Securing the Integrity of Decentralized IoT Marketplaces — Challenges and Solutions
Threats to DLT-based systems have been outlined many times. At iBlockchain, a special focus is laid on the use case of choice, a decentralized IoT marketplace for manufacturing services and goods. In this article, we take a closer look at possible safety and security issues which might be brought up. These issues were gathered in discussions and interviews with externals about the proposed marketplace structure. Solutions for the problems at hand will be considered in the explicit design of the marketplace.
Authors: Philipp Sandner and Marcel Kaiser
Technological threats to IT architectures are a crucial and important aspect of information systems research, however, this article deals with non-technological security challenges. In the iBlockchain project, a special focus is laid on the use case of choice, a decentralized IoT marketplace for manufacturing services and goods. In this article, we take a closer look at possible market security issues which might become relevant. These issues were gathered in discussions and interviews with externals about the proposed marketplace structure. The threats to the infrastructure discussed in this article are of economic and design nature. We present a collection of challenges and their solutions for a functional and decentralized marketplace protecting the vulnerable information of participants and avoiding market failures.
Issue #1: Malevolent parties infiltrate the market
All of the functionality of a properly designed marketplace can solve certain coordination problems but a decentralized design provokes the question of whether unqualified suppliers can collect money from buyers and exploit them. Identification and verification of participants can be mandatory for certain roles, depending on final design decisions. Consequently, it is arguable who is legitimate enough to fulfill the role of the identity validator. Luckily, there is a related project in the German industry which goes by the name LISSI — Let’s initiate self-sovereign identity. This project group aims to provide infrastructure for identification via trusted protocols and defines requirements for it. This platform (or a similar one) could be used for the iBlockchain marketplace to alleviate the problem of shady activity. The proposed process for the marketplace regarding the described identity mechanism is a top-down approach: a company has to verify its authenticity to the SSI system and can then verify its branches. They could be able to verify their fleets and machines. Thus, only one entry in an SSI system is required while the marketplace contains the tree of rights for the respective entity. It is thereby impossible for unaccountable agents to harm participants on the marketplace by setting up false offers or trying to gain insights. Figure 1 provides a visualization of the process.
It is still being discussed how far verification of identity has to go in order to ensure fully qualified services to buyers. This fact reflects the aspect that the quality of machines and expertise of suppliers might possibly not live up to the expectation of the buyer. However, with the use of smart oracles, this issue can be resolved, as measurements and data about used machinery can be made available on the blockchain as well. Unaltered data can automatically be transmitted to (e.g.) a DLT if the right devices are installed.
Issue #2: Undesirable perfect information as a threat for firms
The proposed marketplace approach will further connect buyers and sellers and thus approach the state of perfect information. This state is often assumed in economic models and entails that each participant in a market (all consumers and producers) has perfect and instantaneous knowledge of all prices, their utility, and their costs. A popular belief is that perfect information in marketplace settings leads to welfare increases and is thus generally good. It is, however, a double-edged sword. In direct B2B communication firms still could strategically disclose or conceal certain information. This would change in a completely transparent open marketplace. The abundance of transaction data in an open DLT-supported marketplace invites suppliers to infer their rival’s costs and possibly even critical manufacturing secrets. In the worst-case scenario, direct competitors of market participants who do not participate obtain and exploit information for free, effectively rendering the proposed marketplace not only ineffective but also creating incentives to avoid participation. Modern data analysis techniques are easily accessible. Zhu et al. (2004) have found that firms’ incentives to join a B2B exchange are sensitive to their relative cost positions, the nature of the products, the types of competition, and the degree of uncertainty of information. They also found that full disclosure can benefit some types of firms with a specific product and cost configuration. Montag and Winter (2020) recently analyzed that the effect of mandatory price disclosure depends on market characteristics and is not always beneficial, not even for customers.
To sum up, the resulting information asymmetry can likely be worse for affected companies than in the platform context described in the use case. The fear of this scenario can strengthen the alternatives of platform monopolies conquering markets and generally increase information asymmetry. As a consequence, it is vital for the iBlockchain project that information disclosure is limited. While it will remain an important aspect to be neutral and open as a matchmaking instance, concealing proprietary information is required. Given that firms’ incentives to participate depend on the information structures of the proposed digital marketplace, the trade-off between transparency (access) and opacity (control of information) has to be considered in the appropriate design and governance (Young et al. 2018). This already has to be considered in the design of the demonstrator. Belleflamme and Peitz (2019) discuss platform competition and found that more opacity on a two-sided market will result in the market being less desirable for users in the end. Platform monopolies are more transparent than their competitors and thus more favorable for end-users. This is a tricky situation in terms of market design. An efficient and just marketplace will have to protect crucial information while maintaining a high level of transparency (possibly optional) to attract users with increased competition.
