The Dawn of Cryptofinance
The Internet of Values is arising, but financial applications on it are few. What are the reasons for its current status and what is the future of cryptofinance — Finance on the Internet of Values?
The rise of the Internet has brought great changes to people’s daily life because it caused fundamental transformations to many industries. The internet disrupted the music industry and changed the way people consume music; Online shopping squeezed the market share of the retail stores and made shopping much more convenient; And it reshaped the media industry. But the impact on finance was not as big as it has been on the industries mentioned above. The so-called ‘Internet finance’ only improves the way in which financial institutions like banks, insurance companies or securities companies reach their customers or helps to digitize paperwork into electronic forms. Although mobile payments became popular in China, the underlying banking system remains the same. The interaction of values between organizations still mainly relies on paper contracts, which is inefficient and costly.
The two key reasons behind this are 1. Currencies are controlled by different central banks and the ledgers are in ‘silo’-type systems, and 2. Contracts and signatures are intensively used in financial transactions. Although electronic contracts and electronic signatures can be used within an organization, it remains difficult to apply them on a large-scale among individuals and organizations. In order to prevent double-spending and make transactions automatic, central agencies are needed to provide bookkeeping services, such as digital ledgers, contracts and digital signatures, which is why, although these services are neither flexible nor scalable, their services are still important in current societies.
A glimpse of a new finance
The rise of the blockchain has ensured that for the first time centralized bookkeeping can be replaced by distributed ledgers on unstoppable peer to peer networks, people’s handwriting signatures can be replaced by crypto signatures, and paper contracts can be programmed and automated by smart contracts. It seems that the blockchain technology is the one that will bring fundamental changes to the traditional finance.
Bitcoin, which went live on January 3, 2009, produced the first distributed ledger, and the script on its first block reads: “The Times 03/Jan/2009 Chancellor on brink of second bailout for banks.” This makes a mockery of the traditional finance, and reveals that a new era of finance is coming.
At that time, the subprime mortgage crisis and the European debt crisis made people realize that the most developed countries in the world who traditionally play as stabilizers of the world economy are also susceptible to financial crises, for which there are almost no effective solutions. The financial crises are like wandering devils, who from time to time, make people feel frustrated. Not only that finance based on fiat is full of problems, fiat currency in itself has a problem of inflation like an incurable disease. There is no suitable international currency too. Even the US dollar issuer may say: “our currency, your troubles”, but this is an objective statement.
The traditional finance is unsatisfactory. Cryptofinance can solve the problems of trust, and create the birth of international currencies. It seems that people should embrace cryptofinance wholeheartedly.
However, after the creation of Bitcoin, there is a long night for cryptofinance. From January 3, 2009, when the first application of cryptofinance, Bitcoin, went live, to the end of 2016, seven years had passed, but except for a large number of alternative currencies that mimic or improve Bitcoin, we have not seen any laudable cryptofinancial applications created.
Traditional finance VS cryptofinance
Before we discuss cryptofinancial applications, we need to answer: What is finance? What kind of blockchain applications are considered financial applications? And we need to compare cryptofinance with the traditional finance.
In essence, finance is defined by its functions. Although the forms of realizing financial functions are changing with time, financial functions are stable.
Financial functions can be generalized into two layers:
The first layer includes the monetary functions, which are payment, pricing, value storage, international currency and so on. This layer of functions has somehow been achieved by bitcoin or other similar tokens, though they have not been widely used and their prices are volatile. Cryptocurrencies solve the double spending problem through distributed ledgers, allowing currencies to be issued and transferred without intermediaries or central agencies. Thus, the functions of central banks and the clearing houses have been realized by distributed ledgers.
The second layer includes the financial functions derived from the monetary functions, such as debt, equity, insurance, trust, derivatives, and so on, which are the reorganization of the financial assets in space and time. The functions of price discovery and risk management can be included in the second layer, since they are derived from some fundamental functions. However, there has not been a corresponding solution in cryptofinance for the financial functions in the second layer.
Banks are pools of deposits, which use the cash flow of loans to meet the cash flow of deposits. Securities, including bonds and stocks as well as structured financial products such as ABS and MBS, are the securitization and restructuring of future cash flows. Insurances, including property insurance, life insurance, reinsurance, CDS, are future cash flows triggered by different types of events. Trusts, funds, financial leasing and so on all fall into the category of wealth management, which focuses on selecting different assets into investment portfolios. Around the above functions, supporting industries, such as exchanges, clearing houses, guarantee, accounting, auditing, legislation, and mobile payment, have been created.
