Designing a Global Fabric for Finance (G3F)

Over the past two weeks there have been a number of news stories related to R3 — a fintech startup that I now work at.  The first of which was from the Financial Times, entitled Blockchain initiative backed by nine large investment banks.  Today we announced an additional 13 banks have joined our effort.

Although I cannot speak for the whole team, I can give you the vision I have with the aim of bringing clarity to the various bits of information that have been circulating.


Over the past year, the R3 team has spent copious amounts of time conducting due diligence on the greater “distributed ledger” or “shared ledger” space.  I joined as an advisor in January when they were already knee deep in the task; I am now Director of Market Research.

What I and several others on the team found is that while there were a number of orthogonally useful pieces floating around (such as multisig and ideas like Engima), none of the publicly available technology platforms that has been funded by venture capital provided a flexible, holistic base layer with the specific functional requirements for secure, scalable enterprise use.

This includes incorporating non-functionals that globally regulated financial institutions must adhere to such as: compliance, privacy, reporting and reconciliation.  Similarly, many of the venture funded projects also failed to address the business requirements of these same institutions.

In sportsball terms, the nascent industry is 0-for-2 in their current approach.

Some of that is understandable; for example, Bitcoin solves a set of problems for a niche group of individuals operating under certain security assumptions (e.g., cypherpunks not wanting to interface with banks or governments).  Regulated financial institutions do not operate under those assumptions, thus axiomatically Bitcoin in its current form is highly unlikely to be a solution to their problems at this time.  As a consequence, the technology solutions pitched by many of these startups are hammers looking for nails that do not exist in the off-chain world.

R3 is not a Bitcoin company nor a cryptocurrency company.  We are not seeking to build a “better” or even a different type of virtual currency.  Why not?  Instead of starting with a known solution, such as a spreadsheet, we are starting with the problem set which continually influences the customized solution.  This is one of the biggest reasons I was attracted to this specific effort: R3 is not a re-enactment of Field of Dreams.  Build it with the hopes that someone will come is the siren song, the motto even, for throngs of failed startups.

But weren’t the original shared ledgers — often called blockchains — robust enough to protect all types of assets and a legion of use-cases?

Many public ledgers were originally designed to secure endogenous, on-chain information (e.g., the native token) but in their current incarnations are not fit for purpose to handle off-chain titles.  For instance, Bitcoin was not initially designed to secure exogenous data — such as transmitting high-value off-chain securities — vis-a-vis pseudonymous miners.  And it appears all attempts to mutate Bitcoin itself into a system that does, ends up creating a less secure and very expensive P-o-P network.

What are we doing then?

Rather than try to graft and gerrymander our business requirements onto solutions designed for other problems, we are systematically looking at a cornucopia of challenges and cost-drivers that currently exist at financial institutions.  We will seek to address some of these drivers with a generalized agnostic fabric, with layers that fulfill the critical infrastructure specifications of large enterprises and with services that can be run on top in a compliant fashion.

What is a Global Fabric for Finance (G3F) then?  If you had the chance to build a new financial information network from scratch that incorporated some of the elements and learnings of the shared ledger world, what would it look like?

For starters, a fabric specifically built for and by trusted parties does not need something akin to mining or block rewards.  In fact, not only is there is no Sybil spoofing problem on a trusted network but there are already many known, existing methods for securely maintaining a transaction processing system.  Consequently, needing a block reward may (or may not) be a red herring and has likely been a costly, distracting sideshow to other types of utility that this technology represents.

If trust is not an issue, what use (as Arvind Narayanan and certain high profile enthusiasts have asked) is any part of the shared ledger toolkit?  There are a number of uses, many of which I touched on in a paper back in April.

What about specific use-cases?

While a number of ideas that have surfaced at conferences and media events over the past summer, R3 remains focused on an approach of exploration and ideation.

And while there will likely be some isolated tests on some use-case(s) in sand boxes in the coming year, it is important to reflect on the G3F vision which will be further elaborated on by Richard Brown (our head of technology) in the coming weeks.  If the fabric is only capable of handling one or two specific asset classes, it will fall short of the mandate of being a generalized fabric used to secure financial information for enterprises.

Why directly work with banks during this formative stage?  Why not just raise money and start building and shipping code?

To be frank, if financial institutions and regulatory bodies are not involved and engaged  from the beginning, then whatever fabric created will likely: 1) fail to be viewed as an authoritative and legal record of truth and 2) fall short of adequately address their exacting needs.  It would be a non-starter for a financial institution to use technology that is neither secure, or whose on-chain record is considered non-canonical by off-chain authorities.

What does that mean?

While some in the shared ledger community would like to believe that dry, on-chain code supersedes off-chain wet-code, the facts on the ground continue to contradict that thesis.  Therefore, if you are going to create a non-stealth fintech startup, it must be assumed that whatever products and services you create will need to operate under existing laws.  Otherwise you will spend most of your time hiding out in remote Caribbean islands or Thailand.


The R3 team is comprised of pragmatic thinkers and doers, experienced professionals who understand that a financial system cannot be built with up and down votes on reddit or whose transaction processors may reside in sanctioned countries.


Source: XKCD

While nothing is finalized at the time of this writing, it is our aim at R3 to make the underlying base layer of this fabric both open sourced and an open standard.

After all, a foundation layer this critical would benefit from the collective eyeballs of the entire programming community.  It also bears mentioning that the root layer may or may not even be a chain of hashed blocks.

Furthermore, we are very cognizant of the fact that the graveyard for building industry standards is deep and wide.  Yet, as I mentioned to IBT, failing to create a universal standard will likely result in additional Balkanization, recreating the same silos that exist today and nullifying the core utility of a shared ledger.

It is a pretty exciting time in modern history, where being a nerd — even a cryptonerd — means you are asked to appear on stage in front of decision makers, policy makers, captains of industry and social media influencers.  Some even get to appear in person and not just as a telepresence robot.  Yet as neat as some of the moon math and cryptographic wizardry may be, failing to commercialize it in a sustainable manner could leave many of the innovative forks, libraries and github repos no more than starry-eyed science fair projects.

To that end, we are currently hiring talented developers keen on building a scalable, secure network.  In addition, rather than reinventing the wheel, we are also open to partnerships with existing technology providers who may hold key pieces to building a unified standard.  I am excited to be part of this mathematical industrial revolution, it’s time to strike while the iron is hot and turn good academic ideas into commercial reality.  Feel free to contact us.

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Cryptocurrency KYSF: Know Your Source of Funds part 2

ecommerceA few days ago I was asked a number of questions from a reporter at CoinDesk regarding on-chain trade volume; this was a follow-up from some questions back in early May.

A few of my responses were published in a new article today: Dark Web Markets ‘Processed more Bitcoin than BitPay in 2014’

Below are my unabbreviated comments:

Q: How have the recent posts from Coinbase and BitPay impacted the diagram you outlined in that previous post? Has it had any impact at all?

A: The most striking data point from the Coinbase and BitPay posts was what was missing: actual real user numbers.  Neither one of them is willing to publicly say how many monthly active users (MAU) they have which stands in contrast to other fintech companies, financial institutions and “social media” startups they like to compare themselves to.

For instance, even though Coinbase claims to have 2.4 million users/3.1 million wallets, what does that mean?  Are these all fully KYC’ed accounts?  What percent have logged on in the past month?  What percent have actually used Coinbase’s services?  How many simply create an account, deposit $10 and never log on again?

Similarly, BitPay numbers are actually pretty sobering.  We know demographically from both the CoinDesk report and the leaked Coinbase pitch deck that the over 80% of all bitcoin holders/owners are males between the ages of 18-45.  And that the majority of the overall users reside in North America.  Yet according to the BitPay charts, North American volume has been relatively flat the last 6 quarters.

So if the largest group of bitcoin owners are not using their holdings despite a marked increase in available merchants, that is probably not an indication that they are interested in spending their funds and probably see bitcoins as an investable asset than actual money.  BitPay also does not disclose aggregate USD or euro volume.  Startups like to make noise when they are doing good or can show growth; if the value of their volume was actually growing, they probably would say.

And while transaction count in Europe and Latin America appear to be growing, perhaps the collective value has stayed the same (the Latin America numbers are also a bit misleading; it’s easy to show large growth percentages when you start from 0).

Another point about BitPay’s post is that they don’t really say what “IT services” is.  Notably absent from this post, compared with their post in April, is what “mining” related activity is.  Recall that some miners, such as KnC and now defunct BFL were (are) using BitPay as their payment processor.  In fact, in BitPay’s post earlier this year, “Bitcoin Mining” — by volume — represented the largest share of volume processed.  Does “IT services” now include this previously large segment?

Lastly, one number they do not include is the total aggregate transactions by each quarter.  Eye-balling it, it appears for Q2 2015 they processed about 180,000 transactions.  Divided by 60,000 merchants comes to around 3 transactions per quarter or 1 transaction per month per merchant.

In all likelihood usage follows a power law or a 80-20 rule, that 20% of the merchants account for the majority of transaction volume.  My understanding is that Gyft uses (or used BitPay) as their payment processor and since 9% of all bitcoin-related transactions last quarter were related to gift cards, it is likely that the lionshare of this “gift card” activity in the power law distribution is represented by just one or two companies (e.g., FoldApp and are a couple potential ones to look at as well).

Startups like Blockseer, Sabr, Coinalytics and Chainalysis have APIs and address labeling that may be able to tell us more about specific merchant/payment processor activity,

Q: Also, are clearnet tx outweighed by darknet tx with bitcoin? Silk Road and other marketplaces were the first use case for bitcoin, but are they still the biggest?

A: According to a new paper (Soska and Christin 2015), if you look at Figure 5 and the discussion involved, prior to Operation Olympus, six large dark net marketplaces collectively accounted for more than $600,000 in sales per day.  It is unclear how much of that activity was expressly illegal, although the paper does attempt to break down the amount of illicit drugs being sold on the same sites.

dark net market volume

Source: Soska and Christin

During the same time frame (most of 2014), volume at payment processors such as BitPay and Coinbase were relatively flat with a few outliers during days with speculative and media frenzies as well as ‘Bitcoin Black Friday.’

As of today it is unclear what activity is the “biggest” — we would need to aggregate all of the dark net marketplaces and compare that with the reused addresses BitPay uses plus the self-disclosed numbers from Coinbase.

In the chart above, illustrating off-chain activity between August 14, 2014 – August 13, 2015, it is also unclear from Coinbase’s number what a “off-chain” transaction is.  Is it only related to merchant activity?  Does it also include movement between users or with cold storage as well?

Therefore based on past historical trends (above) I do not think that “clearnet” or on-chain “licit” activity outweighs illicit transactions.  One darknet market alone — Evolution — processed roughly the same amount of bitcoins last year as BitPay did.

Q: Do you think consumer volumes will change significantly in the next year – what would it take for this to happen?

A: It depends on what we mean by “consumer volume.”  If this includes both illicit and licit activity, sure, maybe.  If it also includes “off-chain” transactions, then yes, probably as well.  But it is important to note you are not using Bitcoin (or bitcoin) when you go off-chain.  The transparency and auditability trail disappears and a user is now reliant on a trusted third party — many of whom in the “Bitcoin space” have a checkered past on financial controls — to protect and secure your privkeys.

I think we have already largely witnessed what the “killer apps” that incentivize increased usage of on-chain bitcoin activity are: censorship-resistant activities.

If the goal of Bitcoin was to provide a censorship-resistant payment processing platform (the word “payment” appears 12 times in the white paper) then it is safe to say that: dark net markets, casino sites, ransomware and other activities that require censorship-resistance and cannot be globally accessed on permissioned networks will continue to attract users towards it.1

It is my view that the following two laws explain the on-chain phenomenon we observe on a regular basis.  Folk law: “Anything that needs censorship-resistance will gravitate towards censorship-resistant systems.”  In contrast is Sams’ law: “Anything that doesn’t need censorship-resistance will gravitate towards non censorship-resistant systems.”

As far as other “apps” such as sites like Zapchain, while boasting growth numbers, appears to recreate a trusted third party system (e.g., facilitate deposit-taking and MSB activities like other hosted wallets) all while simultaneously scraping content from other sites.2

So Buzzfeed, but with bitcoins.

Does it have legs?  Porter Bibb would probably say no.

In closing, one last comment related to real on-chain trade (as opposed to spam-like “long-chain transactions“) is the recent announcement / non-announcement from TigerDirect.  Jorge Stolfi, a computer science professor in Brazil, probably best summarized the nebulous responses from the electronic retailer:

  • How much have you been making in bitcoin payments? “While Expedia has seen a decrease in bitcoin payments, TigerDirect shared a different story.”
  • How many customers are paying with bitcoin? “46 percent of customers purchasing with bitcoin are new users”
  • Sorry, how much did you say you made with bitcoin payments? “the average order placed with bitcoin is 30 percent larger than the average order.”
  • Yes, but, how much are you selling with bitcoin? “TigerDirect sees the highest volume of bitcoin orders during periods of volatility for bitcoin price.”
  • We would really like to know how much, roughly, you are getting from bitcoin payments. “TigerDirect has still seen consistent bitcoin transaction volume.”
  1. According to Kotov and Rajpal, bitcoins are now the most common method of payment for ransomware.  See Understanding Crypto-Ransomware. []
  2. Zapchain uses Coinbase as a wallet provider for deposits — the tipping of transactions is done via via BlockCypher. []
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What is permissioned-on-permissionless?

As of this writing, more than half of all VC funding to date has gone into building permissioned systems on top of a permissionless network (Bitcoin). Permissioned-on-Permissionless (PoP) systems are an odd hydra, they have all of the costs of Sybil-protected permissionless systems (e.g., high marginal costs) without the benefits of actual permissioned systems (e.g., fast confirmations, low marginal costs, direct customer service).

Thus it is curious to hear some enthusiasts and VCs on social media and at conferences claim that the infrastructure for Bitcoin is being rolled out to enable permissionless activity when the actual facts on the ground show the opposite is occurring.  To extract value, maintain regulatory compliance and obtain an return-on-investment, much of the investment activity effectively recreates many of the same permission-based intermediaries and custodians that currently exist, but instead of being owned by NYC and London entities, they are owned by funds based near Palo Alto.

For example, below are a few quotes over the past 18 months.

In a February 2014 interview with Stanford Insights magazine, Balaji Srinivasan, board partner at Andreessen Horowitz and CEO of 21inc, stated:

Thus, if the Internet enabled permissionless innovation, Bitcoin allows permissionless monetization.

In July 2015, Coinbase announced the winners of its hackathon called BitHack, noting:

The BitHack is important to us because it taps into a core benefit of Bitcoin: permissionless innovation.

Also in July 2015, Alex Fowler, head of business development at Blockstream, which raised $21 million last fall, explained:

At Blockstream, our focus is building and supporting core bitcoin infrastructure that remains permissionless and trustless with all of the security and privacy benefits that flow from that architecture.

Yet despite the ‘permissionless’ exposition, to be a customer of these companies, you need to ask their permission first and get through their KYC gates.

For instance, in Circle’s user agreement they note that:

Without limiting the foregoing, you may not use the Services if (i) you are a resident, national or agent of Cuba, North Korea, Sudan, Syria or any other country to which the United States embargoes goods (“Restricted Territories”), (ii) you are on the Table of Denial Orders, the Entity List, or the List of Specially Designated Nationals (“Restricted Persons”), or (iii) you intend to supply bitcoin or otherwise transact with any Restricted Territories or Restricted Persons.

Is there another way of looking at this phenomenon?

There have been a number of interesting posts in the past week that have helped to refine the terms and definitions of permissioned and permissionless:

Rather than rehashing these conversations, let’s look at a way to define permissionless in the first place.

Permissionless blockchains

permissionless blockchainA couple weeks ago I gave a presentation at the BNY Mellon innovation center and created the mental model above to describe some attributes of a permissionless blockchain.  It is largely based on the characteristics described in Consensus-as-a-service.

DMMS validators are described in the Blockstream white paper.  In their words:

We  observe  that  Bitcoin’s  blockheaders  can  be  regarded  as  an  example  of  a dynamic-membership multi-party signature (or DMMS ), which we consider to be of independent interest as a new type of group signature. Bitcoin provides the first embodiment of such a signature, although this has not appeared in the literature until now. A DMMS is a digital signature formed by a set of signers which has no fixed size.  Bitcoin’s blockheaders are DMMSes because their proof-of-work has the property that anyone can contribute with no enrolment process.   Further,  contribution is weighted by computational power rather than one threshold signature contribution per party, which allows anonymous membership without risk of a Sybil attack (when one party joins many times and has disproportionate input into the signature).  For this reason, the DMMS has also been described as a solution to the Byzantine Generals Problem [AJK05]

In short, there is no gating or authorizing process to enroll for creating and submitting proofs-of-work: theoretically, validating Bitcoin transactions is permissionless.  “Dynamic-membership” means there is no fixed list of signatories that can sign (i.e. anyone in theory can).  “Multi-party” effectively means “many entities can take part” similar to secure multi-party computation.1

Or in other permission-based terms: producing the correct proof of work, that meets the target guidelines, permits the miner (block maker) to have full authority to decide which transactions get confirmed.  In other words, other than producing the proof-of-work, miners do not need any additional buy-in or vetting from any other parties to confirm transactions onto the blockchain. It also bears mentioning that the “signature” on a block is ultimately signed by one entity and does not, by itself, prove anything about how many people or organizations contributed to it.2

Another potential term for DMMS is what Ian Grigg called a Nakamoto signature.

Censorship-resistance, while not explicitly stated as such in the original 2008 white paper, was one of the original design goals of Bitcoin and is further discussed in Brown’s post above as well as at length by Robert Sams.

The last bucket, suitable for on-chain assets, is important to recognize because those virtual bearer assets (tokens) are endogenous to the network.  DMMS validators have the native ability to control them without some knob flipping by any sort of outside entity.  In contrast, off-chain assets are not controllable by DMMS validators because they reside exogenous to the network.  Whether or not existing legal systems (will) recognize DMMS validators as lawful entities is beyond the scope of this post.

Permissionless investments

What are some current examples of permissionless-related investments?

zooko permissionless

Source: Twitter

This past week I was in India working with a few instructors at Blockchain University including Ryan Charles.  Ryan is currently working on a new project, a decentralized version of reddit that will utilize bitcoin.

In point of fact, despite the interesting feedback on the tweet, OB1 itself, the new entity that was formed after raising $1 million to build out the Open Bazaar platform, is permission-based.

How is it permission-based when the DMMS validators are still permissionless?  Because OB1 has noted it will remove illicit content on-demand from regulators.

In an interview with CoinDesk, Union Square Venture managing partner, Brad Burnham stated that:

Burnham acknowledged that the protocol could be used by dark market operators, but stressed the OpenBazaar developers have no interest in supporting such use cases.  “They certainly won’t be in the business of providing enhanced services to marketplaces that are selling illegal goods,” he noted.

Based on a follow-up interview with Fortune, Brian Hoffman, founder of OB1 was less specific and a bit hand-wavy on this point, perhaps we will not know until November when they officially launch (note: Tor support seems to have disappeared from Open Bazaar).

One segment of permissionless applications which have some traction but have not had much (if any) direct VC funding include some on-chain/off-chain casinos (dice and gambling games) and dark net markets (e.g., Silk Road, Agora).  Analysis of this, more illicit segment will be the topic of a future post.

What are some other VC-funded startups that raised at least a Series A in funding, that could potentially be called permissionless?  Based on the list maintained by Coindesk, it appears just one is — ($30.5 million).

Why isn’t Coinbase, Xapo or Circle?  These will be discussed below at length.

What about mining/hashing, aren’t these permissionless activities at their core?

Certain VC funded mining/hashing companies no longer offer direct retail sales to hobbyists, this includes BitFury and KnC Miner.  These two, known entities, through a variety of methods, have filed information about their operations with a variety of regulators.3  To-date BitFury has raised $60 million and it runs its own pool which accounts for about 16% of the network hashrate.  Similarly, KnC has raised $29 million from VCs and also runs its own pool, currently accounting for about 6% of the network hashrate.

What about other pools/block makers?  It appears that in practice, some require know-your-customer (KYC), know-your-business (KYB), know-your-miner (KYM) and others do not (e.g., selling custom-made hardware anonymously can be tricky).

  • MegaBigPower gathers KYC information.
  • Spondoolies Tech is currently sold out of their hardware but require some kind of customer information to fill out shipping address and customs details.  They have raised $10.5 million in VC funding.
  • GHash allows you to set up a pseudonymous account with throwaway email addresses (or via Facebook and Google+), but they have not published if they raised any outside funding
  • Most Chinese hashing and mining pools are privately financed.  For instance, Bitmain has not needed to raise funding from VCs (yet).  The also, currently, do not perform KYC on their users.  I spoke with several mining professionals in China and they explained that none of the big pools (Antpool, F2pool, BTC China pool, require KYM at this time.  Over the past four days, these pools accounted for: 21%, 17%, 10% and 8% of the network hashrate respectively — or 56% altogether.  Update 7/29/2015: a representative at BTC China explained that: “Yes, we do KYC the members of our mining pool. We verify them the same way we KYC all registered users on BTCC.”
  • 21inc, not much more is known publicly at this time but if the idea of a “BitSplit” chip is correct, then what could happen is the following: as more chips are flipped on in devices, the higher the difficulty level rises (in direct proportion to the hashrate added).  As a result, the amount of satoshi per hash declines over time in these devices.  What this likely will lead to is a scenario in which the amount of satoshi mined by a consumer device will be less than “dust limit” which means a user will likely be unable to move the bitcoins off of the pool without obtaining larger amounts of bitcoin first (in order to pay the transaction fee).  Consequently this could mean the users will need to rely on the services provided by the pool, which could mean that the pool will need to become compliant with KYC/AML regulations.  All of this speculation at this time and is subject to changes.  They have received $121 million in VC funding.
  • As explained above, while individual buyers of hashing equipment, Bob and Alice, do typically have to “doxx” themselves up to some level, both Bob and Alice can resell the hardware on the second-hand market without any documentation.  Thus, some buyers wanting to pay a premium for hashing hardware can do so relatively anonymously through middlemen.4  This is similar to the “second-hand” market for bitcoins too: bitcoins acquired via KYC’ed gateways end up on and sold at a premium to those wanting to buy anonymously.

Notice a pattern?  There is a direct correlation between permissionless platforms and KYC/AML compliance (i.e., regulated financial service businesses using cryptocurrencies are permissioned-on-permissionless by definition). attempts to skirt the issue by marketing themselves as a software platform and for the fact that they do not directly control or hold private keys.5

This harkens back to what Robert Sams pointed out several months ago, that Bitcoin is a curious design indeed where in practice many participants on the network are now known, gated and authenticated except the transaction validators.

