Editor’s Note: On May 10, Cai Weide, Senior Researcher of the Chongyang Institute of Finance of Renmin University of China, Professor of Beijing University of Aeronautics and Astronautics, Tsinghua Changjiang Chair Professor, and Director of the Digital Society and Blockchain Lab of Beihang University, shared his views on “Blockchain” in the fourth lecture of the “Technology, Market and Regulation in the New Currency War” series of live events hosted by NPC Chongyang. He shared his latest thoughts on “Blockchain Technology Reform”. The content of this session is divided into two parts, the following is the live video and the transcript of the next part.
When we look at Bitcoin and PFMI, it is easy to see that it is very risky. a key point between PFMI and digital currencies is whether transactions are separated from settlements, is this a step back or progress?
Is it possible that P2P network protocols will wipe out financial markets? It’s possible, as you can see by the large amount of foreign exchange that is already leaping through Bitcoin in many countries right now. If not Bitcoin, there are new digital tokens that will come out later, and they will have higher technology than the current Bitcoin technology.
It is not “decentralized” but has many central units, regulatory units and financial institutions on it, which is a new type of financial blockchain system.
Principles of Financial Market Infrastructure Establishment: PFMI Architecture
A very important principle is the Principles of Financial Market Infrastructure (PFMI). You will find that if the financial system of the whole world complied with PFMI during the international financial crisis in 2008, the financial crisis in one country would not have spread to other countries. So when the PFMI was proposed, more than 150 countries, including China, signed up to participate.
In 2017, the Bank of Canada took the lead in using PFMI to evaluate blockchain systems. PFMI is the evaluation of financial systems, and in 2018 I proposed that blockchain basically cannot change PFMI, and blockchain will change because of PFMI. Because financial principles cannot be changed casually, PFMI is a conclusion reached by thousands and tens of thousands of people, and there are many lessons in it.
- List of PFMI principles
l General structure: 1) legal basis (legal basis), 2) governance (governance), 3) integrated risk management framework.
l Credit risk and liquidity risk management: are there 4) credit risk, 5) collateral risk, 6) margin risk and 7) liquidity risk.
l Settlement: 8) finality of settlement, 9) monetary settlement, and 10) how physical delivery is resolved.
l Central securities depositories and exchange systems (central securities depositories): on why to do 11) central securities depository systems (CSD), the British and some units have had discussions, but did not come to very mature conclusions. 2019 the Bank of France adopted a blockchain-based CSD system, which is a very important system.12) Value exchange settlement system.
l Default management: 13) Default systems, rules and procedures for participant-default (participant-default rules and procedures). 14) Isolation and portability.
l Business and operational risks: 15) General business risks, 16) Custody and investment risks, 17) Operational risks.
l Access management: 18) Access and participation requirements, etc.
l Efficiency: 21) Efficiency and effectiveness, 22) Communication procedures and standards.
l Transparency: 23) Disclosure of rules, key procedures and market data; 24) Market data disclosure.
As can be seen, PFMI is a very complete set of systems.
- PMFI Application and Interpretation
One PFMI alone is not enough to design a blockchain system. the PFMI is a generic principle, if it is a traditional system, we use an interpretation based on the PFMI of the traditional system; if it is a new system, an interpretation based on the PFMI of the new system is needed.
Since the Bank of Canada started doing it, many research institutions have been discussing the relationship between PFMI and blockchain. Initially, the first generation blockchain system was formed by Ether or some supply chain system, and the interpretation of the first generation blockchain system PFMI was generated based on the first generation blockchain system PFMI, and the design of the second generation blockchain system was generated based on this interpretation. Each time the interpretation is different, the principles are the same, but the use will have some gaps in landing. When discussing the use of PFMI to guide blockchain design, the design ideas involved need to be well considered, because while more than 90% of the issues have been concluded, there is room for discussion in 5% to 10%.
- whether transactions and settlements should be separated can be discussed
Some PFMI rules are not related to the blockchain system or to the digital currency system. If the digital currency is with token, as long as you get the token, it means there is cash and there is no credit risk. I have talked about how the Bank of England started because there is no credit risk with digital currencies. With digital currency, the credit risk of the currency is gone, but there are other risks, and the financial risk of the institution still exists.
