HR And Blockchain 1. Explain the four types of business models for blockchain networks. 2. Explain how blockchain has the potential to change business mode

HR And Blockchain 1. Explain the four types of business models for blockchain networks. 2. Explain how blockchain has the potential to change business models.

500 words paper: Introduction, Question 1, Question 2, Conclusion, References 

References

 

1. Morkunas, V. J., Paschen, J., & Boon, E. (2019). How Blockchain technologies impact your business model. Business Horizons, 62, 295-306.

2. Bussgang, J. J., Berk, E. B., & Schwalb, N. (2019, January 15). AirFox (A): Embracing the Blockchain and an ICO. Harvard Business School. AirFox (A): Embracing the Blockchain and an ICO
In June 2017, Victor Santos, the 26-year-old CEO of AirFox, paused to catch his breath as he approached the Harvard Launch Lab early in the morning, just as the sun was rising. He was considering publicly releasing an announcement that his company would undertake a dramatic pivot and change its business model. If he chose to go through with it, the announcement would have profound consequences. Santos knew that a key board member would resign and other employees would likely follow, and that he would be embarking into uncharted territory for his fledging startup. Outside the building’s entrance, Santos asked himself one more time whether it was the right decision and whether the risks would be simply too great.
AirFox was an early-stage startup that sold software to wireless carriers. The company had signed three enterprise customers, was generating revenue, and had a pipeline of incoming deals. However, AirFox was on track to run out of cash in three months. Santos had already laid off employees and dramatically reduced wages for the remaining team members. After months of trying, Santos had failed to find new investors to keep the company afloat. He believed that pivoting to use an emerging technology called blockchain and executing an ambitious financing through an Initial Coin Offering would be the best path forward for AirFox. But doubts were starting to creep into his mind. Was he willing to bet the company that he was right?

Founding AirFox
Santos was born in Brazil and moved to the U.S. with his family when he was 12. He attended the University of California–Berkeley and graduated with a BS in business administration in 2013. While still a student, he cofounded Ciao, a telecom services company with operations in Brazil. The company saw modest success and grew to millions of dollars in revenue. But after graduation, Santos wanted to work for Google to learn from the best, joining as a Product Marketing Manager in 2013 while retaining a connection to Ciao. Then, in 2014, he returned to Ciao full-time as its COO and embarked on launching its U.S.-based telecom service expansion.
In 2014, four major wireless carriers (Verizon Wireless, AT&T, Sprint, and T-Mobile) dominated the
U.S. cellular network market. These leading players sold wireless plans to consumers as well as excess

Senior Lecturers Jeffrey J. Bussgang and Edward B. Berk and Associate Case Researcher Nate Schwalb (Case Research & Writing Group) prepared this case with the assistance of Executive Director Carin-Isabel Knoop (Case Research & Writing Group). It was reviewed and approved before publication by a company designate. Funding for the development of this case was provided by Harvard Business School and not by the company. Jeff Bussgang has limited investment exposure to AirFox through a limited partnership investment in Techstars, a start-up accelerator that supported AirFox. HBS cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management.

Copyright © 2018, 2019 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545- 7685, write Harvard Business School Publishing, Boston, MA 02163, or go to www.hbsp.harvard.edu. This publication may not be digitized, photocopied, or otherwise reproduced, posted, or transmitted, without the permission of Harvard Business School.

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network capacity wholesale to small brands. The small wireless brands were called Mobile Virtual Network Operators (MVNOs) because they operated a virtual network rented from another company rather than owning their own network equipment and towers. They often served niche populations, for whom they could design differentiated plans and pricing, including plans marketed to lower- income consumers.1
Santos planned to launch a new U.S.-based MVNO aimed at low-income customers. Subscribers would be able to lower their monthly costs by watching advertisements.
However, Ciao soon confronted serious challenges. Ciao Brazil, the MVNO’s parent company, faced financial trouble and an exodus of management talent. The new U.S. plan also had difficulty winning a large number of subscribers, and it suffered from high customer acquisition costs due to fierce competition.
Santos concluded that his team’s core competency lay in advertising software that could subsidize smartphone plans. Rather than try to run a mobile operator and market telecom services, Santos thought it would be easier for Ciao to market an app. The app would show users ads on their smartphone lock screen and reward them per ad viewed by subsidizing their cell phone bill or paying out a cash reward.
A software-based business model would be more scalable because the business could distribute the app to millions of users without asking those users to change cell phone plans or buy new phones. Santos decided to pursue this new path as a new company, unencumbered by Ciao’s financial baggage. Santos branded the new company AirFox.

