Bullet points about fundraising for Bitcoin startups

I was looking through my email archive today and came across an email related to Bitcoin startups that I sent to a friend back in July.  Most of the points are still relevant today.

Bitcoin Startups! These Are The Trends We See by Adam Draper

  • Through the first half of 2014, an estimated $240 million in funding has gone into the cryptocurrency space, up from $74 million last year — most of which has gone into exchanges and wallet companies.
  • Number of Mining applications has stayed flat
  • Gambling started strong but has wavered

A Few Reasons Your Bitcoin Startup Might Fail by Sean Percival

  • Bad Branding, do not use “bit,” “block” or “coin” in your name — often that it’s causing consumer (and investor) confusion
  • Solving Problems Too Far Downfield — it’s certainly possible to be too early on many business ideas, especially if your idea is going to take immediate scale to be sustainable
  • Your Office Is An Airport — conference overload, travelling too much and not building the product and business; all that money you spend on travel is money you’re not spending on your company
  • IPO Schemes and Fundraising Fails — we’ve seen a few new approaches to fundraising, including IPO schemes that leverage crypto technology in some way. I would say this is the biggest red flag that the business or idea is doomed to fail
  • Your best plan of action is to launch an MVP (minimum viable product), raise an advisory round of $100K–$500K, and be able to sustain yourself for the next 12–18 months.

False Positives, False Negatives, and Reading Decks in Advance by Charles Hudson

  • at SoftTech we invest primarily in seed stage companies – we are investing in the team and the opportunity, not just what’s in the presentation.
  • reading decks in advance creates more false negatives than it saves false positives
  • Poorly conceived idea – I find that a simple paragraph gives me enough context to figure out whether the basic market opportunity and company idea sounds interesting. If the paragraph is well-written and compelling, I find the deck tends to be so as well. When I struggle to get the big idea from the intro paragraph, I’ll usually just sent a follow-up email to ask more. Still beats looking at slides.
  • Decks do not communicate personal connection and energy – I find that even the most well-crafted deck or presentation does not tell me anything about how I’ll feel when the entrepreneur or team comes in to present. I value the opportunity to get a sense for the energy and personality of the team when they present live.

Why did Investor X not look through the entire deck, the info is right there in font 8 on slide 27?!?!

Put simply due to time constraints this may not be possible.  I don’t have the link, but I recall Jeremy Liew at Lightspeed Venture Partners says he looks through 150 presentations/decks (not including executive summaries) for each investment.  In my own anecdotal experience, based on pitches I have seen over the past year I would probably say to keep it simple to get the point across in less than 15 slides because many investors do not have the time to look through every detail on the first round of a pitch (some, as Charles suggested above, may not even look at it at all).

Startups going through accelerators and incubators such as Plug and Play and 500 Startups may only have as little as 3 minutes to pitch during Demo Day.  So unfortunately for geeks, you would likely need to remove all the techno mumbo jumbo even if your company is say, an analytics startup.  Talk to your mentors to find out more on catering your marketing message.

Send to Kindle

Fintech in the news #2

A few links of interest this past week:

Send to Kindle

Blockstream’s sidechain’s is announced

I just finished reading through the new sidechains paper (pdf).  The team has clearly been thinking of clever solutions to a multitude of challenges.

Below are my first thoughts which could change as more information is released and/or code is implemented.

The biggest issue they did not address (so far) is how to incentivize mining after block reward halvings, though that probably was not their intent.  Also, and again this is just day one, but it is also unclear if the IP will be released as open source and if someone could use that code to create Blockstream 2, 3, etc.?

My comments below each block quote:

Because the miners do not form an identifiable set, they cannot have discretion over the rules determining transaction validity. Therefore, Bitcoin’s rules must be determined at the start of its history, and new valid transaction forms cannot be added except with the agreement of every network participant.

Even with such an agreement, changes are difficult to deploy because they
require all participants to implement and execute the new rules in exactly the same way, including edge cases and unexpected interactions with other features.

How can this be done in a trustless manner? Mining was supposed to be anonymous.  If they are identifiable by good actors, then they’re also identifiable by bad actors and not-so-good actors.

One problem is infrastructure fragmentation: because each altchain uses its own technology stack, effort is frequently duplicated and lost. Because of this, and because implementers of altchains may fail to clear the very high barrier of security-specific domain knowledge in Bitcoin[Poe14c], security problems are often duplicated across altchains while their fixes are not. Substantial resources must be spent finding or building the expertise to review novel distributed cryptosystems, but when they are not, security weaknesses are often invisible until they are exploited. As a result, we have seen a volatile, unnavigable environment develop, where the most visible projects may be the least technically sound. As an analogy, imagine an Internet where every website used its own TCP implementation, advertising its customised checksum and packet splicing algorithms to end users. This would not be a viable environment, and neither is the current environment of altchains.

Non sequitur.  The same complaint could be leveled at German carmakers versus American carmakers with the fragmentation in something like unit of measurement (meters vs Imperial).  The auto industry did not collapse because of fragmentation.

In addition, there is fragmentation within Bitcoin itself, with different pools relaying different types of transactions (or censoring others).  A couple days ago Dominic Williams pointed this out (in a different email), that there are different payment processors and different wallets that are incompatible (you can send money between them, but you can’t open one wallet with another).

A second problem is that such altchains, like Bitcoin, typically have their own native cryptocurrency, or altcoin, with a floating price. To access the altchain, users must use a market to obtain this currency, exposing them to the high risk and volatility associated with new currencies. Further, the requirement to independently solve the problems of initial distribution and valuation, while at the same time contending with adverse network effects and a crowded market, discourages technical innovation while at the same time encouraging market games. This is dangerous not only
to those directly participating in these systems, but also to the cryptocurrency industry as a whole. If the field is seen as too risky by the public, adoption may be hampered, or cryptocurrencies might be deserted entirely (voluntarily or legislatively).

Why are floating prices considered a bad thing?  Besides, the issues in this paragraph are exactly the same problem bitcoin faces each day and a solution to risks/volatility is not addressed in this white paper.  See Ferdinando Ametrano’s paper as well as Robert Sams’ upcoming draft on Seigniorage Shares.