What about permissioned-on-permissionless efforts from Symbiont, Chain and NASDAQ?  Sams also discussed this, noting that:

Now, I am sure that the advocates of putting property titles on the bitcoin blockchain will object at this point. They will say that through meta protocols and multi-key signatures, third party authentication of transaction parties can be built-in, and we can create a registered asset system on top of bitcoin. This is true. But what’s the point of doing it that way? In one fell swoop a setup like that completely nullifies the censorship resistance offered by the bitcoin protocol, which is the whole raison d’etre of proof-of-work in the first place! These designs create a centralised transaction censoring system that imports the enormous costs of a decentralised one built for censorship-resistance, the worst of both worlds.

If you are prepared to use trusted third parties for authentication of the counterparts to a transaction, I can see no compelling reason for not also requiring identity authentication of the transaction validators as well. By doing that, you can ditch the gross inefficiencies of proof-of-work and use a consensus algorithm of the one-node-one-vote variety instead that is not only thousands of times more efficient, but also places a governance structure over the validators that is far more resistant to attackers than proof-of-work can ever be.

This phenomenon is something I originally dubbed “permissioned permissionlessness” for lack of a better term, but currently think permissioned-on-permissionless is more straightforward and less confusing.

What does this mean?


PoP blockchainThe Venn diagram above is another mental model I used at the BNY Mellon event.

As mentioned 3 months ago, in practice most block makers (DMMS validators) are actually known in the real world.

While the gating process to become a validator is still relatively permissionless (in the sense that no single entity authorizes whether or not someone can or cannot create proofs-of-work), the fact that they are self-identifying is a bit ironic considering the motivations for building this network in the first place: creating an ecosystem in which pseudonymous and anonymous interactions can take place:

The first rule of cypherpunk club is, don’t tell anyone you’re a cypherpunk.  The first rule of DMMS club is, don’t tell anyone you’re a DMMS.

The second bucket, neither censorship resistant nor trade finality, refers to the fact that large VC funded companies like Coinbase or Circle not only require identification of its user base but also be censor their customers for participating in trading activity that runs afoul of their terms of service.  Technically speaking, on-chain trade finality hurdles refers to bitcoin transactions not being final (due to a block reorg, a longer chain can always be found, undoing what you thought was a confirmed transaction).  This has happened several times, including notably in March 2013.

For instance, in Appendix 1: Prohibited Businesses and Prohibited Use, Coinbase lays out specific services that it prohibits interaction with, including gambling.  For example, about a year ago, users from Seals with Clubs and other dice/gambling sites noticed that they were unable to process funds from these sites through Coinbase and vice versa.

brian armstrong coinbase

Source: Twitter

The tweet above is from Brian Armstrong is the CEO of Coinbase, which is the most well-funded permissioned-on-permissionless startup in the Bitcoin ecosystem.  For its users, there is nothing permissionless about Bitcoin as they actively gate who can and cannot be part of their system and black list/white list certain activities, including mining (hashing) itself.6  It is not “open” based on common usage of the word.

In other words, contrary to what some Coinbase executives and investors claim, in an effort to extract value in a legally palatable manner, they must fulfill KYC/AML requirements and in doing so, effectively nullify the primary utility of a permissionless network: permissionlessness.  Furthermore, Coinbase users do not actually use Bitcoin for most transactions as they do not control the privkey, Coinbase does.  Coinbase users are not using Bitcoin on Coinbase, they are using an internal database.7 Or to use the marketing phrase: you are not your own bank, Coinbase is — which leads to a bevy of regulatory compliance questions beyond the scope of this post.8 However, once your bitcoins are out of Coinbase and into your own independent wallet where you control the private key, then you get the utility of the permissionless platform once more.

What are other permissioned-on-permissionless platforms?  Below are twenty-seven different companies that have raised at least a Series A (figures via CoinDesk) in alphabetical order:

  • ($4 million)
  • BitGo: ($14 million)
  • BitGold: ($5.3 million)
  • Bitnet: ($14.5 million)
  • BitPay: ($32.5 million)
  • Bitreserve: ($14.6 million)
  • Bitstamp: ($10 million)
  • BitX: ($4.82 million)
  • BTC China ($5 million)
  • ChangeTip: ($4.25 million)
  • Chain: ($13.7 million)9
  • Circle: ($76 million)
  • Coinbase: ($106 million)
  • Coinplug: ($3.3 million)
  • Coinsetter: ($1.9 million)
  • Cryex: ($10 million)
  • GoCoin: ($2.05 million)
  • Huobi ($10 million)
  • itBit: ($28.25 million)
  • Korbit: ($3.4 million)
  • Kraken: ($6.5 million)
  • Mirror, formerly Vaurum: ($12.8 million)
  • OKCoin: ($11 million)
  • Ripple Labs ($37 million)
  • Vogogo ($21 million)
  • Xapo: ($40 million)

Altogether this amounts to around $492 million, which is more than half of the $855 million raised in the overall “Bitcoin space.”

What do these all have in common again?  Most are hosted wallets and exchanges that require KYC/AML fulfillment for compliance with regulatory bodies.  They require users to gain permission first before providing a service.

pie chart bitcoin fundingThe chart above visualizes funding based on the schema’s explored in this post.  Based on a total venture capital amount of $855 million, in just looking at startups that have received at least a Series A, 57.5% or $492 million has gone towards permissioned-on-permissionless systems.  An additional $224 million, or 26.1% has gone towards mining and hashing.10

Permissionless-on-permissionless includes, ShapeShift, Hive, Armory and a sundry of other seed-stage startups that collectively account for around $50 million or 5.8% altogether.  The remaining 10.6% include API services such as Gem and BlockCypher; hardware wallets such as Case and Ledger; and analytic services such as Tradeblock.  In all likelihood, a significant portion of the 10.6% probably is related to permissioned-on-permissionless (e.g., Elliptic, Align Commerce, Bonafide, Blockscore, Hedgy, BitPagos, BitPesa) but they have not announced a Series A (yet) so they were not included in the “blue” portion.

Ripple Labs

Why is Ripple Labs on that funding list above?  While Ripple is not directly related to Bitcoin, it is aggregated on the funding list by CoinDesk.

Is it permissioned or permissionless?  A few weeks ago I met with one of its developers, who said in practice, the validator network is effectively permissionless in that anyone can run a validator and that Ripple Labs validators will process transactions that include XRP.11

This past week, Thomas Kelleher tried to outline how Ripple Labs is some kind of “third way” system, that uses ‘soft permissions’ in practice.  There may be a case for granular permissions on a permissionless network, but it did not coherently arise in that piece.

For example, in early May, Ripple Labs announced that it had been fined by FinCEN for not complying with the BSA requirements by failing to file suspicious activity reports (SARs), including notably, on Roger Ver (who did not want to comply with its KYC requests).

In addition to the fine, Ripple Labs also implemented a new identification gathering process for KYC compliance, stating:

The Ripple network is an open network. No one, including Ripple Labs, can prevent others from using or building on the Ripple protocol as they desire. However, when Ripple Labs provides software, such as the Ripple Trade client, Ripples Labs may impose additional requirements for the use of the software. As such, Ripple Labs will require identification of Ripple Trade account holders.

We will ask you to submit personally identifiable information (PII) similar to what you would submit to open a bank account, such as full name, address, national ID number, and date of birth. Users may also be asked to upload their driver’s license or other identifying documents. We will use this information to verify your identity for compliance purposes. We take privacy seriously, so the information you provide during the customer identification process is encrypted and managed by Ripple Trade’s Privacy Policy.

In other words, Ripple Labs was just fined by FinCEN for doing the very thing that Kelleher wants you to believe he is not required to do.   All new Ripple Labs-based “wallets” (Ripple Trade wallets) require user info — this likely means they can control, suspend and block accounts.12  All eight of the main Ripple gateways are also obliged to gather customer information.  The current lawsuit between Jed McCaleb and Ripple Labs, over the proceeds of $1 million of XRP on Bitstamp, will probably not be the last case surrounding the identification and control of such “wallet” activity (e.g., specific XRP flagged).

Thus, while the Ripple network started out as permissionless, it could likely become permissioned at some point due to compliance requirements.  Why?  If you download and install rippled, in practice you are going to use the default settings which rely on Ripple Labs core nodes. In practice, “choose your own” means “choose the default” for 99% percent of its users, ergo Ripple Labs sets the defaults.13 In a paper recently published by Peter Todd, he explained there is no game theoretic advantage to selecting non-default configurations which were not discussed in Kelleher’s essay.

Bob cannot choose his own rules if he has to follow compliance from another party, Ripple Labs. The UNL set may converge on an explicit policy as nodes benefit from not letting other nodes validate (they can prioritize traffic).14

I reached out to Justin Dombrowski, an academic who has spent the past year independently studying different ledger systems for a variety of organizations.  In his view:

I have a hard time thinking of Ripple as anything but plain permissioned because I have a hard time thinking of a realistic circumstance under which an active user wouldn’t also have an account subject to KYC, or be indirectly connected to one. Sure, I can run a node for the purpose of experimenting with some Ripple app I’m developing, but at the end of the day I expect to be payed for that app. And I could mine for free—and yeah, in that case the network is permissionless for me—but that’s a atypical, trivial example I’d think. Ripple is theoretically permissionless, but practically not because incentives align only with permissioned uses.

As Dombrowski noted, things get taxonomically challenging when a company (Ripple Labs) also owns the network (Ripple) and has to begin complying with financial service regulations.  This trend will likely not change overnight and until it explicitly occurs, I will probably continue to put an asterisk next to its name.

Challenges for DMMS validators in a permissioned-on-permissionless world

Over the past month, I have been asked a number of questions by managers at financial institutions about using public / communal chains as a method for transferring value of registered assets.

For instance, what happens if Bank A pays a fee to a Bitcoin or Litecoin miner/mining pool in a sanctioned country (e.g., EBA concerns in July 2014)?

In February 2015, according to a story published by Free Beacon, Coinbase was on “the hot seat” for explicitly highlighting this use-case in an older pitch deck because they stated: “Immune to country-specific sanctions (e.g. Russia-Visa)” on a slide and then went on to claim that they were compliant with US Treasury and NY DFS requirements.

Another question I have been asked is, what if the Bitcoin or Litecoin miner that processes transactions for financial institutions (e.g., watermarked tokens) also processes transactions for illicit goods and services from dark net markets?  Is there any liability for a financial institution that continues to use this service provider / block maker?

Lastly, how can financial institutions identify and contact the miner/mining pool in the event something happens (e.g., slow confirmation time, accidentally sent the wrong instruction, double-spend attempt, etc.)?  In their view, they would like to be able to influence upgrades, governance, maintenance, uptime (i.e., typical vendor relationship).


In the Consensus-as-a-service report I used the following chart showing trade-offs:permissioned tradeoffsI also used the following diagram to illustrate the buckets of a permissioned blockchain:

permissioned chainsRecall that the term “mintette” was first used by Ben Laurie in his 2011 paper describing known, trusted validators and was most recently used in Meiklejohn (2015).

The general idea when I published the report several months ago was that permissionless-on-permissioned (what effectively what Ripple sits) is untenable in the long-run: due to regulatory pressure it is impossible to build a censorship-resistant system on top of a permissioned network.

Ryan Shea pointed this out in his recent piece, noting that:

Permission-ed blockchains are useful for certain things but they are limited in what they can do. Fully decentralized, permission-less, censorship-resistant applications CANNOT be built on them, which for many is a deal-breaker.

What does this mean for your business or organization?  Before deciding what system(s) to use, it is important to look at what the organizations needs are and what the customer information requirements are.


As explored above, several startups and VC funds have unintentionally turned an expensive permissionless system into a hydra gated permissioned network without the full benefits of either.  If you are running a ledger between known parties who abide by government regulations, there is no reason to pay the censorship-resistance cost.  Full stop.15

fixing bitcoin

[The optics of permissioned-on-permissionless]

Most efforts for “legitimizing” or “fixing” Bitcoin involves counteracting features of Bitcoin that were purposefully designed such that it enables users to bypass third parties including governmental policies and regulations.  Businesses and startups have to fight to turn Bitcoin into something it isn’t, which means they are both paying to keep the “naughty” features and paying to hide them.  For example, if Satoshi’s goal was to create a permissioned system that interfaces with other permissioned systems, he would likely have used different pieces — and not used proof-of-work at all.

The commercial logic of this (largely) VC-backed endgame seems to be: “privatize” Bitcoin through a dozen hard forks (the block size fork is the start of this trend that could also change the 21 million bitcoin hard-cap).16

It seems increasingly plausible that some day we may see a fork between the “permissionless-on-permissionless” chain (a non-KYC’ed chain) and the “permissioned-on-permissionless” chain (a fully KYC’ed chain) — the latter comprising VC-backed miners, hosted wallets, exchanges and maybe even financial institutions (like NASDAQ).  The motivations of both are progressively disparate as the latter appears uninterested in developer consensus (as shown by the special interest groups wanting to create larger blocks today by ignoring the feedback from the majority of active core developers and miners).  At that point, there is arguably minimal-to-no need for censorship resistance because users and miners will be entirely permissioned (i.e. known by/to participating institutions and regulators).

When drilling down, some of the permissioned-on-permissionless investment appears to be a sunk cost issue: according to numerous anecdotes several of these VCs apparently are heavily invested in bitcoins themselves so they double down on projects that use the Bitcoin network with the belief that this will create additional demand on the underlying token rather than look for systems that are a better overall fit for business use-cases.17

This raises a question: is it still Bitcoin if it is forked and privatized?   It seems that this new registered asset is best called Bitcoin-in-name-only, BINO, not to be confused with bitcoin, the bearer asset.18

If the end game for permissionless systems is one in which every wallet has to be signed by something KYC/KYB approved, it appears then that this means there would be a near total permissioning of the ledger.  If so, why not use a permissioned ledger instead for all of the permissioned activity?

The discussion over centralized versus institutionalized will also be discussed in a future post.

[Acknowledgements: thanks to Richard Apodaca, Anton Bolotinsky, Arthur Breitman, Richard Brown, Dustin Byington, Justin Dombrowski, Thomas Kelleher, Yakov Kofner, Antony Lewis and John Whelan for their feedback.]


  1. See Does Smart Contracts == Trustless Multiparty Monetary Computation? []
  2. Thanks to Richard Brown for this insight. []
  3. In raising funds, they have “doxxed” themselves, providing information about founders and management including names and addresses.  They are no longer pseudonymous. []
  4. Thanks to Anton Bolotinsky for this insight. []
  5. Are there any other non-mining projects that are VC funded projects that do not require KYC?  A few notable examples include ShapeShift (which de-links provenance and does not require KYC from its users) and wallets such as Hive and Armory.  All three of these are seed-stage. []
  6. For more about know-your-miner and source of funds, see The flow of funds on the Bitcoin network in 2015 []
  7. Perhaps this will change in the future.  Coinbase users can now send funds both on-and-off-chain in a one-click manner. []
  8. Learning from the past to build an improved future of fintech and Distributed Oversight: Custodians and Intermediaries []
  9. Chain is working with NASDAQ on its new issuance program which requires KYC compliance.  In contrast, I created a new account for their API product today and it did not require any KYC/KYB. []
  10. See What impact have various investment pools had on Bitcoinland?  It bears mentioning that BitFury raised an additional $20 million since that post, bringing the publicly known amount to around $224 million. []
  11. Visited on July 2, 2015 []
  12. Using similar forensics and heuristics from companies like Chainalysis and Coinalytics, Ripple Labs and other organizations can likely gather information and data on Ripple users prior to the April 2015 announcement due to the fact that the ledger is public. []
  13. Two years ago, David Schwartz, chief cryptographer at Ripple Labs, posted an interesting comment related to openness and decentralization on The Bitcoin Foundation forum. []
  14. Thanks to Jeremy Rubin and Roberto Capodieci for their feedback. []
  15. Thanks to Arthur Breitman for this insight. []
  16. Thanks to Robert Sams for this insight. []
  17. Richard Apodaca, author of the forthcoming Decoding Bitcoin book, has another way of looking at VCs purchasing bitcoins, that he delves into on reddit twice. []
  18. One reviewer suggested that, “this would cease being bitcoin if the measuring stick is what Satoshi wanted.” []
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Buckets of Permissioned, Permissionless, and Permissioned Permissionlessness Ledgers

A few hours ago I gave the following presentation to Infosys / Finacle in Mysore, India with the Blockchain University team.  All views and opinions are my own and do not represent those of either organization.

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Learning from the past to build an improved future of fintech

[Note: below is a slightly edited speech I gave yesterday at a banking event in Palo Alto.  This includes all of the intended legalese, some of which I removed in the original version due to flow and time.  Special thanks to Ryan Straus for his feedback.  The views below are mine alone and do not represent those of any organization or individual named.]

Before we look to the future of fintech, and specifically cryptocurrencies and distributed ledgers, let’s look at the most recent past.  It bears mentioning that as BNY Mellon is the largest custodial bank in the world, we will see the importance of reliable stewardship in a moment below.

In January 2009 an unknown developer, or collective of developers, posted the source code of Bitcoin online and began generating blocks – batches of transactions – that store and update the collective history of Bitcoin: a loose network of computer systems distributed around the globe.

To self-fund its network security, networks like Bitcoin create virtual “bearer assets.” These assets are automatically redeemable with the use of a credential.  In this case, a cryptographic private key.  From the networks point of view, possession of this private key is the sole requirement of ownership.  While the network rules equivocate possession and control, real currency – not virtual currency – is the only true bearer instrument.  In other words, legal tender is the only unconditional exception to nemo dat quod non habet – also known as the derivative principal – which dictates that one cannot transfer better title than one has.

Several outspoken venture investors and entrepreneurs in this space have romanticized the nostalgia of such a relationship, of bearer assets and times of yore when a “rugged individual” can once again be their own custodian and bank.1 The sentimentality of a previous era when economies were denominated by precious metals held – initially not by trusted third parties – but by individuals, inspired them to invest what has now reached more than $800 million in collective venture funding for what is aptly called Bitcoinland.

Yet, the facts on the ground clearly suggests that this vision of “everyone being their own bank” has not turned into a renaissance of success stories for the average private key holder.  The opposite seems to have occurred as the dual-edged sword of bearer instruments have been borne out.  At this point, it is important to clearly define our terms.  The concepts of “custody” and “deposit” are often conflated.  While the concepts are superficially similar, they are very different from a legal perspective.  Custody involves the transfer of possession/control.  A deposit, on the other hand, occurs when both control and title is transferred.

Between 2009 and early 2014, based on public reports, more than 1 million bitcoins were lost, stolen, seized and accidentally destroyed.2 Since that time, several of the best funded “exchanges” have been hacked or accidentally sent bitcoins to the wrong customer.  While Mt. Gox, which may have lost 850,000 bitcoins itself, has attracted the most attention and media coverage – rightfully so – there is a never ending flow of unintended consequences from this bearer duality.3

For instance, in early January 2015, Bitstamp – one of the largest and oldest exchanges – lost 19,000 bitcoins due to social engineering and phishing via Gmail and Skype on its employees including a system administrator.4 Four months later, in May, Bitfinex, a large Asian-based exchange was hacked and lost around 1,500 bitcoins.5 In another notable incident, last September, Huobi, a large Bitcoin exchange in Beijing accidentally sent 920 bitcoins and 8,100 litecoins to the wrong customers.6  And ironically, because transactions are generally irreversible and the sole method of control is through a private key they no longer controlled them: they had to ask for the bitcoins back and hope they were returned.

A study of 40 Bitcoin exchanges published in mid-2013 found that at that time 18 out of 40 – 45% — had closed doors and absconded with some portion of customer funds.7 Relooking at that list today we see that about another five have closed in a similar manner.  All told, at least 15% if not higher, of Bitcoin’s monetary base is no longer with the legitimate owner.  Can you imagine if a similar percentage of real world wealth or deposits was dislocated in the same manner in a span of 6 years?8

In many cases, the title to this property is encumbered, leading to speculation that since many of these bitcoins are intermixed and pooled with others, a large percentage of the collective monetary base does not have clean title, the implications of which can be far reaching for an asset that is not exempted from nemo dat, it is not fungible like legal tender.9

As a consequence, because people in general don’t trust themselves with securing their own funds, users have given – deposited – their private keys with a new batch of intermediaries that euphemistically market themselves as “hosted wallets” or “vaults.” What does that look like in the overall scheme?  These hosted wallets, such as Coinbase and Xapo, have collectively raised more than $200 million in venture funding, more than a quarter of the aggregate funding that the whole Bitcoin space has received. Simultaneously, the new – often unlicensed – parties collectively hold several million bitcoins as deposits; probably 25-30% of the existing monetary base.10 Amazingly, nobody is actually certain whether a “hosted wallet” is a custodian of a customers bitcoin or acquired title to the bitcoin and is thus a depository.

Yet, in recreating the same financial intermediaries that they hoped to replace – in turning a bearer asset into a registered asset – some Bitcoin enthusiasts have done so in fashion that – as described earlier – has left the system ripe for abuse.  Whereas in the real world of finance, various duties are segregated via financial controls and independent oversight.11 In the Bitcoin space, there have been few financial controls.  For example, what we call a Bitcoin exchange is really a broker-dealer, clearinghouse, custodian, depository and an exchange rolled into one house which has led to theft, tape painting, wash trading, and front-running.12 All the same issues that led to regulatory oversight in the financial markets in the first place.

And while a number of the better funded and well-heeled hosted wallets and exchanges have attempted to integrate “best practices” and even third-party insurance into their operation, to date, there is only one Bitcoin “vault” – called Elliptic — that has been accredited with meeting the ISAE 3402 custodial standard from KPMG. Perhaps this will change in the future.

But if the point of the Bitcoin experiment, concept, lifestyle or movement was to do away or get away from trusted third parties, as described above, the very opposite has occurred.

What can be learned from this?  What were the reasons for institutions and intermediation in the first place?  What can be taken away from the recent multi-million dollar educational lesson?

We have collectively learned that a distributed ledger, what in Bitcoin is called a blockchain, is capable of clearing and settling on-chain assets in a cryptographically verifiable manner, in near-real time all with 100% uptime because its servers – what are called validators – are located around the world.  As we speak just under sixty four hundred of these servers exist, storing and replicating the data so that availability to any one of them is, in theory, irrelevant.13

Resiliency, accountability and transparency, what’s not to like?  Why wouldn’t financial institutions want to jump on Bitcoin then, why focus on other distributed ledger systems?