Launching and Scaling AirFox
In 2015, the vision behind AirFox was to enable wireless carriers to distribute the startup’s ad- serving software to their subscribers, integrating with the carriers’ back-end systems to handle advertising, payments, and billing. The carrier would distribute the software to subscribers by either installing it on their phones pre-sale or encouraging subscribers to download the app post-sale. Once the software was installed and the ads were enabled to display on the phone’s lock screen, ad revenue would be generated to subsidize the subscribers’ plans. The business model was a revenue split between AirFox and the carrier. End users would benefit by receiving cheaper plans subsidized by the advertising. The carrier would benefit by maintaining more competitive rates without sacrificing margins.
Santos believed that selling to carriers would offer AirFox several advantages over marketing to users directly. First, AirFox would be able to scale with less investor capital, because the wireless companies could more efficiently distribute the lock screen app to end users. Second, partnering with carriers created an opportunity to sell additional software. In particular, Santos believed AirFox could build and sell more flexible application programming interfaces (APIs)a that would allow its MVNO customers to offer different data costs for different smartphone apps, thus creating more customized offerings. The ability to customize plans, pricing, and packaging would augment the MVNOs’ natural advantage of being able to pursue niche markets in the face of competition from dominant carriers. There were over a thousand MVNOs and small carriers globally.2 Santos was confident: “They all wanted revenue streams that weren’t dependent on the underlying carrier and the distribution.”

a APIs were a set of programming tools that could help third parties work with the same underlying software.

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AirFox’s goal was not simply to make money. Santos and the employees he recruited were also motivated by AirFox’s social mission to make smartphone data more affordable for low-income users. In a 2015 survey of smartphone owners, Pew Research found that financial constraints led 23% of respondents to cancel or shut off their cell phone service. The survey further found that 37% of smartphone owners reached their maximum allowable data limit. Americans who were less educated, lower-income, or nonwhite were especially vulnerable to limited connectivity.3 The AirFox team was energized to make the internet more affordable and accessible, initially for Americans and then eventually for billions of users globally.
Santos pursued product development, customer acquisition, and investor financing at the same time. He applied and was accepted to Techstars Boston, an accelerator program that invested in and coached early-stage startups in exchange for equity. Techstars helped AirFox with its strategy, recruiting, and business development efforts, as well as exposure to potential investors. After the program ended in the summer of 2016, AirFox closed a $1.1 million seed round from respected local angels and seed venture capital firms.
The team was ecstatic to sign their first carrier contract after just three weeks of discussions and saw it as a sign of validation for AirFox’s business model. AirFox was able to integrate its software with the pilot customer in just two months. Three more carrier deals followed, as well as a pipeline of interested contacts at other carriers. By December 2016, AirFox had built its user base with the initial customers and was generating $40,000 in monthly recurring revenue, earning $0.15 to $0.80 monthly per active paid user.
The pipeline of potential deals, however, did not convert to revenue quickly over the course of 2017. Santos explained, “The sales cycle was proving to be brutal. Among the deals AirFox successfully closed, it would take 6 to 10 weeks to close the sale. And that was only the beginning. It would be a further 8 to 12 weeks for integration, followed by 4 to 8 weeks to agree on a launch plan, and then another 4 to 8 weeks to ramp up and saturate the customer’s base of subscribers.” When launching with a new carrier, AirFox would send texts and notifications to subscribers to inform them about the new program. Generally, 20% to 40% of subscribers would uptake the app, with 70% to 80% retention.
The slow pace of converting the carrier pipeline to revenue made it clear that follow-on financing would be a challenge. Santos wanted to raise several million dollars of Series A capital from institutional investors. As he met potential backers, he found that investors were not sufficiently impressed with the startup’s progress or its fundamental business model. “We were pitching to VCs [venture capitalists] and not getting anywhere,” Santos recalled. “Our end users were low-income, and our customers were small carriers with a long sales cycle.” As one team-member put it, “We were making some money, but not enough money to hit the typical Series A milestones.”
Santos believed he could attract investors for the round if AirFox could accelerate the closing of new accounts, particularly one potentially lucrative contract with a prospective carrier that seemed to be falling into place. Santos decided to raise a small bridge loan to finance the business for a few extra months, during which AirFox could close the new deals that would solidify its case for a Series A.
In January 2017, he landed an introduction to a partner at a seed-stage venture fund. Impressed with AirFox, the partner committed $500,000 as a lead investor for the bridge. This development convinced several smaller backers to commit to the financing round, including the micro-seed fund that led AirFox’s seed round and held a seat on AirFox’s board of directors. In anticipation of the new financing, which had grown as large as $1 million, Santos began hiring. He expanded the engineering team and recruited an experienced Chief Technology Officer (CTO) from the West Coast.

