Impact of Blockchain on IT Audit Agenda Blockchain

Impact of Blockchain on IT Audit

Agenda Ø Ø Ø Ø Blockchain Technology Overview Three Levels of Blockchain, Tokens Alliances and Industry Adoption Smart Contracts Identity Management Criticism and Challenges Impact on the IT Audit Function Learning and Engagement

Blockchain Overview Blockchain technology is a digital innovation that is poised to significantly alter financial markets within the next few years, within a cryptographic ecosystem that has the potential to also significantly impact trusted computing activities and therefore cybersecurity concerns as a whole.

Student Exposure How many of you: • Have heard of bitcoins? • Own cryptocurrency? • Feel you understand the underlying blockchain technology? • Feel you can summarize for us the benefits of the “trust economy”? • Are involved in projects that involve blockchain technology implementation or related activities?

Where It All Started Blockchain technology was first introduced in a whitepaper entitled: “Bitcoin: A Peer-to-Peer Electronic Cash System, ” by Satoshi Nakamoto in 2008. • No reliance on trust • Digital signatures • Peer-to-peer network • Proof-of-work • Public history of transactions • Honest, independent nodes control majority of CPU computing power • Nodes vote with CPU computing power • Rules and incentives enforced through consensus mechanism https: //bitcoin. org/bitcoin. pdf

Cryptocurrency Summarized • Bitcoin was the first digital, i. e. , cryptocurrency • A maximum of 21 million Bitcoins can be generated • Just as with real world mining, energy must be invested to solve complex mathematical problems by which systems earn Bitcoins • https: //www. cryptocoincharts. info/coins/info claims to be indexing 4, 220 cryptocurrencies • Most circulated: Bitcoin, Ethereum, Litecoin

The Technology Behind Bitcoin • Think of Bitcoin as an electronic asset (as well as a digital currency) • A network of computers keeps track of Bitcoin payments, and adds them to an ever-growing list of all the Bitcoin payments that have been made, called “The Bitcoin Blockchain” • The file that contains data about all the Bitcoin transactions is often called a “ledger” • Bitcoin value is created through transaction processing, referred to as “mining, ” which is performed by distributed processors called “nodes” of the peer-to-peer network A Gentle Introduction to Bitcoin by Antony Lewis, https: //bravenewcoin. com/assets/Reference-Papers/AGentle-Introduction/A-Gentle-Introduction-To-Bitcoin-WEB. pdf

Mining Evolution • Mining is the process whereby value is created through transaction processing that occurs on nodes of the network. • In 2009, one could mine 200 Bitcoins with a personal, home computer. In 2015, it would take about 98 years to mine just 1 Bitcoin. • Today there is almost no money to be made through traditional home mining. • ASIC (Application Specific Integrated Circuit) has been designed strictly for mining Bitcoins. • Groups of miners have formed mining pools, with each being paid their relative share for their contribution to the work performed. My Dirty Little Bitcoin Secrets by Ofir Beigel, www. 99 bitcoins. com

Three “Levels” of Blockchain 1. Storage for digital records 2. Exchanging digital assets (called tokens) 3. Executing smart contracts - Ground rules – Terms & conditions recorded in code - Distributed network executes contract & monitors compliance - Outcomes are automatically validated without third party Tech Trends 2017, The Kenetic Enterprise, “Blockchain: Trust economy”, Deloitte University Press, 2017

A General Discussion about Tokens • A broader use is supported by the digital infrastructure introduced through Bitcoin, as represented by “tokens”. • A “token” can be defined as a “scarce digital asset based on underlying technology inspired by Bitcoin. ” • Tokens may use similar codebases but different blockchain databases. • Ethereum was Bitcoin-inspired but has its own blockchain and is engineered to be more programmable. Tokens can be issued on top of the Ethereum blockchain. • Token buyers are buying private keys, which are similar to API keys, but can be transferred to other parties without consent. “Thoughts on Tokens”, Balaji S. Srinivasan and Naval Ravikant

