5
billion (Kosobutskaya & Rudakova, 2018).
2. Money Laundering
The definition of Money Laundering is "the process of making illegally-gained
proceeds (i.e. 'dirty money') appear legal (i.e. 'clean')" (Bryans, 2014).
Money Launderers try to disguise the proceed of crime without any suspicion
to be able to re-use that illegal money as if it were obtained legally. Their idea
is to break any link with the underworld (Brenig et al., 2015).
The biggest portion of illegal profits is in cash due to its anonymous and
untraceable properties, making it difficult to be caught by authorities (Brenig
et al., 2015).
Placement, layering, and integration are the three phases of Money
Laundering. This process can be seen below in Figure 1. Placement is when
the launderer place the illegal money into the financial system (i.e. legitimate
small business) (Mabunda, 2018) in a way or place that authorities are less
likely to suspect (Brenig et al., 2015).
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The second phase layering is when a sequence of transactions is made in
different institutions or jurisdictions to make the traceability of the criminal
gain more difficult and more distant from the committed crime (Mabunda,
2018). The type of transactions could be by buying and selling investment
instruments or by transferring the illegal money to multiple accounts,
preferentially, to accounts in jurisdictions where the AML controls are
ineffective (Brenig et al., 2015).
The third and final phase is the Integration. At this stage, the criminal fund is
re-integrated into the financial system as if it was gained as legitimated, such
as selling a good or service and depositing the amount back into the bank
(Mabunda, 2018).
As the distance between the ill-gotten fund and the crime increases, this makes
it more difficult to detect. Businesses and particularly financial institutions
should have tactics and procedures in place to detect the crime in the early
stages (Cabral, 2019).
The biggest problem regarding money laundering across the world is the direct
interference it causes in the countries’ economies and its integrities, including
in financial institutions, having as a consequence, interference in the cash flow
and international investments avoidance (Mabunda, 2018).
Besides, Money Laundering is, also, intimately connected to terrorism
financing, corruption, and infiltrating politics (Gonçalves, 2019). Concerning
terrorism, the financing can proceed from legal or illegal actions. What it is
difficult to detect from this activity is that terrorism financing is, usually, made
of transactions of small amounts and from a legit source. The main difference
between money laundering and terrorism financing is the purpose of both. One
intends to hide the gain obtained from criminal activity, while the other focuses
on hiding the intention for what that money is going to be used for (Cabral,
2019).
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Figure 1. Three phases of Money Laundering. European Institute of Management &
Finance (2018).
Although the act of money laundering is a non-violent crime, criminals are
always searching for new methods to cleanse their illegal money and the
internet and crypto currencies has provided them with ways to do this
(Gonçalves, 2019).
Banks and financial institutions are the preferred method used by criminals.
However, virtual currencies are becoming popular which is increasing online
money laundering (Mabunda, 2018).
2.1. Impact of Money Laundering in Society
Crimes such as drugs, sex, human trafficking and illegal gambling are
incentivized to operate and to grow when criminals can make profits from such
illegal networks and are successful in doing it. This causes a serious threat to
society (Brenig et al., 2015), as it is not a victimless crime, producing suffering
around the world (Weber et al., 2019).
Money laundering threatens the financial systems as well when, for example,
'the financial resources for criminals and terrorists to operate and expand their
business, undermine the legitimate private sector and financial markets and
diminish tax revenues' (Brenig et al., 2015).
2.2. Money Launderers X AML Controls
Until 2018, 'the annual value of money laundered globally stands between 2%
and 5% of global gross domestic product, meaning that between US$800
billion and US$2 trillion are laundered each year' (Gonçalves, 2019).
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63
For the money laundering to be successful, it depends 'on the existence of
information asymmetries between money launderers and investigative
authorities' (Brenig et al., 2015). This process is called the Money Laundering
Process and it is performed through a Money Laundering instrument.
