Open Questions Flashcards

1
Q

Assume you own one coin of the cryptocurrency “Fork-a-lot”. At one point, there is a protocol update and some miners refuse to go along with the protocol update. As a consequence of the hard fork, these miners keep mining the old protocol which they call “Fork-a-lot Classic”. The majority of miners, however, upgrades and continues mining “Fork-a-lot”.
Which coin will you own after the hard fork?

A

Both, consider you had 100 fork-a-lot at the moment of the hard fork. after the hard fork, this balance is recorded on both chains. you now own 100 fork-a-lot and 100 fork-a-lot classic.

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2
Q

What are the four key innovations that Nakamoto integrated into Bitcoin?

A
  • Digital signatures -> Ensures bitcoin can only be transacted by the person who owns the bitcoin (gives controlled access to your wallet)
  • Distributed ledger -> Replaces a trusted third party to guarantee that the data are correct
  • The blockchain -> makes changing the ledger impossible because changing one entry of the ledger would require to change the entire blockchain, one would have to rewrite the entire blockchain
  • Proof of work -> validates transactions, prevents double spending
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3
Q

What are the three key questions that a distributed consensus mechanism needs to answer? What are Bitcoin’s answers to these questions?

A

1)Who maintains the ledger of transactions?
answer bitcoin: miners (nodes) maintain the ledgers by expressing their acceptance and including it in the next block.
2)Who has authority over which transactions are valid?
answer bitcoin: the nodes. The decision to add a transaction to the chain is made by consensus. this means that the majority of the nodes must agree that the transaction is valid
3)Who creates new bitcoin?
answer bitcoin: new bitcoins are released through mining, which is a process of confirming Bitcoin transactions. At the moment, when a miner finds a new block, they are rewarded with 6.25 BTC.

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4
Q

What is a mining pool?

A

A mining pool is a joint group of cryptocurrency miners who combine their computational resources over a network to strengthen the probability of finding a block or otherwise successfully mining for cryptocurrency. It can be joined by any miner willing to contribute “hashes” to the pool. The pool charges a fee for pooling miners.

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5
Q

What is the economic rationale behind mining in a mining pool rather than mining on your own?

A

Risk sharing benefit of mining pools: certainty equivalent more than doubles and risk sharing benefits increase in pool size. You search together for the answer on the mining puzzle. Because you work together, the chances on finding the solution increase, but if the solution is found, the reward has to be divided between all the participants of the pool.

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6
Q

Explain the impossibility triangle.

A

The triangle exists out of 3 points: Decentralization, Consensus and Scalability. It is considered impossible to achieve these 3 characteristics at the same time. records made in large scales with decentralization are hard to synchronize and achieve consensus. If you achieve decentralization and consensus record at the same time (like bitcoin), scalability is reduced.

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7
Q

Name and explain one recent layer-2 innovation that addresses the scalability problem associated with proof-of-work-based blockchains.

A

Rollups is one recent layer-2 innovation. Rollups are the solution for scalability problems. Rollups perform transaction execution outside the main Ethereum chain (layer 1) but post transaction data in layer 1. as transaction data is on layer 1, rollups are secured by layer 1. inheriting the security properties of layer 1 while performing execution outside layer 1 is defining characteristics of rollups.

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8
Q

If I provide you with a SHA256-hash of my name, would it be in principle possible for you to verify whether the hash is indeed the output of my name?

A

For a hash the input is converted to a hexi-decimal “hash” by scrambling it in a way that is impractical to invert. You cannot use patterns of characters in the output (the hash) as a roadmap for recovering the input, even of you know the hash function that generates the output. But, if I put the same info (in this example your name) in a hash generator, it should come up with the same hash all the time. i can compare this outcome with the hash you gave me and via this way verify if the hash you gave me is indeed the hash of your name.

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9
Q

What is the purpose of Ethereum’s Beacon chain?

A

Coordinates stakers and committees, cross-links shard chains and mainnet, central registry of all levels of data stored in Ethereum 2.0

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10
Q

A liquidity pool operated by an automated market maker contains 3000 Ether (ETH) and 9,000,000 Tether (USDT). You want to exchange 50,000 USDT into ETH. How many ETH can you take out of the pool?

A

N(ETH) x N(USDT) = 3,000 x 9,000,000 = 27,000,000,0000 = constant
current market price for 1 ETH: 3,000 USDT
you want to exchange 50,000 USDT into ETH:
USDT pool increases to 9,050,000
27,000,000,000/9,050,000 = 2,983.425
3,000 - 2,983.425 = 16.575

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11
Q

Follow-up to previous question: What is the exchange rate after the transaction (with USDT being the numeraire)?