Our proposed solution is to transfer assets by providing proofs of possession in the transferring transactions themselves, avoiding the need for nodes to track the sending chain. On a high level, when moving assets from one blockchain to another, we create a transaction on the first blockchain locking the assets, then create a transaction on the second blockchain whose inputs contain a cryptographic proof that the lock was done correctly. These inputs are tagged with an asset type, e.g. the genesis hash of its originating blockchain.

This has me thinking about token history and fungibility.  Perhaps it could be argued that moving these coins to a sidechain is an act of “mixing.”  Are atomic swaps a form of mixing?

Also, if the proof-of-burn effectively means “deposits” (from one chain to another) and value transfer is taking place, is this impacted by regulations such as 12 U.S. Code § 1831t – Depository institutions lacking Federal deposit insurance

This is true for almost all aspects of Bitcoin: a user running a full node will never accept a transaction that is directly or indirectly the result of counterfeiting or spending without proving possession. However, trustless operation is not possible for preventing double spending, as there is no way to distinguish between two conflicting but otherwise valid transactions. Instead of relying on a centralised trusted party or parties to take on this arbitration function like Bitcoin’s predecessors, Bitcoin reduces the trust required — but does not remove it — by using a DMMS and economic incentives.

It is still unclear what the additional economic incentives will be in the Blockstream/sidechains model.  Is it just the fees in section 6.1, such as the clever time-shifting mentioned later on?

This gives a boost in security, since now even a 51% attacker cannot falsely move coins from the parent chain to the sidechain. However, it comes at the expense of forcing sidechain validators to track the parent chain, and also implies that reorganisations on the parent chain may cause reorganisations on the sidechain. We do not explore this possibility in detail here, as issues surrounding reorganisations result in a significant expansion in complexity.

What are the costs of running and maintaining this validator?

No reaction. The result is that the sidechain is a “fractional reserve” of the assets it is storing from other chains. This may be acceptable for tiny amounts which are believed to be less than the number of lost sidechain coins, or if an insurer promises to make good on missing assets. However, beyond some threshold, a “bank run” of withdrawals from the sidechain is likely, which would leave somebody holding the bag in the end. Indirect damage could include widespread loss of faith in sidechains, and the expense to the parent chain to process a sudden rush of transactions.

Who determines insurance of a blockchain?  Will FDIC or similar bodies have jurisdictional grounds as described in the above USC citation (not a joke, Blockstream founders are not anonymous nor most large farm & pool operators)?

As miners provide work for more blockchains, more resources are needed to track and validate them all. Miners that provide work for a subset of blockchains are compensated less than those which provide work for every possible blockchain. Smaller-scale miners may be unable to afford the full costs to mine every blockchain, and could thus be put at a disadvantage compared to larger, established miners who are able to claim greater compensation from a larger set of blockchains.

We note however that it is possible for miners to delegate validation and transaction selection of any subset of the blockchains that they provide work for. Choosing to delegate authority enables miners to avoid almost all of the additional resource requirements, or provide work for blockchains that they are still in the process of validating. However such delegation comes at the cost of centralising validation and transaction selection for the blockchain, even if the work generation itself remains distributed. Miners might also choose instead to not provide work for blockchains that they are still in the process of validating, thus voluntarily giving up some compensation in 360 exchange for increased validation decentralisation.

How can that be done trustlessly?  How does that deal with the issues Dave Hudson talked about with respect to IHPP in general?  Until IHPP is changed or modified, Hudson’s models will remain valid.

By using a sidechain which carries bitcoins rather than a completely new currency, one can avoid the thorny problems of initial distribution and market vulnerability, as well as barriers to adoption for new users, who no longer need to locate a trustworthy marketplace or invest in mining hardware to obtain altcoin assets.

This doesn’t seem to be addressing several other reasons for why alts exist: who will pay independent developers wanting to build on sidechains? What about non-SHA-based hardware (like scrypt or X11)?  What is to prevent someone from forking “sidechains” code and creating a similar business?

An alternate mechanism for achieving block rewards on the sidechain is demurrage, an idea pioneered for digital currency by Freicoin (http://freico.in). In a demurring cryptocurrency, all unspent outputs lose value over time, with the lost value being recollected by miners. This keeps the currency supply stable while still rewarding miners. It may be better aligned with user interests than inflation because loss to demurrage is enacted uniformly everywhere and instantaneously, unlike inflation; it also mitigates the possibility of long-unspent “lost” coins being reanimated at their current valuation and shocking the economy, which is a perceived risk in Bitcoin. Demurrage creates incentives to increase monetary velocity and lower interest rates, which are considered (e.g. by Freicoin advocates and other supporters of Silvio Gesell’s theory of interest[Ges16]) to be socially beneficial. In pegged sidechains, demurrage allows miners to be paid in existing already valued currency.

I am not sure Freicoin is a particularly good example here because in practice few participants want an asset to always lose value (what investors actively demand demurrage?).  Maybe this is reflected in its lack of adoption (thus far).  Perhaps that will change, perhaps Freicoin will grow over the course of the next few years. But this also touches on the issue of whether or not these “coins” are commodities or a currency in the first place (I have argued they are informational commodities).

The point about reanimation is an interesting one (and good) because of the uncertainties of “zombie” coins (as John Ratcliff calls them) that jump back onto the market.

Also, while the experimentation use-cases in section 5.1.1 seem to have some active demand (as measured by crowdsales and hype this past year) they could also (IANAL) lead to legal issues that these 2.0 projects are having with respect to unregistered securities (see the SEC with its Howey test).  This is a legally risky area as discussed by these lawyers.  Also, if users can create digital tokens pegged to real world assets — if these are non-deliverable, does this turn that chain into a large “bucket shop“?

Co-signed SPV proofs. Introducing signers who must sign off on valid SPV proofs, watching for false proofs. This results in a direct tradeoff between centralisation and security against a high-hashpower attack. There is a wide spectrum of trade-offs available in this area: signers may be required only for high-value transfers; they may be required only when sidechain hashpower is too small a percentage of Bitcoin’s; etc. Further discussion about the usefulness of this kind of trade-off is covered in Appendix A.

