Lecture Notes: Blockchain and Its Intersection with Finance and Money

Introduction

• Lecturer: Gary Gensler, Senior Lecturer at MIT Sloan, Advisor at MIT Media Lab
• Course: 15.S12: Blockchain and Finance
• Objective: Understanding blockchain and its potential as a catalyst for change in finance
• Audience Interaction: Gary will engage through cold calling and questions

Key Points

Initial Questions for Class

• Ownership and experience with cryptocurrency/blockchain projects
• Syllabus and reading assignments
• Two main study questions:
  1. What is blockchain?
  2. Why might it be a catalyst for change in finance?

Historical Context

• Evolution of the internet: Ethernet, TCP/IP, HTTP
• Early commercial attempts (Pizza Hut and online sales)
• Cryptography as a crucial element (ancient cyphers, Enigma machine, public-key and private-key cryptography)

Blockchain Basics

• Definition: Time-stamped append-only logs forming a verifiable, secure, tamper-resistant database
  • Early blockchain concepts from the 1990s (Stuart Haber, Bell Labs)
• Cryptographic fundamentals: Hash functions, digital signatures, public-key cryptography
• Consensus Protocols: Deciding who appends the next block
  • Addressing the cost of trust and Byzantine Generals' Problem

Real-world Applications and History

• First real-world Bitcoin transaction (Pizza Day, May 22, 2010)
• Cryptocurrencies and initial blockchain innovations (PayPal, DigiCash, Liberty Reserve)
• Successful innovations: M-Pesa in Kenya

Financial Sector Context

• Role and functions of money (medium of exchange, store of value, unit of account)
• Role of finance: Moving money, allocating resources, pricing valuations, managing risk
• Financial sector challenges: Instabilities, economic rents, crises, centralized intermediaries
• Central banking issues: Legacy payment systems, financial inclusion

Blockchain in Finance

• Potential to reduce verification costs and introduce decentralized network models
• Issues and technical challenges in the financial sector:
  • Performance and scalability
  • Privacy and security
  • Interoperability
  • Governance
  • Commercial use cases

Permissioned vs. Permissionless Blockchains

• Permissioned Blockchains: Used by organizations like the Australian Stock Exchange, controlled nodes
• Permissionless Blockchains: Open to all participants, used by cryptocurrencies like Bitcoin
• Economics of permissionless systems (incentives, crypto finance)

Public Policy and Regulation

• Key areas of concern:
  • Illicit activities
  • Financial stability
  • Investor protection and regulation
• Regulatory perspectives and the importance of compliance
• The “Duck Test” for evaluating activities and technologies

Incumbents and Startups

• Response and adaptation by financial incumbents
• Volatility and trading opportunities
• Characteristics of fintech startups vs. traditional financial institutions

Course Structure

• Act 1: Fundamentals of Blockchain
• Act 2: Economics of Blockchain
• Act 3: Financial Sector Use Cases

Assignments and Participation

• Class Participation: 30%
• Individual Write-ups: Two (one on fundamentals, one on financial applications)
• Team Project: Up to four students, focused on an entrepreneurial or incumbent use case

Upcoming Study Questions

• Roles and characteristics of money
• Fiat currency and its history
• Ledger systems and their impact on finance

Conclusion

• Overview of the potential for blockchain as a peer-to-peer alternative addressing cost of trust
• The goal of the course: Critical thinking skills and exploration of financial applications
• Encouragement to engage, learn, and enjoy the journey