- PFMI still needs to be reinterpreted in the next generation of financial blockchain system
The general secretary talked about China’s intention to develop an international standard, and one of the international standards can be discussed, under the guidance of PFMI, how to propose the right of interpretation for the second generation blockchain system, which is a topic that can be studied.
- The evaluation of digital tokens now
From PFMI can see that digital tokens are just full of risks
- is transaction=settlement good or bad?
When we take Bitcoin and PFMI and look at it, it is easy to see that it is very risky. a key point between PFMI and digital currencies is whether transactions are separate from settlements. is this a step back or a step forward? The U.S. Private Digital Dollar Project and the U.S. Treasury Department believe that “transaction = settlement” is good, but regulators such as the Bank for International Settlements believe that it is bad, and you can see that compliance agencies are divided into two factions, one that believes that transactions and settlements should be separated, and the other that they cannot.
The Bank of England proposed to do RTGS real-time full settlement system, its “real-time” is 2 hours real-time settlement, 2 hours is very long in digital currency. The Bank of England proposed to set the real-time settlement based on RTGS for 2 hours is enough, but in 2 hours, the regulatory platform may have run the risk analysis in the background for a thousand times.
Blockchain core design issues
Previously talked about blockchain is block sub-chain + multi-node + Byzantine General.
- Blockchain is basically to support the inability to tamper.
- Multi-node is to support data consistency, digital consistency of distributed systems.
- Byzantine general is to discover liars.
This blockchain definition supports immutability, data consistency, and discovering liars, but this also means that blockchain has no transactivity, blockchain has no self-contained transactional completeness of its own, and there is no discussion of regulativity. All these need to be added to the blockchain system.
Blockchain as a trust machine is incapable of tampering, data consistency and detection of insider lying, which are the three basic trust mechanisms of blockchain. But blockchain systems do not come with transactional and regulatory properties.
Transactivity is when the same input yields the same result; consistency + transaction ordering is what is called transactivity. Transaction ordering is always getting the same result regardless of how the system is run. For example, any optimization can be done in execution (e.g. parallel processing, slicing, etc.), but the final result is consistent, and the final transaction ordering determines the final result of the financial transaction. For example, a financial system can buy (payment) or sell (revenue), and if it pays without revenue, the system goes wrong.
- Blockchain systems cannot support digital currencies without transactivity
Some blockchains have good consensus and Byzantine generals but no transactivity, then they can’t pass the important Fed hurdles and this chain is basically useless in financial markets. Transactivity can be done in different ways.
- A simple one is to find a central node and line up all the transactions so that you can have transactional completeness, but the system becomes centralized and it becomes a pseudo-chain instead of a blockchain, which is the reason why blockchains have always had pseudo-chains.
- For example, bitcoin and ethereum have token tokens that are rolled back with a fork, and it becomes a so-called probabilistic.
- The third is that it’s harder to do transactional processing together while doing consensus. In fact it was a study I did back in 2015 where I was doing consensus while doing transactional, and distributed processing, and the algorithms on both sides of that were grinding against each other.
- I spent a lot of time getting it done in 2015 and 2016, but then a new idea emerged that transactional and consensus don’t need to be tied together at all, transactional is transactional and consensus is consensus, which turned into a next-generation blockchain system. Why should transactional and consensus be separated? Because consensus is only consistency, and transaction has to have transaction sorting in addition to consistency, so consistency should be below, and transactivity should be above. After this, the whole blockchain kernel structure and system will be changed, and some engineering problems that were difficult before suddenly become very simple, so this is a major breakthrough of the next generation blockchain system in 2020.
An important concept of financial blockchain Any financial blockchain design must solve the transactional and regulatory nature in a distributed environment before considering other system functions, otherwise the chain will have systemic risk or money laundering risk, and the faster the speed, the greater the risk. If these problems cannot be solved, the chain cannot be used on the financial system, because even if only one or two transactions go wrong, it will cause a big chaos in the financial system and banking system.