Issue #3: Governments lose control over critical goods
The recent (and ongoing) COVID-19 pandemic has created a situation in which multiple governments forcefully allocated certain goods away from the market (i.e. masks and medical supplies) to centrally allocate them. This possibility may be challenged by a fully digital marketplace in which a significant amount of transactions might be performed automatically. As a consequence, the general public might suffer from opportunists exploiting the urgent situation or, in a less drastic variant: they might allocate critical resources away from critical infrastructure. There is no direct way to deal with this issue in regular operations. However, certain products or services could be removed from the market by deleting entries in the listing available to certain roles (verified by the SSI). If a crisis were to erupt which requires special access to markets for governments, a special role assigned to the participating government can be used to reserve certain services or resources to them. Generally speaking, a role-based access control policy on a decentralized marketplace can be very hard to implement as a slight centralization around certain parties can take place but a single special role for scenarios as described can probably be enforceable. An illustration can be seen in Figure 2.
Issue #4: Exchange rate risk
As often established, exchange rate risk with crypto currency has been one of the major critique points for widespread adoption. Stable coins mitigate risk in this regard but yet, no lock-in into a single currency has happened. As a consequence, the IoT marketplace runs the risk of decreasing its scaling potential massively if the wrong protocol is chosen. The possibility to include many tokens in a modular way is an aspect that alleviates the issue on two layers: first, it will allow for adaptation of the platform to serve the market interests. Second, it will equip participants with higher flexibility in terms of capital usage. For example, the capital lock-up in terms of a CBDC Euro can be reduced if money can be extracted instantly without the conversion of currency for further use in the company. For the marketplace use case, a digital currency would be optimal, but also the use of an IoT token is considered possible. A modular multi-currency option comparable to the one proposed in Diem can make international participation easier. The buyer and seller pay in the form of an IoT stablecoin which can be converted into their respective currencies. The stability mechanisms of such an IoT token would have to be elaborated on in a different kind of research.
Issue #5: Capital lock-up
If the marketplace’s design inherits features of common platforms, a higher capital lock-up, whether in a digital Euro or an IoT token can occur. The capital which is present in the company but can not be utilized as liquidity as it is frozen in an asset is called locked up capital. Its status will, in a digital age, not be maintained too long. This means that there is, especially in digital, blockchain-related systems, a fast settlement of transactions. But depending on the case, it might require manual effort. Thus, companies will have to align their algorithmic intelligence with the market to automatically and efficiently be able to access their earnings in the marketplace. The bad practice would be to let the wallets of the profit centers overflow (whether it is machines or fleets or even company branches). The cash conversion cycle in Figure 3 shows that receivables are converted into cash which can effectively be spent. On the marketplace, running dry on cash is less likely to happen but still a possibility for mismanaged fleet intelligence.
Another aspect closely related to the described phenomenon is the capital lock-up in a possible IoT token. This token (assuming there is no digital Euro) can surely be converted into Euro relatively easily. However, this implies an additional step in the process of cash conversion. While it can be assumed that exchange rate risk is relatively limited by the design of a token if it were to happen, capital will likely always be locked up in some of the IoT tokens (in case more payments to the marketplace have to be made in certain scenarios). This kind of lock-up is probably still less problematic than current lock-ups in lengthy payment processes but reduces the welfare gain described in former articles.
Conclusion
Finally, it remains to state that the security of decentralized marketplaces protecting businesses from information asymmetry highly depends on the specific design. We introduced five possible security and governance challenges for the marketplace and clarified how to avoid them or deal with them. These five issues include non-compliance of participants, excess information disclosure, government intervention mechanisms, exchange rate risk and capital lock-up. All of these issues can be tackled before the implementation of such a marketplace so that they can not impair the integrity of it. Bringing supply and demand for services and goods and services together is of utmost importance in working markets, which is why this analysis had to be made.
Remarks
This research and development project was funded by the German Federal Ministry of Education and Research (BMBF) within the funding number 16KIS0906 and implemented by the VDI/VDE Innovation + Technik GmbH. The authors are responsible for the content of this publication.
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More information about the iBlockchain research project can be found here.
More information about the Frankfurt School Blockchain Center can be found here.
Prof. Dr. Philipp Sandner is head of the Frankfurt School Blockchain Center (FSBC) at the Frankfurt School of Finance & Management. In 2018, he was ranked as one of the “Top 30” economists by the Frankfurter Allgemeine Zeitung (FAZ), a major newspaper in Germany. Further, he belongs to the “Top 40 under 40” — a ranking by the German business magazine Capital. The expertise of Prof. Sandner, in particular, includes blockchain technology, crypto assets, distributed ledger technology (DLT), Euro-on-Ledger, initial coin offerings (ICOs), security tokens (STOs), digital transformation and entrepreneurship. You can contact him via mail (email@philipp-sandner.de) via LinkedIn (https://www.linkedin.com/in/philippsandner/) or follow him on Twitter (@philippsandner).
Marcel Kaiser is a project owner and research assistant at the Frankfurt School Blockchain Center (FSBC). His expertise is decentralized finance (DeFi) and industrial blockchain applications. He analyzes the impact of blockchain technology on the economy. He speaks at public events about topics like DeFi, Diem and blockchain in general. Feel free to contact him via mail (marcel.kaiser@fs-blockchain.de), LinkedIn, or Xing.
Literature
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