One of the design assumptions in Bitcoin is that its validators are unknown and untrusted – that there is no gating or vetting process to become a validator on its open network.  Because it is purposefully expensive and slow to produce a block that the rest of the network will regard as valid, in theory, the rest of the network will reject your work and you will have lost your money.  Thus, validators, better technically referred to as a block maker, attempt to solve a benign math problem that takes on average about 10 minutes to complete with the hope of striking it rich and paying their bills. There are exceptions to this behavior but that is a topic for another time.14

The term trust or variation thereof appears 13 times in the final whitepaper.  Bitcoin was designed to be a solution for cypherpunks aiming to minimize trust-based relationships and mitigate the ability for any one party to censor or block transactions. Because validators are unknown and untrusted, to protect against history-reversing attacks, Bitcoin was purposefully designed to be inefficient.15 That is to say attackers must expend real world resources, energy, to disrupt or rewrite history.  The theory is that this type of economic attack would stave off all but the most affluent nation-state actors; in practice this has not been the case, but that again is a topic for another speech.

Thus Bitcoin is perhaps the world’s first, commodity-based censorship resistance-as-a-service.  To prevent attackers on this communal network from reversing or changing transactions on a whim, an artificially expensive anti-Sybil mechanism was built in dubbed “proof of work” – the 10 minute math problem.  Based on current token value, the cost to run this network is roughly $300 million a year and it scales in direct proportion to the bitcoin market price.16

Thus there are trade-offs that most financial institutions specifically would not be interested in.

Why you may ask?

Because banks already know their customers, staff and partners. Their counterparties and payment processors are all publicly known entities with contractual obligations and legal accountability.  Perhaps more importantly, the relationship created between an intermediary and a customer is clear with traditional financial instruments.  For example, when you deposit money in your bank account, you know (or should know) that you are trading your money for an IOU from the bank.17 On the other hand, when you place money in a safe deposit box you know (or should know) that you retain title to the subject property.  This has important considerations for both the customer and intermediary.  When you trade your money for an IOU, you are primarily concerned with the financial condition of the intermediary.  However, when you retain title to an object held by somebody else, you care far more about physical and logical security.

As my friend Robert Sams has pointed out on numerous occasions, permissionless consensus as it is called in Bitcoin, cannot guarantee irreversibility, cannot even quantify the probability of a history-reversing attack as it rests on economics, not technology.18 Bitcoin is a curious design indeed where in practice many participants on the network are now known, gated and authenticated except the transaction validators.  Why use expensive proof-of-work at all at this point if that is the case?  What is the utility of turning a permissionless system into a permissioned system, with the costs of both worlds and the benefits of neither?

But lemonade can still be squeezed from it.

Over the past year more than a dozen startups have been created with the sole intent to take parts of a blockchain and integrate their utility within financial institutions.19 They are doing so with different design assumptions: known validators with contractual terms of service. Thus, just as PGP, SSL, Linux and other open source technology, libraries and ideas were brought into the enterprise, so too are distributed ledgers.

Last year according to Accenture, nearly $10 billion was invested in fintech related startups, less than half of one percent of which went to distributed ledger-related companies as they are now just sprouting.20

What is one practical use?  According to a 2012 report by Deutsche Bank, banks’ IT costs equal 7.3% of their revenues, compared to an average of 3.7% across all other industries surveyed.21)  Several of the largest banks spend $5 billion or more in IT-related operating costs each year.  While it may sound mundane and unsexy, one of the primary use cases of a distributed ledger for financial institutions could be in reducing the cost centers throughout the back office.

For example, the settlement and clearing of FX and OTC derivatives is an oft cited and increasingly studied use case as a distributed ledger has the potential to reduce counterparty and systemic risks due to auditability and settlement built within the data layer itself.22

How much would be saved if margining and reporting costs were reduced as each transaction was cryptographically verifiable and virtually impossible to reverse? At the present time, one publicly available study from Santander estimates that “distributed ledger technology could reduce banks’ infrastructure costs attributable to cross-border payments, securities trading and regulatory compliance by between $15-20 billion per annum by 2022.”23

With that said, in its current form Bitcoin itself is probably not a threat to retail banking, especially in terms of customer acquisition and credit facilities.  For instance, if we look at on-chain entities there are roughly 370,000 actors.  If the goal of Bitcoin was to enable end-users to be their own bank without any trusted parties, based on the aggregate VC funding thus far, around $2,200 has been spent to acquire each on-chain user all while slowly converting a permissionless system into a permissioned system, but with the costs of both.24

That’s about twice as much as the average bank spends on customer acquisition in the US.  While there are likely more than 370,000 users at deposit-taking institutions like Coinbase and Xapo, they neither disclose the monthly active users nor are those actual Bitcoin users because they do not fully control the private key.

If we were to create a valuation model for the bitcoin network (not the price of bitcoins themselves), the network would be priced extremely rich due to the wealth transfer that occurs every 10 minutes in the form of asset creation.  The network in this case are miners, the block makers, who are first awarded these bearer instruments.

How can financial institutions remove the duplicative cost centers of this technology, remove this $300 million mining cost, integrate permissioned distributed ledgers into their enterprise, reduce back office costs and better serve their customers?

That is a question that several hundred business-oriented innovators and financial professionals are trying to answer and we will likely know in less time it took Bitcoin to get this far.

Thanks for your time.


  1. Why Bitcoin Matters by Marc Andreessen []
  2. Tabulating publicly reported bitcoins that were lost, stolen, seized, scammed and accidentally destroyed between August 2010 and March 2014 amounts to 966,531 bitcoins. See p. 196 in The Anatomy of a Money-like Informational Commodity []
  3. Mt. Gox files for bankruptcy, hit with lawsuit from Reuters []
  4. Bitstamp Incident Report []
  5. Bitfinex Warns Customers to Halt Deposits After Suspected Hack from CoinDesk []
  6. Why One Should Think Twice Before Trading On The Bitcoin Exchanges from Forbes []
  7. See Beware the Middleman: Empirical Analysis of Bitcoin-Exchange Risk by Tyler Moore and Nicolas Christin []
  8. This has occurred during times of war.  See The Monuments Men []
  9. Bitcoin’s lien problem from Financial Times and Uniform Commercial Code and Bitcoin with Miles Cowan []
  10. Based on anecdotal conversations both Coinbase and Xapo allegedly, at one point stored over 1 million bitcoins combined. See also: Too Many Bitcoins: Making Sense of Exaggerated Inventory Claims []
  11. See Distributed Oversight: Custodians and Intermediaries []
  12. See Segregation of Duties in the CEWG BitLicense comment []
  13. See Bitnodes []
  14. See Majority is not Enough: Bitcoin Mining is Vulnerable from Ittay Eyal and Emin Gün Sirer []
  15. See Removing the Waste from Cryptocurrencies: Challenges and More Challenges by Bram Cohen and Cost? Trust? Something else? What’s the killer-app for Block Chain Technology? by Richard Brown []
  16. See Appendix B []
  17. See A Simple Explanation of Balance Sheets (Don’t run away… it’s interesting, really!) by Richard Brown []
  18. Needing a token to operate a distributed ledger is a red herring []
  19. See The Distributed Ledger Landscape and Consensus-as-a-service []
  20. Fintech Investment in U.S. Nearly Tripled in 2014 from Accenture []
  21. IT in banks: What does it cost? from Santander []
  22. See No, Bitcoin is not the future of securities settlement by Robert Sams []
  23. The Fintech 2.0 Paper: rebooting financial services from Santander []
  24. One notable exception are branchless banks such as Fidor which is expanding globally and on average spends about $20 per customer.  See also How much do you spend on Customer Acquisition? Are you sure? []
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A blockchain with emphasis on the “a”

Over the past month a number of VCs including Chris Dixon and Fred Wilson use the term “the blockchain” in reference to Bitcoin, as if it is the one and only blockchain.1

There are empirically, many blockchains around.  Some of them do not involve proof-of-work, some of them are not even cryptocurrencies.  Yet despite this, Dixon blocked Greg Slepak on Twitter (creator of okTurtles and DNSChain) for pointing that out just a couple weeks ago.

But before getting into the weeds, it is worth reflecting on the history of both virtual currencies and cryptocurrencies prior to Bitcoin.

The past

Below are several notable projects that pre-date the most well-known magic internet commodity.

  • DigiCash (1990)
  • e-gold (1996)
  • WebMoney (1998)
  • PayPal (1998) “Bitcoin is the opposite of PayPal, in the sense that it actually succeeded in creating a currency.”  — Peter Thiel
  • Beenz (1998)
  • Flooz (1999)
  • Liberty Reserve (2006)
  • Frequent flyer points / loyalty programs
  • WoW gold, Linden Dollars, Nintendo Points, Microsoft Points

According to an excellent article written a couple years ago by Gwern Branwen:

Bitcoin involves no major intellectual breakthroughs, so Satoshi need have no credentials in cryptography or be anything but a self-taught programmer! Satoshi published his whitepaper May 2009, but if you look at the cryptography that makes up Bitcoin, they can basically be divided into:

  • Public key cryptography
  • Cryptographic signatures
  • Cryptographic hash functions
  • Hash chain used for proof-of-work
    • Hash tree
    • Bit gold
  • cryptographic time-stamps
  • resilient peer-to-peer networks

And what were the technological developments, tools and libraries that spearheaded those pieces?  According to Branwen:

  • 2001: SHA-256 finalized
  • 1999-present: Byzantine fault tolerance (PBFT etc.)
  • 1999-present: P2P networks (excluding early networks like Usenet or FidoNet; MojoNation & BitTorrent, Napster, Gnutella, eDonkey, Freenet, i2p etc.)
  • 1998: Wei Dai, B-money
  • 1997: HashCash; 1998: Nick Szabo, Bit Gold; ~2000: MojoNation/BitTorrent; ~2001-2003, Karma, etc
  • 1992-1993: Proof-of-work for spam
  • 1991: cryptographic timestamps
  • 1980: public key cryptography
  • 1979: Hash tree

Other prior art can be found in The Ecology of Computation from Huberman.2 One open question for permissionless systems is whether or not a blockchain is a blockchain if it is neither proof-of-work-based or proof-of-stake-based (“Cow system” in Bram Cohen’s terminology).  But that’s a topic for another post.

The present

About two weeks ago, /r/bitcoin learned that Bitcoin was not the creator of all this fundamental technology.  That indeed, there were over 30 years of academic corpus that cumulatively created the system we now call “a blockchain,” in this case, Nakamoto consensus.  And this has spawned a sundry of other experiments and projects that have since been kickstarted.

For example:

  • CoinMarketCap currently tracks 592 cryptocurrencies / 59 assets
  • CoinGecko tracks 225 cryptocurrencies/assets
  • Ray Dillinger’s “Necronomicon” includes over 100 dead altcoins
  • Map of Coins is currently tracking 686 derivatives of various cryptocurrencies; this includes all hashing functions (e.g., scrypt, X11, X13) and includes existing and defunct chains
  • These are just publicly known blockchains and there are likely dozens if not hundreds of private trials, proof of concepts in academia, institutions and from hobbyists (e.g., Citibank announced in July 2015 that it was testing out three blockchains with a “Citicoin” to better understand use-cases)

So it appears that there are more than one in the wild.

Yet, a couple weeks ago Fred Wilson wrote that:

If you think of the blockchain as an open source, peer to peer, massively distributed database, then it makes sense for the transaction processing infrastructure for it to evolve from individuals to large global corporations. Some of these miners will be dedicated for profit miners and some of them will be corporations who are mining to insure the integrity of the network and the systems they rely on that are running on it. Banks and brokerage firms are the obvious first movers in the second category.

He later clarified in the comments and means the Bitcoin blockchain, not others.

One quibble is that transaction processing is not clearly defined relative to hashing.  Today, bitcoin transactions are actually processed by very small, non-powerful computers (even a Raspberry Pi).

What about the pictures with entire rooms filled with computers?  Why does it cost so much to run a hashing farm then?

Because of the actual workhorse of the network: ASICs designed to generate proofs-of-work.  These hashing systems do not do any transaction processing, in fact, they cannot even run a Bitcoin client on them.3

Tangentially William Mougayar, investor and author, stated the following in the AVC thread:

Only trick is that mining is not cheap initially, and the majority is done in China. It presents an interesting energy challenge: you need lots of electricity to run the computers, but also to keep them cool. So, if you’re using solar you still need to cool them. And if you put them in cool climates like near the north pole, there is no solar. Someone needs to solve that equation.

Mining cannot be made “cheaper” otherwise the network becomes cheaper to attack.

In fact, as Bram Cohen mentioned last week, “energy efficient” proofs-of-works is a contradiction in terms.

Thus, there is no “equation to solve.”  In the long run, miners will bid up the marginal costs to which they equal the marginal value (MC=MV) of a bitcoin in the long run.  We see this empirically, there is no free lunch.  If hashing chips somehow became 50% more efficient, hashing farms just add 50% more of them — this ratcheting effect is called the Red Queen effect and this historically happens in a private seigniorage system just as it does in proof-of-work cryptocurrencies.4

organ proportionalismAs shown in the chart above, hashrate follows price; the amount of resources expended (for proof-of-work) is directly proportional to market value of a POW token.

Furthermore, in terms of Wilson’s prediction that banks will begin mining: what benefit do banks have for participating in the mining process?  If they own bitcoins, perhaps it “gives them a seat at the table.”  But if they do not own any, it provides no utility for them.

Why?  What problem does mining solve for organizations such as banks?  Or to put another way: what utility does proof-of-work provide a bank that knows its customers, staff and transaction processors?5

Permissioned Permissionlessness, BINO-style

One goal and innovation for Bitcoin was anonymous/pseudonymous consensus which comes with a large requirement through trade-offs: mining costs and block reorganization risk.

To quote Section 1 of the Nakamoto whitepaper regarding the transaction costs of the current method of moving value and conducting commerce:

These costs and payment uncertainties can be avoided in person by using physical currency, but no mechanism exists to make payments over a communications channel without a trusted party


  • Bitcoin was designed with anonymous consensus to resist censorship by governments and other trusted third parties.
  • If you are running a ledger between known parties who abide by government regulations, there is no reason to pay that censorship-resistance cost.  Full stop.

Today several startups and VC funds have (un)intentionally turned an expensive permissionless system into a hydra, a gated permissioned network without the full benefits of either.  Consequently, through this mutation, some of these entities have also turned a bearer asset into a registered asset with the full costs of both.

For instance, it is currently not possible to build a censorship-resistant cash system on top of a permissioned ledger (due to the KYC requirements) yet this is basically what has attempted with many venture funded wallets such as Coinbase.

The end result: Bitcoin in name only (BINO).  In which a permissionless network is (attempted to be) turned into a permissioned network.  It bears mentioning that companies such as Peernova and Blockstack are not trying to compete with Bitcoin — they are not trying to build censorship-resistant cash.

While financial institutions can indeed download a client and send tokens around, Bitcoin was purposefully designed not to interface with financial intermediaries as it was modeled on the assumption that no one can be trusted and that parties within the network are unknown.  Therefore if parties transacting on the network are both known and trusted, then there probably is no reason to use Bitcoin-based proof-of-work.  Instead, there are other ways to secure transactions on a shared, replicated ledger.

Ask the experts

I reached out to several experts unaffiliated with Bitcoin itself to find out what the characteristics of a blockchain were in their view.

Ian Grigg has spent twenty years working in the cryptocurrency field and is the author of the Financial Cryptography blog as well as the Ricardian Contract and most recently the “Nakamoto signature.”  Below are his thoughts:

As far as *history* is concerned, it looks like just about every individual component of Bitcoin was theorised before 2009.  The last thing that I’d thought was new was the notion of a shared open repository of transactions, but it seems Eric Hughes actually proposed it in the 1990s.  And of course Todd Boyle was banging the triple entry drum in the late 1990s.

Bitcoin has no monopoly on any term except bitcoin and BTC as far as I can see. The big question is really between permissioned and permissionless ledger designs.

If you go for a permissioned ledger, then you can do some more analysis and also reduce the need for the consensus signing to be complicated. At the base level, just one signatory might be enough, or some M of N scheme. But we don’t need the full nuclear PoW-enfused Nakamoto Signature.

But also, the same analysis says we don’t need a block. What’s a block? It’s a batch of transactions that the ‘center’ works on to make them so. But if we’ve got permissioned access, and we’ve reduced the signing to some well-defined set, why not go for RTGS and then we haven’t got a block.

The block in the blockchain exists because of the demands of the networking problem – with a network of N people all arguing over multiple documents, we know it can’t be done in less than a second for a small group and less than 10 seconds for a large group. So to get the scaling up, we *have to make a block* or batch of *many* transactions so we can fit the consensus algorithm over enough tx to make it worthwhile.

Therefore the block, the Nakamoto Signature, PoW and the incentive structure all go together. That’s the blockchain.

Zaki Manian, co-founder of SKUChain and all around Bay-area crypto guru:

Cryptography is interesting right now because the primitives have matured and pre-cryptographic systems are becoming less and less robust.

Commitment schemes are widely used in cryptography. Nakamoto signatures (if Adam Back wants to concede the naming rights) are the thermodynamic commitment to a set of values. A conventional signature in attributable commitment.

A cryptocurrency is an application of a ledger. A distributed ledger needs to syndicate the order of stored transaction. There is a lot of value to syndicating and independently validating the commitments to interested parties. Generalized Byzantine Agreement, n-of-m signatures and transaction syndication decrease the discretion in the operating of systems. Ultimately, discretion is a source of fragility. I think Ian’s reference to RTGS is somewhat disingenuous. Systems with a closed set of interacting parties aren’t particularly helpful. Open participation systems are fundamentally different.

There don’t seem to be any settle lines between the properties of permissioned and permission-less systems. We have both and time will tell.

Pavel Kravchenko, formerly chief cryptographer at Stellar, now chief cryptographer at Tembusu Systems:

I’ve seen the discussion, it seems rather political and emotional. Since the term blockchain is not clearly defined people tend to argue. To make everything clear I would start from security model – who is the adversary, what security assumptions we are making, what is the cost of a particular attack etc. For now (still very early days of crypto-finane) using blockchain as a common word for such variety of conditions is acceptable for me.

Vlad Zamfir, who has helped spearhead the cryptoeconomics field alongside others at Ethereum (such as Vitalik).  In his view:

“Blockchains” are a class of consensus protocols (hence why I like to pedantically refer to them as blockchain-based consensus protocols).  They are not necessarily ledgers, although blocks always do contain ordered logs.

These logs need not be transactions – although we can call them transactions if we want, and so you can call it a ledger if you want – it’s just misleading.

Blockchains are characterized by the fact that they have a fork-choice rule – that they choose between competing histories of events.

Traditional consensus protocols don’t do this, so they don’t need to chain their blocks – for them numbering is sufficient.

Economic consensus protocols contain a ledger in their consensus state, in which digital assets are defined – assets who are used to make byzantine faults expensive.

It is much less misleading to refer to this class of protocols as ledgers, than to blockchains generally speaking – although it is still misleading.

You can make an economic consensus protocol that lets people play chess. It would have a ledger, but it wouldn’t be fair to call it a distributed ledger – it’s a distributed chess server.

Economic consensus allows for public consensus, which acts as a (crappy) public computer.

Public consensus protocols have no “permissioned” management of the computers that make up this crappy public computer.

Non-public consensus protocols have “permissioned” management of these computers.

I think the main thing that is consistently lacking from these discussions is the fact that you can have permissioned control of the state of a public consensus protocol without “permissioning” the validator set.

Robert Sams, co-founder of Clearmatics who has done a lot of the intellectual heavy lifting on the “permissioned ledger” world (I believe he first coined the term in public), thinks that:

If I were to guess, I’d say that the block chain design will eventually yield to a different structure (eg tree chains). It’s the chaining that’s key, not the particular object of consensus (although how the former works is parasitic on the latter).

I think Szabo’s use of “block chain” rather than “blockchain” is more than a question of style. Out of habit I still merge adjective and noun like most people, but it’s misleading and discourages people from thinking about it analytically.

I tell you though, the one expression that really gets on my nerves is “the blockchain” used in contexts like “the blockchain can solve problem X”. Compound the confusion with the definite article. As if there’s only one (like “the internet”). And even when the context assumes a specific protocol, “the” subconsciously draws attention away from the attacker’s fork, disagreements over protocol changes and hard forks.

Anyway this debate with people talking up their Bitcoin book and treating innovation outside its “ecosystem” as apostasy is tiresome and idle.

Christopher Allen, who has had a storied career in this space including co-authoring the TLS standard:

I certainly was an early banner waiver — I did some consulting work with Xanadu, and later for very early Digicash. At various points in the growth of SSL both First Virtual and PGP tried to acquire my company. When I saw Nick’s “First Monday” article the day it came out, as it immediately clicked a number of different puzzle pieces that I’d not quite put together into one place. I immediately started using the term smart contracts and was telling my investors, and later Certicom, that this is what we really should be doing (maybe because I was getting tired of battles in SSL/TLS standards when that wasn’t what Consensus Development had been really founded to solve).

However, in the end, I don’t think any thing I did actually went anywhere, either technically or as a business, other than maybe getting some other technologists interested. So in the end I’m more of a witness to the birth of these technologies than a creator.

History in this area is distorted by software patents — there are a number of innovative approaches that would be scrapped because of awareness of litigious patent holders. I distinctly remember when I first heard about some innovative hash chain ideas that a number of us wanted to use hash trees with it, but we couldn’t figure out how to avoid the 1979 Merkle Hash Tree patent whose base patent wouldn’t expire until ’96, as well as some other subsidiary hash tree and time stamp patents that wouldn’t expire until early 2000s.

As I recall, at the time were we all trying to inspired solve the micropayment problem. Digicash had used cryptography for larger-sized cash transactions, whereas First Virtual, Cybercash and others were focused on securing the ledger side and needed larger transaction fees and thus larger amounts of money to function. To scale down we were all looking at hash chain ideas from Lamport’s S/KEY from the late 80’s and distributed transactional ledgers from X/Open’s DTP from the early 90s as inspirations. DEC introduced Millicent during this period, and I distinctly remember people saying “this will not work, it requires consumers to hold keys in a electronic wallet”. On the cryptographic hash side of this problem Adam Back did Hashcash, Rivest and his crew introduced PayWord and Micromint. On the transaction side CMU introduced NetBill.

Nick Szabo wrote using hashes for post-unforgeable transaction logs in his original smart contract paper in ’97, in which he referred to Surety’s work (and they held the Merkle hash tree and other time signature patents), but in that original paper he did not look at Proof of Work at all. It was another year before he, Wei Dai, and Hal Finney started talking about using proof-of-work as a possible foundational element for smart contracts. I remember some discussions over beer in Palo Alto circa ’99 with Nick after I became CTO of Certicom about creating dedicated proof-of-work secure hardware that would create tokens that could be used as an underlying basis for his smart contract ideas. This was interesting to Certicom as we had very good connections into cryptographic hardware industry, and I recommended that we should hire him. Nick eventually joined Certicom, but by that point they had cancelled my advanced cryptography group to raise profits in order to go public in the US (causing me to resign), and then later ceased all work in that area when the markets fell in 2001.