Robustness, scalability, security can not destroy the transactional and regulatory. every paragraph of the PFMI document that talks about scalability talks about reliability, it can be extended, but it must be very reliable, so if it is not reliable, do not extend it.
- the previous P2P protocol almost wiped out the music industry, so the technology is suitable in the financial industry?
Including bitcoin and ethereum, there are many blockchains that also incorporate P2P network protocols after design. First of all, it is important to know that P2P network protocols almost wiped out the world’s music industry at that time. It took a number of music companies coming together to sue the founders of the P2P network to bring back the music industry, but it also caused the entire music industry to change the way it served its customers and go online a lot.
P2P network protocols are very difficult to remove and adaptive. Now is it possible that this technology that was almost the world’s music industry is the right technology for the financial system and money industry?
To this day, many people still put this P2P protocol into the definition of blockchain, and many blockchain books believe that without this protocol, it is not a blockchain system.
- the use of P2P protocol is to prepare the financial industry to be wiped out
Is it possible that P2P network protocols will wipe out the financial market? It’s possible, as you can see by the large amount of foreign currency that is now flowing through Bitcoin in many countries. If not Bitcoin, there are new digital tokens that will come out later, and they will have higher technology than the current Bitcoin technology.
How can the system avoid P2P network protocols wiping out the financial system? Because there will always be people using such technology, and such technology could then disrupt the current financial system. a JP Morgan report in February 2021 said that a large part of the current foreign exchange management is not that effective anymore, because many people can use bitcoin but without going through SWIFT and the banks’ methods.
In mid-2020 the U.S. RegTech released data saying that a lot of foreign exchange has been going through Bitcoin all over the place, so the U.S. is starting to regulate these strictly indirectly. But eventually we’re going to have to solve the problem with directness, and that requires the interlinked network, because the interlinked network can remove systems like this.
Many countries are studying how to remove this problem technologically, to solve the “hard to remove” feature. So for the last year I have been talking about the importance of the Internet, which is a huge opportunity for the network.
- Give up multi-node means give up transactivity and regulation
Some people say to give up multi-node feature (the same information exists on each node, and each node works independently), but if we give up the mechanism of multi-node, it means different nodes have different information, which is equal to giving up the transaction, and also giving up the regulation, because not every node has the same data, and it is hard to make transactions. To date, there is no effective solution to give up multi-node and still maintain transactional or regulatory nature.
Inappropriate sharding gives up transactivity
Some people say that computers do sharding (that is, putting data or computation on different servers), but this has many difficulties. Some sharding techniques are not designed well and run into the same problem of giving up multiple nodes, which also gives up transactivity.
Abandoning transactivity is the same as welcoming systemic financial risk
Some say that disregarding transactional ordering is like Bitcoin Ether without special ordering and putting it straight up for trading. First of all, Bitcoin doesn’t give up transactivity, it just uses a different approach to this problem. Bitcoin and ethereum use token technology, network-wide bookkeeping, and probabilistic, and rollback when problems arise. Because of the uniqueness of token, these digital token systems can be solved by this method. However, the method is very inconvenient, very difficult to scale, and very poorly regulated, which cannot be accepted by the financial market. If there is no tradability, it equals to a systemic risk.
Financial Blockchain Design Principles
I propose a financial blockchain design principle.
Transactional, regulatory, security, trust and scalability, whether the transaction has consensus, completeness, process, whether it can be rolled back, with these things to be considered a financial blockchain design.
Then there is regulatory, whether there is KYC, AML, whether it is able to query and escrow, whether there is such a regulatory agreement, and whether it is able to support multi-asset regulation.
If consensus and completeness are separated, and consensus and transaction are separated, things will be simpler.
- New definition of blockchain
Traditional blockchain architecture is blockchain + prophecy machine, now the overall blockchain architecture is blockchain + smart contract + prophecy machine, the system is greatly extended.
The prophecy machine, smart contract system and blockchain system we see in 2021 are not the same as before, but basically they are still
- Blockchain systems (ledger systems) control the data.
