The first two decades of the 21st century have seen technology advance at an unprecedented scale, true to Moore's law. This accelerated progress led to the rise of numerous new industries and impacted every existing industry in significant ways. With the advent of emerging technologies, the world of finance is transforming from CeFi to DeFi, ie, centralised financial system to decentralised financial system. CeFi and DeFi have become the new buzzwords.
Crypto or digital currencies are the product of information technology innovations in the world of decentralised finance. In this article, we will first talk a little bit about the evolution of information technology, the advancement of digital computers and communications, and also emerging technologies such as artificial intelligence, machine learning, and blockchain, which have all become interrelated. Later we will look into the fascinating world of Bitcoin, cryptocurrencies, DeFi, and tokenomics, and the opportunities and challenges they present before India.
Evolution of information technology
The binary system, invented by George Boole (1815-1864) in the 1850s, is fundamental to digital computers. He developed the entire Boolean algebra based on the binary number system that has only two symbols, 0 and 1. The entire digital computer system in the world works on this basic principle of 0 and 1. It does not understand anything other than 0 and 1. Later in the 1930s, programmable computers were invented by Alan Turing (1912-1954). John von Neumann (1903-1957), a globally renowned mathematician, is known as the father of digital computer architecture.
During World War II, only analogue computers were used to calculate the trajectory of long-range artilleries. Digital computers were not well developed back then, as the vacuum tube was very complex to manufacture. ENIAC was the first functional vacuum tube digital computer. With the invention of transistors, digital computer manufacturing has progressed exponentially since the 1950s.
The development of 'integrated circuit' in the 1950s and 60s, enabled a digital computer to run faster. High-level programming languages like Fortran and COBOL (Common Business-Oriented Language) were also developed in this period. The first commercial digital computer was IBM 1401. It was an 8-bit business data processing computer with a programming language called auto-coder. This was followed by the development of IBM 1620, a 16-bit scientific computer with the Fortran language. Scientific and business computers were two separate entities those days. In the 1960s, IBM built the first hierarchical database management system called the IMS (Information Management System).
In 1969, two mathematics professors Edgar F. Codd (1923-2003) and Christopher J. Date (b. 1941) developed the 'relational data model', which is being used even today. Databases like Oracle and DB/2 (or Db2) are all relational data models. Later, many high-power computers like the IBM 360 and IBM 7044 series were developed by IBM, the premier in computer manufacturing. ICL, a British company also came up with successful models like the ICL 1900 and ICL 2900 series of computers, besides few other US computer manufacturers. Punched cards were the data processing input medium in these computers. They used batch processing instead of online processing.
Advancement in microelectronics
The 1970s and 80s saw further advancement in microelectronics. Intel Corporation invented the 4-bit microprocessor in 1971, followed by the development of LSI (Large Scale Integration) and VLSI (Very Large-Scale Integration) chips. The concept of virtual computers was introduced in the 1970s by IBM, with the release of VM/370 operating systems.
In 1973, IBM declared the unbundling of software products, which led to significant changes in the computer industry. Until then, the company used to give all software for free, along with the hardware. In 1973, they decided to monetise software separately. This resulted in the growth of companies like Microsoft and Oracle, which produced software for different computer applications.
India entered the arena of computer manufacturing during this period, with companies like ECIL (Electronics Corporation of India Ltd.) and HCL (Hindustan Computers Limited). Minicomputers and desktop personal computers were getting more popular in the 1980s. The basic operating system in these computers was Unix and the programming language was C. Computer networking and client-server architecture were also getting popular. The arrival of office automation products like Microsoft Office completely transformed the office environment. Soon, fully relational database management systems like Oracle and DB/2 that could store and manipulate millions of records, were in place.
In the 1990s, software development witnessed a significant shift in approach, called Software Engineering. Until then, the software was developed as an artisan's product and not an engineering product. A lot of push from the industry to move towards the engineering process led to the creation of Computer-Aided Software Engineering (CASE) tools that enabled the development of software applications without programming.
Meanwhile, there was a glitch called the "Y2K" that led to large-scale funding for software updates. It was a problem created by programmers when they compressed the four-digit year to two digits to save memory. It was alright in the 80s and 90s, but as 2000 approached, the two-digit year that becomes 00 would screw up the programs. It created a substantial fund in the industry for further development.