I truly believe that would could have had cryptographic smart contracts by ’04 if Certicom had not focused on short-profits (see Solution #3 at bottom of this post for my thoughts back in 2004 after a 3-year non-compete and NDA)…

What is required, I believe, is a major paradigm shift. We need to leave the whole business of fear behind and instead embrace a new model: using cryptography to enable business rather than to prevent harm. We need to add value by making it possible to do profitable business in ways that are impossible today. There are, fortunately, many cryptographic opportunities, if we only consider them.

Cryptography can be used to make business processes faster and more efficient. With tools derived from cryptography, executives can delegate more efficiently and introduce better checks and balances. They can implement improved decision systems. Entrepreneurs can create improved auction systems. Nick Szabo is one of the few developers who has really investigated this area, through his work on Smart Contracts. He has suggested ways to create digital bearer certificates, and has contemplated some interesting secure auctioning techniques and even digital liens. Expanding upon his possibilities we can view the ultimate Smart Contract as a sort of Smart Property. Why not form a corporation on the fly with digital stock certificates, allow it to engage in its creative work, then pay out its investors and workers and dissolve? With new security paradigms, this is all possible.

When I first heard about Bitcoin, I saw it as having clearly two different parts. First was a mix of old ideas about unforgeable transaction logs using hash trees combined into blocks connected by hash chains. This clearly is the “blockchain”. But in order for this blockchain to function, it needed timestamping, for which fortunately all the patents had expired. The second essential part of Bitcoin was through a proof-of-work system to timestamp the blocks, which clearly was based on Back’s HashCash rather than the way transactions were timestamped in Szabo’s BitGold implementation. I have to admit, when I first saw it I didn’t really see much in Bitcoin that was innovative — but did appreciate how it combined a number of older ideas into one place. I did not predict its success, but thought it was an interesting experiment and that might lead to a more elegant solution. (BTW, IMHO Bitcoin became successful more because of how it leveraged cypherpunk memes and their incentives to participate in order to bootstrap the ecosystem rather than because of any particularly elegant or orginal cryptographic ideas).

In my head, Bitcoin consists of blocks of cryptographic transactional ledgers chained together, plus one particular approach to time-stamping this block chain that uses proof-of-work method of consensus. I’ve always thought of blockchain and mining as separate innovations.

To support this separation for your article, I have one more quote to offer you from Nick Szabo:

Instead of my automated market to account for the fact that the difficulty of puzzles can often radically change based on hardware improvements and cryptographic breakthroughs (i.e. discovering algorithms that can solve proofs-of-work faster), and the unpredictability of demand, Nakamoto designed a Byzantine-agreed algorithm adjusting the difficulty of puzzles. I can’t decide whether this aspect of Bitcoin is more feature or more bug, but it does make it simpler.

As to your question of when the community first started using the word consensus, I am not sure. The cryptographic company I founded in 1988 that eventually created the reference implementation of SSL 3.0 and offered the first TLS 1.0 toolkits was named “Consensus Development” so my memory is distorted. To me, the essential problem has always been how to solve consensus. I may have first read it about it in “The Ecology of Computation” published in 1988 which predicted many distributed computational approaches that are only becoming possible today, which mentions among other things such concepts as Distributed Scheduling Protocols, Byzantine Fault-Tolerance, Computational Auctions, etc. But I also heard it from various science fiction books of the period, so that is why I named my company after it.

The future

What about tokens?

Virtual tokens may only be required for permissionless ledgers – where validators are unknown and untrusted – in order to prevent spam and incentivize the creation of proofs-of-work.  In contrast, if parties are known and trusted – such as a permissioned ledger – there are other historically different mechanisms (e.g., contracts, legal accountability) to secure a network without the use of a virtual token. 6

Is everything still too early or lack an actual sustainable use-case?

Maybe not.  It may be the case, as Richard Brown recently pointed out, that for financial institutions looking to use shared, replicated ledgers, utility could be derived from mundane areas, such as balance sheets.  And you don’t necessarily need a Tom Sawyer botnet to protect that.

What attracts or repels use-cases then?

  • Folk law: “Anything that needs censorship-resistance will gravitate towards censorship-resistant systems.”
  • Sams’ law: “Anything that doesn’t need censorship-resistance will gravitate towards non censorship-resistant systems.”

Many financial institutions (which is just one group looking at shared, replicated ledgers) are currently focused on: fulfilling compliance requirements, reducing cost centers, downscaling branching and implementing digital channels.  None of this requires censorship-resistance.  Obviously there are many other types of organizations looking at this technology from other angles and perhaps they do indeed find censorship-resistance of use.

In conclusion, as copiously noted above, blockchains are a wider technology than just the type employed by Bitcoin and includes permissioned ledgers.  It bears mentioning that “permissioned” validators are not really a new idea either: four years ago Ben Laurie independently called them “mintettes” and Sarah Meiklejohn discussed them in her new paper as well.


  1. See The financial cloud from Adam Ludwin []
  2. Thanks to Christopher Allen for pointing this out. []
  3. See The myth of a cheaper Bitcoin network: a note about transaction processing, currency conversion and Bitcoinland []
  4. See Bitcoins: Made in China []
  5. Why would banks want to use a communal ledger, validated by pseudonomyous pools whom are not privy to a terms of service or contractual obligation with? See Needing a token to operate a distributed ledger is a red herring and No, Bitcoin is not the future of securities settlement []
  6. See also Needing a token to operate a distributed ledger is a red herring and Consensus-as-a-service []
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Panel with financial service professionals involved with baking shared, replicated ledgers into organizations

The last part of the PwC discussion 10 days ago involved a panel with myself moderating, Peter Shiau (COO of Blockstack) and Raja Ramachandran (co-founder of eFXPath and an advisor at R3CEV).  Robert Schwentker (from Blockchain University) also helped provide a number of questions for us.

We cover a number of topics including use-cases of distributed ledgers for financial institutions.

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Q&A regarding the Distributed Ledger Landscape

About 10 days ago I had the pleasure of speaking at Blockchain University (hosted over at PwC) regarding distributed ledgers (permissioned and permissionless).  One of the slides was intentionally taken out of context by a user on reddit and unsurprisingly the subsequent /r/bitcoin thread covering it involved a range of ad hominem attacks that really missed what was being discussed at the actual talk: what are the characteristics of a blockchain.

I will likely write a post on this topic at length in the next couple of days.  In the meantime, below is the video which incidentally pre-emptively answered a few of the questions from that thread.

Also, for those curious to know who were asking the good questions in the audience, this included: Jeremy Drane (PwC), Christopher Allen (co-creator of the TLS standard) and Nick Tomaino (Coinbase) among others.

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Bram Cohen: “Removing the Waste from Cryptocurrencies: Challenges and More Challenges”

Bram Cohen, the creator of BitTorrent, has opined on Bitcoin over the years on social media (such as Twitter).  Over the last couple of weeks he has been increasingly vocal on some hurdles such as the increase in block sizes (via a hard fork) and the dangers of accepting and institutionalizing zero-confirmation transactions.

Last week he gave a presentation at the SF Bitcoin Dev meetup in which he covered a variety of alternatives to proof-of-work such as proof-of-steak (which he dubs “Cow systems”).

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The Distributed Ledger Landscape: Who is developing shared, replicated ledgers and why

Earlier today I gave a presentation for Blockchain University hosted at PricewaterhouseCoopers in San Francisco.  It covers the different startups developing permissioned ledgers, the use-cases they are looking at and the reasons for why permissionless systems are currently inadequate to fulfill similar business requirements.

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Unable to dynamically match supply with demand

This post will look at an amalgam of ideas touched on by Eli Dourado in a post several days ago regarding Bitcoin.  This includes volatility, cross-border payments, nemo dat, settlement finality and machine-to-machine transactions.

I also answered a few frequently-asked-questions that have been emailed to me that intersect with some of the same ideas.


On Sunday Eli Dourado posted a response to Noah Smith and JP Koning both of whom previously discussed why bitcoin has not become a medium-of-exchange.

I don’t want to turn this into a post solely on volatility so if you’re interested in other ideas, skip to the next section titled cross-border payments.

The problem with Dourado’s analysis on volatility is that it does not look at what the actual causes of volatility are, the core of which is a perfectly inelastic money supply.

What does it mean to have a “perfectly inelastic money supply”?  In short, irrespective of the quantity demanded, the money supply itself does not change or shift.  For a Bitcoin-like network, its supply is programmed to remain static irrespective of external conditions.  While some advocates and enthusiasts consider this a feature, it is a bug if bitcoin wants to be used as a modern medium-of-exchange.  Why?  Because the only way to reflect changes in demand is through a change in price, which as described below, is done so via volatility, often violently.

And consequently, determining what the elasticity of demand could be is effectively impossible due to the opaqueness in both the exchange and OTC markets, which partly explains the unpredictability around cryptocurrency prices in general.1

In contrast to Dourado’s view, Robert Sams recently provided a more cohesive look at the fundamental reasons for why, despite the creation of new “liquidity” venues, uncertainty cannot be removed in a similar manner:

volatility 1

volatility 2

volatility 3

The three slides above appear in an April 2015 presentation by Sams.

Yet it is Sams’ short white paper on stable coins that probably, succinctly, describes the issue of future uncertainty with present day prices:

It is the nature of markets to push expectations about the future into current prices. Deterministic money supply combined with uncertain future money demand conspire to make the market price of a coin a sort of prediction market on its own future adoption.  Since rates of future adoption are highly uncertain, high volatility is inevitable, as expectations wax and wane with coin-related news, and the coin market rationalises high expected returns with high volatility (no free lunch).

In other words, at present bitcoin’s price inelasticity of demand means bitcoin’s price isn’t a function of the availability of bitcoin or, for that matter, demand for it.  This makes bitcoin vulnerable largely to the machinations of prognosticators (e.g., pumpers), not tangible market forces.2

Below are a few other questions that have hit my inbox related to volatility which tie into the ideas addressed by Dourado and others above.

Some short Q&A on volatility and prices

Visible volatility appears to have declined in the past 5 months, why?

One possible explanation relates to the inelasticity argument: if traders “feel” that this is a good price and there is no motivation or incentive to trade, thereby moving it up or down, it will tend to stay there (i.e., trading based on sentiment).

Another potential explanation for why there has been less volatility in the last couple months could be that as participants have left the market, there has been less demand from speculators due to a lack of interest and thereby a corresponding lack of volume.3  We may not know for sure what the actual trading volume is at exchanges in aggregate for years to come.

For instance, contrary to the Goldman report, the Chinese RMB does not compromise 80% of the trading volume; this “volume” as discussed by Changpeng Zhao (former CTO of OKCoin) were a combination of internal market making bots, wash trades and tape painting.4  If there was a legitimate increase in demand from speculator then there would have been corresponding increases.  Maybe “whales” will return again after Fed tightening or concerns over Greece.  Or maybe not.

In addition, VC funded companies like BitPay are stating on record that they absorbing some (all?) bitcoins onto their balance sheet, this likely in the short run reduces some of the volatility but is not sustainable.

Why not?

Because with roughly $400,000 – $800,000 in trade volume per day that BitPay processes, it simply does not have the cash on hand to absorb all of the incoming bitcoins for more than a few weeks at most.  Thus, despite the claims (video) from Jason Dreyzehner — that BitPay tries to keep all of the bitcoins that they process — after talking with several contacts at large exchanges, it turns out BitPay does in fact sell bitcoins in bulk to exchange and OTC partners.  See also, A pre-post-mortem on BitPay.

Another common question I have received: with a string of “positive” developments lately such as GBTC, new exchange infrastructure, and more VC funding, why hasn’t bitcoin’s price risen?

It hasn’t risen in part because of elasticity.  Bitcoin’s value can be susceptible to external factors, but it does not need to be if there is inelasticity of demand.  In that case, steady prices amounts to Newton’s First Law.5

In addition, thus far there is no compelling reason for:

1) Consumer-based transactional demand.  To most consumers in developed countries, trying to use bitcoin is an added friction, so they are not interested in doing that.  What are the demographics of a bitcoin owner?  Based on several sources we know what the owner demographics are: a North American / European male in his early 30s, they have access to other payment platforms and own bitcoins primarily as an investment, not virtual cash.6

2) Speculative demand has not increased (yet) because it is now an old story for some active traders — they know what a “bitcoin” as an asset is and how to get it.  As Nathaniel Popper (from NYT) discussed a couple weeks ago at Plug and Play, editors and writers at large media companies are tired of the same stories, these Bitcoin companies need to now go execute which few have actually done.

What about the new exchange companies and liquidity providers being added to the market?

As noted above, as of this writing the price of bitcoin is largely a function of speculative demand still.  Companies like Coinalytics have looked at the on-chain data to show that there has not been much of an increase in on-chain usage or demand from above-board commercial entities.7 Perhaps that will change.

Therefore if consumers are not participating, bitcoin is left with movements dictated by changes in the unpredictable demand curve (and appetite) of speculators.  There are startups that provide different types of instruments: SolidX, LedgerX, Mirror, Tera Exchange and Hedgy but none has likely gotten much volume and only have limited capital to absorb the continual bitcoin production rate of miners and other sell-side participants.  Again, maybe this will change over time.

What if bitcoin adoption were to proceed more aggressively in non-currency applications (real-time securities settlement, for e.g.), what is the impact from that on bitcoin’s price?

First off, the Bitcoin network is not a real-time securities settlement, at most it clears one batch in roughly 10 minutes — not real-time.  But if we are truly defining post-trade finality in terms of title transfer, Bitcoin itself cannot do that with off-chain assets.  Why not?  Because Bitcoin’s validators — in this case mining pools — have no control over off-chain assets.  Title still resides and is controlled off-chain, out of the purview of miners.8

Ignoring that for a moment the main reason why watermarked methods have seen a surge in interest is so that a company (or financial institution) does not need to buy gobs of bitcoins in order to represent socially-recognized value on the edges (houses, cars, airplanes, boats) — thus since watermarking takes a small fraction of a bitcoin, even in aggregate it probably does not add much demand to bitcoin itself.  Whether that is a secure method for transferring value is another topic altogether.9

On this point I also spoke with George Samman, co-founder of and weekly contributor to CoinTelegraph.  In his view:

When talking about settlement and clearing the sheer size – in dollar terms – of the FX and equity markets, it makes a 51% attack on watermarked assets much more of an eventuality than a probability simply because it’s now worth the effort to do so.  Why?  Because the increase in aggregate asset value transferred on a blockchain incentivizes attacks.  In fact a new paper suggests that an attacker does not even need 51% to achieve their goals.

How might Bitcoin help FX traders and arbitrageurs more easily and quickly align their books and execute a global strategy?

As of June 2015, probably none. The market simply is not deep or liquid enough compared to the multi-trillion dollar FX space.  Even if we took the volume of Bitcoin exchanges at face value — that operators are not exaggerating their numbers which we know they are10 — you would need volume to increase by several orders of magnitude before FX traders probably are interested in using it either as a vehicle or as part of their “global strategy.”

According to Bitcoinity — which uses self-reported volumes — total global bitcoin trading volume over the past 24 hours amounted to 312,532 BTC (~$78 million), though 70-80% of that is likely market making bots and wash trading.  For comparison, according to the BIS, in April 2013 the daily FX turnover globally was $5.3 trillion.  This number has stayed roughly the same over the past several years.11

What impact can the BitLicense have now that it has been finalized?

Again, I’m one of the few people that thinks the BitLicense is not a bad thing — it may seem expensive but if a Bitcoin company provides the same good and service as a traditional company then it would make sense to have them liable to the same type of compliance — why do they get an exception just because of the word Bitcoin?  With that said I do think that it could bring in more players who believe this now provides regulatory certainty.

For example, I am looking forward to seeing how Gemini impacts the network now that there is a legitimate exchange you can “short” bitcoin on — it may provide a new incentive to destabilize the network in order to gain.

For perspective I reached out to Raffael Danielli, Quantitative Analyst at ING Investment Management.  In his view:

The points made in Robert Sams recent post are worth looking at. It is a reason to be wary of a professional exchange such as Gemini. Also it adds to the volatility problem. It is probably just a question of time until we see some hedge fund disrupt the network somehow while profiting from it with a massive short. The incentives will be in place sooner or later.

Honestly, I believe that the misconception about volatility (“it will go down over time”) might blow up in the face of many people. The argument that Robert Sams makes is strong. As long as supply cannot be dynamically adjusted to match changes in demand expectations (essentially what the Fed is trying to do) volatility is unlikely to decrease.

It is worth pointing out that a trader can currently “short” bitcoin on Tera Exchange and Crypto Facilities via their forwards contracts (and swaps in the case of the former).  So far the only participants interested are miners for obvious reasons (though it is unclear if anyone involved is generating much revenue yet).  It is also unclear what the incentive for doing a swap is too, with the inability to predict or model exchange rate changes months into the future.

I also reached out to George Samman once more.  According to him:

It is more about the implied volatility which for bitcoin, is always higher than other asset classes and the reason I believe this is because bitcoin is still a giant unknown. Bitcoin continues to trade mainly on sentiment and technicals as well, and this in turn makes it by nature a more volatile asset.

I would also say to the disappearing volume on exchanges it has to do with a lack of trust, hoarding by deep pockets, and its been going off-exchange.  For example LocalBitcoins volume hit record highs in May, while volume at the biggest exchange and the one used by the most active traders use, Bitfinex, has declined steady all year long.12

Kraken, the San Francisco-based crypto currency exchange, is launching a new “DarkPool” option for volume traders who want to buy and sell coins in larger orders. Typically, large orders in the exchange swing the price of bitcoin dramatically, but with the new dark pool trading option, it lets people or institutions order in a way that the rest of the market does not see. Think of it as a level of privacy for people buying or selling bitcoin in bulk. The service will cost users an addition point-one-percent on orders.

Kraken is not the first exchange to bring a “dark pool” to market.  In 2013 Tradehill launched a service called “Prime” that purportedly acted as a “dark pool.”  In addition, one of the attractions to LocalBitcoins may be that it does not require traders to provide identification (via KYC); its volume could decline if it tried to comply with similar KYC/AML/BSA requirements that many other exchanges do.

Cross-border payments

Dourado’s explanation for how credit card processing work is not fully fleshed out.  For a more detailed explanation I recommend readers peruse two posts from Richard Brown found below in the notes.13 In short, Dourado’s explanation for the alleged value proposition between Bitcoin versus a credit card ignores the biggest difference: there is no native credit facility or lending ability on the Bitcoin network.

At best the comparison should be with debit cards.  In addition, in his example, not only is there unnecessary foreign exchange fees in moving into and out of bitcoin, but transactions do not occur instantaneously (even zero-confirmations take longer than a card swipe).  Furthermore, the current Bitcoin network is unable to handle everyone wanting to use bitcoin today (there is a continuous backlog of unconfirmed transactions, sometime measuring into the thousands).  One thing he could have mentioned is that that foreign exchange trades may offset merchant fees, but he did not (yet).

For instance, Dourado states:

You may use a payment processor such as BitPay to instantly convert the bitcoins you receive into dollars. I may use a wallet that instantly converts dollars to Bitcoin at the time I want to make a payment. We both have trust relationships with intermediaries, but because the transaction and settlement occurs on the blockchain, we no longer have to trust the same intermediary.

There is no reason to use Bitcoin itself to do this.  Since users on both ends of the transaction are not only identified but they also need to “trust” a trusted third party, they could just as easily use a different payment method.  And empirically they do, hence one of the reasons why JP Koning wrote the first post in the first place.  In practice, Bitcoin as a payment system is just an added friction: why go from USD->BTC->USD when a user can simply bypass this artificial friction and pay in USD?

Dourado does not provide a cost-benefit analysis nor does he explain why credit card companies work the way they do (see again Brown’s posts in the end notes).   Instead, he discusses the example of unbanked and underbanked, stating:

This is relevant when thinking about bringing the next few billion people online and into the global economy. These people will not have credit histories that are accessible to the same intermediaries that I am set up to use. They may have local intermediaries that they can use, or they may be willing to use Bitcoin directly. If that is the case, they will be able to enter into the stream of global commerce.

In my lengthy book review on The Age of Cryptocurrency I explained 3-4 reasons for why Bitcoin probably is not the savior of the unbanked and underbanked.

One of the reasons is volatility, another is compliance and customer acquisition costs.

One more is the fact that nearly all venture capital (VC) funded hosted “wallets” and exchanges now require not only Know-Your-Customer (KYC) but in order for any type of fiat conversion, bank accounts.  Thus there is a paradox: how can unbanked individuals connect a bank account they do not have to a platform that requires it?  This question is never answered in the book yet it represents the single most difficult aspect to the on-boarding experience today.

Thus contra, Dourado and others, Bitcoinland has recreated all of the same types of intermediaries as the traditional financial world, only with less oversight and immature financial controls.

In terms of “rebittance,” in practice, what ends up happening in these emerging markets is that local residents attempt to cash out into their local currency, irrespective of whatever cryptocurrency funds were originally sent with.14 It is highly recommended that readers peruse analysis below in the notes from Yakov Kofner who studies this at SaveOnSend — looking at actual data such as margins and fees15 And again, maybe this will slightly change through the efforts of Align Commerce, and BitX but it has not yet.

Continuing Dourado writes:

We will finally have a unified global financial system to which everyone will have access. Capital controls will become impossible, or nearly so.

Unlikely via Bitcoin, perhaps through other distributed ledger systems being developed (with mintettes).  The above statement may be the hopes and dreams of many Bitcoin investors, but recall the drama surrounding Coinbase this past February when the leaked pitch deck (pdf)  — which highlighted Bitcoin’s ability to bypass sanctions on Russia — ended up in the hands of regulators.  The head of compliance at Coinbase ended up leaving and the startup was on thin ice (maybe still is?).16

Settlement finality

Another quibble with Dourado’s piece is based on his statement:

So in order to do apples-to-apples comparisons, we might want to examine other systems of final settlement. One such system is cash. Cash of course has some limitations, chief among them that it is not possible to send cash online without an intermediary.

The problem with this is that cash in the real world is given exception to nemo dat and bitcoin is not.  I tried pointing this out to him on Twitter, to which he responded with one word: “Absurd.”  Nemo dat is the legal rule that states that Bob cannot purchase ownership of a possession from Alice if she herself does not have title to the possession.

And it is not absurd.

In fact, as described two months ago, when talking to attorneys such as Amor Sexton, Ryan Straus and George Fogg we learned that one of the problems facing bearer instruments like bitcoin is that many of these virtual assets do not have clean title — that they are encumbered.  What this means is that while the Bitcoin network itself may provide settlement with respect to the transfer of private key credentials, on the edges of the network in the social ‘wet code’ world, the title to these credentials could be non-final.