- Smart contracts control the process. Smart contracts can’t just be written, they have to be standardized, and they are serviceable. So, it has to have a model for smart contracts, it has to have methods, it has to be regulated, and the execution is complex, and the whole smart contract system is not the same as the traditional one anymore.
- The prophecy machine is in contact with the outside world and controls the interface of the outside system, but now the prophecy machine can again use the blockchain and smart contracts.
Such a system has changed dramatically in 2020 and 2021, and now we use the same terms as blockchain systems, smart contracts and prophecy machines, but we have a different interpretation and view.
- The prophecy machine joins the blockchain family
The diagram below is used in my book “Smart Contracts: Reframing the Social Contract”, which talks about how blockchain applications are now a complex system that includes prophecy machines, foreign exchange rates, insurance, contract terms, automatic enforcement, logic, and other aspects.
Now to use the blockchain system is complex, not “decentralized”, but there are many central units, regulatory units and financial institutions are on it, this is a new type of financial blockchain system. This is a new type of financial blockchain system. There are insurers, insurance companies, banks and various parties, and the whole system architecture, structure and participants are different, so it becomes a complex environment, and this complex environment is also a new type of software engineering.
- The next generation blockchain architecture changes
For the market, the blockchain system becomes a multi-asset open payment system instead of a single-asset closed system. As an open system, the financial underlying market will also change, the network, operating system, and database will have to change, all of which are coming, and we can find some prototypes of the system have already appeared.
When the transactions are separated from the consensus, there is basically no rollback for each consensus. Previously, if one of the 5000 transactions in a block was wrong, all 5000 transactions would have to be rolled back, and if one transaction failed, all transactions would be counted as failures, and all 5000 transactions would be rolled back and started again. But the transaction and consensus decomposition, the transaction failure is not required to roll back, this piece is also not changed and continue to move forward, only that one transaction to do a consensus again. Such a mechanism system is much more stable than before, and system stability is a necessary and prerequisite for blockchain, so that the possibility of error is much smaller. 2018 this happened in our lab, after our system ran for several days and nights, I suddenly got a call to be told that the system was all down. We found that one transaction failed, which resulted in thousands of transactions failing at the same time, and these thousands of transactions failing at the same time caused tens of thousands, millions, and tens of millions of transactions to fail at the same time behind them, and the system went down. This is a very serious problem, so the transaction consensus must be split, must be completely different mechanisms, so that the system will be very stable.
For regulatory purposes, the transaction and settlement systems are separated, which is a major breakthrough and a principle of PFMI, but the U.S. Treasury and the Digital Dollar Initiative are in favor of its non-separation.
For system simplification, code and data are separated, its previously bundled together.
For regulatory purposes, embedded regulatory mechanisms at the protocol level, which were not available before.
For expansion and market, LSO (Ledgers, Smart Contracts, Oracles) ledger system, prophecy machine system, and contract system are all decoupled in order to make the system more stable, thus turning into an engineering scientific development that eventually produces very big changes in all aspects of standardization, networking, and service.
- Diem plans to propose an overall solution
The Facebook system is a good case study. The figure below is proposed by the Bank for International Settlements when the Facebook system comes out in 2020. The Facebook system is a hybrid model, a development of wholesale chains and retail coins, and it is a hybrid regulation, that is, it is regulated by local regulation plus embedded regulation. Transactions are resolved locally if they can be resolved at a local financial institution, and only on the chain if they can’t be resolved.
Facebook’s design is a hybrid model, blending blockchain and traditional financial institutions
In this environment, the blockchain design is different and the overall design is simplified (due to the fact that there is no need to deal with personal ledgers). But this design takes into account at the same time 1) support for digital assets; 2) support for financial market structures; 3) support for regulatory compliance; 4) computer system design; 5) support for related transaction processes; and 6) support for financial system design principles. This is the case of a new type of blockchain design. And the digital currency system designed according to such system is also different from the traditional digital tokens.
Posted by:CoinYuppie，Reprinted with attribution to:https://coinyuppie.com/how-blockchain-is-shaping-the-new-financial-system-frontier-experts-explain/
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