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Down to the Wire
In April 2017, Santos had secured the lead investor’s signature on the bridge note documents and sent him wiring instructions; the investor had filled out the wire and returned it with the requisite signatures. However, the bank transfer did not go through. When Santos inquired as to the status of the funds, he learned that the investor was in litigation with his business partners, and a Delaware court had frozen his bank account. With the funds frozen, the investor had to back out of the financing, causing the other bridge investors to step away as well. The existing investors who had sponsored AirFox’s seed round offered emotional support but did not step up financially because they did not have deep enough pockets to carry AirFox on their own. One team member remarked wryly, “It was nice to have our investors’ support. However, it didn’t pay our engineers’ salaries.”
The day after the financing fell through, Santos called an emergency board meeting. The company had a gross burn rate of $130,000 per month, seven full-time employees, numerous contractors, and only $100,000 left in the bank. (See Exhibits 1a and 1b for AirFox financials.) To save the company, Santos proposed a plan to the board that would dramatically reduce salaries; lay off five contractors, most of whom were supporting engineering; and let the new CTO go.
After the board meeting, Santos approached the remaining team members. He asked them to work at minimum wage for two months and then at half salary for three months afterward. To make up for the lost wages, the board offered the remaining employees triple their original stock option grants. Santos also promoted two engineers to more senior roles, including elevating engineer James Seibel to CTO.
On the financing side, Santos pursued dual tracks. He scrambled to find new cash infusions to continue operations and began discussions with larger companies about an acquisition. Santos approached his old employer, Google, about an acqui-hire (i.e., an acquisition in name only, but really a wholesale hiring of the team rather than a substantial payment for the company itself). He also spoke about mergers with several other startups that served the low-income mobile market. Unfortunately, no potential acquirer or partner was interested enough to make a satisfactory offer in such a short time frame.

Finally, Santos approached his two existing MVNO customers for funding. When an initial conversation with a customer went nowhere, Santos changed his approach when talking with the second partner. “I decided to hold my cards closer to the chest,” Santos recounted, explaining how he chose to deploy a more nuanced pitch. “I told them, ‘We have a note open. This is the opportunity of a lifetime, and based on our relationship, we want you to lead with $1 million.’” The customer decided to invest $250,000, buying AirFox another six months at its reduced burn rate. Santos was relieved to receive the new commitment, but he knew it was just a temporary lifeline. To grow the company, Santos needed more cash. However, as he pitched more and more VCs, Santos found they were still not interested. AirFox had a few more months of runway, but Santos felt unsure of his long-term plan without additional capital. He reflected, “This was the moment to step back. Breathe. And figure out, ‘What the heck do we do?’”

