Research Pulse #85 10/03/2022

  1. Systematization of Knowledge: Synthetic Assets, Derivatives, and On-Chain Portfolio Management
    Authors: Abrar Rahman, Victor Shi, Matthew Ding, and Elliot Choi

Synthetic assets are decentralized finance (DeFi) analogues of derivatives in the traditional finance (TradFi) world—financial arrangements which derive value from and are directly pegged to fluctuations in the value of an underlying asset (ex: futures and options). Synthetic assets occupy a unique niche, serving to facilitate currency exchange, giving traders a means to speculate on the value of crypto assets without directly holding them, and powering more complex financial tools such as yield optimizers and portfolio management suites. Unfortunately, the academic literature on this topic is highly disparate and struggles to keep up with rapid changes in the space. We present the first Systematization of Knowledge (SoK) in this area, focusing on presenting the key mechanisms, protocols, and issues in an accessible fashion to highlight risks for participants as well as areas of research interest. This paper takes a broad perspective in establishing a general framework for synthetic assets, from the ideological origins of crypto to legal barriers for firms in this space, encapsulating the basic mechanisms underpinning derivatives markets as well as presenting data-driven analyses of major protocols.

Link to Paper

  • DeFi’s goal is to redefine how financial institutions operate and disintermediate financial services and products as much as possible.
  • This ambitious goal entails not only copying legacy financial products, such as futures, but also creating entirely new types of products, such as flash loans.
  • Needless to say, there is a lot of complexity involved in this new paradigm. This paper provides a Systemization of Knowledge and does an excellent job explaining the key concepts involved.
  1. Measurement, Analysis, and Insight of NFTs Transaction Networks
    Author: Prakhyat Khati

Non-fungible tokens (NFTs) are unique digital items with blockchain-managed ownership. Ethereum blockchain-based smart contract created the environment for NFTs (ERC-721) to reach its one of the most important future application domains. Nonfungible tokens got more attention when the market saw recordbreaking sales in 2021. Virtually anything of value can be traced and traded on the blockchain network by minting them as NFTs. NFTs provide the users with a decentralized proof of ownership representation, as every transaction and trade of NFTs gets recorded in the Ethereum network blocks. The value of NFTs is derived from their being “non-fungible,” meaning that the token cannot be replaced with an identical token (giving it inherent scarcity). In this paper, we study the growth rate and evolutionary nature of the NFT network and try to understand the NFT ecosystem. We explore the evolving nature of the NFT interaction network from a temporal graph perspective. We study the growth rate and observer the semantics of the network. Here on the observer network, we will run two graph algorithms on the dataset. Lastly, observe and forecast the survival of NFTs bubble by applying the Logarithmic periodic power law (LPPL) model to the time series data on one of the most famous NFT collections,” CryptoPunks” (predicting price increase), which has seen sales of around $23.7million around mid of 2021.

Link to Paper

  • NFT continue to contribute to the popularization of cryptoassets, but academic research on the nature of how they are used is still thin.
  • This study sheds light on how NFT users interact via a topology analysis, effectively making NFT addresses “nodes” and graphing their relationship.
  • This type of temporal graph analysis can be helpful in understanding NFT market cycles and the different types of user archetypes involved, from retail users to funds.
  1. Property-Based Automated Repair of DeFi Protocols
    Authors: Palina Tolmach, Yi Li, and Shang-Wei Lin

Programming errors enable security attacks on smart contracts, which are used to manage large sums of financial assets. Automated program repair (APR) techniques aim to reduce developers’ burden of manually fixing bugs by automatically generating patches for a given issue. Existing APR tools for smart contracts focus on mitigating typical smart contract vulnerabilities rather than violations of functional specification. However, in decentralized financial (DeFi) smart contracts, the inconsistency between intended behavior and implementation translates into the deviation from the underlying financial model, resulting in monetary losses for the application and its users. In this work, we propose DeFinery—a technique for automated repair of a smart contract that does not satisfy a user-defined correctness property. To explore a larger set of diverse patches while providing formal correctness guarantees w.r.t. the intended behavior, we combine search-based patch generation with semantic analysis of an original program for inferring its specification. Our experiments in repairing 9 real-world and benchmark smart contracts prove that DeFinery efficiently generates high-quality patches that cannot be found by other existing tools.

