Blockchain & Cryptos A Deeper Look at a Few Concepts - Union Securities Switzerland
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Blockchain & Cryptos
A Deeper Look at a Few Concepts
For Qualified Investors Only
Introduction
In this document we continue our exploration into the world of Cryptocurrencies by providing a deeper
look at a few key concepts that are crucial to understand and navigate the crypto space.
Table of Contents:
• Part 1: A Few Concepts
Ethereum, Dapps, DeFi, Forking
• Part 2: More on Wallets
Hot versus Cold Wallet, Metamask
• Part 3: More on Security and Validation
Public-key Cryptography, Satoshi Test, Proof of Work vs Proof of Stake
More on Wallets
•Ethereum •Public-Key Cryptography
•Dapps •Satoshi Tests
•Smart Contract •Hot vs Cold Wallets •Proof of Work vs Proof of
•DeFi •How to trade in a Cold Stake
•Forking Wallet
•Metamask
More on Security
A Few Concepts
& Validation
This content is for informational purposes only and does not constitute a solicitation,
recommendation or endorsement to buy or sell any securities.
For Qualified Investors only
A Few Background Concepts
What is Ethereum?
Ethereum is a decentralized, open-source blockchain with smart contract functionality, meaning that it can be used
for other computer purposes and not only Cryptocurrencies. The difference between Bitcoin and Ethereum will be
covered in more detail in an upcoming document.
What are Dapps?
Decentralized Applications (Dapps) are software applications that run on a decentralized blockchain platform like
Ethereum. Dapps are developed using Smart Contracts to specify the rules and conditions of each Dapp. Smart
Contracts are simply computer programs written on a blockchain that automatically execute the terms of the
contract when certain conditions are met.
What is Decentralized Finance (DeFi)?
Decentralized Finance (DeFi) is the variety of financial instruments and services that can be provided by
decentralized blockchains. Specifically, DeFi transactions are conducted through cryptocurrencies on decentralized
applications.
What is Forking?
In software engineering, a project fork happens when developers copy the source code from one software package
and start independent development on it to make a new, separate version of the software.
In the Crypto world, a Fork happens when two versions of the same blockchain diverge, effectively creating two
different Cryptocurrencies. This usually happens when two groups of users have diverging views regarding the future
of the Crypto. This has already happened a few times on the Bitcoin blockchain alone. The new Cryptos can be
successful or not depending on their adoption.
An example of a
fork is the split
between Bitcoin &
Litecoin
For Qualified Investors only
Different Crypto Wallets
Once you have entered the “Crypto World”, you have several possibilities: you can keep your cryptocurrencies on
the exchange wallet (which gives the exchange custody of your funds), or you can withdraw them to an external
wallet to take full custody of your funds.
A Hot Wallet is a cryptocurrency wallet connected to the internet. A Cold Wallet is a crypto wallet where your
private keys are stored on hardware.
Holding your funds on the Exchange Platform (a type of Hot Wallet):
Pros Cons
The exchange manages the storage of your The capital leaves your books and the platform holds its
cryptocurrencies for you for you
You don’t have to open a wallet for each You have a counterparty risk in trusting the exchange
cryptocurrency, the platform does it for you not to default
You don’t have any transaction fees from the You have a cybersecurity risk. If a hacker hacks the
Blockchain, only the trading fees platform (or your account on the platform) they can
access your funds
Withdrawing your funds (Cold Wallet): You can buy a physical wallet (kind of like a hard drive) to store your cryptos
on it.
These wallets store a user’s address and private key on something that is not connected to the internet, and
typically come with software that works in parallel so that users can view their portfolio without putting their
private key at risk.
Pros Cons
The cold wallet is unaffected by viruses Physical failure of the storage device: it is very rare but
can happen if the device is old
The design is Open Source (but obviously not the key to “Expensive”- most cold wallets cost around $100
the wallet), so the community will spot if there are any
vulnerabilities
You can have any backup you want There is a limited variety of cryptocurrencies they can
store, which means if you buy a small unknown coin you
may not be able to store it
These devices emphasize security so much that they You have to use a third party software to make
have a reputation for being impenetrable Transactions (often provided by the cold wallet)
Every time you want to deposit or withdraw cryptos you
will pay transaction fees on the blockchain, which can
be high if the network is saturated
For Qualified Investors onlyHow to Trade With a Cold Wallet
This example explains how to trade in and out of a Cold Wallet using the most simple form of Cold
Wallet: a code written on a piece of paper. While you do not necessarily have to use Cold Wallets in
practice, this example illustrates just how decentralized Bitcoin and cryptocurrencies in general can be .