A

if currency X held twice the market value of a unit of the numeraire (USDT), the relative price of currency X is 2. formula is numeraire/ Currency X
in this case numeraire = USDT, currency X = ETH
after the transaction, there are 9,050,000 USDTs and 2983,425 ETH in the liquidity pool.
9,050,000/ 2983,425 = 3033.426 ETH/USDT
price for 1 ETH = 3033.426 USDT

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12
Q

What are the main differences between Bitcoin and Ethereum?

A

1) Bitcoin is only a coin, while Ethereum is a blockchain/ platform with (extended) smart contract functionality
2) Transaction-based ledger vs. Balance-based ledger
3) Decentralized vs. decentralized with de facto leadership around Vitalik Buterin
4) Blocks created every 10 minutes vs. blocks created every 12 seconds.
5) Blocks size of maximum 1 MB (can be more using SegWit) vs. target size of 15 million gas, max 30 million gas. Gas fees moderate target size
6) Mining fee halves every 210,000 blocks vs. mining fee constant, but protocol brought down the fee from 5 ETH to 3 ETH in 2019
7) Mining supports arms race in mining hardware vs. mining discourages the use of ASICs (at least has for some time)
8) Turing incomplete script vs. Turing complete programming language

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13
Q

Every 210,000 blocks the mining reward for mining Bitcoin gets reduced. By what percentage do mining rewards get reduced?

A

It halves every 210,000 blocks (approx. every 4 years). So it gets reduced by 50%. In may ‘20 the reward changed from 12.5 BTC per block to 6.25 BTC per block. In 2024 it will go to 3.125 BTC per block.

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14
Q

What is the difference between a staker and a validator in Ethereum 2.0?

A

A staker activates and runs a validator (software) by sending 32 Ether to staking deposit contract located on Mainnet. The validator proposes new blocks and attests new blocks by being part of committees. A staker can run more than one validator.

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15
Q

What is an ERC-20 token?

A

It is one of the 2 standarized tokens on the Ethereum platform. It is the standard for fungible tokens. It is a common interface with a list of required functions. Finally, it is interoperable. This means that it allows other smart contracts to recognize/utilize any ERC20-token

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16
Q

Name and explain the two major concerns voiced about Tether.

A

Not transparent on their activities
You do not know what happens with your dollars, it might be that they invest into risky investment
It might also be true that when too many people want to get their dollars back this results in a bank-run as it is not clear how much of the dollars they still have available to serve

Unregulated
Tether could just be printed extra (fe. when bitcoin prices went down, they printed extra tether to buy bitcoin and drive up the price of bitcoin) , but here is no clear regulation for and as it is based on a ‘created illusion’ that one tether is worth one dollar => they must try to keep their credibility otherwise loses its value

17
Q

Filecoin is an open-source, public cryptocurrency and digital payment system intended to be a blockchain-based cooperative digital storage and data retrieval method. Filecoin is built by Protocol Labs and will be launched in the near future. Filecoin allows users to rent unused hard drive space. A blockchain mechanism is used to register the deals. Due to Filecoin’s decentralized nature, it protects the integrity of data’s location making it easily retrievable and hard to censor. It also allows people on their network to be their own custodians of the data that they store. Additionally, Filecoin also rewards the network nodes that mine and store data on their blockchain network. Filecoins have been sold to accredited investors. Is Filecoin a coin, a security token, or a utility token. Why?

A

Filecoin is a utility token; the utility of the network is reflected in the attractiveness of the goods and services that participants (i.e. customers) produce in the network. So it secures commitment from future customers. Next to this, the overall goal is to efficiently produce attractive storage-related goods and services that can be exported to the outside world. Producing more goods efficiently, leads to more demand and more demand for the network’s token, so it fastens the network effects. And lastly, network creators are rewarded with a cheaper service to the world. So no operational control as reward.

18
Q

Is Filecoin a security according to U.S. securities law? Why?

A

the US security law uses the Howey test to identify if something is a security. it should met 4 conditions:

1) an investment of money is made by the purchaser: yes
2) the investment is part of a common enterprise among numerous purchasers: yes
3) the success of the enterprise depends on the effort of a third-party promoter: no, Filecoin is decentralized and does not have a management that determine the success of Filecoin
4) purchaser has an expectation of a financial return, such as capital gains

Yes, any project that sold SAFTs that hasn’t launched yet is subject to regulation by the SEC. So having sold SAFTs seems sufficient to make the Filecoin token a security based on this injunction.

19
Q

Name and explain three benefits of utility tokens

A

1) Utility tokens secure commitment from future customers
2) hasten network effects
3) reward network creators without giving them operational control after the network has launched.

20
Q

How does Szabo (1986) define smart contracts?

A

“a smart contract is a set of promises, specified in digital form, including protocols, within which the parties perform on these promises.”
they are not really smart
not necessarily legal
not necessarily a contract

21
Q

What is the difference between a hard fork and a soft fork?