Link to Paper

  • Smart contracts are irreparable once encoded on the blockchain, making it difficult for developers to balance experimentation and safety.
  • Given this dynamic, smart contract developers are constantly evaluating new tools that not only automate the detection of bugs but also patch them automatically.
  • The latter is often called Automated Program Repair (APR) in the field of computer science, and it represents the use of various techniques to make software “heal” itself.
  • This paper proposes an APR scheme for smart contracts called DeFinery, which is designed to automatically patch a smart contract as vulnerabilities are identified.
  1. Ring Signatures with User-Controlled Linkability
    Authors: Dario Fiore, Lydia Garms, Dimitris Kolonelos, Claudio Soriente, and Ida Tucker

Anonymous authentication primitives, e.g., group or ring signatures, allow one to realize privacy-preserving data collection applications, as they strike a balance between authenticity of data being collected and privacy of data providers. At PKC 2021, Diaz and Lehmann defined group signatures with User-Controlled Linkability (UCL) and provided an instantiation based on BBS+ signatures. In a nutshell, a signer of a UCL group signature scheme can link any of her signatures: linking evidence can be produced at signature time, or after signatures have been output, by providing an explicit linking proof.
In this paper, we introduce Ring Signatures with User-Controlled Linkability (RS-UCL). Compared to group signatures with user-controlled linkability, RS-UCL require no group manager and can be instantiated in a completely decentralized manner. We also introduce a variation, User Controlled and Autonomous Linkability (RS-UCAL), which gives the user full control of the linkability of their signatures.
We provide a formal model for both RS-UCL and RS-UCAL and introduce a compiler that can upgrade any ring signature scheme to RS-UCAL. The compiler leverages a new primitive we call Anonymous Key Randomizable Signatures (AKRS)—a signature scheme where the verification key can be randomized—that can be of independent interest. We also provide different instantiations of AKRS based on Schnorr signatures and on lattices. Finally, we show that an AKRS scheme can additionally be used to construct an RS-UCL scheme.

Link to Paper (paywalled)

  • Ring Signatures are amongst the most popular techniques used to achieve transactional privacy in the field of cryptoassets. Monero, one of the most popular privacy-oriented cryptoassets, relies on Ring Signatures to hide the footprint of XMR senders on its blockchain.
  • Nevertheless, as a means to privacy, much still needs to be researched about Ring Signatures to fully assess their trade-offs, especially as it relates to both their efficacy as a privacy solution as well as efficiency on-chain.
  • This paper discusses a new type of Ring Signature called Ring Signatures with User-Controlled Linkability (RS-UCL), which gives users more flexibility when generating privacy-preserving transactions.
  1. Verifiable Timed Linkable Ring Signatures for Scalable Payments for Monero
    Authors: Sri Aravinda, Krishnan Thyagarajan, Giulio Malavolta, Fritz Schmid, and Dominique Schröder

Decentralized cryptocurrencies still suffer from three interrelated weaknesses: Low transaction rates, high transaction fees, and long confirmation times. Payment Channels promise to be a solution to these issues, and many constructions for cryptocurrencies, such as Bitcoin and Ethereuem, are known. Somewhat surprisingly, no solution is known for Monero, the largest privacy-preserving cryptocurrency, without requiring system-wide changes like a hard-fork of its blockchain like prior solutions.
In this work, we close this gap for Monero by presenting the first provably secure payment channel protocol that is fully compatible with Monero’s transaction scheme. Notably, the payment channel related transactions are identical to standard transactions in Monero, therefore not hampering the coins’ fungibility. With standard techniques, our payment channels can be extended to support atomic swap of tokens in Monero with tokens of several other major currencies like Bitcoin, Ethereum, Ripple, etc., in a fungible and privacy-preserving manner.
Our main technical contribution is a new cryptographic tool called verifiable timed linkable ring signatures (VTLRS), where linkable ring signatures can be hidden for a pre-determined amount of time in a verifiable way. We present a practically efficient construction of VTLRS which is fully compatible with the transaction scheme of Monero, and allows for users to make timed payments to the future which might be of independent interest to develop other applications on Monero.
Our implementation results show that even with high network latency and with a single CPU core, two regular users can perform up to 93500 payments over 2 min (the block production rate of Monero). This is approximately five orders of magnitude improvement over the current payment rate of Monero.

