RESEARCH PAPERS

Decentralized Finance (DeFi) is a popular form of financial contracting in the cryptocurrency space. A key attraction is the reduction in transaction costs due to the elimination of intermediaries in favor of an atomic swap of tokens between the counterparties. The benefits of DeFi are driven by code and algorithms that are meant to ensure correct execution and accounting of the trade. However, these same advantages also remove or substantially weaken legal protections and complicate regulatory oversight. Extending DeFi to the securities industry faces these same hurdles.

DeFi for the Securities Industry report available on the Finadium website.  

Bank Stablecoins vs. Central Bank Digital Currencies for Capital Markets

Most major central banks are investigating the issuance of a central bank digital currency (CBDC). One motivation has been to stave off competition from stablecoins like Tether that have gained adherents, but which are not necessarily backed by safe and liquid collateral. As a retail product, CBDCs could upend long-standing frameworks of commercial bank deposit money and monetary policy transmission. There are other digital alternatives however: one is bank-issued stablecoins backed by reserves and another is a wholesale CBDC that is traded between banks.

Bank Stablecoins vs. Central Bank Digital Currencies for Capital Markets report available on the Finadium website

We develop a mechanism that implements the socially optimal hashrate in a Proof-of-Work system by adjusting block rewards in response to observed network effort. The mechanism embeds a Pigouvian tax/- subsidy schedule directly into the protocol using only public, on-chain data. We prove equilibrium existence, convergence, and robustness to noisy measurement. Applied to Bitcoin, the mechanism yields a reward rule—Targeted Nakamoto—that balances security and carbon externalities while preserving monetary neutrality. The result is a decentralized implementation of optimal effort under limited observability 

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 Blockchain technology and smart contracts have revolutionized digital transactions by enabling trustless and decentralized exchanges of value. However, the inherent transparency and immutability of blockchains pose significant privacy challenges. On-chain data, while pseudonymous, is publicly visible and permanently recorded, potentially leading to the inadvertent disclosure of sensitive information. This issue is particularly pronounced in smart contract applications, where contract details are accessible to all network participants, risking the exposure of identities and transactional details.  

To address these privacy concerns, there is a pressing need for privacy-preserving mechanisms in smart contracts. To showcase this need even further, in our paper we bring forward advanced use-cases in economics which only smart contracts equipped with privacy mechanisms can realize, and show how  fully-homomorphic encryption (FHE) as a privacy enhancing technology (PET) in smart contracts, operating on a public blockchain, can make possible the implementation of these use-cases. Furthermore, we perform a comprehensive systematization of FHE-based approaches in smart contracts, examining their potential to maintain the confidentiality of sensitive information while retaining the benefits of smart contracts, such as automation, decentralization, and security. After we evaluate these existing FHE solutions in the context of the use-cases we consider, we  identify open problems, and suggest future research directions to enhance privacy in blockchain smart contracts.

SoK: Fully-homomorphic encryption in smart contracts available at the Cryptology ePrint Archive.

 We present a model of a market that is intermediated by broker-dealers where there is multiple equilibrium. We then design a smart-contract that receives messages and algorithmically sends trading instructions. The smart-contract resolves the multiple equilibrium by implementing broker-dealer joint profit maximization as a Nash equilibrium. This outcome relies upon several factors: Agent commitments to follow the smart contract protocol; selective privacy of information; a structured timing of trade offers and acceptances and, crucially, trust that the smart-contract will execute the correct algorithm. Commitment is achieved by a legal contract or contingent deposit that incentivizes agents to comply with the protocol. Privacy is maintained by using fully homomorphic encryption. Multiple equilibrium is resolved by imposing a sequential ordering of trade offers and acceptances, and trust in the smart-contract is achieved by appending the smart-contract to a public blockchain, thereby enabling verification of its computations. This model serves as an example of how a smart-contract implemented with cryptography and blockchain can improve market outcomes. 

Smart-Contract to Resolve Multiple Equilibrium in Intermediated Trade available at arXiv.org 

 A repo trade involves the sale of a security coupled with a contract to repurchase at a later time. Following the 2008 financial crisis, accounting standards were updated to require repo intermediaries, who are mostly banks, to increase recorded assets at the time of the first transaction. Concurrently, US bank regulators implemented a supplementary leverage ratio constraint that reduces the volume of assets a bank is allowed record. The interaction of the new accounting rules and bank regulations limits the volume of repo trades that banks can intermediate. To reduce the balance-sheet impact of repo, the SEC has mandated banks to centrally clear all Treasuries trades. This achieves multilateral netting but shifts counterparty risk onto the clearinghouse, which can distort monitoring incentives and raise trading cost through the imposition of fees. We present RepoMech, a method that avoids these pitfalls by multilaterally netting repo trades without altering counterparty risk. 

RepoMech: A Method to Reduce the Balance-Sheet Impact of Repo Intermediation  available at arXiv.org 

 In a Proof-of-Work blockchain such as Bitcoin mining hashrate is increasing in the block reward. An increase in hashrate reduces network vulnerability to attack (a reduction in security cost) while increasing carbon emissions and electricity cost (an increase in externalities cost). This implies a tradeoff in total cost at different levels of hashrate and the existence of a hashrate interval where total cost is minimized. Targeted Nakamoto is a Proof-of-Work protocol augmentation that incentivizes miners to hone in on a target hashrate interval. When hashrate is above target a ceiling is placed on the block reward a miner can receive. When hashrate is below target a floor is placed underneath the miner's block reward. Monetary neutrality is maintained by a proportional increase in spending potential among addresses holding UTXO's to match a deduction from total block reward when the ceiling is operative and a proportional reduction in spending potential among addresses holding UTXO's to match an increase over the total block reward when the floor is binding. 

Targeted Nakamoto: A Bitcoin Protocol to Balance Network Security and Carbon Emissions available at arXiv.org 

We introduce an empirical framework for valuing markets in environmental offsets. Using newly-collected data on wetland conservation and offsets, we apply this framework to evaluate a set of decentralized markets in Florida, where land developers purchase offsets from a small number of long-lived producers that restore wetlands over time. We find that offsets led to substantial private gains from trade, creating about $2.2 billion of net surplus from 1995–2018 relative to a historical conservation mandate. Offset trading also led to large differences in hydrological outcomes, driven by significant differences between restored and existing wetlands in terms of area and location. A locally differentiated Pigouvian tax on offset transactions would have prevented $1.3 billion of new flood damage while preserving more than two-thirds of the private gains from trade. 

Conservation Priorities and Environmental Offsets: Markets for Florida Wetlands Available on the National Bureau of Economic Research website.

Proof-of-Work mining is intended to provide blockchains with robustness against double-spend attacks. However, an economic analysis that follows from Budish (2018), which considers free entry conditions together with the ability to rent sufficient hashrate to conduct an attack, suggests that the resulting block rewards can make an attack cheap. We formalize a defense to double-spend attacks. We show that when the victim can counterattack in the same way as the attacker, this leads to a variation on the classic game-theoretic War of Attrition model. The threat of this kind of counterattack induces a subgame perfect equilibrium in which no attack occurs in the first place. 

Double-Spend Counterattacks: Threat of Retaliation in Proof-of-Work Systems available at arXiv.org 

This dissertation is composed of three chapters. Each essay describes and models the structure of a market; identifies an inefficiency in outcomes and proposes an incentive scheme to reduce the inefficiency.  

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