This means that because of how trusted third parties such as Xapo or Coinbase originally pooled and commingled (e.g., did not segregate) customer deposits, some customers may unknowingly end up with encumbered bitcoins.  Whether anyone litigates on this issue may be a matter of time as Mt. Gox may have practiced the same behavior with pooled deposits.

Ignoring this could impact the bitcoins you may have.  Did you mine the coins yourself or did you buy them through an OTC provider like Charlie Shrem?  There is currently no method of “cleansing” these virtual commodities from previous claims.  Thus, as described earlier in this post, while settlement finality is a potential benefit of distributed ledgers, it probably needs to be integrated within the current custodial framework in order to be effective. 17

Machine to machine

My last quibble regarding Dourado’s piece is where he states:

Direct settlement also means that machine-to-machine transactions will be possible without giving your toaster a line of credit or access to your full bank account. What new inventions will people create when stuff can earn and spend money?

The core innovation around Bitcoin are censorship-resistant cash and its decentralized ledger — thus trying to merge costly pseudonomity with the KYC of a traditional financial system and then innovate on top of that seems like a one step forward and then one step back.

Therefore it makes little sense for why Dourado, Antonis Polemitis, 21inc and others continue to bring up machine-to-machine as if it is the “killer app” for Bitcoin.  What is the need for proof-of-work in these cases?  I briefly looked at this in Appendix B: why can’t prepaid cards be used to pay for the same service?  If parties — or washing machines and toasters — are known, what benefit does this asset provide that cannot be done with other systems?  Why do you need to insert censorship-resistant virtual cash in a transaction that ultimately will need national currency on both sides of the transaction?

Furthermore, even if machine-to-machine transactions somehow did take off and the Bitcoin blockchain was used, it would quickly become bogged down due to block size issues.  For more on this point, it’s worth reviewing the two most recent posts from TradeBlock below in the notes.18


It is unlikely that many early adopters or those who believe static money supplies are a feature, will find any of the discussion above of merit.19  Yet, as Noah Smith pointed out again yesterday, bitcoin’s volatility may need to become “boring” (non-existent) if it ever were to become a viable medium-of-exchange.  However as described above, there are multiple external factors for why this may not occur including the fact that there is no current method to automatically, trustlessly rebase the purchasing power in Bitcoin.

Last fall Robert Sams published a short paper (pdf) proposing one solution, via a “stable coin” — an idea that has subsequently been explored by Ferdinando Ametrano20 and may eventually be emulated in projects like Augur and Spritzle.

Whether or not this feature is adopted by the Bitcoin community remains and open question.  What is probably not an open question is whether volatility will ever disappear for a perfectly inelastic money supply, particularly one without a type of rebasement mechanism.

[Acknowledgements: thanks to Raffael Danielli, Justin Dombrowski, Yakov Kofner and George Samman for their feedback.]

End notes:

  1. See What is the “real” price of bitcoin? and Too Many Bitcoins: Making Sense of Exaggerated Inventory Claims []
  2. I would like to thank Justin Dombrowski for bringing this point to my attention. []
  3. Readers may be interested in Low Volatility and The Shanghai Composite Are Killing Bitcoin by Arthur Hayes.  Note that you can have liquidity from underlying demand as a transactional cryptocurrency, but that does not seem possible to coordinate with a limited, decentralized money supply in the Bitcoin model. []
  4. The Goldman Sachs report used self-reported numbers from the exchanges themselves.  See 80% of bitcoin is exchanged for Chinese yuan from Quartz. []
  5. I would like to thank Justin Dombrowski for this insight. []
  6. See New CoinDesk Report Reveals Who Really Uses Bitcoin as well as the the leaked Coinbase pitch deck (pdf). []
  7. See The flow of funds on the Bitcoin network in 2015 and A gift card economy: breaking down BitPay’s numbers []
  8. See: Consensus-as-a-service as well as No, Bitcoin is not the future of securities settlement by Robert Sams and On the robustness of cryptobonds and crypto settlement by Izabella Kaminska []
  9. See also: Will colored coin extensibility throw a wrench into the automated information security costs of Bitcoin? and Can Bitcoin’s internal economy securely grow relative to its outputs? []
  10. See Too Many Bitcoins: Making Sense of Exaggerated Inventory Claims []
  11. See Daily FX volumes hold above $5 trillion in Feb-CLS from Reuters []
  12. George Samman suggested interested readers look at a presentation he made for Coinsetter last week, starting at slide 93. []
  13. A simple explanation of fees in the payment card industry and Why the payment card system works the way it does – and why Bitcoin isn’t going to replace it any time soon both from Richard Brown []
  14. See The Rise and Rise of Lipservice: Viral Western Union Ad Debunked []
  15. Western Union: permanent leader of international money transfer? and Does Bitcoin make sense for international money transfer? both from Yakov Kofner []
  16. In addition, while an organization like a government may not be able to totally eliminate Bitcoin itself, they could likely severely reduce its use by imposing such absurd punishments that most would fear to use it.  But that is a topic for another post. []
  17. See also: No, Bitcoin is not the future of securities settlement by Robert Sams []
  18. Bitcoin Network Capacity Analysis – Part 3: Miner Incentives and Bitcoin Network Capacity Analysis – Part 4: Simulating Practical Capacity from TradeBlock []
  19. This concept, of static money supplies, is not an unknown idea for central banks.  David Andolfatto, VP at the St. Louis Federal Reserve, pointed this out in his presentation last month. []
  20. Slides and video from Ametrano’s March 2015 presentation []
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A pre-post-mortem on BitPay

Yesterday at the MoneyConf in Belfast, BitPay’s CEO Stephen Pair announced that they were pivoting away from payments and towards technological infrastructure for banks and enterprises.

This is an interesting announcement in that a year ago, almost to the day, I published an article, A Marginal Economy versus a Growth Economy, that mentioned how on-chain transaction volume was not following the growth in merchant adoption.  That it was relatively flat.  Reddit and parts of the Bitcoin community derided that analysis yet the data was correct.

In fact, on-chain data later showed that BitPay volume plateaued throughout last year, see The flow of funds on the Bitcoin network in 2015 and A gift card economy: breaking down BitPay’s numbers.

What kind of tech does BitPay currently offer the marketplace?

  • ChainDB, introduced in March, though it seems a bit late to the party already started by ErisDB (and from Ripple’s NuDB).
  • Copay is in a packed group of multisig offerings including GreenAddress, BitGo and CryptoCorp.
  • Insight was their first API / blockchain explorer but everything has moved over to Bitcore.
  • Bitcore competes with BlockCypher, Chain, Coinkite,, and others.
  • (Their API also has some kind of payment channel which could compete with the Lightning Network)
  • Foxtrot seems to also compete with IPFS (and perhaps to some degree Filecoin and DNSChain from okTurtles).

Social media has recently been filled with other hype and rumors but no other big product lines have been announced (yet).

There are a couple open questions.  How will they scale and monetize to a new customer base after such a large pivot in an increasingly competitive fintech market?

For instance, they built their company around consumer payments, but they have let about 20 people go over since the Bitbowl, including the Bitbowl team in large part because consumers as an aggregate did not spend bitcoins (their developer evangelist just left recently too).

For example, in his interview with Business Insider, Pair stated that:

We keep adding merchants – we’re up to over 60,000 now — but they’re selling to the same pool of Bitcoin early adopters. At Bitpay we’ve never thought there’d be this overnight adoption where you get people using it this year or even next year. It’s going to take some time. In the industry there’s a realisation that yes it’s an incredible technology but it’s going to take a while for it to mature.

Again, based on demographic research from CoinDesk and others the typical “owner” of a bitcoin is a North American male in their early 30s that is not living hand-to-mouth.1 They likely have a low-time preference and long-term time horizon and thus are unlikely to spend bitcoins because they view it as an investment, not virtual cash.2  Another data point: in moving to Switzerland, Wences Casares noted that 96% of the customer deposits on Xapo do not move, that they are stagnant.

But Xapo is primarily storage right?  Why would customers frequently move their deposits in and out of bunkers?

transactions coinbase

Source: Coinbase

Above is the off-chain transaction chart over the past year at Coinbase.  Up until recently it has been relatively flat with around 3,500 – 4,000 transactions per day.  In October 2014, Brian Armstrong and Fred Ehrsam, co-founders of Coinbase, did a reddit AMA.  At the 31:56 minute mark (video), Fred discussed merchant flows:

One other thing I’ve had some people ask me IRL and I’ve seen on reddit occasionally too, is this concept of more merchants coming on board in bitcoin and that causing selling pressure, or the price to go down. [Coinbase is] one of the largest merchant processors, I really don’t think that is true.  Well one, the volumes that merchants are processing aren’t negligible but they’re not super high especially when compared to people who are kind of buying and selling bitcoin.  Like the trend is going in the right direction there but in absolute terms that’s still true.  So I think that is largely a myth.

Echoing Pair’s view, in a March 2015 interview with CoinDesk, Steve Beauregard, CEO of GoCoin, a payment processor stated:

“I believe merchants have been widely disappointed by the number of transactions they see in bitcoin,” Beauregard said.  He went on to state that “consumer adoption is the problem”, speaking out against the ‘if you build it they will come’ mentality of the bitcoin ecosystem in past years.

Thus it is unsurprising that a company, BitPay, that in public previously stated it would generate revenue via transaction and SaaS fees, was unable to in a market filled with stagnant coins.  Behind the scenes, as described later below, they were telling people (and investors) that they hoped to generate money via the market appreciation of bitcoins themselves.

Is it the only explanation?

Last month Moe Levin, former Director of European Business Development at BitPay, was interviewed by deBitcoin, below is one detailed exchange starting at 1:57m:

Q: There was a lot of stories in the press about BitPay laying off people, can you comment on that?

A: Yea, what happened was we had a high burn rate and the company necessarily needed to scale back a little bit on how many people we hired, how many people we had on board, how much we sponsored things.  I mean things were getting a little bit out of hand with sponsorships, football games and expansion — more care needed to be put on how and where we spent the money.

Q: Can you elaborate on the burn rate?  Tim Swanson wrote a piece on BitPay in April, published this piece about the economy, the BitPay economy. Posted this piece on the burn rate and actual figures, have you read that piece?  Can you comment on that?

A: Yes, it is especially hard for a company to build traction when they start off.  Any start up is difficult to build traction.  It’s doubly hard, the hardness is amplified when a company enters a market with competitors that have near unlimited resources because the other companies can either blow you out of the water or have better marketing strategies or they can do a ton of different things to make your startup more irrelevant.  Standard in any company but it is doubly difficult when you enter a market like that.  In the payments industry, forget about Bitcoin for a second, in the payments industry and the mobile commerce, ecommerce, company-to-company payments industry there are massive players with investments and venture backed companies in the billions.

Competing at that stage is tricky and it necessarily requires a burn rate that is much higher than the average startup because of how you need to compete in this space.  What is also important is that the regulation costs a lot of money for the startups in the Bitcoin economy.  It’s the perfect storm of how a startup will be hit with a ton of expenses early on and that can hurt the growth of a company.  Even though a lot of the money that went into it was growth capital it takes a while to get the balance right between spending and growing.

I do think this explains some of the pivot but not all of it.

According to AngelList, at the time of this writing there are 1,870 payments startups.  Some of these, as Levin stated, are well-funded.

While it likely will not win any friends on Reddit, I think BitPay’s effort to succeed in consumer payments was likely hindered due to the first factor, the fixed inelastic money supply.

As Robert Sams noted in May 2014:

There is a different reason for why we maybe should be concerned about the appreciation of the exchange rate because whenever you have an economy where the expected return on the medium of exchange is greater than the expected return of the underlying economy you get this scenario, kind of like what you have in Bitcoin.  Where there is underinvestment in the actual trade in goods and services.

For example, I don’t know exactly how much of bitcoin is being held as “savings” in cold storage wallets but the number is probably around $5 billion or more, many multiples greater than the amount of venture capital investment that has gone into the Bitcoin space.  Wouldn’t it be a lot better if we had an economy, where instead of people hoarding the bitcoin, were buying bitshares and bitbonds.  The savings were actually in investments that went into the economy to fund startups, to pay programmers, to build really cool stuff, instead of just sitting on coin.

I think one of the reasons why that organic endogenous growth and investment in the community isn’t there is because of this deflationary nature of bitcoin.  And instead what we get is our investment coming from the traditional analogue economy, of venture capitalists.  It’s like an economy where the investment is coming from some external country where Silicon Valley becomes like the Bitcoin equivalent of People’s Bank of China.  And I would much prefer to see more organic investment within the cryptocurrency space.  And I think the deflationary nature of bitcoin does discourage that.

Based on talks with several other companies in the same space, it is probably not the last announcement of a pivot out of consumer payments.

A next step

So hire experts in financial services right?  It might not be so easy.

Why not?

How will all the bitcoins sitting on BitPay’s books impact their ability to pivot?

The video above is a clip from an two week old interview with Jason Dreyzehner a UI/UX engineer at BitPay.

After watching that, is BitPay: 1) a payment processor 2) exchange 3) forex trading house 4) asset manager 5) all of the above?3

It sounded like they were all of the above.  But perhaps they will just raise another round (downround?), hope for the best and ignore these sunk costs.4

What about banks then?

This quote Pair provided Business Insider is probably not fully accurate:

Banks are desperate to figure out how to apply this technology to mainstream currencies and the likes of Citi, UBS and Santander are all looking at blockchain technology.

I’m not sure what banks Pair has been talking to but from my conversations they are not primarily looking at how to “apply this technology” for currencies.  Though perhaps my sample size is too small.

Rather, in my experience, financial institutions are looking at how to use some kind of distributed ledger to achieve a number of goals, namely in reducing cost centers and complexities within the back office and this is (so far) largely unrelated to currencies.

The entrepreneurs view

For perspective I reached out to Alex Waters, CEO of, a NYC-based cryptocurrency payment processor.  According to him:

In light of recent regulations, and their impact – I see several bitcoin companies pivoting. Payment processing was already a tight margin business when it wasn’t considered an MSB. Now with the regulatory costs involved, it would be a challenging line of business for any startup.

ChainDB and Copay are outstanding, and Bitpay’s open source culture makes them a desirable place to work. The regulatory environment may be a blessing in disguise as it can free some companies from investor and branding pressure. Freeing them to pursue new models.

In addition, when asked how BitPay can pivot into the finance and enterprise sector with a team built around consumer payments, Waters noted that:

I think that’s really challenging. Not only is it a different development skillset to do SaaS, but the existing team may not want to work on that model.

For additional perspective I reached out to Steve Beauregard, CEO of GoCoin.  In his view:

I’ve been publicly speaking out for the last year about merchant adoption sharply our pacing consumer adoption.  Whereas BitPay is shifting their focus to helping banks settle transactions more quickly, GoCoin has decided to address the problem head-on. Clearly merchants see the value proposition, so the thesis behind our merger with Ziftr is to combine our technologies to provide consumers incentives in the ways they currently expect them.  The new merged GoCoin / Ziftr will provide merchants with a digital coupon platform where they can give coins to consumers as incentive to make product purchases.  Our wallet will be a hybrid in that it will store tokenized credit cards similar to ApplePay, yet also enable payments with multiple cryptocurrencies including Bitcoin, Litecoin, Dogecoin, tether and zifterCOIN.

While I agree the consumer adoption is not happening at the pace any of the early pioneers believed it would, but we are taking the dog to the fight so to speak to provide the tools to merchants to change the behavior to the safest, lowest cost payment alternative.

In addition I reached out to Nikos Benititis, CEO of CoinSimple, an Austin-based payment processor.  In his view:

Tim, your thoughts on the cost of regulation and market size already provide a reasonable framework for explaining the recent developments. What I would like to contribute to those is the issue with the “bifurcation” of the bitcoin startup scene.

The first batch of bitcoin startups, which includes BitPay, is quite different from the second batch. In the first batch, you had entrepreneurs who got support from bitcoin early adopters to launch businesses that helped the ecosystem. In the second batch, you have serial entrepreneurs, running companies like Xapo, Circle and 21e6, who got millions from Silicon Valley VCs. Startups from the first batch have to make tough choices, given that interest in bitcoin (see price) is not what it used to be, and that they have to get “traditional” funding to survive. If they get such funding, like BitPay did, they may have active investors questioning the direction of the company, looking at the market size etc. In other words, the price of bitcoin and the lack of crowdfunding does not allow startups from the first batch, to continue working on “ideological” agendas, like bitcoin merchant and user adoption. Startups of the first batch can continue working on what they started on only if the bitcoin price rebounds, or if large bitcoin holders support them. BitPay had to pivot in order to create a sustainable business because it could not afford to do otherwise.

CoinSimple, that provides a merchant processing, because it never touches customer or merchant funds (unlike Coinbase, or BitPay), continues to try to contribute to wider Bitcoin merchant adoption. With a product that works, and we minimum overhead, we can afford to grow organically and contribute to the growth of the ecosystem.

Whatever the reasons for pivoting were, this is a very fluid market place as companies are still looking to find product-market fits.  The next post will look at what Noah Smith and JP Koning have been writing on as it relates to a medium-of-exchange.

Update: according to a new tweet from Stephen Pair: “@BitPay has not pivoted, never even considered it…every line of code we write is about extending our lead in payment processing”

[Acknowledgements: special thanks to Fabio Federici and Pete Rizzo for their feedback.]

End notes:

  1. See New CoinDesk Report Reveals Who Really Uses Bitcoin as well as the the leaked Coinbase pitch deck (pdf).  Regarding “owning” a bitcoin see Bitcoin Ownership and its Impact on Fungibility from CoinDesk []
  2. If they believe the future utility (value) of a bitcoin is greater than the value they would receive by using it today, it is rational to hold.  For more specifics see Chapter 12 in The Anatomy []
  3. Based on reliable contacts at large exchanges,  BitPay does in fact sell directly to other exchanges. []
  4. Future researchers may also be interested in valuations.  A number of VC-funded Bitcoin companies raised on strong user growth totals in the consumer market so in absence of this, it is unclear how BitPay would show a similar “rocketship: growth in enterprise.  How did and how will VCs judge a company that basically sells them on massive user growth that then almost completely evaporates? []
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Needing a token to operate a distributed ledger is a red herring

Over the last few weeks a number of posts and interviews on social media have promoted the position that “you cannot separate bitcoin from the blockchain” and that only Bitcoin (and no other distributed or decentralized ledger) is the future of finance.

In prose form this includes Adam Ludwin, CEO of Chain (here), Martin Tiller (here) and many more on reddit.

Others include Jerry Brito, executive director at Coin Center, who recently tweeted:

jerry brito tweet

Source: Twitter

At the most recent Inside Bitcoins NYC event, Barry Silbert, co-founder of DCG, spoke about several myths surrounding Bitcoin (video):

[The second myth] is that the technology is great, but the currency is not necessary. […] The reason why Bitcoin blockchain is transformative is because it’s a secure ledger and you have the ability to process large amounts of transactions.

The only reason why it is secure and it has that transaction capacity is because you have thousands of miners around the world that have been provided a financial incentive to invest resources, capital to build the facilities that is what makes the ledger secure and gives the protocol the capacity to do transactions.

So if you eliminate the financial incentive which is the currency there is no incentive for miners to mine and thereby you don’t have a secure network and you don’t have the ability to process large amounts of transactions.

Why the “only-Bitcoin” narrative is (probably) incorrect for Financial Institutions

In the other corner, Robert Sams described in detail why Bitcoin will not be the future of securities settlement, Piotr Piasecki explored a couple different attack vectors on proof-of-work blockchains (as it relates to smart contracts) and even Ryan Selkis pointed out a number of problems with the Bitcoin-for-everything approach.

So why is the Bitcoin maximalism narrative at the very top probably incorrect for financial institutions?

Because these well-meaning enthusiasts may not be fully looking at what the exact business requirements are for these institutions.

  • What do financial institutions want?  Cryptographically verifiable settlement and clearing systems that are globally distributed for resiliency and compliant with various reporting requirements.
  • What don’t they need?  Censorship resistance-as-a-service and artificially expensive anti-Sybil mechanisms.

The two lists are not mutually exclusive.  I published a report (pdf) two months ago that covered this in more detail.

Bitcoin tries to be both a settlement network and a provider of a pseudonymous/anonymous censorship resistant virtual cash.  This comes with a very large trade-off in the form of cost: as the network funds mining operations to the tune of $300 million this year (at current market prices) for the service of staving off Sybil attacks.1 This cost scales in direct proportion with the token value (see Appendix B).

The financial institutions that I have spoken with (and perhaps my sample size is too small) are interested in operating a distributed ledger with known, legally accountable parties.  They do not need censorship resistant virtual cash or proof-of-work based systems.  They do not have a network-based Sybil problem.2

If you do not need censorship resistant as a feature, then you do not need proof-of-work

Recall that one of the design assumptions in the Bitcoin whitepaper is that the validators are unknown and untrusted.

In section 1, Nakamoto wrote:

What is needed is an electronic payment system based on cryptographic proof instead of trust, allowing any two willing parties to transact directly with each other without the need for a trusted third party.   Transactions that are computationally impractical to reverse would protect sellers from fraud, and routine escrow mechanisms could easily be implemented to protect buyers.  In this paper, we propose a solution to the double-spending problem using a peer-to-peer distributed timestamp server to generate computational proof of the chronological order of transactions.  The system   is   secure   as   long   as   honest   nodes   collectively   control   more   CPU   power   than   any cooperating group of attacker nodes.

And later in section 4:

To implement a distributed timestamp server on a peer-to-peer basis, we will need to use a proof- of-work system similar to Adam Back’s Hashcash [6], rather than newspaper or Usenet posts.

Financial institutions operate under completely different conditions.  They not only know the identities of their customers, staff and partners but their processing providers are also known, legally accountable entities.  There is no Sybil problem to solve for them on the network.  There is no need for proof-of-work or $300 million in annual mining costs.

If you don’t need proof-of-work, you don’t need necessarily a token to incentivize validation or secure the network

Instead, validation can be done by entities with contractual obligations that are legally enforced: known validators with real-world identities and reputations.

Permissioned distributed ledgers using this type of known validator, such as Hyperledger and Clearmatics (disclosure: I am an advisor to both), are not trying to be “cryptocurrencies” or even entrants in the virtual cash marketplace.

Nor are they trying to provide pseudonymous-based censorship resistant services.  Instead they are attempting to provide a solution for the financial institution requirements above.

But if Bitcoin has the largest user base of pseudonymous virtual cash, wouldn’t concepts like sidechains allow systems like Hyperledger to be run on a sidechain and therefore we should all focus on Bitcoin?

Again, permissioned ledger systems like Hyperledger are not a cyrptocurrency, so sidechains (as they are currently proposed) would probably not provide any benefit to them.  Bitcoin may – temporarily or permanently – have the largest mind share for cryptocurrency as whole and for censorship resistant services but this does not seem to really be a top priority for most financial institutions.