Who will maintain these?  No Free Lunch.

Send to Kindle

Fintech in the news #1

I am retiring the previous list name “Cryptocurrency in the news” because I think that fintech (financial technology) is a more accurate, all encompassing term for this space.  There are other possible names like “dapps” (decentralized applications) however I prefer fintech because decentralization may not be what the market chooses as an end game.

Some links of interest:

Send to Kindle

Traffic analysis from Sarah Meiklejohn

Sarah Meiklejohn is a researcher now at UCL.  She is probably best known for her authorship of one of the best research papers in the digital currency space: A Fistful of Bitcoins: Characterizing Payments Among. Men with No Names.

She recently gave a presentation covering this paper (which admittedly has older data) and talks about some of the new privacy projects like CoinJoin which she says had a noticeable impact on a heuristic used in the study.  The Q/A session at the end also has some good comments.

Send to Kindle

Cryptocurrency in the news #30

When digital archeologists peruse Reddit in 20 years, to look at what happened to the Bitcoin community, it is posts like this pumper that will serve as a case study — an exhibit of how false information was used to promote adoption.  As shown in the comments, the Klarna Group is not in fact adopting Bitcoin.  It is unclear who is behind these type of posts, but it is unfortunately very common.

Below are some other interesting stories related to digital currencies and China.  Link is not an endorsement to services:

Send to Kindle

Thoughts on the 2.0 space

I recently became a mentor for Koinify, a venture-backed company based in Mountain View. CoinDesk reached out and asked several questions related to the startup and published a few of the comments in a story, “Crypto 2.0 Roundup: The Overstock Effect, Counterparty Debates and a Crypto iTunes.

Readers may be interested in a few more of my thoughts below.  Disclosure: there is no financial compensation for the mentor role.  Furthermore, I am also an advisor for Hyperledger and head of business development at Melotic.

  • As of today, Koinify is probably the only serious venture-backed startup that solely focuses on building decentralized applications and decentralized autonomous corporations (DACs).   It is also setting some ‘best-practices’ in transparency that has been largely missing in this community.  You will see that soon with Koinify’s following announcements.
  • The biggest problem in the altcoin/decentralize app space is that virtually all of them lack any original utility, are blatant scams or simply cannot fulfill the paper-based promises of their vocal promoters.  In short, virtually all digital asset projects have thus far been overpromised and underdelivered, including, arguably Bitcoin itself and we see that with a dearth of mainstream end user adoption for any of them.  What I’d like to help provide Koinify is the knowledge of the past, to avoid the pitfalls of other projects.  To accomplish this, Melotic is looking to provide liquidity to unique curated assets, potentially those incubated at Koinify.  Thus, this is a mutually beneficial partnership.
  • I have been following the growing list of distributed computing and computational consensus proposals.  Beyond the annual academic Dijkstra Prize, the nascent digital currency space has been fast in proposals but slow in actual production-level roll-outs.  To be frank, I have been fairly disappointed with both the quality of product and traction of 2.0 projects in general, especially given the community euphoria in the first quarter when I did research for Great Chain of Numbers.  However, with that said, if something like Bitcoin is allowed to be given a 5-6 year “grace period” I think it is only fair for a similar runway to be given to other proposals as well.  Furthermore, there are economic trade offs depending on the level of trust and consensus required, but shoving everything onto one ledger, some kind of jack-of-all-trades Houdini ledger, is a bit like the clown car at a circus.  It can be filled with a cornucopia of clowns and coins (and clowncoins) but the economic incentives might not align with the duct tape holding it together. Consequently, the community has evolved and created several new potential methods for untrusted nodes on a public network to arrive at consensus, to the point where consensus-as-a-service is becoming its own commoditized subindustry.  In the future, this will likely be abstracted away and developers will be able to fine tune and granularize the level of centralization and trust they want to expose their users to.  Another big development that I am increasingly paying attention to is the regulatory and compliance arena, which many people seem to want to ignore and handwave away.  It is not going to disappear and structuring your project, company and even ledger in a way that reduces your personal liabilities will be an ongoing concern from now on.  There is no point in being a martyr when there are many other areas to push the envelope on in this expanding space.
  • A few weeks ago I gave a presentation covering a number of factors as to why Bitcoin protocol development has plateaued in the past year and as a result how most of the innovation has effectively been outsourced to the altledger ecosystem.  Here a steady stream of both old and new entrepreneurs and developers are toying with variables that cannot be touched with Bitcoin itself due to its current development cycle.  A friend compared the speed at which this industry moved with dog years and this is particularly true in the altledger space.  As a result, a new ledger can be forked, tweaked and spun up that incorporates the latest ideas in this space.  Most do fail and will likely fail in the future, but that’s the nature of iteration in technology.  The biggest challenges for Koinify is on boarding high quality decentralized apps that bring the utility and value that is now expected by the community.   On the one hand creating a platform that allows access to something like cryptosecurities such as Overstock.com sounds neat, yet it is a hundred year old idea (equity) married to a different type of database (a blockchain). On the other hand, the decentralized app economy that Koinify is attempting to create is in fact has a different form, yet still pragmatic enough given existing technology.  Market participants want to experiment, poke, prod and have choices — this effervescent vitality is attractive and I am excited to try and help out.
Send to Kindle

Cryptocurrency in the news #29

Turns out about 15 months ago, someone had already figured out how the mining costs of hash-based proof of work moved relative to the market prices of tokens, see “Why Bitcoin will never be a good store of value” by Stefan Loesch.  One common retort to Loesch’s argument is that at some point in the future, for some reason, users will one day start paying higher tx fees.  This is unlikely because it is a collective action problem.  Why would people pay several orders of magnitude more to have the same exact service?

A new feature/dashboard that I came across is CoinGecko — has some interesting metrics to look at.

Other links related to digital currencies and China (linking is not an endorsement of service, coin, chain, etc.):

Send to Kindle

Explaining trading volumes in China

CoinDesk recently reached out to me to ask and see if I had any views on the divergent Bitcoin trading volumes between China relative to the rest of the world.  The piece they ran included a few of my comments as well as some from several other traders and exchange operators, “China’s Market Dominance Poses Questions About Global Bitcoin Trading Flows.”