Second generation internet
Once the Y2K was over, many corporations and government agencies had billions of dollars in surplus funds, which they put into upcoming technology. The next couple of years witnessed a lot of investment, but nothing much happened. This resulted in the 2000s' dot-com bubble. Subsequently, the economy recovered, and high-volume transactions on the internet were soon made possible. Large databases began to be used for artificial intelligence, machine learning, and cloud computing. Tech companies such as Google, Microsoft, Oracle & IBM etc., deserve much appreciation in this regard.
Earlier, the computers were called client-servers. Every company and organisation had its own main server to which all computers were connected. With the advent of cloud computing, it became possible that the server could be located anywhere, and any computer could be connected through the clouds to the global network. TCP/IP protocol, the backbone of the communication system, was further enhanced by SMTP (Simple Mail Transfer Protocol) to enable email interoperability.
The launch of Bitcoin in 2009 ushered in the first blockchain system. Blockchain is a software concept that first appeared in a white paper published by an anonymous Satoshi Nakamoto, who is said to have developed the entire blockchain system to launch Bitcoin. When bitcoin was initially released, its price was roughly 20 cents as there was no demand. Today, the price of a Bitcoin is as high as $58,000.
Soon, there was a proliferation of internet applications (called APPs) for smartphones, tablets, and computers. The development platforms were essentially Java and Dot net (.NET), and they were also the frontrunners of reusable software codes. Next-generation internet, with new protocols, frameworks, and platforms, soon further revolutionised the information technology ecosystems.
Protocols are nothing but the basic concepts in codified form, and frameworks are software developed to perform the protocols. Platforms are named for a particular type of application. In other words, these protocols, frameworks, and platforms are an integral part of the computer system. To give an example, until about 10-15 years back, video streaming was not available on the internet. A protocol, framework, and platform called OTT (Over-The-Top) was developed, which turned out to be a big move for the video streaming industry. Quite similarly, stock exchanges developed their own software to run stock trading. Thus, the protocols, frameworks, and platforms are basically structures and components for developing a software system.
Blockchains and cryptocurrencies
Blockchain technology is a bit different from the existing computer systems where everything is centrally controlled and processed—there is a central computer to do everything. But the concept of blockchain is a decentralised peer-to-peer computer network architecture that is distributed all over in the form of computer nodes, ie, personal computers, smartphones, etc. All nodes are connected to each other on a one-to-one basis.
An interesting feature of the blockchain is that data is encrypted and stored in chained records called blocks. This helps enhance data security and privacy which was a serious concern in the regular internet system. Encrypting the data before storage using a mathematical process called cryptography, prevents hackers from stealing the data. The data stored is with hashing algorithms ie, each record gets a timestamp precise to microseconds, in addition to record keys. Record keys are developed using PKI-public key infrastructure. Thus, once a record is stored in the blockchain, it becomes immutable, unremovable, and unchangeable.
Network access is controlled by a Public Key Infrastructure (PKI) that provides two keys to access any blockchain network—a public key and a private key. The private key is very confidential for a particular node or user, while the public key is available to all nodes for the data to be recorded. Thus, both keys are required to access any specific recorded data. This is quite like the lockbox in banks where one key is with the bank and the other key is provided to the user. Unless both keys are together, the lockbox cannot be opened. Blockchain works on an equivalent, but mathematically oriented process. Thus, the Public Key Infrastructure system operates autonomously, with no central control.
Hitherto all computer systems were centrally controlled, managed, and operated without any autonomous processing. In blockchain technology, the computer system operates autonomously. A good example of an autonomous process is the autopilot system in modern airplanes that takes the GPS number of destination and origin points and enables the plane to fly and land autonomously. The computer system in the plane takes care of everything, and no human control is required for the entire flight duration, making it an autonomous process. Another example is the self-driving car, once given the destination, navigates through the roads to reach the desired location. Similarly, the software of blockchain technology is developed and designed to run autonomously.