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Brainstorming a Pivot
In May 2017, Santos asked Seibel and two other employees to meet him in a conference room, take stock of the situation, and brainstorm together about what could be next for AirFox. They decided to first focus on the assets they felt they already had. Santos recalled, “We wrote out on a whiteboard the assets we had. Technology, Team, Contracts. What can we make with these?” (See Exhibit 2 for a mock- up of the whiteboard.)
Santos recalled, “We kept coming back to ‘Who is our customer?’ and ‘What problem are we trying to solve?’ We saw that we were struggling with reaching the end user to help them with their finances by selling through the carriers. We wondered: Can we remove the carriers? Maybe take more risk? What if we sold direct to consumers? This was an option, but we would need a lot more money.”
The team considered whether they could help carriers set dynamic pricing based on cell phone usage data. They considered the advertising exchanges they integrated with, and how these exchanges might be interested in acquiring rare data on AirFox’s lower-income core segments.
Over the course of the discussions, the group kept coming back to AirFox’s users. “What is their chief problem?” Santos remembers asking. “The problem they face is affordability.” This led the group to think about making small loans, called microloans, to low-income subscribers who wanted to purchase more minutes and data.
The talk of microloans prompted Seibel to share his hobbyist interest in blockchain—a new set of software protocols that created and maintained ledgers. Blockchain was an innovation with growing popularity among technologists and investors. Advocates believed it could allow transactions and contracts to occur without relying on centralized third parties, such as banks. However, it had few proven, real-world use cases at the time.
Santos wrote the word “blockchain” on the whiteboard and asked, “What could we use this for?” “Honestly, I am not sure yet,” Seibel responded. “Right now, the most popular applications are
creating payment systems and creating new currencies. Maybe we could use it to help users pay their
bills. Or keep track of their microloans. There are a lot more uses. One day, this technology will be big.”
“OK, let’s leave blockchain on the whiteboard for now,” Santos replied. “We can research it more later.”
They broke to grab lunch. Several bites into his sandwich, Santos saw a text message from Seibel on his screen. It read, “BOOM,” and contained a hyperlink to a TechCrunch article titled “Former Mozilla CEO raises $35M in under 30 seconds for his browser startup Brave.”4

The story immediately caught Santos’s attention. According to the article, Brave was building a browser that used blockchain and had successfully raised $35 million in crowdfunded capital. “For the first time, I felt something real was going on here,” Santos remembered thinking. “The former CEO of Mozilla has a serious reputation and raised a lot of money. I decided to drop everything and read all I could about blockchain and decentralized ledgers.”

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Blockchain

Decentralized Ledgers

The term “blockchain” referred to a succession of data records (“blocks”) that were individually time-stamped and referenced each other, forming a ledger (“chain”) of data entries.5 Rather than a single copy stored in a central sever, thousands of identical copies of the ledger were stored in various computer nodesb across a broad network.6
By removing reliance on a central server, blockchains were theoretically more trustworthy than traditional centralized database technologies. There would be no chance for an entity controlling the central computer to manipulate the data, transcribe an error, or be hacked.7 Blockchain could also theoretically be more open than other database technologies. With decentralized data, no company or government would be able to make data access difficult for its own benefit.8 Further, electronic transactions could be made without relying on trust, because the public ledger contained a full history of the transactions, sealed cryptographically and immutable.
These properties of greater trustworthiness and openness through decentralization were attractive, and some blockchain champions saw the technology as a powerful business process improvement tool. To them, blockchain could help reduce costs and decrease wasted time in processes where multiple organizations needed to share data and agree on the data’s accuracy.9 Other blockchain advocates saw society-wide implications for how entire organizations were financed, built, and managed.10 Some proponents saw it as “the next internet.”11
Two professors wrote in a Harvard Business Review article about blockchain:
The parallels between blockchain and TCP/IPc are clear . . . TCP/IP unlocked new economic value by dramatically lowering the cost of connections. Similarly, blockchain could dramatically reduce the cost of transactions. It has the potential to become the system of record for all transactions. If that happens, the economy will once again undergo a radical shift, as new, blockchain-based sources of influence and control emerge.12

Building Blockchains

Computers on a blockchain network all operated according to a protocol, which was a shared set of rules that made data mutually intelligible between network participants. A central part of the blockchain protocol was to provide incentives to encourage participants to maintain the decentralized nodes and ledgers and a consensus mechanism to enforce any rules and incentives. (See Exhibit 3 for an overview of how blockchains worked.)
Blockchain protocols generally provided a core set of guarantees:
1. Past entries would be accurately maintained.
2. New entries that followed the rules would be validated before broadcasting to all of the nodes in the network.

b The term “node” referred to a point in a communications network that could communicate with other points.

c Transmission control protocol/internet protocol (TCP/IP) —a common protocol for communication between computers across networks—was one of the key innovations that enabled the internet.