Readers may also be interested in a few other comments I provided them, a few of which are slightly edited (removed some names and numbers):

  • I should preface this by saying that the OTC/off-chain liquidity/inventory is something that is not being factored into most of the overall discussion on trade volume.  I know that all the mining farms in China have liquidity partners (usually with the big three exchanges) and I could introduce you to one in particular who might be willing to talk on the record, or at least give you color.  The reason I mention this is because if you can some how dig up the OTC/dark inventory numbers, the aggregate volume might actually be larger in USD than RMB (at least, that would be my guess).
  • To answer your first two questions I think it bears mentioning that there really hasn’t been any new VC-backed exchange that has setup in the US in the past 6 months or so (itBit moved its SG operations to NYC).  Perhaps once the legal issues are more defined this can change.
  • In addition to having no fees on trades, I think this short comment on reddit describes some of the internal structural differences at the Chinese exchanges for question #3.
  • They’re busily trying to answer question #4 with a variety of value-added services like margin trading and issuing of derivative products as well as integrating with API services and even building out support for mining contracts (BTCChina apparently just acquired a mining pool/farm to do just that).
  • As far as your last question, I think it would be fair to say that public/open consumer-based exchanges are centered in China, but based on the OTC numbers that I hear throughout each month, USD is still probably bigger.  For instance, BitPay sells around XXXX BTC a day to its liquidity partners. That’s usually more than ______ does (at least this past summer).  Their daily sales are chopped/sliced up and sold to liquidity partners.  Charlie Shrem briefly touched on this a week or so ago.
Send to Kindle

Tim, why don’t you send yourself to a provably unspendable address?

Jeffrey Robinson is the author of over 20 books  This past week he published a new book that looks at the history and some characters of the Bitcoin ecosystem called “BitCon: The Naked Truth About Bitcoin.”  Earlier this summer he contacted me and asked me several questions, the answers of which appear in several spots in the book.

If you are tired of the continuous pumping on reddit, Twitter and conferences you will likely enjoy his challenges to cliche arguments.

For instance he pointed out that all the wars in the 16th, 17th and 18th century were not funded by central banks therefore it is unlikely that in the event Bitcoin did somehow take over the world, it probably would not make war disappear.  The term he uses to identify “true believers” that make such argument is Planet-Bitcoin — a place where this vocal group of people reside.  Speaking of which, probably the best quip throughout the book was at the end when a “true believer” calls him a “currency denier.”   Is that a thing now?

Two errors that stood out that I noticed: the Icelandic government actually ignored auroracoin entirely (it was just some random people that did the “airdrop”).  The other part is he stated, “So much so that amateurs have been thrown overboard by mining pools who can afford the ever-increasingly gigantic [...]”  Technically these are farms not pools.

Two economic terms that are frequently glossed over by many digital currency advocates:

Recreating a circular flow of income when there are already dozens of competing currencies (e.g., USD, euro, yen) that currently fulfill this task will always be an ongoing hurdle for Bitcoin-like digital currencies.

Regarding my last quote in the book, I should point out that Ripple may not necessarily be a “better” protocol, it just solves different needs in different circumstances.  Though for some of the purposes for which Bitcoin is being shoe horned for, Ripple may be a better solution of the two.  However this is an empirical issue, we cannot know a priori and a TCO analysis should be undertaken by each enterprise.  As far as the fate of Bitcoin — that it can survive because its big holders will subsidize it — perhaps this could be the case, but it is also hard to say how long “whales” or big holders will be willing to subsidize any chain.  It is also unclear how many coins that purported whales actually control still (versus how much they have cashed out) — I have heard all sorts of ownership numbers and if you add them all up, they total more than 13.2 million coins that have been mined so someone at these conferences is embellishing.

A taste of quotes

While the user adoption, merchant adoption and transactional volume numbers will likely change in the coming weeks and months, it is a quick read and below are some choice quotes that stuck out to me.

On first-movers and fads:

The Dot-Com boom, and subsequent bust, of the 1990s rewrote that script. So did Betamax, mood rings, semi-automatic transmissions, floppy disks, 8-Track, Amphicars, Apple Lisa, WebTV, IBM PCjr, Zune, and the Segway.

On the externalizing the costs of mining:

Some miners even employ methods that are not exactly “cricket.” There was one in Holland who literally stole the electricity he needed to run 21 rigs. He eventually got caught. (source)

Regarding the continually misquoted numbers pulled from Coinometrics, Robinson asks co-founder Jonathan Levin for clarification:

“[...] It was right around the December price increase, so there was lots of stuff going on in the press about bitcoin, and all over social media, as well. Everyone was using social media to promote bitcoin Black Friday. It was a massive promotion and it paid off with big sales. But the numbers I’ve got for that period worked out at around 5%. So when you’re talking about comparing PayPal and Western Union with bitcoin the rest of the time, then only about 3% are for goods and services. That puts you at one-hundredth of any other network.” A good reason why, Levin says, might be because, “Bitcoin is terribly inefficient. It’s all about decentralized trust. But if you don’t need to have decentralized trust, updating a spreadsheet in a bank is far more efficient. The cost of updating the ledger is more expensive with bitcoin and takes much longer than any system in the world.” With bitcoin verifications taking up to 10 minutes, he asks, “What happens with Visa? How quickly do they reconcile their database? Instantaneously. Bitcoin introduces the ability to cut out the middleman. That’s fine. But the paradigm is that while the blockchain technology offers decentralization, it doesn’t give you a more efficient system.” That’s not bitcoin’s only “bragging rights” problem. According to Levin, “There is no correlation with the increase of merchants allowing customers to pay with bitcoin and the amount of bitcoins being used for transactions. It’s linear.”

On his use of imagery:

The New York Post’s Sunday business editor Jonathon Trugman wittily describes bitcoin as, “The Tinkertoy crypto-currency,” likening it to, “A modern-day game of three-card monte, with a little Sudoku thrown in, just to add a touch of mystique.”