A coin is created in the blockchain system through a process called data mining, and cryptocurrencies are mined using mathematical algorithms called Consensus Algorithms. All computer nodes in the network work together on the same software concurrently. In bitcoin operations, when someone wants to transfer money to another, every computer in the mining facility competes for collecting the recording privilege. If there are say 50 computers, all equally competing for the recording privilege using a consensus algorithm, a very complex mathematical problem that takes about 10 minutes to calculate, is given to them. Whoever solves the problem first is given the privilege to record the data. This recording of data in the database is called mining. The recording privilege is given to the computer who solved the problem first, which is approved by all other computers concurrently. There are other ways too to raise coins, which we will look into later.
Bitcoin is the first cryptocurrency in the world developed using blockchain technology. As of now, there are over 10,000 cryptocurrencies in place.
Cryptocurrency coins and tokens
Using the cryptocurrency platform, one can issue something called initial coin offerings (ICOs). Initial coin offering is a process by which a blockchain platform is initiated, and the developers issue a part of their assets as coins to raise capital through crowdsourcing. These coins are generated at the platform operation launch. Many platforms are available for initial coin offerings.
There are two things in the crypto world—coins and tokens. The difference between coins and tokens can be easily understood thus: coins can be conceived as something equal to a currency, while the tokens as stocks issued by a company. So, tokens and coins are interchangeable, but they are not the same.
These days, coins are more popular than tokens in the field of decentralised finance. Multiple companies are issuing coins and for these coins to be interoperable, scalable, and maintain data privacy, a lot of procedures have been developed in the blockchain. As of now, there are many multi-billion dollar platforms under development. These platforms are generally categorised as public, private, or permissioned networks.
After Bitcoin, which is today a $50 billion foundation based in Switzerland, Ethereum is the second-most popular blockchain application. Ethereum was developed by one of the active participants in Bitcoin along with a few other computer scientists.
Blockchain DeFi ecosystem partners
Bitcoin is not developed for all kinds of financial transactions. It takes about 10 minutes to do just one transaction. However, they are now modifying their network, called the Lightning Network. MIT lab is also actively participating in the Bitcoin development platform. As has been mentioned earlier, Ethereum is the second-most popular platform, supported by the Ethereum Foundation.
IBM has also come up with its own blockchain platform called Hyperledger Fabric, using the IBM Linux Foundation. Hyperledger Fabric is a more versatile platform, developed for any kind of application, not just financial applications. Some of the multi-billion dollar DeFi application products now available are Avalanche ($AVAX), Polkadot ($DOT), Solana ($SOL), Cardano ($ADA), Aion ($AION), ArcBlock ($ABT), Corda, Ardor ($ARDR), Eosio ($EOS), etc. Many of them are currently under development, while some are already partially available for use. Though cryptocurrencies are not under government regulations at present, the US government and many European governments have introduced two new controls on cryptocurrencies - KYC and AML (Anti Money Laundering). KYC is nothing but "Know Your Customer". Before a user ID is issued for cryptocurrency operations, the exchanges are required to get full knowledge of the customer and also enforce anti-money laundering regulations. All exchanges have to follow these two requirements.
The rise of DeFi
In the world of cryptocurrency, there are three important subsets or sub institutions—one is the mining company that holds the complete data storage capabilities. There are many mining companies who mine and keep their own currencies. Bitcoin is a limited supply asset and only a few millions were released initially. As of today, about 19 million out of the total 21 million, have been released. Since its value depends upon the supply and demand, they control the supply to improve the price. This is what is happening in the case of most cryptocurrencies. The supply is controlled, and the price ignored, which makes it a kind of gambling. Blockchain is based on no control system and no intermediaries.
In the case of decentralised finance, there are no intermediaries like banks, brokerage firms, or money exchanges. Everything is self-governed using a governing process called a Smart Contract. A smart contract is nothing but a piece of program, a software developed and executed to perform the entire function in binding contract terms. It is binding on the contractors as the software is developed with the help of attorneys, software experts, and financial experts. All legal and financial terms that are required for a transaction are embedded in the smart contract. Once the smart contract is executed, it cannot be reversed. Thus, the speed at which smart contracts can operate is tremendously higher when compared to a centralised finance system.