Thus, it would be comparable to saying why don’t we connect all Excel workbooks directly onto the Bitcoin blockchain?


Source: Gizmag

Or akin to the Wright brothers trying to sell a biplane to modern day international air carriers.  Just because you created the first proof-of-concept and own a lot of equity in the companies in the supply chain for Wright brothers wooden airplanes (because you know aeronautical vehicles is a growth industry), does not mean the first model will not be iterated on and evolved from.  Even modern day dirigibles provide different utility than large wide-body air cargo planes.

There is a case to be made that you only need a token as an incentive within proof-of-work-based (and proof-of-stake) cryptocurrency networks.  Yet as described elsewhere, there are other ways to build distributed networks and economic consensus mechanisms that do not need follow the Nakamoto design (see Vlad Zamfir’s forthcoming Reformalizing Consensus paper).

Thus, the authors cited at the beginning of this post are likely asking the wrong question.  What these writers seem to be collectively saying is: “Hey banks, you want a better settlement method?  Then you need Bitcoin.”  Instead they should be asking banks, “What problems do you have?  Would a censorship-resistant service like Bitcoin’s blockchain sustainably solve that problem?”

Financial institutions each face different problems and challenges but it is unlikely that  proof-of-work necessarily solves them.3  Nor is it the case that banks need yet another currency to manage and hedge.  Though to be even handed, perhaps other financial institutions like hedge funds will find it useful for speculation.

Blocks and miners

Not to pick on Barry Silbert (this is just an example), but his statement above is wrong: “you have the ability to process large amounts of transactions.”

Bitcoin, with the current 1MB block size, is in theory able to process about 7 transactions per second.  If some of the expansion proposals under discussion are enacted, then block sizes may increase to 20 MB in the coming year.  This, again in theory, would mean that the Bitcoin blockchain would be able to process about 140 transactions per second.

One bullish narrative has been that Bitcoin will one day be able to handle transaction processing rates on part with networks like Visa (which on average handles 2,000 – 3,000  transactions per second each day).4   For comparison, in 2013 PayPal had 128 million active accounts in 193 markets and 25 currencies around the world and processed more than 7.6 million payments every day.

Baring something like a full roll-out of the Lightning Network, is unlikely to occur without the use of trusted parties.

Thus it is unclear what metric Silbert is using when he references the “large amounts” being processed, because in practice the Bitcoin network only handles about 1.5 transactions per second on any given day, and most traffic is comprised of spam and long-chains transactions and not the actual commerce that Visa handles.

trade block 1trade block 2

Source: TradeBlock

Above are two charts from TradeBlock which recently published some analysis on block sizes and capacity.  Based on their analysis and following the current trend in block size usage, the 1 MB capacity will be reached in about 18 months, so only in December 2016 will 2.8 transactions per second be achieved.  Dave Hudson ran simulations last year and came to a similar conclusion.

Further, Visa’s network — although centralized — is actually very secure (with moats and all).  No one hacks Visa, they hack the edges, institutions like Target and Home Depot.  This is similar to Bitcoin, where it is cheaper to hack Bitstamp, Bitfinex, Mt. Gox and countless others (which have all been hacked over the past 18 months), than it is to do a Maginot Line attack via hash rate.

In fact, if we measure adoption and usage by actual end users (i.e., where most transactions actually take place), the adoption is not with Bitcoin’s blockchain, but instead with trusted third parties like Coinbase, Circle, Xapo and dozens of other hosted wallets and exchanges.  As I mentioned in my review of The Age of Cryptocurrency, one of the funnier comments I saw on reddit last month was someone saying, “You should try using Bitcoin instead of Coinbase.”

blockchain longtail

Source: the long tail usage of blockchains by Vitalik Buterin

Are permissioned distributed ledgers the solution for financial institutions?

Maybe, maybe not.  It depends on if they securely scale in a production environment..  It also depends on the specific business requirements.  It could turn out that distributed databases like Chubby or HyperDex are a better fit for some problems.

It is also hard to say that a large enterprise can axiomatically replace its existing systems with a new distributed ledger network and save X amount of money.  There are a variety of costs that have to be factored in: compliance costs, reconciliation costs, legal costs, IT costs, costs from capital tied up in slow settlement times, etc. 5  Add them all together and there is, in theory, room for large saving, but this is still unknown.  It cannot be derived a priori.

Another common claim is, “Bitcoin is a larger, better supported blockchain and therefore will win out since it has market makers and market support.”

But Bitcoin, as a censorship-resistance payment rail and virtual cash, is a solution for cypherpunks, not for financial institutions who again, have known counterparties.  A proof-of-work blockchain only matters for untrusted networks and pseudonymous validators.

It may seem repeitive, but if you are designing a semi-trusted/trusted networks, then the token itself is more akin to a receipt than an informational commodity.  Bitcoin, in its current form, likely needs a token because it needs to pay its pseudonymous validators for the censorship-resistance service.  If you operate a bank, with a state charter and KYC/AML requirements, this is probably not a must-have feature.

Either way, it is too easy to become caught up in this red herring and miss the utility of a distributed settlement system for the roller coaster ride surrounding the token.

But isn’t using known validation just centralization by any other name?

No, it could be institutionalized (which is different than centralization) in that the nodes are globally separated and controlled by different keypairs and organizations.6  In effect, distributed ledgers are a new, additional tool for financial controls — and an attempt to abuse the network would require additional compromises and collusion that the edges of a proof-of-work networks are also prone to.

Yet in the event an attack occurs on a permissioned ledger, the validators are contractually and legally accountable to a terms of service — pseudonymous validators are not and thus end users for something like Bitcoin have no recourse, legal or otherwise, and are left with options like begging mining pools on reddit.7


Bitcoin may be a solution to some market needs, but it is likely not the silver bullet that many of its promoters claim it is.  This is especially true for financial institutions, particularly once the costs of mining and censorship-resistance, is added into the mix.

There is room for both types of networks in this world, just like there is room for dirigibles and jumbo jet freighters.  Yet it is impossible to predict who will ultimately adopt one or the other or even both.8

But as shown in the picture below, the Bitcoin mining game (within a game) includes mining pools that are not always incentivized to include transactions.9  Which raises the question: how can you require them to since there is no terms of service?

blockchain block 1 tx

Source: Block 358739

Every day there is always one or two blocks (sometimes more) that include a lonesome transaction, the coinbase transaction. In fact, in the process of writing this post, F2Pool included no additional transactions in block 359422, this despite the fact that there are  unconfirmed transactions waiting for insertion onto the communal chain.

Mining pools have differing incentives as to whether or not to include actual transactions, to them the bulk — roughly 99.5% of their revenue still comes from block rewards so sometimes they find it is not worth processing low fee transactions and instead propagate smaller blocks so as to lower orphan races and instead work on the next hash; see for instance Chun Wang’s comment related to F2Pool and large block sizes posted last week.

I reached out to Robert Sams, CEO of Clearmatics, who has written on this topic in the past.  According to him:

To me the crux of the issue is that permissionless consensus cannot guarantee irreversibility, cannot even quantify the probability of a history-reversing attack (rests on economics, not tech).

It’s a curious design indeed where everyone on the Bitcoin network is now known and authenticated… except the transaction validators!

I also reached out to Dan O’Prey, CEO of Hyperledger.  According to him:

It all comes down to starting assumptions. If you want the network to be censor-resistant from even governmental attacks, you need validators to be as decentralised as possible, so you need to allow anyone to join and compensate them so they do, so you need to use proof of work to prevent Sybil attacks and have a token.

If you’re dealing with legal entities that governments could shut down then you don’t get past step one. If you’re dealing with a private network between multiple participants then you don’t need to incentivise validators – it’s just a cost of doing business, just as web servers are.

Fun fact: according to, there have been 85275 blocks with one transaction and 12438 blocks with 2 transactions (the bulk of which occurred in the first year and a half).10

Is that the type of game theoretic situation upon which to build a mission-critical, time sensitive settlement system for off-chain assets with real-world identities on top of?11 Maybe, maybe not.  Both types of networks have their trade-offs but focusing on a token is probably missing the bigger picture of meeting business requirements which vary from organization to organization.

[Acknowledgements: thanks to Pinar Emirdag, Todd McDonald, Dan O’Prey, Robert Sams and John Whelan for their feedback.]


  1. This annualized number comes from the following calculation: money supply creation (1,312,500 bitcoins) multiplied by current market price (~$230). []
  2. Large institutions and enterprises may have issues with authentication and identification of customers/users but that is a separate operational security issue. []
  3. It is important to note that if the costs of mining somehow decreased then so too would the costs to successfully attack a proof-of-work network.  See The myth of a cheaper Bitcoin network: a note about transaction processing, currency conversion and Bitcoinland []
  4. Note: In the UK, Visa Europe currently settles over RTGS though Mastercard does not.  See: The UK Payments landscape []
  5. Thanks to Dan O’Prey for his thoughts on the matter. []
  6. It bears mentioning that having 15 banks in 15 different countries operating validators is more decentralized than a few mining pools in a couple of countries, although it is not a fully direct comparison. []
  7. In theory on-chain “identity” starts pseudonymously and later users can either fully identity themselves (via traditional KYC, or signing of coinbase transactions) or attempt to remain anonymous by not reusing addresses and through other operational security methods.  Miners themselves can be both known and unknown in theory and practice.  Other terminology refers to them as a dynamic- membership multi-party signature (DMMS). []
  8. Peter Todd has argued that financial institutions can take a hash from a permissioned ledger and insert it into a proof-of-work chain as a type of “audit in depth” strategy. []
  9. According to John Whelan who reviewed this post, “The science of incentives is far more complex than just ‘show me the money’.  Indeed, workplace incentive specialists have coined the term ‘total rewards of work’ that recognizes that there are many levers other than compensation that may be pulled to motivate employees to perform at their maximum potential (e.g., workplace rewards).  With distributed ledger systems there is a lot of room to gain a clearer understanding of the kinds of incentives that will motivate transaction validators or nodes that offer other services such as KYC/AML, etc.  It is definitely not a one-size-fits-all.” []
  10. For comparison, Litecoin has 245447 blocks with 1 transaction and 105765 blocks with two. []
  11. At an event in NYC last month Peter Todd opined that perhaps some firms will take this risk and will encode a series of if/then stipulations in the event that a history-reversing attack occurs. []
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The final version of the BitLicense was released

A reporter from CoinDesk reached out yesterday to ask if there were any questions I had in relation to the final version of the BitLicense being released.

They subsequently posted a follow-up story with one of the comments I sent.  Below are the remaining questions and comments that came to mind after quickly reading through the final BitLicense.

The current wording in the final version still seems to leaves a few unanswered questions:

1) When a miner (hasher) sends work to a pool, the pool typically keeps the reward money on the pool before sending it to the miner or until the miner manually removes it.  Would mining pools be considered a custodian or depository institution since they control this asset?  What if a pool begins offering other services to the miner and these assets remain on the pool? (e.g., some pools have vertically integrated with exchanges)  Update:  The mining pool BTC Guild has announced it is closing down and citing concerns over the BitLicense with respect to these issues.

2) Are there any distinguishing factors or characteristics for entities that issue or reissue virtual currencies?  For instance, both non-profit groups (like Counterparty, Augur) and for-profit organizations (like Factom, Gems) issued virtual currencies and it appears that federated nodes that operate a sidechain, in theory, will effectively (re)issue assets as well.  Are they all custodians?  In light of the FinCEN enforcement action with Ripple, do these projects need to be filing suspicious activity reports (SAR) as well?

3) How hosted wallets comply with 200.9(c) and whether startups like Coinbase violate that given this UCC filing (pdf)? (E.g., assuming the bitcoins held by Coinbase for customers are covered by the filing, it seems as if it could violate 200.9)

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Housing all financial controls under one roof, managed by one person

A new story up on FusionFormer Mt. Gox CEO: Current Bitcoin exchanges are a ‘disaster waiting to happen’ — looks at a recent post from Mark Karpeles regarding the segregation of financial controls within the Bitcoin exchange framework.  I provided a couple of quotes for some perspective.

In addition to the snippets in the article, it bears mentioning that I would disagree with his view that it is possible to make a fully decentralized exchange today due to the fact that cash is centrally created and thereupon controlled by a variety of agencies.  He is right about the intersection of AML and how some companies are unable (or more likely, unwilling) to legally comply with it due to how they operate (such as LocalBitcoins and

As an aside, virtually most (if not all) VC-funded, US-based hosted wallet and exchange is likely in non-compliance of a variety of custodian/depository regulations though it is unclear if/when any jurisdiction will prosecute them:

One last comment about that story, there may be ways to create financial controls to reduce the ability for maleficence to occur but as Karpeles ironically pointed out (he did not acknowledge it but probably is aware of it), by converting bitcoins into an altcoin, you effectively are delinking provenance and creating a money laundering mechanism.  Based on a number of conversations with altcoin traders I suspect that a non-negligible portion of the litecoin trading volume on a daily basis (on BTC-e and are related to money laundering type of activities.  Though this would be hard to verify and prove without building a good network heuristic and/or access to the server logs at these companies.

See also: CEWG BitLicense comment

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A few results from the first intentional stress test on a communal blockchain

I have covered the issue of increasing the Bitcoin block size a few times in the past:

Three days ago several individuals within the development community (and on reddit) — in order to test to see how the network would handle (and is impacted by) a large increase in transactions — went ahead and repeatedly sent transactions (via scrypts) onto the network.

Below are multiple graphs illustrating what this traffic looked like relative to “normal” days:

blockrio graphs

Source: (over the past 30 days)

Above are two charts from illustrating the block sizes over time and average block fee over the past 30 days.

transaction fees in USD

Source: (fees denominated in USD)

transactions per day

Source: (number of transactions per day including popular addresses)

excluding chains

Source: (excluding chains longer than 10)

Above are three charts from covering the past year (365 days) activity related to: fees to miners, transactions to all addresses (including popular), transactions excluding chains longer than 10 (see Slicing data for an explanation).

statoshi clearing

Data Source: / Image source (reddit thread)

Above is a screengrab from (run by @lopp).  It illustrates the roughly 20 hour time period in which this stress test took place.


There were multiple reddit threads that attempted to break down the findings, below are some of their comments with slight amendments

  • A peak of approximately 24,000 unconfirmed Bitcoin transactions occurred
  • Nearly 133,000 transactions were included in blocks during one day, a new all time high
  • Blocks became full starting at block 358596 at 23:38 UTC
  • And remained consistently full until block 358609 at 03:21 UTC
  • The majority of mining pools cap block size at 0.75 MB instead of 1 MB
  • Some transactions were “mysteriously” not broadcast until 2 hours post their actual broadcast time (Broadcast between 23- 24:00 UTC, shows 02:54 UTC)
  • The majority of low fee/minimum fee transactions required 3-4 hours for the first confirmation

Brute force fan fiction

While not necessarily a surprise, for approximately $3,000 an individual can effectively spam the network, filling up blocks and annoying users for several hours.  Because it became increasingly expensive for transactions to be included within blocks, the “attack” probably is not the most effective way to cause many transactions to be permanently slowed down.

Yet it does show that the Maginot Line narrative — that the only way to “attack” the network is to acquire hundreds of millions of dollars in hashing power to brute force the network — is just fan fiction.  A well-organized and minimally financed group of savvy internet users — not even professional hackers — can create headaches for settlement systems, payment processors or anyone else running time sensitive applications reliant on a public blockchain.

Thus, as Robert Sams pointed out a couple weeks ago: it would probably be financially irresponsible for a large organization like NASDAQ to use a communal blockchain — whose pseudonymous validators are not held contractually liable or accountable for transaction processing (or attacks thereof) — to clear and settle off-chain assets (Ryan Selkis briefly touched on a similar point last week as well).  Whether this kind of test convinces NASDAQ and others to rethink their pilot programs on a public blockchain is an open question.

Governance issues with “the commons”

Over the past 4-5 weeks there are probably well over a hundred reddit threads, blog posts and Bitcoin Talk forum posts related to increasing the block size.

Instead of rehashing all of the arguments here, the decision to increase block sizes seems to boil down to two things:

  1. Conflicts in governance (e.g., politics and special interest groups)
  2. Subjectivity in how many nodes represent “decentralization”

The first issue is much harder, perhaps impossible to solve because no one owns the network — it is a communal, public good.  Chronically lacking a clear and effective governance model, decisions are typically made based on: how many retweets someone gets, how many upvotes a poster receives, or increasingly, Six Degrees of Satoshi: how often Satoshi directly responded to your comments in the past.

We see this quite frequently with the same clique of developers using a type of argument from authority.  Perhaps they are correct and one person was left “in charge” by fiat — by Satoshi one spring morning in 2011.  Yet it was not Satoshi’s network to “give” in the first place — he was not the bonafide owner.  No one is, which presents a problem for any kind of de jure governance.1

gavin mike hearn

Source: reddit

The second issue, in terms of how many validating nodes are needed for decentralization, this is an issue that Vitalik Buterin, Jae Kwon and several others have been talking about for over six months, if not longer.

In short, as block sizes increase in size, fewer validating nodes will operate on the network due to a number of factors but largely related to the economic costs of running them (bandwidth is typically cited as the biggest consideration).  We see this empirically occur over the past 18 months on the Bitcoin blockchain (with validators dropping from over 13,000 in March 2014 to just under 6,000 today).

Appealing to amorphous social contracts

Social contracts historically fall apart due to their nebulous mandate and they also — non-governmental versions specifically — typically lack explicit enforcement mechanisms.

Bitcoin suffers from both.  There is no terms of service or explicit service agreement to the end user.  Nor is there a way to enforce an “ethos” onto a physically decentralized userbase.

Yet ironically several key developers are now appealing to a social contract to make decisions for how block sizes should and should not evolve.

Irrespective of what is decided on social media, there will ultimately be a solution that arises in the coming months, but not everyone will be happy.

How to solve this in the future?  What are other projects doing?

Tezos, if we come to believe that it is valuable or safe (because others are using it, or is scientifically verified), has a self-amending model which bakes in governance into the code itself.

Ethereum is also trying to create specific, technical ways for “explicit governance” to direct its evolution as it achieves certain milestones.  For instance, its developers plan to eventually transition the proof-of-work process into a proof-of-stake network (via a poorly marketed “bomb“).

Whether either of these projects is successful is another topic, but at least the developers recognize the governance issue as paramount to the ultimate “success” of the project.

Other projects in the distributed ledger arena, such as the “permissioned” ledgers I did a report (pdf) on earlier last month, also do not have this type of governance problem due to the fact that they each have a private sponsor (sometimes in the form of an NGO, others in the form of a company) where the buck finally, explicitly stops.

There may be non-technical ways to govern (via organizational structure), but Bitcoin’s model is both ad hoc and largely devolves into unproductive shouting matches.  Is this really how a financial system and series of products is best developed?  Probably not.

But this is a topic for political archaeologists to pour through in the coming years.

Other experts weigh in

Chun Wang, who is a member of the F2Pool operating team (F2Pool, also known as Discus Fish, is one of the largest mining pools), made the following comment two days ago on the Bitcoin development mailing list:

Hello. I am from F2Pool. We are currently mining the biggest blocks on
the network. So far top 100 biggest bitcoin blocks are all from us. We
do support bigger blocks and sooner rather than later. But we cannot
handle 20 MB blocks right now. I know most blocks would not be 20 MB
over night. But only if a small fraction of blocks more than 10 MB, it
could dramatically increase of our orphan rate, result of higher fee
to miners. Bad miners could attack us and the network with artificial
big blocks. As yhou know, other Chinese pools, AntPool, BW, they
produces ASIC chips and mining mostly with their own machines. They do
not care about a few percent of orphan increase as much as we do. They
would continue their zero fee policy. We would be the biggest loser.
As the exchanges had taught us, zero fee is not health to the network.
Also we have to redevelop our block broadcast logic. Server bandwidth
is a lot more expensive in China. And the Internet is slow. Currently
China has more than 50% of mining power, if block size increases, I
bet European and American pools could suffer more than us. We think
the max block size should be increased, but must be increased
smoothly, 2 MB first, and then after one or two years 4 MB, then 8 MB,
and so on. Thanks.

I reached out to Andrew Geyl (Organ of Corti) to see what was on his mind.  He independently concurred with LaruentMT, who suggested re-running the tests a few more times for more data:

The transaction “stress test” was well overdue. It’s impossible to understand exactly how increasing block sizes (or even reducing time between blocks) will affect transaction confirmations if we’re only using the network to capacity, and Testnet won’t be much use.

By ensuring that there were more transactions than could be confirmed, we understand a little more about the limits of the network’s transaction transmission capacity. As soon as I get access to relevant data I’ll be trying to determine what factors limited the rate of transactions per block per second.

I think this “stress test” should be run again at some point on a Sunday (when it will have least impact on network users) and – to account for variance in block making – for longer than just 8 hours. Maybe 24 hours? If we are are warned ahead of time, this might be more palatable to the bitcoin users. Think of it as preventative maintenance.

I also reached out to Dave Hudson, proprietor of  He has run a number of models over the past year; two notable posts still stick out: 7 Transactions Per Second? Really? and The Myth Of The Megabyte Bitcoin Block.  Below are his new comments:

I’d really like to have time to think about the stress test some more and to look at the numbers, but it demonstrates something that I’m pretty sure a number of people have considered before: 51% attacks are not the biggest cause for concern with Bitcoin; there are dramatically easier ways to attack the system than to build 350 PH/s of hardware.

The delays resulting from large numbers of TX’s sent to the network were entirely predictable (I did the sims months ago).

I doubt this is the only problem area. Consider (and this has been raised a lot in discussions over block size increases) that a lot of miners use the relay network. Attacking that, or shutting it down via some means would certainly set things backwards, especially if we do see larger block sizes.

Other attacks would be massive-scale Sybil attacks. I know there’s the whole argument that it can’t be done, but of course it can. It would be trivial to set up malware that turned 100s of thousands of compromised systems into Bitcoin nodes (even better if this could be done against something embedded where users don’t run malware detection).

It seems to me that the fact this hasn’t happened before is because those people interested in Bitcoin at the moment are more interested in seeing it useful than in bringing it down. When cybercriminals are extorting money in Bitcoin then they want to see it succeed too, but my guess is that if they could find some other equally anonymous way to get paid then we’d have seen some large-scale assaults, not just a few thousand extra TXs done as a thought experiment.