On putting the theft at Mt. Gox into perspective:

If it turns out to be true that $ 400 million has been stolen, it’s more than the sum total of all the bank robberies in the US for the past seven years.

Regarding the hype of adoption and ATMs in Canada:

However, the Canadian Payments Association reported in April 2014 that while Canada is estimated to account for as much as 4% of bitcoin’s global transactions – ranking it number two in the world, behind the United States but  ahead of China – the volume of bitcoin transactions represents a mere 0.01% of Canada’s total debit and credit-based transactions.

“[...] not just that his is the largest company to do that, but a fast check of Google reveals there are actually more piano tuners just in Canada than there are businesses anywhere in the world of any size, keeping bitcoins on their books.

On the continual problem surrounding the ‘circular flow of income‘:

Dr Yanis Varoufakis, a political economist at the University of Texas and the University of Athens, says speculative demand for bitcoin outstrips transactional demand, “By a long mile. Bitcoin transactions don’t go beyond the first transaction. The people who have accepted bitcoins don’t use them to buy something else. It gets back to the circular flow of income. When Starbucks not only accepts bitcoins but pays their workers in bitcoins and pays their suppliers in bitcoins, when you go back four of five stages of productions using bitcoin, then bitcoin will have made it. But that isn’t happening now and I don’t think that will happen.” Because it isn’t happening now, he continues, and because so many more people are speculating on bitcoin rather than transacting with it, “Volatility will remain huge and will deter those who might have wanted to enter the bitcoin economy as users, as opposed to speculators. Thus, just as bad money drives out good money, Gresham’s famous law, speculative demand for bitcoins drives out transactional demand for it.”

On the odds that Bitcoin will supplant the state:

Professor Stephen Mihm, who teaches economic, cultural and intellectual history of 18th and 19th century America at the University of Georgia, is convinced that bitcoin will not survive, because it cannot survive. He’s written, “Anyone who thinks that bitcoin will triumph, has to believe that it will succeed where earlier generations of private currencies failed, that bitcoin will, improbably, manage to overthrow more than centuries’ worth of accumulated state power, jealously guarded and ruthlessly enforced. That’s a preposterous fantasy, and a dangerous one if you’re an investor. Indeed, people who believe that governments of the world will let a stateless crypto-currency usurp their hard-won monetary prerogatives aren’t forecasting the future. They’re living in the past.”

More on whether or not it will supplant the state:

He says, another reason why bitcoin won’t be the one is because, “The misguided notion that you can free government from currency. Governments regulate money. They put certain constraints on it that you have to follow. So the technology that evolves must be ready to accommodate that. Most commerce will still be done in dollars. Currency is backed by the full faith and credit of a government. Bitcoin is backed by the full faith and credit of wasted computer time.” Seeing The Faithful, “Like a tribe,” he likes to think that their enthusiasm will, somehow, someday, “Help make progress towards a more rational digital currency. But, ultimately the providers of those currencies are probably going to be governments.” At this point, Borenstein argues, “No one should see blockchain technology as an end to a means. No one should look on it as a single achievement. Instead, it should be seen as a point on a spectrum. We may be long gone when bitcoin finally dies, but that doesn’t mean it’s been a success.”

On volatility:

David Yermack, a professor at New York University’s Stern School of Business, and director of the Pollack Center for Law and Business, believes that bitcoin resembles a speculative investment similar to the Internet stocks of the late 1990s. Writing in the MIT Technology Review, he summed up bitcoin’s problems this way: “During 2013 its volatility was three to four times higher than that of a typical stock, and its exchange rate with the dollar was about 10 times more volatile than those of the euro, yen, and other major currencies. Bitcoin’s dollar price exhibits no correlation with the dollar’s exchange rates against other currencies. Nor does it correlate with the value of gold. With a currency whose value is so untethered, it is nearly impossible to hedge against risk.”

Even if volatility subsided and bitcoin somehow found a place as a global payment system, because there can only ever be 21 million bitcoins, Yermack pointed out, it is inherently deflationary. “A fixed money supply is incompatible with a growing economy. Workers would have to accept pay cuts every year, and prices for goods would gradually fall. Such conditions might lead to public unrest reminiscent of the late 19th century’s free-silver and populist movements — an ironic consequence of a currency known for its futuristic cachet.

On the talk of losing purchasing power over the past century:

Levine shrugs that off. “Talk of 1913 dollars is completely meaningless. You need a small amount of consistent inflation because the effects of deflation are so awful. Why is everyone holding onto their bitcoins instead of spending them or lending them? Because they think it will be worth more. Back in the 1800s, people put cash in the mattress because nobody was managing the currency and there were no credible markets, except in Britain. These days, only a nitwit puts cash in the mattress.” He throws back at them the classic dilemma that the Founding Father’s faced in the 18th century – the bankers versus the farmers. “Historically, the bankers wanted hard money, which meant gold, so that their dollar denominated assets would become ever more valuable. The farmers, who were always in debt, wanted cheap money, which in the 1800s meant silver, because they wanted some inflation so they could pay off all their loans. This argument starts with Hamilton and basically doesn’t end until we get off the gold standard. Bitcoin is a world where everybody wants to be a banker and nobody admits he’s a farmer.”

Is it similar to how the internet evolved?

I then asked Borenstein what he thought about The Faithful’s often quoted comparison – that the birth and development of bitcoin mirrors the birth and development of the Internet. He wasn’t having any of it. “The Internet was designed by the most open process known to man, there’s not even an organization behind it. Thousands of people are responsible for making the Internet work through endless sessions of technical minutiae where everybody agrees to do something the same way. That does not sound like bitcoin. There may be all sorts of similarities that don’t matter. The same language, the same open source modules, but I don’t see it as being anything at all like the same.” While he remains hopeful that, one day, we will see widespread use of digital currencies, he confidently predicts, “Bitcoin won’t be it. The technology must be configured in such a way as to meet the national, political and social goals of the people who are going to run that currency. You could lay that universal framework at the software level, the systems that will inevitably be out there, to make them interchangeable. If that happens, I doubt that bitcoin’s code will be very useful.”