Even today, if we are to send money from New York to Mumbai, it technically takes only a few seconds, but the money will not be realised until a few days, the reason being, in the centralised finance system, checks and balances are manually processed. The processing is not computerised and automatic, as manual processing is more trusted. In the case of blockchain smart contracts, it is a trust-based system. The blockchain software is programmed with all features and functionalities according to the terms and conditions, and hence is trusted. So, DeFi ecosystem uses smart contract use cases. Ethereum is the first user of DeFi use case implementation as the Bitcoin software platform cannot use smart contract features. Smart contract feature is the one that makes it or other applications work—not only money transfer. In addition, a lot of financial products can be developed using smart contracts. DeFi has its own coin called ETH. Now, other coins are also being initiated.
Coins and tokens are flexible as their value can vary anytime. Now, the industry has come out with new standards in order to avoid such value variations. A new type of coin called the stablecoin, backed by the US dollar, has been issued. Once a stablecoin is converted and used for operating in the network, its value will never be changed in theory. On the other hand, other type of coins and tokens don't guarantee any value. Their value tomorrow can be half or double what it is today - nobody can predict or control their value. Thus, to maintain stability in the decentralised financial system, some additional features have been made, the key feature being the release of stablecoins backed by the US dollar, which never loses value.
There is also the concept of exchangeable tokens and NFTs (Non-Fungible Tokens). The coins are not always stable as their value can go down, even to zero. This led the decentralised finance system to issue non-fungible tokens, ie their value will never go to zero. So, one can start developing an application and then issue non-fungible tokens which will be more valuable than initial coins unless the initial coins are proven and established, like Bitcoin or Ethereum. Ethereum's value was about a couple of hundred dollars last year. Today, it is about $4,300.
DeFi Application Platforms
Today, many DeFi application platforms are available. For example, Aave is a multi-chain lending and borrowing platform. If you have cryptocurrencies, you can lend that money to someone using Aave and earn interest. Aave, Curve Finance, etc are basically exchanges, called DEXes (decentralised exchanges), i.e. if you have money to send or buy new tokens and coins, you can use these exchanges. Many of these decentralised exchanges are operational in India.
Maker is another popular software product. It is a smart contract product from Ethereum for lending and borrowing. If you have cryptocurrency, you need not hold them without earning any interest. You can use that currency for lending operations and the money is pooled and lent to somebody to give you a rate of interest. Similarly, if you are a holder of cryptocurrencies, you can also borrow funds for your projects. These operations are available even today. Another popular company is Nexus Mutual multi-chain. Multi-chain means it uses multiple platforms to develop its software products. They focus on insurance operations. For example, when a project has to be insured, they process the insurance using cryptocurrencies.
Purchasing cryptocurrencies is not that sophisticated a process as it is supposed to be. The first thing is one has to start an account in a crypto exchange. Using fiat currencies like the US dollar (USD) or Indian rupees (INR), any of the cryptocurrencies available in the market can be bought at current exchange rates and a wallet will be issued to the user. A wallet is where you hold your cryptocurrency assets. So, once you start an account and put some money into it, you can trade. The wallet can also be used to trade into other cryptocurrencies, ie you can buy, sell, lend and borrow cryptocurrencies. The main function of the crypto exchange is to initiate transactions of buying and selling.
As has been explained earlier, coin mining is the process of cryptocurrency data being stored in the blockchain. This data is distributed well on everybody's computer and everybody in the network gets the same piece of data. However, one can see only his/her own data as the transactions are cryptographically coded and cannot be accessed without knowing the private key of other users or wallets. In some currency systems like Bitcoin, if the private key to one's wallet is lost, the entire money is lost and cannot be recovered back. This is another reason why products like Non-Fungible Tokens were developed later. "Non-Fungible" means these tokens are irreplaceable and undestroyable.
The most popular exchanges today are Coinbase, CoinBureau, and Binance. Coinbase is a US-listed company with a stock value of about $330 today. CoinBureau is also an equally popular well-established company. These companies are not mom-and-pop shops as skeptics allege, but solid financial institutions like Citibank.