Buy in a Cold Wallet
1. Buy a Bitcoin on a trading platform.
2. Purchase and set up a Cold Wallet (you will get a Public and a Private key).
3. Note the Private Key on a piece of paper.
4. Transfer the Bitcoin from the trading platform to the Wallet using the Public Key.
5. Once the transaction is complete, the Bitcoin will be linked to your Cold Wallet. The only way to access the
Wallet is by using the Private Key written on your piece of paper (your Cold Wallet).
Sell from a Cold Wallet
1. Go to the Wallet interface on a trading platform (see image below for example)
2. Enter your Private Key
3. Transfer your Bitcoin to the trading platform
4. Sell you Bitcoin on the trading platform and receive Dollars in your account
MEW Cold Wallet
Online Interface
What is Metamask?
Metamask is a Hot Wallet which allows its user to store, send, and receive tokens on various compatible
Blockchains (Ethereum, Binance, etc). It also allows users to interact with decentralized applications on a website.
It can be used as mobile app or a web browser extension.
For Qualified Investors onlyPublic-Key Cryptography
Public-Key Cryptography, or asymmetric cryptography, is an encryption scheme that uses two
mathematically related, but not identical, keys: a public key and a private key.
This encryption method is widely used in emails, digital signatures and internet communication (it is the
basis of the https protocol).
How does Public-Key Cryptography work?
The public and private key are large prime numbers that are mathematically related to one another but
are not the same. Whatever is encrypted by the public key can only be decrypted by the related private
key. Public keys are freely shared while the private key must be secured.
The following illustration shows how Public-Key Cryptography can be used to securely transfer a
message. Alice wants to send a message to Bob.
1. Bob sends the message public key to Alice
2. Alice encrypts her message with Bob’s public key
3. Alice sends the encrypted message
4. Bob decrypts the message with his private key
What is a Satoshi Test?
A Satoshi Test is basically a test on the blockchain to verify the ownership of a cryptocurrency wallet. The test is
conducted by a third party, and involves an individual sending a very small quantity of coins (usually $0.01) to the
wallet of the third party to prove that the individual does indeed have control of the wallet. Since blockchains are
open source and all transactions are visible, it is easy to identify a fraudulent transaction.
For Qualified Investors onlyProof of Work vs Proof of Stake
What is Consensus?
In order to make a Blockchain secure it must have a robust mechanism to universally verify and add new
transactions to the chain (see our first document for more details). Consensus is reached when a majority of the
nodes on the blockchain network agree that a transaction is genuine and correct, allowing it to be added to the
ledger.
The first major mechanism to achieve consensus was Proof-of-Work, but its limitations have led to the
development of Proof-of-Stake. Understanding the difference between the two is key to understanding the new
generation of Cryptos that will present in a upcoming document.
What is Proof-of-Work (POW)?
POW uses the calculating power of computers to prove that a new block is valid. This process is called mining,
where every node on the network competes to solve a complex mathematical problem and the first to complete
it wins a certain amount of tokens as an incentive.
What is Proof of Stake (POS)?
POS is built on the idea that in order to add a block, all of the owners of the crypto can vote on whether or not to
add it. This process is called validating, and any owner of the crypto can lock up their funds in a staking pool to
become a validator. Each validator receives a number of votes proportional to the total percentage of the crypto
they own.
POW is a competition between every POS is a democratic determination of who
computer on the network to validate a gets to mine the block, where each owner of
block, and the winner receives a token as an the crypto gets to vote on one computer to
incentive. This is called “mining.” validate a block. This is called “validating.”
For Qualified Investors onlyProof of Work vs Proof of Stake
Consensus Mechanism Pros Cons
Proof of Work Easy to implement Slower transaction processing
Very Secure Consumes a lot more energy and
raw materials
Miners receive tokens as compensation for Fees are higher to compensate
validating transactions miners for energy spent
Proof of Stake Much quicker transaction processing Makes the creation of Blockchain
forks easier
Requires significantly less computing power, raw Validators only receive transaction
materials, and energy fees as compensation for validating
transactions
Staking is more decentralized Much more complicated and time
consuming to develop and
implement
Proof of Work tends to be easier to implement and more secure, yet it is very energy consuming. On the flip side,
Proof of Stake is much more efficient in terms of energy consumption, but it takes much more development to
implement successfully because it is so complicated.
Proof of Work is used by First Generation Crypto platforms such as Bitcoin and Ethereum, while Proof of Stake is a
key feature of emerging blockchain technologies such as Cardano and Ethereum 2.0 (see our upcoming documents
for more details).
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