On hype and irrational exuberance:

Tech guru John Dvorak described it perfectly in one of his columns: “The amount of money squandered during the Dot-Com era because of ‘paradigm shifts’ and ‘new economies’ is staggering. People actually believed that all retailing would be online and that all groceries would be delivered to the home as they were in the 1920s, despite changes that make delivery impractical. Who cares about reality?”

On the wisdom of trying to short exuberance:

Referring to bubbles as “spontaneous optimism,” John Maynard Keynes pointed out, “The market can stay irrational longer than you can stay solvent.”

On the difficulty of creating other derivative products:

His answer to the first question is no. His answer to the second is yes. Bitcoin mining is very expensive, he explains, and most miners barely break even. Then, because the technology is designed to produce fewer and fewer bitcoins, he is concerned with who’s going to pay for verifying each transaction? “Eventually, as the supply of bitcoin diminishes, those fees will increase to cover the cost of authenticating the transactions, and will become competitively close to the fees for international bank wires. The arithmetic is really simple. I don’t see any way around it.” Levine shares Krugman’s doubts about bitcoin as a currency – “For a while I thought it was like Pet Rocks without the rocks” – but now he wonders, “Would you be willing to take out a mortgage written in bitcoin? The volatility suggests no one would. And, what does it say about bitcoin as a currency when nobody is willing to do anything with it besides a spot transaction?”

On MintChip and building things before there is enough demand for it:

The idea of electronic payment systems has been around for a while, but it wasn’t until 1990 that it actually got off the ground. That’s when Dr. David Everett in the UK invented the first “electronic purse.” His system was called Mondex. Developed with National Westminster Bank, it was a revolutionary idea for its day. The cash was your smart card and you spent it at point of sale terminals. For a while it got a lot of attention, then eventually, fizzled out. Everett was severely disappointed.

“I’m afraid it was way before it’s time. Just too early. In hindsight, there was nothing really broken about payment systems at the time. The Internet didn’t really exist yet. Mobile phones didn’t really exist yet. The focus we had was paying at point of sale. It was very good for the merchant, but in the end it was not so for the consumer who argued, why would I bother?” A world expert on payment systems, coding theory and cryptography for the protection of data, Everett is CEO of the Smart Card Group, technical director of Smart Card News and a man who says that his mission in life is still electronic cash. “I am an enormous believer in electronic cash.” When the Canadians asked him to help them design MintChip, he jumped at the opportunity. “MintChip was almost ten years after Mondex and I was convinced about that one too.” The idea that a Mint would produce electronic cash, “Just seemed so logical,” he says. “That’s what mints do. They mint cash.” As technical architect for the project, Everett was looking to reproduce the ease would want to do, so now you’re into merchants. Maybe a big retail chain. Say Walmart. The cost of managing cash for them is quite high, and credit and debit cards carry with them transaction fees. For big merchants, electronic cash is ideal. Here’s a way of handling payments at a fractional cost of handling cash. Walmart Dollars would work very well and if they did it, everyone would follow.” Ideally, he says, whatever the next stage is, it would not be linked to a bank account or a debit card. “We need to be unconnected. In that sense it is like bitcoin because bitcoin is unconnected. But what I want to see is a real electronic object representing cash. That’s very different from bitcoin.” For him, bitcoin is, “A new form of gold. It is electronic gold. Whereas Mondex and MintChip is equivalent to real currency, a real pound or a real dollar. I think there are a lot of nice things in the bitcoin technology, but I don’t think it’s very good for cash. It doesn’t really lend itself to immediate payments. I’m surprised bitcoin has gone as far as it has.”

On the faux news that Mastercard would be adding support for bitcoin as well as a recent patent filing:

[...] assured me Mastercard wasn’t doing anything of the kind. He explained, the application was filed to protect Mastercard’s intellectual property and did not indicate any commitment to bitcoin. “There is no obligation to ever build anything that a patent application covers.” JP Morgan had done a similar thing with a payments’ patent, putting bitcoin in there, and The Faithful reacted in kind. A spokesperson for Morgan gave me much the same answer as Mastercard. Now I brought it up with Borenstein. A man who still spends a large part of every day working on patents, he says that neither company has any intention of ever accepting bitcoins. Instead, he suggests, they harbor more sinister intentions. “Every patent has to describe all the different storage technologies it might reside on. Which really means, they’re arming themselves for a possible war. Just in case bitcoin ever poses a real threat. They’ll do what they can to wipe them out.”

Send to Kindle

Cryptocurrency in the news #28

Much like “The Singularity” was en vogue 10 years ago for a slew of reasons that haven’t really materialized (i.e., “an idea before its time”), it is equally unclear how or why blockchains + the Internet of Things has been receiving so much attention. For instance, IBM recently published: “Device democracy: Saving the future of the Internet of Things.”

Let’s be quite clear: yes this technology could develop to work as stated in the next decade.  However, it is unclear why Ethereum, which has still not launched despite 8 months of non-stop marketing, is being cited as the test bed.  I am skeptical that when it does launch, that its economic model will be able to fuel the use-cases that everyone seems to throw at it.

In the meantime, other stories this past week:

Send to Kindle

The Continued Existence of Altcoins, Appcoins and Commodity coins

Yesterday I gave a presentation at a Bitcoin Meetup held hosted by Plug and Play Tech Center in Sunnyvale.

I discussed the economic incentives for creating altcoins, appcoins, commodity coins and also covered several bitcoin 2.0 proposals.  The slides and video from the event are viewable below.  Download the deck for other references and citations.

Send to Kindle

False analogies in Bitcoinland plus Alibaba

Saw two analogies used today that are inaccurate.

Writing at Forbes, Eric Mu interviewed Jake Smith, better known as “The Coinsman.”  Jake was responding to a comment I wrote last month:

Tim Swanson, the author of The Anatomy of a Money-like Informational Commodity, recently said that you missed the “unseen calculation, the economics of extracting and securing rents on this ledger unit, which consume scarce resources from the real economy.” – Do you think he is wrong?

I think attacking mining from an environmental point of view is quite silly, because pretty much everything in the modern era relies on resource consumption, and for the vast majority of those things society has decided that the trade-off is worth it. I think Bitcoin is one of the most valuable and revolutionary inventions the world has ever seen, so even if it is using a lot of electricity I don’t think that’s a valid criticism against it. The internet uses vastly more electricity than Bitcoin, no one is bashing the internet for using resources.