Tokens, continued • Tokens have a value and therefore a price. • Tokens are a new model for technology and can be an alternative to equity-based financing. • Tokens do not dilute capital. They introduce a huge increase to buyer base and time-to-liquidity. • Token launches differ from equity sales; however, they can be issued as a way to share profits. • Tokens can be sold internationally over the internet and are always open for business. • Tokens decentralize the process of funding technology. Thoughts on Tokens, Balaji S. Srinivasan and Naval Ravikant

Tokens, continued • Tokens enable a better-than-free new business model. • Tokens will introduce the rise of the “tech savvy senior executive. ” • Tokens accommodate immediate custody without an intermediary. • Tokens can be extended to hardware, as part of the internet of things. Thoughts on Tokens, Balaji S. Srinivasan and Naval Ravikant

Smart Contracts Current paper-based systems drive $18 trillion in transactions per year. Consensus protocols are key to determining the sequence of actions resulting from the contract’s code. This enables peer-to-peer trading of everything from renewable energy to automated hotel room bookings. “Contracts Get Smarter with Blockchain”, CIO Journal, The Wall Street Journal, World Trade Organization, International Trade Statistics 2015, p. 41.

Hyperledger • Hyperledger is an open source collaborative effort created to advance cross-industry blockchain technologies. It is a global collaboration, hosted by The Linux Foundation, including leaders in finance, banking, Io. T, supply chain, manufacturing, and technology. • Business Blockchain Frameworks are hosted with Hyperledger. • Hyperledger addresses important features for a cross-industry open standard for distributed ledgers. The Linux Foundation hosts Hyperledger as a Collaborative Project under the foundation. • To learn more, visit: https: //www. hyperledger. org/. www. hyperledger. org

Hyperledger Projects A few of the Hyperledger Projects include: • Hyperledger Burrow – Permissible smart contract machine with a modular blockchain client, built in part to the specification of the Ethereum Virtual Machine (EVM) • Hyperledger Fabric – Foundation for developing plug-n-play solutions within a modular architecture • Hyperledger Iroha – Simple and easy blockchain framework designed to be incorporated into infrastructure projects requiring distributed ledger technology • Hyperledger Sawtooth – A modular platform for building, deploying, and running distributed ledgers

Ethereum Alliance Ethereum is a decentralized platform that runs smart contracts: applications that run exactly as programmed without any possibility of downtime, censorship, fraud, or third party interference. The Ethereum project was bootstrapped via an ether pre-sale during August 2014 by fans all around the world. It is developed by the Ethereum Foundation, a Swiss nonprofit, with contributions from individuals and organizations across the globe. www. ethereum. org

Ethereum Tools Several Ethereum offerings include: • The Ethereum Wallet, which is a gateway to decentralized applications on the Ethereum blockchain, allowing users to hold and secure ether and other crypto-assets built on Ethereum, as well as write, deploy and use smart contracts • Design and issue your own cryptocurrency/traceable token • Kickstart a project with Crowdsale www. ethereum. org

What is Ether? • Ether is the crypto-fuel for the Ethereum network. • Ether is a necessary element – a fuel – for operating the distributed application platform Ethereum. It is a form of payment made by the clients of the platform to the machines executing the requested operations, functioning as the incentive that ensures that developers will write quality applications, and that the network remains healthy. • The total supply of ether and its rate of issuance was decided by the donations gathered on the 2014 presale. • Developers who intend to build apps that will use the Ethereum blockchain need ether. • Users who want to access and interact with smart contracts on the Ethereum blockchain also need ether. www. ethereum. org

Cross-Industry Adoption Sectors leading the way in blockchain implementation: • Consumer products • Manufacturing • Technology • Media • Telecommunications • Health care • Life sciences Thirty-nine percent of the senior executives at large U. S. companies initially surveyed indicate they have little or no knowledge about blockchain technology. Many deemed it to be crucial for their companies and industries. Forty-two percent believe it will disrupt their industries. “Blockchain Adoption Varies by Industry”, CIO Journal, The Wall Street Journal