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3. Incentives would ensure validators act correctly.13

Bitcoin

Launched in 2009, Bitcoin was the first blockchain protocol to meet these guarantees. After the Bitcoin blockchain was created, other blockchains rapidly followed, such as Ethereum and Ripple, inspired by the Bitcoin protocol and architecture.
The Bitcoin network was designed as a payment network. The network allowed users to pay each other with a digital currency. The digital currency was called bitcoin (and written with a lowercase ‘b’ to distinguish it from uppercase ‘B’ references to the Bitcoin network or Bitcoin protocol).14 There were no physical bitcoin coins or even digital files of bitcoins. There was only a ledger of bitcoin transactions. Bitcoins could be owned by a person only if that person had an entry in the ledger in which he or she had received bitcoin in the past and not yet spent it.15
For the payment network to be trustworthy, new entries to the public ledger needed to be validated to ensure two criteria: (a) nobody spent money from an account they did not own, and (b) nobody spent more bitcoin from an account than that account had previously received. The rules of the Bitcoin protocol were instantiated in software to ensure that both criteria were met in all new entries.
The Bitcoin protocol ensured the first criterion, that nobody spent money from an account they did not own, by using public-key cryptography, a tool that functioned like a digital signature—easy for an initial party to produce and easy for outside parties to validate, but very difficult for an outside party to forge. Bitcoin users would have a private key that allowed them to “sign” data. Anyone viewing the signature could easily identify it with the signer’s digital identity, often called the signer’s public key. As long as the user was the only person in possession of his or her private key, nobody could impersonate that user.16
The Bitcoin protocol also ensured the second criterion, that nobody spent more bitcoin from an account than that account had previously received, by time-stamping every transaction. Data of several transactions would be grouped together into a “block” of transactions. Each block of data referenced the block before it in chronological order.17 Nodes on the Bitcoin network were able to check each new block against the chain of validated prior blocks to ensure nobody overspent their existing balance.18
If there were multiple chains of prior transactions that disagreed with one another and all claimed to be valid, nodes using the Bitcoin protocol adhered to a simple rule: believe the longest chain (i.e., the longest chain is the valid one). The Bitcoin protocol demanded that computers always use the latest time-stamped block on the longest chain of blocks as the true state of the ledger. In other words, the Bitcoin protocol accepted length of the chain as a proxy for validity.19
Using the longest chain as a proxy for validity had the benefit that all computers in the network could agree on which state of the ledger was valid, without a central clearinghouse and without independently validating dozens of blocks into the past to ensure that the accuracy of the chain was unbroken. However, the Bitcoin protocol needed measures to ensure that length-of-chain could serve as a dependable proxy. This was where Bitcoin’s incentive structure came in.20

To ensure that length-of-chain was a dependable proxy for validity, the Bitcoin protocol made it costly for a computer to propose new blocks. This way, a malicious party could not falsify entries to the ledger and then cheaply create enough blocks for the falsehood to become part of the longest chain. To do so, the Bitcoin network required proof-of-work to be part of any new block validation. Performing the proof-of-work involved long calculations that were expensive in both fixed-cost computer

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hardware and variable-cost electricity. In order to propose more blocks than the honest actors, a dishonest actor would need to control a majority of the expensive computing resources in the network. In practical terms, this would make fraud prohibitively expensive and push the validators to act honestly.21,d
In this way, the Bitcoin network stored data in a decentralized ledger of transactions and used incentives to maintain the ledger. It ensured that past data was immutable. It ensured that new entries would be checked for violations of the rules and that incentives would ensure that nodes acted correctly. The model first used by Bitcoin would inspire all the blockchain projects that followed.