Lawmakers and authorities are in charge of procedures and regulations to
establish AML controls. The stronger the AML control is, the more difficult is
for money launderers to proceed with their cleansing obtained on their criminal
acts. 'They aim at decreasing the information asymmetries between money
launderers and investigative authorities' (Brenig et al., 2015).
Basically, the money launderers will be more incentivized to utilize certain
Money Laundering instruments when the AML controls are weaker, as
criminals will keep their expenses at a minimum, turning profits during the
cleansing process higher. For this reason, some ML instruments will be more
advantageous than others from an economic perspective. In addition to that,
another motivational factor is concerning the risk. When procedures and
policies are heavily implemented in specific instruments, it causes a negative
incentive as the risk of detection of suspicious activities and on individuals
increase. “This risk imposes costs on criminals and therefore negatively
influences their economic incentives for utilizing a ML instrument” (Brenig et
al., 2015).
To reduce the level of risk, money launderers may increase the level of
methods, such as multiple transactions, multiple jurisdictions, additional
parties, etc. However, such implementation would increase the cost of the
Money Laundering process. Another option, when available, would be to use
less risky instruments or not launder the money that was originated from the
criminal act. “That is the case when the costs for laundering money undetected
are greater than its valuation” (Brenig et al., 2015).
3. Anti-Money Laundering Controls
It is not the purpose of this literature review to analyze individual AML
controls that financial institutions and specific sectors are required to be
compliant with the recommendations of the Financial Action Task Force
(FATF) or any other regulation, directives or acts, in international or national
level, however, the most effective prevention against money laundering is the
risk approach method through Know Your Customer (KYC) process, followed
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64
by High-risk countries analysis, record keeping, auditing, training and the
obligation to report suspicious activities. For the purpose of this literature
review, a superficial explanation of KYC will be made.
3.1. Know your Customer
KYC is the most efficient method of combating money laundering as it
provides businesses (banks or required sectors) to identify their customer, by
their identification document, proof of address, and photography (Brenig et al.,
2015)
This requirement of KYC can be grouped in 3 different moments: a) in the
beginning of customer-business relationship; b) During the customer-business
relationship, called ongoing monitoring; c) after the business relationship,
when the business needs to keep a record for audit trails purposes (Brenig et
al., 2015)
The purpose of the KYC is not only to know the customer's identification but
to "know enough about their customers to be able to determine the risk level
they represent to the institution." (Financial Crimes Enforcement Network,
2019).
4. Virtual and Digital Currencies
Digital currencies include e-money (digital 'fiat currency') and virtual currency
('non-fiat currency’) as the two types of digital representations (Gonçalves,
2019).
Different to e-money, virtual currency is not controlled by any financial
institution or jurisdiction and the users must validate it to make a valid
representation of the payment. Also, virtual currency can be convertible, when
it can be exchanged for fiat currency, and non-convertible, when no exchange
is possible, as they are issued by a central authority (centralized). Convertible
virtual currencies can be centralized or decentralized (Gonçalves, 2019).
Whereas decentralized currencies are not issued or supervised by any central
authority, centralized currencies are, “which means that a third party controls
the system as it "issues the currency; establishes the rules for its use; maintains
a central payment ledger; and has the authority to withdraw the currency from
circulation” (FATF, 2014).
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65
Figure 2. Digital Currencies. Gonçalves (2019).
For this Literature Review, only cryptocurrencies will be explored, and any
indication of virtual currency may be understood as cryptocurrency. Although
there are many cryptocurrencies available on the market, Bitcoin will be used
on this project as it is the most popular among academics.
4.1. Cryptocurrency
One of the main reasons for the creation of virtual currencies was to have an
alternative payment method that could be used by a portion of society that did
not have access to financial institutions due to their low-income (Weber and
Domeniconi et al., 2019).
This is because AML controls are costly to financial institutions which means
that it has a negative impact on low-income people, refugees, and immigrants.