Swanson’s quote would also imply that Bitcoin is not part of “the real economy”. I would say that by virtue of its existence, it is.

Further, Bitcoin’s value is derived in part from the fact that it is difficult to create.

The biggest problem with the analogy above, which is commonly used by Bitcoin advocates, is that it is not an apple’s to apple’s comparison.  In this instance, Bitcoin acts as a distributed Excel workbook, a spreadsheet application that uses the internet to distribute itself.  Thus it is incorrect to equate it with the much broader umbrella that is the entirety of the internet.

This same problem happens when people claim that Bitcoin can and/or will replace the banking system.  For instance, last month Jake interviewed Nan Xiaoning, CEO of Bitocean:

I think Satoshi had a lot of foresight in this regard. He wasn’t a dummy, I’m sure he considered different ways of distributing coins.

Some people say that bitcoin wastes a lot of electricity. But the banking industry surely uses more resources than bitcoin does. But bitcoin is a peer-to-peer system. I think using resources to guarantee its security and stability is the way it should be.

Another inaccurate analogue/comparison.  Bitcoin’s protocol does not provide any of the functionality of the banking system beyond a security lock box (that should not be confused with a distinctly different term, a savings account) and a corresponding ledger of access and usage (the debate over whether or not someone “owns” a privkey corresponding to a UTXO it is still being argued over by lawyers globally).  The current protocol does not natively allow for lending, saving, notary, underwriting debt and equity or setting of interest rates (among many other services real banks actually provide).

In both cases above the examples above miss the forest from the trees.  As Robert Sams pointed out a few days ago, the proof of work mechanism used in Bitcoin was designed to make Sybil attacks expensive.  The verification process is a marginally trivial task and can be handled (and in practice actually is handled) by mining pools via small computers such as a Pi-based box.

How specialized is the hashing (not verification) process?  A good comment on reddit yesterday noted that:

Rather than taking the whole header, they mine using something called a midstate. Due to the nonce being at the end of the header, the software hashes up to just before the nonce, and then sends that (called a “midstate”) to the mining chip. The mining chip then only needs to add a nonce, do the end of a SHA256 round, and then one more, and then check if the result is good enough. Rather than returning data, they just return nonces which look to be valid.

Instead, a more accurate way to look at this issue is from the spectrum of centralized to decentralized (which was also discussed by the Hyperledger team in an interview a couple days ago).

Centralized tools and services have certain vulnerabilities (e.g., single point of failure and potential abuse) but its cost basis is different than say, a decentralized entity.  The economics of both need to be accounted for (and are) when rolling out a new system internally (this is called the Total Cost of Ownership).

On the other end, decentralized systems are less vulnerable to some of the same issues that centralized systems are, yet to make them less vulnerable in fact requires consuming scarce resources that centralized solution do not have to (because they are trusted networks).  In the case of Bitcoin, bitcoin miners (or technically hashers) effectively destroy (or “burn”) a corresponding amount of energy (technically exergy) to protect the network from Sybil attacks on an untrusted network.  This is a real cost that cannot be ignored yet as shown above, is often handwaved away.

[Note: as an aside, most miners, mining farms and mining manufactures do not pay for their capex or opex in bitcoins, nor is this likely going to change anytime soon.  Instead they must rely on and permaborrow the unit of account of fiat (typically a USD or RMB) to effectively measure and allocate resources.  This unit of account issue -- wherein economic activity within the Bitcoin world is measured with the unit of account that is fiat to create this network -- was also broached by Robert Sams several months ago.]

Furthermore, as I mentioned in chapter 8, if the TCP/IP analogy was correct then the marginal revenue for ISPs would split in half every 4 years.  And that through competition the marginal cost of protecting and sending packets would equal the marginal value of those packets.  This would not be an effective way to run a business let alone design a network topology.

In the real world, the marginal costs of running an ISP, which is centralized, have to be less than the marginal revenue otherwise they go bankrupt as they could not pay for overhead.  So yes, in fact, ISPs do try to actually mitigate the leakage, wastes and otherwise inefficiencies in its own internal network and they do this through a myriad of ways.

Bitcoin’s existence is on the other side of the spectrum.  Bitcoin was purposefully designed to make it cost prohibitive to spam ownership change on a public, untrusted network — the complete opposite in organization that an ISP is designed to operate as.  The average person would likely see this as inefficient, but that is because up until the past decade — with the advent of Bittorrent and other distributed systems — the public at large was unfamiliar with how these systems are designed.  And as Sams pointed out, using the word “efficient” versus “inefficient” may not be the most accurate terminology, because each model has different attack vectors they have to account for.

Thus again, it is not about being pro or anti proof-of-work.  Rather it is acknowledging that proof of work requires a certain economic model that have real costs that scale with token value and in the case of Bitcoin, is not environmentally “greener” than some centralized solutions (e.g., ApplePay).

The case of Alibaba

Over the past couple of days some Bitcoiners have recently claimed that the recent dip in market prices for bitcoins is because of the Alibaba IPO; “Alibaba’s US IPO May Have Crashed the Bitcoin Price.”

Not only does this show that several vocal Bitcoiners are unfamiliar with how real IPOs work (underwriters typically represent the lion’s share of additional equity ownership and the date is fixed weeks and months ahead of time) but that it illustrates how some Bitcoiners like to blame people and go on a witch hunt when prices decline but then reassure themselves that they are investment geniuses when prices trend northerly.

In point of fact, the Alibaba IPO was not a surprise to anyone, the investors are all large financial institutions and not hoi polloi.  The IPO was oversubscribed and not even well heeled, well connected HNWIs could get into an allotment — only banking institutions were able to because of the enormous demand.  And none of those institutions are: 1) large bitcoin holders and 2) needed to sell bitcoins to raise funds to buy Alibaba shares.

Perhaps this will change in the future, but that is not the case in this instance (be sure to also check out Izabella Kaminska’s lively twitter feed).

Send to Kindle

Why do prices fluctuate #2?