Blockchain beyond Bitcoin

Running the Bitcoin blockchain came with costs and inefficiencies.
First, there were direct computing and power costs required for the proof-of-work. Running a computer to validate transactions using proof-of-work was called mining. Mining heavily used electricity by using a lot of computing power. Estimates of Bitcoin’s electricity cost varied widely, but by some estimates Bitcoin miners used an amount of continuous electricity similar to that of Ireland in late 2017. There were some proposed solutions to reducing energy consumption without compro- mising security for other blockchain technologies, but Bitcoin had implemented none of them in 2017.22
Second, the Bitcoin network was slow compared with some centralized payment networks. In December 2017, Bitcoin took an average of 78 minutes to process a transaction, and processing time could spike to over 1,000 minutes on high-congestion days.23 According to some estimates, the theoretical maximum for the Bitcoin network was 3 transactions per second. In contrast, PayPal, an online payments processor, achieved 450 payments per second on Cyber Monday in 2016. Credit card network VisaNet achieved 1,667 transactions per second on average in 2016. A spokesperson for Visa claimed that, if needed, Visa’s platform had the capacity to process over 50,000 transactions per second.24
Third, private keys were not always stored securely. Hackers were sometimes able to steal private keys, resulting in massive thefts. In 2014, hackers stole the private keys for 850,000 bitcoin (worth $450 million at the time) from Mt. Gox, the leading bitcoin exchange at the time.25 In 2016, hackers stole $77 million worth of bitcoin from the popular exchange Bitfinex. The exchange assessed losses from its user base at 36% of users’ accounts.26 To avoid the possibility of theft, some Bitcoin users began using cold storage. This kept their private keys on a physical drive or hardware wallet disconnected from the internet entirely, which made rapid transactions difficult.27
Fourth, the Bitcoin network was open and participation was pseudonymous, which allowed criminal organizations to create accounts and use the currency to finance illegal activities without revealing their true identities.28 Specialized websites, such as Silk Road, began using bitcoin and similar currencies to facilitate the sale of illicit goods, such as hard drugs.29 Security analysts suspected that the military regime in North Korea was using bitcoin and other digital currencies to avoid financial sanctions.30

d To encourage validators to actually pursue the costly proof-of-work, successful validation was rewarded with a small amount of digital currency, either by a fee from the parties or by crediting the validator with newly minted currency. (Source: Satoshi Nakamoto, “Bitcoin: A Peer-to-Peer Electronic Cash System,” Bitcoin, October 31, 2008, https://bitcoin.org/bitcoin.pdf, accessed January 2018.)

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Despite the costs and inefficiencies of bitcoin, the underlying blockchain technology held significant promise and represented a transformational opportunity that some referred to as an innovative wave as large as the internet itself. The blockchain represented a platform with proxies for trust built in, such that peer-to-peer transactions could be conducted directly, independent from any centralized authority. The role of banks, governments, and other centralized institutions could be transformed if blockchain applications became mainstream methods for transferring money and completing transactions.31
Examples of innovative blockchain applications began to emerge around the world, taking the core innovation of Bitcoin and expanding it to create new distributed applications. For example, the Republic of Georgia was collaborating with a blockchain company to build a secure land registry on a decentralized ledger, making it tamper-proof regardless of the party in power.32 Finland began a project to implement a blockchain-based digital identification system to help securely track refugees, independent of their paperwork or passports.33 The United Nations kicked off a project in partnership with Microsoft and Accenture to build an identity system for the 1 billion refugees who did not have physical proof of citizenship or identity. “Without an identity you can’t access education, financial services, healthcare, you name it. You are disenfranchised and marginalized from society,” David Treat, a Managing Director in Accenture’s financial services practice, said in an interview. “Having a digital identity is a basic human right.”34 In 2017, the technology giant IBM deployed over 1,500 professionals working on over 400 blockchain projects.35 IBM sought to use blockchain to improve the accuracy of supply chains, financial services, and cybersecurity.36 Several large banks began developing a private blockchain to conduct more efficient financial transactions among themselves that did not require expensive and lengthy processes to validate separate ledgers of transactions.37 Several entrepreneurs built alternate versions of the Bitcoin protocol that sought to increase its scalability for everyday transactions38 or anonymity for hidden transactions.39
One of the most influential blockchain projects was Ethereum, initially conceived and proposed by Vitalik Buterin, a 19-year-old programmer in Canada, in late 2013 and launched in 2015.40 Ethereum enhanced the Bitcoin protocol by creating a new protocol that created a virtual machine that enabled software code to be implemented on the Ethereum blockchain. This innovation allowed developers to build a wide range of new applications on top of the Ethereum blockchain and internalize its benefits, without building their own blockchain from scratch.41 Developers used Ethereum and its richer computational platform to construct smart contracts, which one prominent blockchain researcher described as “little programs that execute ‘if this happens then do that,’ run and verified by many computers to ensure trustworthiness. If blockchains give us distributed trustworthy storage, then smart contracts give us

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