Approximately 1.7 billion adults are unbanked. In addition to the costs of
policies and procedures implementations, the risk of compliance failures
increases the negative impact on the less favored, a risk that the financial
institutions do not want to bear (Weber and Domeniconi et al., 2019).
“Consider global remittances to low-and middle-income countries, which
reached a record-high $529 billion in 2018, far outpacing the global aid
contribution of $153 billion. The current average cost of sending $200 is an
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66
expensive 7 percent, with some countries suffering rates of over 10 percent.
The United Nations Sustainable Development Goal number 10.7 targets a
reduction to 3 percent by 2030” (Weber and Domeniconi et al., 2019).
For these reasons, cryptocurrencies were well-received for their low costs and
accessibility as they do not involve a third party due to their peer-to-peer
network protocol (Pocher, 2020).
Cryptocurrency is defined as "a type of unregulated, digital money, which is
issued and usually controlled by its developers, and used and accepted among
the members of a specific virtual community" (ECB, 2012).
Undeniably, Bitcoin is the most popular cryptocurrency that exists and to
create a Bitcoin account (software), the user needs to download the Bitcoin
software at https://bitcoin.org/en/choose-your-wallet, and users will have a
digital wallet where they can store their bitcoins (digital currency). To create
a Bitcoin account, users do not need to provide their real names or proof of
identity. Once the account is created, each individual user is a node in the peerto-peer Bitcoin network, making them, part now of the Blockchain structure
(Böhme et al., 2015).
“Bitcoin is built on a transaction log that is distributed across a network of
participating computers. It includes mechanisms to reward honest
participation, to bootstrap acceptance by early adopters, and to guard against
concentrations of power. Bitcoin's design allows for irreversible transactions,
a prescribed path of money creation over time, and a public transaction
history” (Böhme et al., 2015).
The idea of this literature review is to not go into the deep technicalities of
cryptocurrency. For this reason, a superficial explanation of its characteristics
will be explained to understand its vulnerabilities that could be used by money
launderers.
4.1.1. Anonymity
Bitcoin is well-known for being anonymous, however, it is considered to be
pseudonymous and, although it might be difficult to identify the person behind
the transaction, it is not impossible. One of the solutions would be to have
identities requested in the moment that cryptocurrencies are exchanged by fiatcurrency on the terminals and vice-versa (Mabunda, 2018).
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According to Pfitzmann & Hansen (2010), "a pseudonym is an identifier of a
subject other than the subject's real names". Therefore, without access to
identifying information from outside the system connecting public keys with
subjects, it is impossible to identify particular individuals (Brenig et al., 2015).
As blockchain analysis has been enhanced, a certain degree of traceability is
also been improved over time and there will be always ways to connect real
identities to public addresses, even when the account creator did not inform his
real identity (Pocher, 2020).
The anonymity will be preserved as long as the users do not interact with third
parties that are not involved in the network, such as exchanges and online
retails (Brenig et al., 2015).
Additionally, Bitcoin mixers were created involving “inputs and outputs of
different transactions into a larger one, in order to sever the links between
addresses of senders and recipients” (Pocher, 2020). This type of mixing
service is offered to obscure the traceability record (Pocher, 2020) and the most
efficient is located in countries where the AML controls are soft (Crawford &
Guan, 2020).
The anonymity of cryptocurrency is useful for illegal purposes as it can be an
effective feature for money laundering. The pseudonymous feature of the
cryptocurrency is a positive incentive for money launderers to use the network
as a money laundering instrument. However, due to the transaction records, if
the traceability connects to an account where the user can be identified, it can
cause a negative incentive to use this instrument (Brenig et al., 2015).
4.1.2. Speed and Portability
Transaction within the peer-to-peer network allows the user to transfer
cryptocurrencies in real-time and to any jurisdiction without any impediments,
as long as the internet is available. Portability incentivizes money launderers
positively as it makes transactions monitoring more difficult (Brenig et al.,
2015) and causing jurisdictional issues (Pocher, 2020).