DeFi Smart Contracts and Dapps
Smart contracts are the engines of decentralised finance. They are nothing but software modules called Dapps, which are basically crypto platform apps. We have seen earlier that an app is an internet application module. So, a Dapp is nothing but a crypto app. It is the common method of transaction interfacing, ie the transactions are created and executed using the Dapp.
Dapp use case developers are in very high demand now, as hundreds of Dapps are being developed and many are already available. The development of Dapps is going to be a highly demanding field. It also needs to be mentioned that Dapps enable the liquidity of Non-Fungible Tokens.
Although DeFi is an innovative new technology, it is highly reliant on the digital technology network, on which the entire financial system depends. It is growing and evolving fast, though still in the infancy stage as of now. DeFi has a long way to go.
Participation of third-world countries in decentralised finance is poor and slow, primarily because of the lack of awareness. In fact, the decentralised system is more useful for third-world countries because it's a more egalitarian approach to finance in a country. For example, software platforms like Cardano have been actively working with the government of Ethiopia to introduce the decentralised financial system to their rural population.
At present, there are no regulations by sovereign central banks, International Monitory Fund (IMF) or Financial Regulatory Board on DeFi. As a result, the uncertainty around decentralised finance cannot be overlooked. Another important concern is the questionable liquidity flow of DeFi. We are all familiar with the controversies of Swiss bank Panama papers and Pandora papers. All these funds are managed by vested interests. DeFi programs are developed keeping in mind the possibility of vested interests attempting to take over the decentralised finance system as well. It is hoped that the liquidity of this fund will, sooner or later, flow into third-world countries. In the current system, the wealthy invest their money in Swiss Banks and other tax havens, which never come back to poor countries. The wealth gets accumulated in rich countries, but that could likely be reversed with the advent of DeFi. On the other hand, the dangers of a parallel decentralised world economy cannot be disregarded. As this system is not based on fiat currency, it is going to be based on new tokens, hence the name 'tokenomics'. Though the system is extremely complex, it has tremendous potential for the concentration of global wealth.
One of the major challenges of blockchain is a lack of technical perfection. Even though the concept is brilliant, refinement of the technological process is uncompromisable, especially in a financial system. The hardware deployment is overly redundant, and scalability often becomes a major issue. Poor transaction processing speed, high infrastructure cost, and slow adoption rates have also slackened the growth of DeFi.
In a nutshell, the future is likely to lead to a tussle between the controlled monetary systems of the Central Banks, the IMF, and the Financial Stability Board, versus the crypto economy of DeFi. DeFi security protocols are still vulnerable to fraud or acute risk of currency substitution to crypto assets and therefore coordinated regulations are inevitable.
DeFi: Indian Opportunities
As a software development country, India has tremendous opportunities to get into the DeFi ecosystem development. However, today, there is a lack of awareness and clear understanding about DeFi business prospects. Unless proper awareness is created, India is unlikely to be a major player in the sphere of decentralised finance, and we may miss this great opportunity to prepare millions of manpower resources need for the development of DeFi applications.
DeFi applications are going to stay as a tremendous growth potential for India, especially since they require software people, financial experts as well as legal experts. This can create a lot of job opportunities in the Indian software, finance, and legal industries. With the exponential growth of Dapp smart contract production, we need a steady supply of appropriate software-trained human capital. If India produces this human capital, there is a great potential to increase the flow of DeFi capital to India. It will also create opportunities for private participation in new DeFi ventures.
Blockchain, artificial intelligence, and machine learning are the most emerging and useful technologies we know now. Cryptocurrencies are likely to be the new source of capital, as it holds the promise of an effective global system of decentralised financial transactions. As no cryptocurrency can exist without blockchain, the evolution of blockchain determines the future of cyberspace. It is the backbone of the emerging DeFi explosion.
Autonomous, equitable, open-source DeFi platforms are supported by the blockchain and have tremendous growth potential in the next decade. Like the internet that changed the human lifestyle forever, cryptocurrencies have the potential to fundamentally alter the way we transact business across the globe.
Krish Pillai is a former business owner and information technology consultant for over thirty years. This article is an abstract from an online presentation made by the author to Cochin Chamber of Commerce and Industry in November 2021. He acknowledges the efforts of Nandakishore Nair in transcribing and editing it from digital recordings