Yesterday CoinDesk asked for my take on the current downtrend in market prices.  Incidentally, nearly a month ago, this same question was sent to me (here was my response then).  I sent them a statement and they published a couple of the comments in a new article, “Downward Pressures Persist as Bitcoin’s Price Declines to Near $400.”

Readers may be interested in a few of the other comments I mentioned to CD below:

Charlie Shrem made some interesting comments about OTC liquidity earlier today.  However, the fact that merchants and some miners are not dealing with exchanges directly, does not mean they cannot move the price.  That is what we are seeing now — it may not matter how many people are “buying off-chain” or “off-market” because no one wants to lose money.

And in other cases, an OTC buyer can affect exchange via “buy pressure.”  If he begins buying directly from an OTC provider, avoiding an exchange, the exchange loses its buy wall thus affecting price.  The sell pressure forces the price down and once a large buyer goes “off-market,” he is weakening the buy pressure.  If all the buyers and sellers are “off-market,” we can say that exchange price and price discovery is distorted.  As my friend Raffael Danielli recently said, “Information is never off-chain and ultimately information makes the price.”  Consequently today information spreads very quickly and if a broker can make money because he facilitates “off-chain” transaction and knows “better” what the real price is then game theory dictates he should take advantage off this (investment banks do the same with OTC).

So in addition to partnership agreements, they probably also sell somewhere else to mitigate exposure to this volatility.  In addition, many miners have to finance their operations and at current prices of $410, roughly $1.6 million is created every day via block rewards and it has to go somewhere.  Fewer people buying?  Down we go.

People are always rationalizing things in a down turn.  Maybe an early adopter bought a house or car and cashed out a couple of million worth the past couple of days.  Or maybe some of the dev teams that recently raised funds via crowdsales need to sell in order to fund development.  Just because the ticker price says $410 doesn’t mean every bitcoin in the world is worth $410.  It is temporal and the public market is still very illiquid, so start cashing out and see what happens to market prices.  Again, it is only as valuable as another party is willing to pay for it.  And in theory, it will only stop once the marginal cost of creating new coins equals the current price (MV=MC), which Robert Sams wrote about earlier this week..  Though in practice, some miners can operate at loss to recover at least some funds — however it would be in their best interest to simply turn off their equipment instead and buy bitcoins with the expectation of price appreciation.  It also depends on how much they’re leveraged at places like Paymium, BTCJam and Bitfinex.

Send to Kindle

Cryptocurrency in the news #27

One of the most interesting story this week is commentary from Robert Sams, “Some Crypto Quibbles with Threadneedle Street,” who discusses the marginal costs of mining and addresses some of the statements from last weeks Bank of England papers.

Also, a couple of interesting emails/thread from the past from Gavin Andresen and Mike “Hearn: My first message to Satoshi…

Below are stories and posts from over the past week that are related to digital currencies.  Linking does not constitute endorsement of service, coin or project.

[Note: creating a "Better Business Bureau" or Consumer Reports of Bitcoin is in its nascent stage via Proof-of-Developer and Coinist and Coin Source Trust Index.]

Send to Kindle

Cryptocurrency in the news #26

Closing tabs.  Some China related news scattered below as well.

The Bank of England published a couple of papers that have been making the rounds.  One area of contention, by some, is a section in the 2nd paper The sustainability of digital currencies’ low transaction fees which discusses some of the issues brought up in Chapter 3.

Link is not an endorsement of service or coin.

Send to Kindle

Cryptocurrency in the news #25

Closing tabs.

If you’re interested in a blast from the past — to see just how fast the cryptocurrency space has moved in the past 16 months, look at the list of Panelists and Speakers from the San Jose 2013 conference and the projects they were working on.  Or is the more appropriate word, “pivoting?”

Below are links of interest and are not an endorsement for services:

Send to Kindle

Does Smart Contracts == Trustless Multiparty Monetary Computation?

My friend, Zaki Manian, who is working on a very interesting project called SKUChain (discussed in chapter 16), thinks we should reframe how we perceive or rather how we should define ‘smart contracts.’

In his view:

Here is my proposal.

We stop calling the idea ” smart contracts” and we start calling the idea “Trustless Multiparty Monetary Computation”. That should also tell the lawyers that we don’t really need them here at the moment….

Programming Language researchers use the term “contracts” as a way of formally reasoning about multi-part or distributed computation. But PL researchers also understand that this is idea has deep formal connections with reasoning about the relationship between people and organizations.

Here is the relevant prior art.
https://en.wikipedia.org/wiki/Secure_multi-party_computation
The SPJ paper from 2000
http://www.lexifi.com/files/resources/MLFiPaper.pdf

Some implementation of the SPJ’s ideas
http://www.itu.dk/people/sestoft/papers/amlp.pdf
https://rucore.libraries.rutgers.edu/rutgers-lib/23837/

This was in response to the panel discussion last weekend and was brought up by Adam Krellenstein from Counterparty.

If anyone is interested in discussing this further, let me know and I’ll put you in touch with Zaki or others.

Send to Kindle

Cryptocurrency in the news #24

Closing tabs.

Got an email asking me more about the War of Spanish Succession related to gold.  My point on that panel wasn’t so much that France only used gold, but their finances were directly tied to specie (technically the French livre was in two forms: silver écu and gold Louis d’or; see also Livre tournois).  The reason I brought it up at all is because of the meme today, that Bitcoin would somehow prevent war because it neutralizes the states ability to expand its money supply, etc..  It won’t though.  Probably a better historical example are European countries from mid-19th century which adopted some form of a gold standard, yet then went on to wage a global war eventually dropping the peg altogether.  Be sure to read a new article from The Economist that discusses this, “Not floating, but flailing.”

Thanks to Izabella Kaminska (follow her on Twitter) and Zaki Manian for a couple links.

Also, be sure to check out Izabella’s thread today on Coinbase.  Based on a conversation with one lawyer I had two weeks ago it looks like a big legal challenge for Coinbase (and others in their vertical) is that they’re acting as depository institutions without having gone through the necessary “Safety & Soundness” tests which opens them up to legal action from a variety of state/federal agencies.

Send to Kindle