Financial Services Industry • As noted by A. Michael Smith in “Creating Assurance in Blockchain, ” trust and efficiency are the main value drivers for any use case. The finance world is driven by technology. • Tracking risk and monitoring compliance with laws and regulations within an increasingly complex cybersecurity environment requires considerable time and resources. • The financial services industry immediately saw opportunities in blockchain and has been investing heavily in its usage, primarily as a part of private implementations. Creating Assurance in Blockchain, Volume 2, 2017, by A. Michael Smith Banking on change: How to respond to new expectations for audit committees by PWC Internal Audit Foundation, Douglas Anderson, CIA, CRMA, Cassian Joe, and Klaas J. Westerling

Identity Management The IT audit is broadly concerned with identity management concerns. Protecting access to data, and the systems that are in place to process, store, and report on that data, requires ongoing resource dedication. Multiple solutions are available, all of which require configuring and managing multiple identifiers for an individual’s various identities. Identity management is an area that will certainly be impacted by widespread use of private keys to secure transactions.

Distributed Access Management • Creating an identity on blockchain can give individuals greater control over who has their personal information and how they access it • Areas impacted include passports, e-residency, birth certificates, wedding certificates, IDs, online account logins, etc • Digital ID’s can provide digital watermarks that can be assigned to every online transaction of any asset “ 21 Companies Leveraging Blockchain for Identity Management and Authentication” by Elena Mesropyan, https: //letstalkpayments. com/22 -companies-leveraging-blockchain-for-identitymanagement-and-authentication/

Protecting Private Keys • Within the blockchain, trust relies on the safekeeping of private keys, in support of a truly distributed identity management • Ultimately, that safekeeping resides with the actions taken by individuals to secure their private key • For cryptocurrency traders, one frequently sees the recommendation to write one’s private key down on a piece of paper and put it up for safekeeping in, for example, a safe deposit box

Digital ID Solutions • May 24, 2017, saw the release of a Digitial ID solution by Netki, a California blockchain startup • Released at Consensus 2017, this is a highly-anticipated Digital ID smartphone app that uses Hyperledger blockchain to provide decentralized, open-source identity management • Approved by governments, fully Anti-Money Laundering (AML) and Know Your Customer (KYC) inclusive https: //bravenewcoin. com/news/netki-launches-digital-id-solution-which-bitt-is-using-with-central-banks-inthe-caribbean/

Criticism and Challenges Critics have cited the following blockchain challenges: • Nascent technology • Uncertain regulatory status • Large energy consumption • Control, security and privacy • Integration concerns • Cultural adoption • Cost • Challenges associated with audit, taxes, and compliance Creating Assurance in Blockchain, Volume 2, 2017, by A. Michael Smith Deloitte’s Blockchain technology: 9 benefits & 7 challenges, https: //www 2. deloitte. com/nl/nl/pages/innovatie/artikelen/blockchain-technology-9 -benefits-and-7 challenges. html

Energy Consumption • An area of heavy criticism has to do with the vast amounts of energy necessary to process and store transactions, especially as the use of blockchain technology increases • The Bitcoin blockchain network’s miners are attempting 450 thousand trillion solutions per second in efforts to validate transactions, using substantial amounts of computer power • Note that there also opportunities to decentralize the energy grid • Wasted resources: Mining Bitcoin wastes huge amounts of energy ($15 million/day) Deloitte’s Blockchain technology: 9 benefits & 7 challenges, https: //www 2. deloitte. com/nl/nl/pages/innovatie/artikelen/blockchain-technology-9 -benefits-and-7 challenges. html Blockchain in the Energy Sector: Institutional Disruption? By Marius Buchmann http: //www. theenergycollective. com/enerquire/2402120/blockchain-energy-sector-institutional-disruption

Summary • Although the technology is still in its infancy, boundless usage opportunities exist • The identity management landscape is likely to shift dramatically • There is sure to be evolution within IT audit as various use cases unfold • Features that create trust could drive unachievable overhead costs • Compliance burden should eventually be eased as the technology is adopted, but this requires regulatory updates, which could take a while