The market capitalization of the traditional financial markets in the world is quite large with more than 300 trillion U.S. dollars, nearly 4 times the global GDP. Among them, the value of equity assets is about 90 percent of the global GDP, that of bonds is about 2 times of the global GDP, and that of loans is about equal to the global GDP. In addition, the nominal value of derivatives is nearly 10 times of the global GDP. It is a little disappointing that at the beginning of 2017, 8 years after the launch of Bitcoin, the total market value of cryptocurrencies is only 17 billion US dollars, and applications in the second layer of financial functions is almost empty.
ICO, asset mapping and asset bonding
An important event in 2017 was the boom of the Initial Coin Offering (ICO). This is the second killer application of blockchain, following the payment application of blockchain. Thanks to ICOs, by the end of 2017, the market capitalization of cryptocurrencies has reached 650 billion U.S. dollars, an increase of nearly 40 times compared with that of the beginning of the year. The number of the types of tokens have increased to more than 1600. The phenomenon, like first ray of light after a long dark night, is a sign of the dawn of cryptofinance after a long night of cryptofinance since the creation of Bitcoin.
But how does cryptofinance work?
Blockchain’s application to finance emerged in January 3, 2009. Satoshi Nakamoto issued the first 50 bitcoins by using a small server called “Node 1” in Helsinki, Finland. But he did not imagine that the distributed ledger technology behind Bitcoin would create a huge blockchain industry and enable various assets, physical or digital, to be mapped onto the Internet of Values.
Most ICO tokens are based on the ERC20 protocol. The ERC20 protocol became available in November 2015, but it prevailed until 2017. Bitcoin and Ether are the native tokens on blockchains, but tokens issued through the ERC20 are mostly representatives of off-chain assets, which are mapped onto Ethereum by tokenization.
Tokenization is actually a counterpart of traditional securitization in the cryptofinancial world. With this artifact, any asset can be mapped onto a blockchain and be empowered with abilities such as digitalization, peer to peer transaction, and programmability.
These abilities are so important that, from now on, people will be eager to map their assets onto blockchains. Not only that some projects that have just finished proof of concept can issue their own tokens, but also physical assets such as diamond, gold, oil, land will be tokenized as values in the Internet of Values.
Cryptofinance and asset bonding services
When many assets are tokenized and programmed by smart contracts, the Internet of Values will be gradually formed. When we consider the types of values in the Internet of Values, we can find three types of values:
1) Mapped tokens: physical values by using smart contracts similar to ERC20 smart contracts to map themselves on blockchains.
2) Data: Data that can be encrypted and traded by smart contract.
3) Original tokens: the tokens embedded in a blockchain and used by the blockchains as bookkeeping fee.
Taking values in the Internet of Values into consideration, there are three types of values in the human world:
1) Physical/Atomic values and their corresponding tokens: the atomic assets that you can touch and their representatives on blockchains.
2) Digital values: the assets of data in the Internet of Information.
3) Gas: the tokens that are used as bookkeeping fee.
For physical values, bonding services are needed to create representation in the Internet of Values. These bonding services make sure that the transactions of the tokens on their blockchains are legitimate in the physical world, and anyone who has some tokens can exercise his/her rights and be delivered the represented tokenized atomic assets.
So what are bonding services?
Many ICOs are just tokens issued by Ethereum’s ERC20 smart contracts. These tokens are merely Ethereum’s bookkeeping symbols. What is the basis of their values? The values of these tokens cannot be guaranteed without the bonding services of centralized organizations. So, although the blockchain services will make many intermediaries useless, many centralized organizations will still be important. The on-chain tokens need to be bonded with the off-chain assets by centralized organizations.
On-chain tokens representing their off-chain assets such as real estates, data, financial assets and so on can be transferred without intermediaries and programmed by smart contract to make transactions automatic, but their corresponding assets need to be hosted, operated, audited, bookkept, verified and legislated by many types of centralized organizations.
Although ICOs have announced the dawn of cryptofinance, there are still many problems to be solved. Among them, the multi-token smart contract problem and the multi-trigger smart contract problem are the top two problems.
The multi-token smart contract problem, however, is also the problem of interoperability of the Internet of Values. It is a shame that the present tokens in the cryptofinancial world should be exchanged with one another in the traditional financial exchanges. Technologies such as sidechains or relay chains are trying to solve these problems, but what people want is not atomic transfers but interaction of tokens within smart contracts in a programmable way.