A

a fork is an update to the protocol.
Hard forks and soft forks are essentially the same in the sense that when a cryptocurrency platform’s existing code is changed, an old version remains on the network while the new version is created. With a soft fork, only one blockchain will remain valid as users adopt the update. Whereas with a hard fork, both the old and new blockchains exist side by side, which means that the software must be updated to work by the new rules. Both forks create a split, but a hard fork creates two blockchains and a soft fork is meant to result in one

22
Q

What are the two key innovations coming to the Ethereum blockchain with Ethereum 2.0?

A

Proof-of-stake

sharding - Horizontal partitioning of a data base

23
Q

What is the role of oracles in smart contracts? Can you provide one example of an oracle used in a smart contract?

A

Oracles are ‘reliable outside sources’ that provide smart contracts with information they need
Example: Automated Market Maker (AMM) uses oracles in their smart contracts that provide the current market price. if the exchange ratio then is too far off, the trade will not be executed. It is a check to ensure that price manipulation does not pay off.

24
Q

You provide 10 Ether and 35,000 DAI to a liquidity pool. With this contribution to the liquidity pool, you provide 10% of the liquidity offered by the pool. One month later, the liquidity pool has earned 0.5 Ether in transaction fees and the price of Ether has increased by 150%. Assuming that your sharee of the liquidity pool stayed constant over the past month, what is your net profit (in Ether) from providing liquidity?

A

Alternative solution:
Calculate the value after the price change if you would not have provided liquidity. In this case 14 ETH. use the impermanent loss formula:
IL = ( 2 x square root ( new price / old price) ) - 1 = - 0.09649
1 + (new price / old price )
Multiply this value with the 14 ETH = -1.3509
Add the earned transaction fees = -1.3509 + 0.05 = 1.3009

25
Q

Describe how the mechanism implemented in MakerDAO’s smart contract MakerVault allows crypto investors to leverage their crypto-investment.

A

you can send ERC20 tokens (for example ETH) with a value of 150$, which the MakerVault will then lock in as collateral. with a collateral ratio of 150%, then the MakerVault mints maximum DAI worth of $100. with this DAI worth 100$ you can buy again ETH worth 100 $. This ETH you can lock in the MakerVault again, receiving DAI worth 66$ etc. I have now ETH worth 250 $ dollar in the fault, with a initial investment of 150 $. you are now more exposed to price fluctuations of ETH.

26
Q

Describe how the mechanism implemented in MakerDAO’s smart contract MakerVault allows crypto investors to hedge their crypto-investment.

A

you can put your ETH in a MakerVault contract. This ETH get locked in as collateral and you will get an X amount of DAI (depending on the current ETH price and the collateral ratio). You swap this DAI in dollars and you have your profit for sure. if ETH crashes, you still have your dollars. if ETH would continue to rise, you could free the ETH again from this MakerVault contract and sell the ETH. you can also use a DAI Savings Rate (DSR) contract

27
Q

According to Cong, Li, Wang (2021), what is the determinant of the value of utility tokens? What does this mean in laymen’s terms (i.e., in your own words)?

A

“Network effect is key driver of token value. Price of tokens is determined by aggregating heterogeneous users’ transactional demand, rather than discounting cash flows”. Network effect provide key driver function for utility tokens and positive externalities comes from user adoption.

28
Q

Name three advantages of a security token offering relative to a traditional IPO?

A

1) less transaction costs: IPO has much higher transaction costs (7% of proceeds). Costs of going public are almost as high when you continue to be public.
2) Lead times for a share transaction will be reduced from several days to minutes
3) Borderless: IPOs are usually performed within the jurisdictions in which the business conducts operations, shutting out foreign investors. With STOs, there is simply no such issue. Investors just need to have an account on the STO platform to take part in it.

29
Q

In a recent article, the Economist argues that regulators should treat Tether like a bank. Would you agree?

A

es/no I think your argument is what matters

Yes, USDT receives fiat USD and issues tether in return. The idea is that the fiat USD remains in a vault and the tether can be exchanged back for fiat USD at the owner’s discretion. But it appears that USDT is not keeping all the fiat in the vault in form of cash, they convert them to cash equivalents and even loan them out. This pretty much looks like a bank, receiving deposits and making loans. It also looks like fractional reserve banking, making them vulnerable to a “bank run”.

30
Q

Name and explain three reasons why regulators are worried about cryptocurrencies

A

1) concerns of financial stability: if for example AliPay goes bankrupt, a lot of deposits will go lost too
2) investor/consumer protection against fraud which is difficult to do with crypto. Who are you gonna punish if the seller of the crypto is ripping you off?
3) lose grip on monetary policy: if there are more private providers of some kind of new money/ currency the central banks lose their ability to apply monetary policies

31
Q

Name and explain the three options the Ethereum community considered to deal with the hack of The DAO

A
  1. Accept the hack and move on
  2. Freeze the stolen Ether (soft fork)
  3. Undo the hack and return the Ether to the DAO investors (hard fork)