Link to Paper

  • Like the previous paper, this paper also discusses Ring Signatures as they are specifically implemented in Monero.
  • Instead of privacy, the focus of this work is to increase the functionality of this signature type by enabling so-called “Timelocks” which open the possibility for Monero to feature better scalability solutions, as well as a level smart contract functionality.
  1. A Privacy-Preserving Watchtower Scheme with Constant Storage Overhead
    Authors: Yan Huang, Ruian Li, Junxin Liu, Yankai Xie, Chi Zhang, and Lingbo Wei

Payment channels are the most promising solution to the scalability issue of Bitcoin, allowing mutually untrusted parties to conduct transactions off-chain. However, parties are required to be online frequently to monitor the blockchain, or they risk losing funds. To alleviate the problem, watchtowers are introduced to help parties monitor the blockchain. Several watchtower schemes have been proposed, but they have problems in storage overhead, privacy, or fund security. In this paper, we propose a Schnorr threshold signature-based watchtower scheme that can guarantee the security of parties’ funds even if a subset of watchtowers crashes or colludes. And, by changing the data kept in watchtowers, our scheme can preserve the privacy of off-chain transactions while just requiring the constant storage overhead of watchtowers. Hence, our scheme is the first watchtower scheme that solves the above problems while remaining compatible with existing Bitcoin and payment channel implementations. Finally, we provide a proof-of-concept to demonstrate the efficiency and feasibility of our scheme.

Link to Paper

  • Payment Channel Networks (PCNs), such as the Lightning Network have the potential to solve one of Bitcoin’s biggest challenges: the scalability and practicality of payments.
  • However, there are still security issues that have prevented the adoption of PCNs such as the requirement for participants to be online.
  • The advent of so-called “Watchtowers” is promising, as they circumvent that impractical requirement by socializing the monitoring of payment channels.
  • This paper introduces a new design for a Watchtower that uses Schnorr threshold signatures to minimize the risk of monitoring being compromised by adversaries.

Systematization of Knowledge: Synthetic Assets, Derivatives, and On-Chain Portfolio Management

A synthetic asset is a tokenized blockchain-based derivative of an underlying asset. Also referred to as synths, synthetic assets can be described as a combination of traditional derivative assets and cryptocurrencies. However, unlike the traditional financial world, synthetic assets add a record for a derivative on a blockchain, thereby creating a crypto token for it. Simply, synthetic assets are tokenized derivatives, with the growth in decentralized finance seen to fuel their growth in the crypto space.

How Do Synthetic Assets Work?

Synthetic assets work similar to the traditional financial derivatives assets. The only difference between synths and traditional financial derivatives such as forwards, futures, and options is that traditional derivatives are backed by a contract while synths are backed by non-fungible tokens commonly referred to as NFTs in DeFi. Basically, the non-fungible tokens are smart contracts built on the blockchain technology. In trading, synths function in the same way as the traditional derivatives so that when the price or value of the underlying blockchain-based asset moves, the value of the synthetic asset moves. In simple terms, synthetic assets mirror the underlying blockchain assets in terms of pricing and value.

How Do You Make Synthetic Assets?

Synthetic assets are made through a process referred to as tokenization. Tokenization in blockchain technologies refers to the conversion of a meaningful piece of data into a random string of characters which has no traceable link to the original data. The process creates a new asset called a token. The token or digital certificate stands for the real-world asset and is issued to the investor as ownership rights. Powered by blockchain, the token cannot be breached to reveal original data. If breached, then data would be meaningless since the token only gives a reference to the data and not the data itself. Tokenization takes place in accordance with the synthetic asset protocol which can be both decentralized and distributed. Any asset can be the underlying asset for the token. The most popular in the recent past has been tokens whose underlying assets are digital art. This shows the extent of the financial revolution that comes with synthetic assets in DeFi.

What are the Advantages of Trading Synthetic Assets?

There are many advantages of trading synthetic assets including those that apply to traditional derivatives. The benefits include hedging risk of exposure, market efficiency, access to unavailable assets or markets, and price discovery or determination. With tokenized derivatives or synths, these advantages are extended. Synths create more liquidity than can be imagined under traditional derivatives with access to the global marketplace. Any person can issue synths or tokenized derivatives so long they follow synthetic asset protocol. There are tools like Synthetix, an open source protocol for the creation of synths. The ease of creating synths is behind the growing mentions of NFTs in the DeFi spaces. Above all, synths and tokenized derivatives enjoy frictionless movement in a borderless trading ecosystem powered by the concepts of DeFi and blockchain. DeFi eliminates the role of financial intermediaries that characteristically raise the transactions through duplicitous efforts especially when the trading is across borders. Trading synths in DeFi attracts almost insignificant cost and without any limitations of geographical borders. Besides, traders can enjoy anonymity which lacks in centralized exchanges for traditional finance. Transactions can still be traced in a distributed ledger making privacy a key step-up in synthetic assets trading.