The multi-trigger smart contract problem, is about the automation and off-chain data visit capability of smart contracts. Current smart contracts such as the typical Ethereum smart contracts are not smart enough. They are not automatic: they can only be triggered by another transaction, otherwise they will not run automatically. They are blind: they cannot read off-chain data.
The above two problems explain why there are almost no financial applications in the second layer of financial functions. We believe that those who can solve these problems can realize all the financial functions in the cryptofinancial world, and they will usher in an exciting new era of the cryptofinance for the Internet of Values.
FUSION and its complete financial functionalities
Except the ICO boom, an important event for cryptofinance happened in 2017 and went almost un-noticed was the FUSION project (fusion.org). The team of FUSION raised more than 13,000 ETH in its private token sale program in 2017. They released its whitepaper and website in January 2018. The release of the FUSION project attracted a large number of people’s attention in very short time. Its telegram channel attracted more than 7000 people in less than ten days. With a creative new ICO mechanism, they draw attention of about 126,000 ETH from more than 130 countries and raised about 50,000 ETH in first ten days of February.
FUSION’s project solved the above two problems cleverly.
For the multi-token smart contract problem, when everybody was thinking about how to implement sidechain technology or lightning network to realize atomic transfers, FUSION uses distributed bookkeeping nodes to generate and control other token’s private keys distributedly to enable all tokens to be mapped onto the FUSION public chain and realize multiple smart contracts.
With its lock-in and lock-out technologies, FUSION makes itself the sidechain for all other blockchains, and all other blockchains can map their tokens onto the FUSION public chain. FUSION uses distributed threshold signatures to control mapped tokens. We can find the FUSION private key distributed generation mechanism in its whitepaper:
By using these technologies, FUSION public chain creates a hosting and presenting layer above all other blockchains, and helps map their tokens to make them programmable in its multi-token smart contracts. We may predict that, in order to interact with other tokens by using FUSION’s multi-token smart contracts, various existing tokens will be mapped to FUSION in the future, and many new projects will issue tokens on FUSION by using a protocol similar to the ERC20.
For the multi-trigger smart contract problem, FUSION enhances Ethereum smart contract by using a “calling list” to enable triggering conditions outside smart contracts. In this way, bookkeeping nodes do not need to load all the smart contracts to check whether they need to run them or not. However, this makes it possible to put event triggers, such as various off-chain data triggers, into the “calling list” to realize the “oracle” function.
With multi-token and multi-trigger functions, FUSION smart contracts can connect blockchains, organizations and off-chain datasources, and implement complete financial functionalities.
Moreover, as we know, not only the cash in your hand today is an asset, but assured future cash flow is also asset. On FUSION, you can have two different types of assets, one is lock-in tokens, another one is financial smart contract which represents a certain future token flow. Even more interesting, this second type of asset can also be transferred or sold. And because this future token flow is governed and guaranteed by codes, it will be even more trust worthy than guaranteed by a centralized organization like bank.
As more and more values are mapped onto FUSION, various tokens can interact with each other, enabling applications such as mortgages, custody, lending, derivatives and many other financial instruments to be completed by FUSION smart contracts, since these applications are essentially based on multiple users, multiple tokens, and multiple triggers that FUSION smart contracts can provide. FUSION will be a platform-level application for cryptofinance in the world of the Internet of Values.
Bitcoin’s launch in 2009 gives hope to a new finance for humankind, but after 8 years of night, the boom of ICO in 2017, for the first time, allows us to see the dawn of cryptofinance. Although there are still two bottlenecks, the multi-token smart contract problem and the multi-trigger smart contract problem, which limit the application of cryptofinance in many areas except payment and tokenization, FUSION lets people see the hope of the boom of the cryptofinance itself.
We can also expect that with the continuous development of blockchain technology, traditional finance will face a transformation from providing financial services to providing bonding services, a large number of intermediaries will no longer be competitive, and the new bonding service industry will arise.
As a new type smart contracts, FUSION smart contracts will shape the financial industry, and the public chains like FUSION will become extremely important cryptofinancial infrastructures.
The year of 2018 may be a turning point for cryptofinance, and witness many financial products we have never seen before. This will not only bring unprecedented challenges to traditional finance, but also bring unprecedented opportunities to them.
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The article is created by FUSION Foundation