The problem here is that most software designers can build really good working systems. They can follow secure coding rules to ensure that their software doesn’t have resource leaks and network security vulnerabilities, but then they don’t consider any part of the system that might not be under their direct control. It’s the assumed-correct behaviour of the rest of the world that tends to be where major risks come in. Constructing a Maginot Line is a waste of time and money when the attacker bypasses it instead. In fact the perceived strengths of a defence usually lead to complacence. The stress test was a great example of this; huge amounts of time have been spent analyzing 51% attacks when this was probably the least likely attack even years ago. It’s essentially back to the crypto geek cartoon where the super-strong password is not cracked technologically, but instead by threatening its owner.

Despite what some entrepreneurs and venture capitalists have proclaimed — that there is a “scalability roadmap” — this is probably not the last time we look at this.

There are certainly proposed roadmaps that scale, to a point, but there are many trade offs. And it appears that some of the hosted wallet and payment processors that have publicly stated they are in favor of Gavin Andresen’s proposal are unaware of the impact that this type of block size increase has.  How it likely accelerates the reduction of nodes and how that likely creates a more centralized network (yet with the costs of decentralization).  Or maybe they are and simply do not think it is a real issue.  Perhaps they are correct.

One final comment — and this is tangential to the conversation above — is that by looking at the long chain exclusion chart we observe that the additional “stress test transactions” appear as normal unchained transactions.

This is interesting because it illustrates how easy it is to inflate the transaction volume metric making it less useful in measuring the health or adoption of the network.  Thus it is unlikely that some (all?) Bitprophets actually know what comprises transactions when they claim the Bitcoin network has reached “an all time high.”  Did they do forensics and slice the data?

See also: Creating a decentralised payment network: A study of Bitcoin by Jonathan Levin and Eclipse Attacks on Bitcoin’s Peer-to-Peer Network by Heilman et al.

  1. See Bitcoin faces a crossroads, needs an effective decision-making process by Arvind Narayanan []
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What impact have various investment pools had on Bitcoinland?

queen bitcoinAccording to public announcements, approximately $790 million has been raised by Bitcoin-related companies over the past three years (and really in earnest since the San Jose conference two years ago).

Where did that funding go?  And how did that impact the price of cryptocurrencies?

Below I attempt to break down the numbers to answer both of the questions.

The tl;dr is that there are multiple unseen cost centers that have likely absorbed capital that would have otherwise been more productively deployed elsewhere.  Some of these costs were related to compliance — which many startups assumed would not exist or could be ignored.  Others included denial of service (DOS) and ransomeware which no one besides Bruce Schneier could have predicted or thought of years ago.

In addition, consumer behavior — or as Buck Turgidson would label “the human element” — is not behaving based on the initial assumptions of many entrepreneurs, enthusiasts and VCs.  Whereas 18-24 months ago cryptocurrency-based payment processors proclaimed that consumers would flock to Bitcoin and other altcoins as a payment rail, this has not occurred (yet).1 Stagnant tokens left in cold storage therefore impacts multiple verticals, especially those relying on large aggregates of transaction fees to fund growth as they scale up.


Investing in mining and hashing is effectively taking out a short position on fiat and long on a cryptocurrency, in this case usually USD for BTC.  It is a foreign exchange play as it enables investors to turn fiat into magic internet money without typically needing to abide by foreign exchange regulations or institutional registration requirements.  For instance, a venture capital firm is typically not permitted or allowed to use LP funds on the open market to purchase forex, or in this case cryptocurrencies — but by funding a mining company they effectively fall within a “loophole” (or at least that is how some pitch it).

What does this look like?

Listed on the continually updated – though slightly inaccurate – CoinDesk Venture Investment spreadsheet are the following capital raises specific to mining:

  • Spondoolies Tech: $10.5 million
  • Avalon Clones: $3 million (likely clones of the Avalon chip)
  • Bitfury: $40 million (in two public rounds)
  • Hashplex: $0.4 million
  • KnC miner: $29 million (in two public rounds; note that KnC however had a pre-tax loss of $4.4 million last year)
  • Peernova (raised $19 million, however they are no longer in the Bitcoin mining space and didn’t raise the Series A round based on mining products)

Not included are funding from:

  • 21inc: according to Nathaniel Popper it has raised $121 million over at least three rounds (perhaps more) and is now building Tom Sawyer botnet hashing chips — consumers are expected to collectively absorb the operating costs such as electrical and administrative costs thereby painting the proverbial white fence; consumers socialize the costs and 21inc privatizes the gains
  • Bitmain: is the largest independent manufacturer, has taken no VC money to date (fully financed via private sources)
  • CoinTerra: bankrupt, previously raised $2.2 million
  • Hashfast: bankrupt, owed creditors over $40 million, “acquired” by a Venezuelan politico
  • Alidyan: part of CoinLab, now bankrupt, spent $4 million building hashing machines
  • Butterfly Labs: sued by FTC for failure to deliver product to customers, collected between $20 million to $50 million in pre-orders, currently sending some refunds
  • Avalon: successfully pre-sold the first commercially available ASICs (see interview with Yifu Guo from Motherboard); Guo is no longer involved with Avalon and the company is now called Canaan Creative
  • ASICMINER: “Friedcat” is the Chinese businessman who created an immersion mining facility in Hong Kong and custom ASIC chip, allowing those with bitcoin to exchange bitcoins for ASICMINER shares; despite allegations, it is still unclear if he absconded with the funds of a new project called AMHash
  • Gridseed (recently merged to become SFARDS): built both SHA256 and scrypt hashing equipment; in late July 2014 they purportedly owned 20 billion dogecoins (via mining) and as recently as April 2015 still supposedly controlled 60% of the hashrate for dogecoin (the management team led by Li Feng was allegedly under pressure by investors to somehow reverse the bear market)
  • ZeusMiner: shifted from building SHA256 ASICs to scrypt (dogecoin, litecoin, etc.)
  • Genesis Mining, Mega Big Power, RockMiner and a variety of small actors in the manufacturing/proprietary farm/pool business
  • DiscusFish, consistently one of the largest pools, may or may not produce some of their own hardware
  • A smorgasbord of cloudhashing scams that didn’t actually have the actual hardware (e.g., GAW mining)

So of the ~$790 million so far:

  • $82.9 million is comprised by known mining manufacturers
  • plus $121 million from 21inc (but misclassified as “Universal” in the spreadsheet)
  • but cannot include the $19 million from Peernova (this is misreported on the spreadsheet and again, they are no longer in that specific vertical)

This comes to: $203.9 million, or about 25% of the publicly known funding has gone directly into converting one currency (fiat) into another (bitcoins, litecoins, etc.).  How much of the capital has been fully deployed to date is unclear.

bitcoin funding

Data source: CoinDesk

Can this full amount impact the market price of specific cryptocurrencies?  We will try to answer that question later below.

Startup life

There are multiple budgetary components to any startup that are not unique to Bitcoinland.

For instance, irrespective of locale, the cost of living for an employee can typically be broken down into:

  • Housing/Rent
  • Utilities (electricity, gas, internet access)
  • Phone
  • Food and clothing
  • Auto/house/health insurance
  • Discretionary income (entertainment, luxury items, vacations, investments, etc.)

We will come back to these later.

For an entrepreneur in Bitcoinland, in addition to the labor costs above, some of the company-specific costs include:

  • Domain name: a large Bitcoin API company is rumored to have spent $350,000 on a five character dotcom domain; for perspective Roger Ver rents out (domain squats?) for roughly $120,000 a year (in 2012 the highest valued domain fetched $2.45 million)
  • Legal fees: some of these are delayed via equity swap deals with law firms, e.g., independent lawyers as well as firms such as Perkins Coie may provide some legal assistance for X% of equity via convertible note; similarly regulatory consultants such as Promontory have done pro bono work to assess the lay of the land for the whole space likely with the goal of converting promising clients into retainers and so forth
  • Office rent/lease/mortgage: co-working spaces are increasingly common for many seed stage companies in order to stay lean and limit the burn rate
  • Utilities and internet access: particularly important for mining farms/pools
  • Attending events: flying to conferences and meetups (which are incidentally, probably one of the few legal, profitable areas for Bitcoin right now; Mediabistro pivoted to focus on this space)
  • Event sponsorships: food and speaker honorariums; e.g., was a lead sponsor for the O’Reilly Media Bticoin & Blockchain event, BitPay sponsored the ill-fated, one-and-done Bitbowl (Platinum sponsorship at the NYC InsideBitcoin event was $13,000 and $12,500 for Singapore)
  • Marketing and advertising: user acquisition, lead generation, brand awareness, e.g., Gyft, eGifter, and purchase many of the ad slots on reddit, various “rebittance” companies purchase ad slots on Facebook, itBit is everywhere on Twitter, ChangeTip attempted to capitalize off of the Nepal earthquake and curates sock puppet spam (BashCo, a reddit moderator now works for ChangeTip)
  • Front-end design: can reach $75,000 to $100,000 and there are now companies such as Humint and Bitsapphire catering to cryptocurrency-related startups
  • Advisory fees to banks: American Banker recently explored the rumors that banks such as SVB charge its clients (such as Coinbase) a monthly “advisory fee” (payola?) which could range $20,000 – $60,000 per month
  • Lobbying special interest groups: a number of Bitcoin-related startups donate to non-profit organizations which in turn pays the salaries for staff at Coin Center, Chamber of Digital Commerce, The Bitcoin Foundation and others in order to influence policy making
  • Board of Directors and Advisors: Larry Summers (Xapo, 21inc), Arthur Levitt (BitPay, Mirror), Sheila Blair (itBit), Gene Sperling (Ripple Labs), and several other VIPs; while some of these relationships are in exchange for equity (0.5%-2%) others may be in the form of cash ($5,000-$10,000 per month) — either way, not free
  • Company outings and vacations: ChangeTip flew out to Argentina, another well-heeled group went to Malta, while others have had traditional typical perks (e.g., company lunches and dinners)
  • Money transmitter licenses: in addition to maintaining a compliance team that regularly submits SARs, it currently costs about $2-4 million to obtain the necessary MSB licenses to operate in all states within the US (recommend readers chat with Faisal Khan and Juan Llanos for more info)
  • Insuring virtual currencies that a company may hold in custody: Xapo, Coinbase, BitGo, Gemini and others now advertise that the holdings (of some kind) are insured by third parties (and purportedly even the FDIC in the case of itBit)
  • Acquiring and maintaining an inventory of cryptocurrencies: many wallets and exchanges need to maintain some kind of ‘hot wallet’ so that customers can quickly transfer their virtual assets.  For instance six days ago the hot wallet at Bitfinex was compromised and a hacker stole 1,459 bitcoins, earlier this year Bitstamp’s hot wallet was hacked and lost 19,000 bitcoins, Coinfloor stated two weeks ago it holds 5,081 bitcoins on behalf of customers and as of this writing Bitreserve states it has $1,716,030 obligations to its customers.  In addition many exchanges run prop desks to trade liquidity with partners (e.g., most VC-funded exchanges have an OTC team that handles large block trades)
  • Customer service and bug bounties: reimbursing customer for problems with R values/RNGs.  For instance, in December 2014, used untested code in a production environment that cost customers at least 267 bitcoins (and again on May 26, 2015).  In April 2015, reddit user vytah fixed a BitGo integer overflow error that cost a customer 85 bitcoins
  • Denial of service (DOS) vandalism and extortion: commonly happens with mining pools (competing pools threaten to do a denial of service unless a certain amount of bitcoins is paid) — in March 2015 at least five different pools were targeted; also happens with media sites such as when Josh Garza (from Paycoin/GAW mining) allegedly attacked Coinfire to prevent stories regarding scams/fraud from surfacing
  • Ransomeware: as noted last month while this type of malware has existed for several years, CryptoLocker itself stole nearly 42,000 bitcoins in the fall of 2013, thus signaling to market participants that this successful method of attack could be copied.  According to Dell, during a six month time frame last year, “CryptoWall infected more than 625,000 computers worldwide, including 250,000 in the United States. During that time, the gang that operated CryptoWall raked in about $1 million in ransom payments.”  Currently hackers are targeting smaller and more marginal actors.  For instance, two months ago the network for Swedesboro-Woolwich School District in New Jersey was held hostage for a 500 bitcoin ransom.  And the Tewksbury Police Department system in Massachusetts recently became just one of many public organizations that has paid similar ransoms in bitcoin.

It is still unclear how much of these variables will ultimately absorb the budgets of each startup.  Not everyone is targeted with ransomeware, some startups eschew conferences and others are uninterested in building consumer facing products.  Similarly, some early employees are content with living in a SOHO or communal setting, thus reducing a rent component for someone.

At some point as the industry matures, as companies are acquired or even go bankrupt, we will likely have a better picture of percentages for each of these categories.  It could be the case that as Bitcoin-related custodians and depository institutions grow and merge, they will continue to absorb the costs borne by the traditional financial industry.

Ignoring the cryptocurrency-related challenges (such as securing hot wallets), perhaps several of these entities named above will end up needing to acquire the same licenses and charters as their peers (banks) do and thus could materially impact their balance sheet and growth targets.2  Thus it will be worth revisiting these shifting characteristics again at the end of the year if not sooner.

Converting salaries into bitcoins

bitwageAnother bullet point that is of interest to this conversation yet falls in the cracks between employer labor costs and employee discretionary income are: those individuals who convert part, or all of their salaries into bitcoins.

Most, if not all, Bitcoin-related organizations now offer some method to convert fiat-based salaries into cryptocurrencies.  Bitwage is a startup that provides a conversion service to do so.  Prior to this service (which BitPay also does), some organizations like The Bitcoin Foundation, at one point (perhaps it still does) offered to pay salaries based on a 30-day rolling average of bitcoin-to-fiat.

Another tangential example: one VC-funded Bitcoin company that raised more than $20 million late last summer bought a tranche of bitcoins (then valued at around $1.5 million) to lay aside for employee benefits.  Their employee deal is to hand over some options in future bitcoins so they wanted the bitcoins locked in to handle the employee liability.

In another instance, it is also worth noting that the $30.5 million round (the largest Series A so far) that was announced in October 2014, was a mixture of bitcoin and USD (primarily USD).

What is the impact on the price of cryptocurrencies if all the employees at these startups converted their salaries into cryptocurrencies?

This has not been analyzed due largely to a lack of public information yet but it bears mentioning that it is likely that most, if not all, employees cannot fully convert their entire salary into cryptocurrencies because, for example, their land lord or utility company likely does not accept it for payment.  Perhaps this will change in the future, until then however: rent, utilities, phone service, food and insurance are probably still largely paid for with fiat.

Recall that each startup also has its own cost structure, some attempt to position themselves as a “just” a software company while others try to compete in the compliance-heavy and saturated exchange/wallet market place.  Thus the types of costs each company has is not uniform.  What this also means is that some portion of the VC funds that have gone into these companies is likely, ultimately kept in fiat and not converted into cryptocurrencies.

But, there is still more to look at.

The on-going Bitcoin crowdsale

Approximately every 10 minutes the Bitcoin network generates 25 bitcoins.  Miners (collectively in the form of mining pools) compete with one another over winning these tokens.  They do this by coordinating with hashing farms which consume large quantities of capital (primarily electricity) to rearrange a few attributes with the goal of finding a target value below a certain threshold.

In a sense, Bitcoin mining is an on-going auction, or crowdsale, to convert one currency for another.  And miners continually bid up to an equilibrium threshold in which the marginal costs of creating a bitcoin equals the market value of a bitcoin (i.e., in the long run it costs a bitcoin to create a bitcoin).34

In theory, over the past two years roughly 2,625,000 bitcoins were created.  In practice the actual amount is about 10% larger due to the fact that blocks are not being created at 10 minute intervals but much quicker, as fast as 7 minutes during October 2013 (as of this writing it is roughly every 8-10 minutes; see Appendix B).  Thus, whereas block reward halvings were expected to take place once every four years, this has accelerated by several months.

The first halvening occurred in late November 2012 and the next one is expected to occur at the end of July or early August 2016.

How does this impact the fiat-denominated price of bitcoin?

If the average weighted fiat value of bitcoin over the past 24 months has been $400 then based on the theoretical growth in money supply approximately $1 billion in bitcoins have been auctioned off to mining pools over the past two years.  Yet because the supply has increased 10% faster than the actual number is probably closer to $1.1 billion.

What does this mean?

This means that the capital spent on mining — primarily a wealth transfer to utility and manufacturing companies — still far outpaces VC investments, especially once mining-related investments are accounted for.  Altogether, once publicly announced mining investments are removed this amounts to $590 million, not $790 million.

Or in other words, since mining pools, farms and hashing participants ultimately have to sell their $1.1 billion in block rewards to pay for land, labor, taxes, equipment and electricity there is a continuous sell-side pressure on bitcoin that even all of the publicly announced VC financing cannot fully absorb even if it were allowed to.  But that does not mean it has not been dampened.  And it is also known that some of the farms and pools have  attempted to hold onto large bitcoin holdings with the expectation that these will appreciate or due to the inability to find reliable OTC partners to liquidate them without slippage.

Based on known figures above, in percentage terms, the acquisition of block rewards via VC mining investment represents about 18.5% of the $1.1 billion rewarded to miners.

While we may not know the exact numbers that venture backed firms, their employers and their investors have spent acquiring tokens, it is likely that the amount is non-negligible and perhaps even has much as several hundred million if not more.

For instance, Tim Draper publicly bought around 32,000 bitcoins last year (from the DPR/Silk Road auction, not freshly mined coins).  While it is unclear where these bitcoins will go, Boost VC (run by his son Adam Draper) is investing an additional 300 bitcoins in each startup that completes demo day (there were 24 startups in the most recent tribe, 21 of which are Bitcoin-related).  Entities like Seedcoin (renamed Coinsilium) have also tried funding startups this way.  This type of fiat conversion into bitcoin could absorb some of the sell-side pressure that comes from seizures, payment processors, miners, ransomeware and scammers liquidating their holdings (see Flow of funds).

There is some added historical precedence to this.  For instance, and as copiously noted in Nathaniel Popper’s new book, between January through March 2013, at least a dozen or so high-net-worth individuals such as Wences Casares, executives at Pantera and the Winklevoss twins collectively bought tens of millions of dollars worth of bitcoin.  The demand of which resulted in a rapid increase in market prices.  On the other hand, a few years from now when we have more data, there may not be a direct causality between outside investment and what effect that had on the price of cryptocurrencies.

Yet, with $1.1 billion in mining rewards virtually popping onto the scene, why is the community still relying on venture capital funding at all?  This native pool of virtual capital created in the past two years alone surely is capable of funding internal improvements and enhancements to the ecosystem?

To be even handed, it is also about having access to the capital (irrespective as to whether it is virtual or fiat-based)..  In practice an individual with an idea is unable to approach miners and ask for capital — many of the pools and farms are not set up or positioned to act as investors and many prefer to remain unknown.  Thus in practice it is probably easier to raise from dedicated firms that advertise the fact that they fund startups (like incubators and accelerators).

A year ago at the May 2014 Amsterdam conference, Robert Sams elaborated on this issue:

There is a different reason for why we maybe should be concerned about the appreciation of the exchange rate because whenever you have an economy where the expected return on the medium of exchange is greater than the expected return of the underlying economy you get this scenario, kind of like what you have in Bitcoin.  Where there is underinvestment in the actual trade in goods and services.  For example, I don’t know exactly how much of bitcoin is being held as “savings” in cold storage wallets but the number is probably around $5 billion or more, many multiples greater than the amount of venture capital investment that has gone into the Bitcoin space.

Wouldn’t it be a lot better if we had an economy, where instead of people hoarding the bitcoin, were buying bitshares and bitbonds.  The savings were actually in investments that went into the economy to fund startups, to pay programmers, to build really cool stuff, instead of just sitting on coin.  I think one of the reasons why that organic endogenous growth and investment in the community isn’t there is because of this deflationary nature of bitcoin.  And instead what we get is our investment coming from the traditional analogue economy, of venture capitalists.  It’s like an economy where the investment is coming from some external country where Silicon Valley becomes like the Bitcoin equivalent of People’s Bank of China.  And I would much prefer to see more organic investment within the cryptocurrency space.  And I think the deflationary nature of bitcoin does discourage that.

It is likely the case that VC funding, and therefore LP funding, is currently propping up both the ecosystem and maybe even the price due to the fact that consumer demand, via transactions remains muted.

How do we know this?

The majority of bitcoins, 96% to be precise, stored in Xapo are inert and that a similar amount is likely left inactive in Coinbase (both of whom store investor and venture partner funds as well).   We also know this is the case indirectly via payment processing figures such as BitPay (as shown below), which have effectively plateaued.

In short, because of a dearth of transactional demand, the internet commodity is reliant on speculative demand to fulfill any movement in market prices.  Perhaps this will change in the future with projects such as BitX, and Alliance Commerce which have been gaining genuine traction.

What, as Sams suggests, would it look like to actually fund internal improvements or other projects with this virtual currency instead of relying on the People’s Bank of China, Silicon Valley or other outside entities?  Where, as economist might say, is the circular flow of income?

Crowdfunding altcoins and altchains

What about non-VC funded startups in this overall space?  What are some examples of people attempting to put to work the virtual capital without relying on exogenous sources?

In early January I looked at a number of the “initial coin offering” (ICO/ITO) that have occurred over the previous 18 months.  The list included:

  • Mastercoin raised 4,740 BTC in August 2013
  • NXT raised 21 BTC in November 2013
  • Maidsafe raised 7,368 BTC and “95,000 MSC” / BitAngels ‘loan’ in April 2014
  • Swarm raised 1,252 BTC in June 2014
  • Bitshares AGS raised 5,621 BTC and 415k Protoshares in July 2014
  • Viacoin raised 610 BTC in July 2014
  • Ethereum raised 31,529 BTC in August 2014
  • StorJ raised 910 BTC in August 2014
  • SuperNET raised 1,201 BTC and “4,536 BTC equivalent” in Sept 2014
  • Peertracks (Bitshares music) raised ~1,436 BTC in November 2014
  • Bitbay raised 5,000 BTC in November 2014
  • Ziftr raised around “2,000” BTC (more than $650k) in Dec 2014
  • Gems raised 2,600 BTC in Dec 2014

Since then, there has been at least one other large token sale, through Factom.  Over the past two months it has received 2,278 bitcoins.

Altogether this amounts to 66,566 bitcoins raised by 14 projects in about 21 months.5

This may sound like a lot, and perhaps it is relative to the illiquid altcoins it represents (such as Mastercoin which has been rebranded as Omni), but for perspective the Bitcoin network generates roughly 3,600 bitcoins per day — an on-going token sale that continually absorbs more real-world capital and resources than most of these projects collectively do.

Yet despite this level of external funding, participants still prefer to store and hold and not actually spend due to a variety of reasons including low time preferences and the expectation that token value will increase. Perhaps that will change in the future.

Furthermore, it bears mentioning that crowdsales such as those above, are not circular.  Costs nearly always end up being paid for by selling the received currency (bitcoin mostly) for fiat.  In practice it is less of a circle and usually just an added step: bitcoin wallet -> altcoin crowdsale -> convert to fiat -> pay real-life costs.