Time efficiency and jurisdiction boundaries are also positive factors to
incentivize money launderers (Brenig et al., 2015).
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68
4.1.3. Decentralization
The idea in the creation of cryptocurrency was to have no intervention from
central authorities whatsoever (Pocher, 2020). For this reason, law
enforcement cannot interfere in illegitimate account creations (even if one
person creates multiple accounts) or to confiscate ill-gotten funds, causing
positive economic incentives to money launderers (Brenig et al., 2015).
4.1.4. Flexibility
Accounts are easily created and transactions are easily operated (Gonçalves,
2019), economically incentivizing positively the use of cryptocurrencies for
money launderers (Brenig et al., 2015).
4.1.5. Low Transaction Costs
As the transaction activities are made between the peer-to-peer accounts, the
only transaction cost existent is the operational cost, which is the cost to have
the payment authenticated and verified (Brenig et al., 2015).
The profit of the Money Laundering is higher when the cost of the transaction
is lower. For this reason, this factor is, also, a positive economic incentive to
money launderers (Brenig et al., 2015).
4.1.6. Lack of Regulations
The lack of AML regulation on cryptocurrencies increases the chances that
criminals will use cryptocurrencies as an instrument to launder their ill-gotten
money (Gonçalves, 2019). Banks are not taking crypto coins seriously due to
the lack of regulation on AML and KYC rules, while some firms are applying
AML compliance methods on their crypto coins services according to existent
AML law (Campbell-Verduyn, 2018).
4.1.7. Irrevocability
When the transaction is completed, it is not possible to be revoked, not even
for law enforcement. This characteristic is also financially positive to money
launders (Brenig et al., 2015).
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69
4.1.8. Price Volatility
As cryptocurrencies are not backed by fiat currencies, their price volatility
fluctuates constantly, forcing money launderers to monitor the market
frequently to not have their funds reduced during the exchange, providing a
negative economic incentive for money launders (Brenig et al., 2015).
5. Cyber Laundering
The evolution of the internet made it possible to money launderers to use the
online environment to cleanse their proceed of crime, due to the development
of virtual currencies and its attractive untraceable feature (Gonçalves, 2019).
In the three stages of money laundering based online, the placement stage
would take advantage of how fast an account can be opened and accessed and
the pseudonymity on the settlement of the ill-gotten funds. The facilitation to
transact to other jurisdictions, using multiple exchanges would implicate the
layering stage. Criminals can purchase services and goods in cryptocurrencies
(Pocher, 2020) or exchange for fiat currencies (Gonçalves, 2019) to complete
the final and last stage of integration (Pocher, 2020).
In Europe, three to four billion pounds ($4.1 to $5.5 billion) of illicit money is
being laundered by criminals, through the purchase of Bitcoin and its
distribution in smaller parts in different e-wallets and addresses (Kosobutskaya
& Rudakova, 2018).
The process and consequences of money laundering in the online environment
is the same, however, the possibilities the cryptocurrencies’ characteristics
provide challenges the regulators (Mabunda, 2018). The Financial Action Task
Force (FATF) has recognized that cryptocurrencies are susceptible to be
exchanged for fiat-money and vice-versa for launderers and terrorists as
transfers between senders and recipients are permitted without proper
identification (Kosobutskaya & Rudakova, 2018).
Launderers may be perpetrating online crimes, such as ransomware, malware,
etc., and laundering the proceeds of those crimes in an online environment as
well, through cyber laundering.
The clean money might be used to commit new illicit crimes as well
(Gonçalves, 2019). Such as the traditional money laundering method,
cryptocurrencies are also used for terrorism financing purposes, however, the
last one provides an even greater advantage to terrorists as increases the level
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70
of anonymity and due to the real-time transactions to other jurisdictions
(Gonçalves, 2019).
Figure 3. Crypto-laundering process. Gonçalves (2019).
5.1. Economic Considerations on Cyber Laundering
There is a lack of in-depth analysis on the economic benefits for money
launderers and, due to this reason, it is assumed that launderers are incentivized
to choose to proceed with cyber laundering instead of traditional money
laundering because of the characteristics of cryptocurrencies. Factors that may
affect the process of money laundering still need to be analysed, as they might
influence the economic incentives on criminals (Brenig et al., 2015).
In contrast, the integration of illegal funds is more limited compared to
traditional money laundering as the acceptance of cryptocurrency is not as
broad in cyber laundering, restricting the movement of large amounts of illicit
funds and posing a negative incentive on money launderers (Brenig et al.,
2015).
The importance of choosing the money laundering instrument that will be
applied to money laundering activities must be taken into consideration as its
costs are transaction costs. As criminals need to make multiple transactions
with their ill-gotten funds and, sometimes, in different jurisdictions to reduce
their risk of being caught, lowering the transaction costs means a higher
revenue to them. For this reason, cryptocurrencies show to be a better costefficient instrument, which offers more positive incentives to launderers
compared to the traditional money laundering. However, “technological
Renta Tenório Sorrentino: Cyber Laundering and its Economic Impact on Money Launderers
71
developments and regulatory approaches may affect the economic incentives”
(Brenig et al., 2015).
Factors that may affect economic incentives would be technological
developments focused on transaction traceability, the applicability of rules to
monitor suspicious transactions, and to link transactions to the real users as
precise as possible. The regulatory approach would, also, influence the
economic incentives. These considerations would increase the costs on money
launderers as they would need to implement new money laundering methods,
or they would need to accept a higher risk of being prosecuted for their illicit
transactions (Brenig et al., 2015).
Particularly concerning Bitcoin transactions, another aspect that might affect
the incentive of launders is the risk scoring tools that were developed by AML
compliance programs and have been implemented by exchanges and services
providers. In the case where a Bitcoin has a suspicious or high-risk past, it may
have its valuable decreased in comparison to Bitcoin with no such risk score
(Crawford & Guan, 2020).
6. Conclusion
As criminals will always pursue new methods to commit their crimes, the
online environment has opened many doors as the risk of getting caught is
lower compared to the physical world. For money launderers, this is no
different.
As traditional money laundering is facing an increase in transaction costs and
the risk of prosecution due to the improvements of AML controls, money
launderers are looking for new instruments of money laundering to reduce their
costs and to decrease the risk of being caught.
Cryptocurrencies are a great invention that can benefit many people. However,
AML controls are facing a serious threat because of the use of cryptocurrencies
for the bad as some of its characteristics is to protect the autonomy of the users,
which encourages criminals to commit online crimes and cyber laundering.
For this reason, criminals are immigrating to the online environment as they
are having better befits from it, financially and risk-wise. The better the
effectiveness the AML control is, the less likely the criminal will use that
method. On the other hand, the weaker AML control is the more likely
criminals are to use that method.
Renta Tenório Sorrentino: Cyber Laundering and its Economic Impact on Money Launderers
72
For example, International regulations such as the Fifth EU Directive,
extended AML obligations to the virtual currency exchange platforms and
custodian crypto wallet providers. However, some other countries around the
world are in a slow-pace discussion about the implementation of rules and laws
about it. The lack of knowledge of lawmakers and governments in the
technological area is one important reason why there are still many countries
struggling to implement AML regulations on virtual currencies.
In addition, filling the technological gap between account users and anonymity
is essential to link money laundering to criminals and enhancing technology
developments to track suspicious activities and patterns are vital as well.
New technologies will emerge from time to time and lawmakers and
governments should act fast, otherwise, their inertia or endless bureaucracies
will be condescending with the launderer's crimes. While cyber launderers get
away with their crimes, society and victims are the ones that are being
punished.
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