While a number of these projects are still less than a year old, where are the scorecards for other cryptocurrency-only projects?  For example, in 2012, administrators at Bitcoin Talk raised nearly 7,000 bitcoins to build a new forum.  What about other projects that are paid for directly with other cryptocurrencies such as those on Lighthouse?

Open questions about the circular flow of LP funding

flow of investment funds in bitcoinland[Note: the image above is a variation of my previous illustration on the movement and source of funds within Bitcoinland]

There are a number of popular predictions percolating on the tubes including Bitcoin investments which are on pace to reach $1 billion by the end of the year.

Perhaps that will take place, however at some point these companies will need to generate some kind of actual non-sock puppet traction and returns to justify their 4x, 5x, even 6x valuations.  If not, then VC funding could decline as they did with cleantech.

How would a decline impact services?

For instance, it is unlikely that more than a handful of non-VC funded companies or individuals are actually paying for API access at platforms such as, Gem or BlockCypher (not to pick on them, just an example).  Perhaps this will change in the future.

Yet by looking at the customer list at API companies we notice two things: 1) these customers are similarly VC-funded startups, 2) most of these services have no real traction yet either and are themselves reliant on VC-funded customers.

If and when VC funding dries up this could have a knock-on effect on both of these as the solvency of other virtual currency startups is heavily reliant on a VC-subsidized customer base and the price of bitcoin itself (if it does not dramatically rise by several orders of magnitude then the forex play does not pan out).

Or in other words, what economists would want to see is a circular flow of income yet what we see occurring is a circular flow of VC funding (or rather LP funding).6

If VC funding withdrew it could not only impact the hashrate (as VC funded miners are turned off) it also could impact the fees to miners.  Why?  Because VC funded companies are more likely to send higher fees because they can dig into what amounts to VC subsidies which currently masks some of the dysfunction in the fee system.

In addition, recall that nearly half of BitPay’s volume last year were miners selling block rewards and other people buying IT services (which could be GPU-based mining gear).  If this extends to the rest of the active, non-cold storage Bitcoin economy as a whole, then the miners collectively account for a large portion of the supply and perhaps even the demand of bitcoins (due to keeping tokens on their books as long-term bets on the appreciation of the token).  People in general are excited about the forthcoming halving because it decreases supply and therefore sell-side pressure, but if the mining industry shrinks, its ripples then impact those dependent on its sales such as non-diversified payment processors.



Source: XKCD

Perhaps as the bullish narrative states, increased consumer demand is around the corner and the trends above will drastically change.

In the meantime some startups in this space are still typically trying to evolve along the lines of an early stage social media app: build an MVP, raise a seed, acquire users, rapidly introduce new features, manage a rational head count and steady burn rate for 12 months before raising the next round all while trying to allegedly build Wall Street 2.0.

While the “move fast and break things” mantra may work for certain sectors of the economy, it probably does not work as effectively with finance.  And contrary to the wisdom from some venture capitalists in this space, nearly all the verticals in the Bitcoin-space are attempting to recreate a financial product or service of some kind that is based on the success of the currency being widely adopted/transacted/used.  Forex plays.

What does that mean?

Last November I made a trip to Singapore and heard a Los Angeles-based VC claim that “Bitcoin and Hashcash reinvented economics” and that we could ignore the world of finance and economic gurus.

Perhaps she is right.  But probably not.

Trying to reinvent hospitals without talking to doctors or nurses would be short sighted just as building a car without talking to mechanics and engineers would likely be asking for problems.

Bitcoinland is filled with hundreds of very bright computer scientists and entrepreneurs who are being funded by well-intentioned capitalists with a mandate to take risks and attempt to disrupt incumbents everywhere.  For instance, who would have guessed three or four years ago that conditions in mainland China, when coupled with guanxi in exchange for sweet land and energy deals, would incentivize a cottage industry of pools and farms to set up shop and pump out more than half the network hashrate?7

However, while this topic is beyond the scope of this article, Bitcoin itself does not natively replicate the plethora of financial services or instruments that the real world currently provides; and its current internal monetary system incentivizes users not to actually spend magic internet beans as they would actual currency but rather store them indefinitely.

Instead it has come down to limited partners — pension funds, insurance companies and high-net worth individuals — whom are directly trying to build a new financial ecosystem yet who, as shown in the flow chart above, indirectly end up owning a lot of this economic dead weight in the form of frozen virtual beans.  These tokens, like gold before them, do not provide dividends or interest, they cannot be natively relent without introducing a new trusted third party and thus are unable to generate additional wealth.8

Again, trends can always change, perhaps linear growth will indeed catalyze into exponential curves.  Perhaps rumors of “major deals” between Bitcoin companies and large banks will eventually germinate and DCG or the Argentinian community buys Necker Island with a few satoshis next year.910 Yet so far, about the only two exponential phenomenon we can empirically observe thus far is the usage of the terms “exponential” and “network effect” at conferences and in media.  Just three more to go and we can finally get a bingo.

[Acknowledgments: thanks to Pascal Bouvier, Ben Doernberg, Dave Hudson, AL, Jake Smith and Fabio Federici for their feedback]


  1. Or in short, the only real activity that seems to be going on still is day trading and arbing, no real above-board commerce yet. []
  2. It bears mentioning that there has been a lot of bonafide innovation and traction around multisig security.  This includes firms such as BitGo, GreenAddress and CryptoCorp as well as hardware “wallets” such as Ledger, Case and if the definition is slightly stretched, Trezor.  Note: as of this writing that an increasing portion of bitcoins have moved to P2SH. []
  3. There are exceptions to this rule, some farms such as those operated by Bitfury and by independent groups in China have “bumper” coins, their costs are significantly lower than competitors and therefore their profit margins are larger. []
  4. See The myth of a cheaper Bitcoin network: a note about transaction processing, currency conversion and Bitcoinland []
  5. The Bitcoin network creates roughly the same amount of tokens in just under 19 days. []
  6. Perhaps this is part of the “fake it till you make it” strategy and some could be argued that this is needed during the journey across the chasm.  And perhaps the VCs pushing this could be right in the long run.  Everyone likes line charts that go up, even if you or others in your industry are paying to make the line rise. []
  7. See Chapter 5 and Bitcoins: Made in China []
  8. See Can Bitcoin’s internal economy securely grow relative to its outputs? []
  9. In addition to pilots from Tembusu, Eris, Ripple Labs and other distributed ledger groups (which are not Bitcoin related), some notable startups trying to bridge Bitcoin directly and specifically with the world of finance include TeraExchange, SolidX, LedgerX, Mirror, Gemini, Open Assets (which NASDAQ is apparently trialing out), TradeBlock, ChromaWay and Hedgy.  See also No, Bitcoin is not the future of securities settlement by Robert Sams []
  10. For some observations on Argentina see also Can Bitcoin Conquer Argentina? by Nathaniel Popper []
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Distributed ledgers, blockchains and Bitcoin in the news

Below are several stories and articles from the past few weeks that either cited one of my papers or where I was quoted:

In a Forbes article today entitled “Five Top VCs Predict The Future” the following claim was made: Traditional banks will keep losing share to startups while bitcoin fades.  Two comments from Bill Gurley of Benchmark Partners and Rebecca Lynn of Canvas Venture Fund were mentioned.  However, given that many of the 5 year predictions cited in the rest of the article sound implausible, it is a bit curious that Bitcoin only made the list in a negative way.

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Book review: Digital Gold

digital goldTwo days ago I had a chance to read through a new book called Digital Gold written by Nathaniel Popper, a journalist at The New York Times.

Popper’s approach to the topic matter is different than other books which cover cryptocurrencies (such as The Age of Cryptocurrency).

This is a character driven story, guided by about a dozen unintentional thespians — key individuals who helped develop and shape the Bitcoin world from its genesis up through at least last summer (when the book effectively tapers off).  Or in other words, it flowed more like a novel than an academic textbook exegesis on the tech.

Below are some of the highlights and comments that came to mind while reading it.


I mentioned that in The Age of Cryptocurrency the authors preferred to use the term “digital currency” over “virtual currency.”  I lost count of the dozens of times they used the former, but the latter was only used ~12 times (plus or minus one or two).  I think from a legalese perspective it is more accurate to use the phrase “virtual currency” (see my review as to why).

While I tried to keep track of things more closely in Popper’s book, I may have missed one or two.  Interestingly the index in the back uses the term “virtual money” (not currency) and the “digital currency” section is related to specific types.  Below is my manual tabulation:

  • digital cash, p. 110
  • digital commodity (as categorized by the Chinese government), p. 274
  • digital code, p. 158
  • digital wallet, p. 159, 160, 179, 262 (likely many more during discussions of Lemon)
  • digital currency, p.67, 146 (Facebook credits), 260 (Q coin), 261 (Q coin),
  • digital money, p. 139, 339
  • blockchain, p. 164, 181, 186, 193, 194 (2x), 203, 235, 238 (2x), 250, 289, 295, 326 (2x), 327 (2x), 328 (14x), 336, 345
  • virtual currency (sometimes with a hyphen), p. 126, 139, 142, 144, 145, 146, 156, 174, 179, 180, 181, 186 (2x), 187 (2x), 196 (4x), 197, 198, 204 (2x), 209, 210, 216, 217, 219 (3x), 225, 234, 236,  250, 252 (2x), 256, 257, 259, 267, 268 (2x), 269 (2x), 273, 274, 280 (2x), 289, 295 (2x), 300 (3x), 302 (2x), 303 (2x). 325 (2x), 343, 349
  • tokens, p. 139
  • digital money p. 4, p. 252, 257
  • cryptocurrency, p. 36 (2x), 186, 251, 261, 286 (2x), 325, 334, 341

In the beginning

[Note: I manually typed the quotes from the book, all transcription errors are my own and should not reflect on the book itself.]

On page 38 he writes about pricing a bitcoin, “Given that no one had ever bought or sold one, NewLibertyStandard came up with his own method for determining its value — the rough cost of electricity needed to generate a coin, calculated using NewLibertyStandard’s own electricity bill.”

I have heard this story several times, NLS’s way of pricing a good/service is the 21st century continuation of the Labor Theory of Value.  And this is not a particularly effective pricing mechanism: art is not worth the sum of its inputs (oils, canvas, frame, brushes).  Rather the value of art, like bitcoins, is based on consumer (and speculative) demand.1

Thus when people at conferences or on reddit say that “bitcoin is valuable because the network is valuable” — this is backwards.  The Bitcoin network (and bitcoins) is not valuable because the energy used to create proofs, rather it is the aggregate demand from buyers that increases (or decreases) relative to the supply of bitcoin, which is reflected in prices and therefore miners adjust consumption of energy to chase the corresponding rents (seigniorage).

On page 42 he writes, “Laszlo’s CPU had been winning, at most, one block of 50 bitcoins each day, of the approximately 140 blocks that were released daily. Once Laszlo got his GPU card hooked in he began winning one or two blocks an hour, and occasionally more. On May 17 he won twenty-eight blocks; these wins gave him fourteen hundred new coins that day.”

That translates to roughly 20% of the network hashrate.

Having noted this, the author writes:

I don’t mean to sound like a socialist,” Satoshi wrote back. “I don’t care if wealth is concentrated, but for now, we get more growth by giving that money to 100% of the people than giving it to 20%.

As a result, Satoshi asked Laszlo to go easy with the “high-powered hashing,” the term coined to refer to the process of plugging an input into a hash function and seeing what it spit out.

It’s unclear how many bitcoins Laszlo generated altogether (he was also mentioned in The Age of Cryptocurrency), but he apparently did “stock pile” at least 70,000 bitcoins whereupon he offered 10,000 bitcoins at a time buy pizzas. (Update: this address allegedly belongs to Laszlo and received 81,432 bitcoins; see Popper’s new letter on reddit)

Thus, there was at least one GPU on the network in May 2010 (though it appears he turned it off at some point).  For comparison, on page 189, Popper states that “By the end of 2012 there was the equivalent of about 11,000 GPUs working away on the network.”

Later in the book, on page 191, Popper described the growth in hashrate in early 2013:

Over the next month and a half, as the rest of Avalon’s first batch of three hundred mining computers reached customers, the effect was evident on the charts that tracked the power of the entire Bitcoin network. It had taken all of 2012 for the power on the network to double, but that power doubled again in just one month after Yifu’s machines were shipped.

It’s worth re-reading the Motherboard feature on Yifu Guo, the young Chinese man who led the Avalon team’s effort on building the first commercially available ASIC.

What does this increase look like?


Source: Dave Hudson

Above is a chart published just over a year ago (April 28, 2014) from Dave Hudson.  It’s the only bonafide S-curve in all of Bitcoinland (so far).

In Hudson’s words, “The vertical axis is logarithmic and clearly shows how the hashing rate will slow down over the next two years. What’s somewhat interesting is that whether the BTC price remains the same, doubles or quadruples over that time the effect is still pronounced. The hashing rate continues to grow, but slows dramatically. What’s also important to reiterate is that these represent the highest hashing rates that can be achieved; when other overheads and profits are taken then the growth rate will be lower and flatter.”

Popper noted that this type of scaling also resulted in centralization:

Most of the new coins being released each day were collected by a few large mining syndicates. If this was the new world, it didn’t seem all that different from the old one — at least not yet. (page 336)

Moving on, on page 192, Popper writes:

The pools, though, generated concern about the creeping centralization of control in the network. It took the agreement of 5 percent of the computer power on the network to make changes to the blockchain and the Bitcoin protocol, making it hard for the one person to dictate what happened. But with the mining pools, the person running the pool generally had voting power for the entire pool — all the other computers were just worker bees. (page 192)

I think there is a typo here.  He probably meant 51% of the hashrate, not 5%.  Also, it may be more precise to say “actor” because in practice it is individuals at organizations that operate the farms and pools, not usually just one person.

On page 52 the author discussed the earliest days of Mt. Gox in 2010:

Mt. Gox was a significant departure from the exchange that already existed, primarily because Jed offered to take money from customers into his PayPal account and thereby risk violating the PayPal prohibition on buying and selling currencies.  This meant that Jed could receive funds from almost anywhere in the world.  What’s more, customers didn’t have to send Jed money each time they wanted to do a trade. Instead, they could hold money — both dollars and Bitcoin — in Jed’s account and then trade in either direction at any time as long as they had sufficient funds, much as in a traditional brokerage account.

Needless to say, Jed’s PayPal account eventually got shut down.

On page 65 the author briefly discusses the life of Mark Karpeles (the 2nd owner of Mt. Gox):

Since then, he’d had a peripatetic lifestyle, looking for a place where he could feel at home. He first tried Israel, thinking it might help him get closer to his Catholicism, but he soon felt as lonely as ever, and the servers he was running kept getting disrupted by rocket fire from Gaza.

Initially I thought Popper meant to write Judaism instead of Catholicism (Karpeles is a Jewish surname), but a DailyTech article states he is Catholic based on one of his blog posts.

On page 67 he writes:

But as the headaches continued to pile up, Jed got more antsy. In January, a Mt. Gox user named Baron managed to hack into Mt. Gox accounts and steal around $45,000 worth of Bitcoins and another type of digital currency that Jed had been using to transfer money around.

It’s not clear what the the other digital currency actually was — based on the timeline (January 2011) this is before Jed created XRP for OpenCoin (which later became Ripple Labs).

Also, I believe this is the first time in the book where the term “digital currency” is used.

On page 77 he writes about Roger Ver:

In the midst of his campaign for the assembly, federal agents arrested Roger for peddling Pest Control Report 2000 — a mix between a firecracker and a pest repellent — on eBay.  Roger had bought the product himself through the mail and he and his lawyer became convinced that the government was targeting Roger because of remarks he had made at a political rally, where had had called federal agents murderers.

This version of the story may or may not be true.

Either way, part of Ver’s 2002 case was unsealed last fall and someone sent me a copy of it (you can find the full version at PACER).  Below are a few quotes from the document (pdf) hosted at Lesperance & Associates between the prosecution (Mr. Frewing) and the judge presiding over the case.

“Mr. Ver’s conduct was serious.  I think one factor that the Court can take into consideration or at least should consider is there were some pipe bombs involved in this case as well that were not charged and are not incorporated in the conduct that’s before the Court except arguably as relevant conduct. The split sentence is — would result only in five months incarceration for what I think is a fairly serious offense.  It’s my recommendation to do the ten-month sentence in prison in total.”


Judge: “Well, I’ve given this case a lot of thought. I’m very troubled by it.  And when I say that I’m troubled by it I’m troubled by it in several ways.  Not only am I troubled by the underlying conduct, which is quite serious, but I don’t want to overreact either and I think that’s what makes it hard.I think if you have a case which strikes you as being particularly severe, in a way that’s kind of an easy thing to just say all right, we’ll throw the book at the defendant and that will satisfy that impulse.”

“But I don’t think judges ought to sentence anybody impulsively.  You have to look at the offense and you have to look at the person who committed it. There are elements in the probation report and in Dr. Missett’s report which concern me a great deal.  One has to be very careful.  Mr. Ver, you’re a young man and you’ve led a law-abiding life for the last two years and you’ve by all accounts performed well on pretrial release.  I did note in your letter that you accepted that your conduct was illegal, and I appreciate that. I also don’t in any way want to confuse your political beliefs, which you are absolutely entitled to have, with your criminal conduct.  There’s a long and honorable tradition of libertarian politics in our country and I don’t mean to in any way hold that against you.  It’s something that you’re entitled to have. The problem, though, is that the law is a representation of authority in a certain way.  People can disagree and they can disagree very vigorously and very reasonably about what ought to be legal and what ought not to be legal and how much the Government ought  to do or ought not to do.   But there is a point at which we start talking about public safety and I think even the most die hard libertarian would agree that one function of government, if there is to be a government, is to protect public safety.  So then it’s just a question of how you do it, how you do it in a way that’s least invasive of individual liberties.   Selling explosives over the Internet doesn’t cut it in any society that I can imagine and I think it’s — the conduct here is simply not tolerable conduct and it’s not — I don’t think one has to be a big government person or believe in government regulation of every aspect of human life to suggest that people should not be selling explosives over the Internet. The other thing that concerns me is that in looking at your social history it seems to me you’ve got some reasons for not trusting authority, and that’s.  I mean, those are feelings that are a product of your life experience.  Nonetheless, those feelings don’t give you the right to be above the same social constraints that bind all of us.”

“And I’m not saying this as well as I’d like to, but I think there’s a difference between saying I believe that the government which governs best governs least and saying that I’m above the law totally, that I’m so smart, I’m so able, I’m so perceptive that I don’t have to follow the rules that apply to other human beings.  There’s a difference between those two positions.  And while one of them is a very respectable position that I think any judge ought to uphold and support rather than punish, the other I think is why we have courts.  It’s when a person believes that he or she is so important and so intelligent and so much better than everybody else that they don’t have to follow even the most basic rules that keep us together in this society.”

“I think that these offenses are very serious.  They could have been a lot more serious.  The bombs could have gone off or people could have used them in destructive ways.  Selling bombs to juveniles is never okay.  I’d like to say that the five and five sentence that your attorney proposed is something that I’m comfortable with, but I just can’t.  And it’s not a desire to be overly punitive or to send you a message.  It’s simply saying that this conduct — when the law punishes behavior, criminal law is directed at conduct.  This conduct to me would have warranted a much stiffer sentence than ten months.  There’s a plea  agreement.  I’m bound by it.  I’m not going to upset it.  It was arrived at in good faith by the Government and by the defense and I will respect it, but I’m not going to dilute it.”

This will probably not be the last time the background and origin story of the characters in this journey are looked at.



Source: Billy Mabrey

On social media there is frequent talk of large “whales” and “bear whales” that are blamed for large up and down swings in prices.

Popper identified a few of them in the book.

For instance, on page 79 he writes about Roger Ver’s initial purchases:

In April 2011, after hearing about Bitcoin on Free Talk Live, he used his fortune to dive into Bitcoin with a savage ferocity. He sent a $25,000 wire to the Mt. Gox bank account in New York — one Jed had set up — to begin buying Bitcoins. Over the next three days, Roger’s purchases dominated the markets and helped push the price of a single coin up nearly 75 percent, from $1.89 to $3.30.

Another instance, on page 113:

But the people ignoring Jed’s advice ended up giving Bitcoin momentum at a time when it was otherwise lacking. Roger alone bought tens of thousands of coins in 2011, when the price was falling, single-handedly helping to keep the price above zero (and establishing the foundation for a future fortune).

Over the past year I have frequently been asked: why did the price begin increasing after the block reward halving at the end of November 2012?  Where did the price increase come from?

A number of people, particularly on reddit, conflate causation with correlation: that somehow the block halving caused a price increase.   As previously explored, this is incorrect.

So if it wasn’t the halvening, what then led to the price increase?

In January 2013, Popper looked at the Winklevoss twins:

The twins considered selling to Roger. But they also believed BitInstant was a good idea that could work under the right management. In January BitInstant had its best month ever, processing almost $5million in transactions. The price of a Bitcoin, meanwhile, had risen from $13 at the beginning of the month to around $18 at its end. Some of this was due to the twins themselves. They had asked Charlie to continue buying them coins with the goal of owning 1 percent of all Bitcoins in the world, or some $2 million worth at the time. This ambition underscored their commitment to sticking it out with Bitcoin. (page 175)

Simultaneously, another group of wealthy individuals, from Fortress Investment Group were purchasing bitcoins:

Pete assigned Tanona to the almost full-time job of exploring potential Bitcoin investments, and also drew in another top Fortress official, Mike Novogratz. All of them began buying coins in quantities that were small for them, but that represented significant upward pressure within the still immature Bitcoin ecosystem.

The purchases being made by Fortress — and by Mickey’s team at Ribbit — were supplemented by those being made by the Winklevoss twins, who were still trying to buy up 1 percent of all the outstanding Bitcoins. Together, these purchases helped maintain the sharp upward trajectory of Bitcoin’s price, which rose 70 percent in February after the 50 percent jump in January. On the evening of February 27 the price finally edged above the long-standing record of $32 that had been set in the hysterical days before the June 2011 crash at Mt. Gox. (p. 180)

Initially discussed introduction, Popper explains when Wences first met Pete Briger (p. 163, from Fortress Investment Group) during a January 2013 lodge in the Canadian Rockies.

A few pages later, in early March 2013, Wences is invited to a private retreat held at the Ritz Carlton in Tucson, Arizona hosted by Allen & Co.  There he met with and explained Bitcoin to: Dick Costolo, Reid Hoffman, James Murdoch, Marc Andreessen, Chris Dixon, David Marcus, John Donahoe, Henry Blodget, Michael Ovitz and Charlie Songhurst.

During this conference it appears several of these affluent individuals began buying bitcoins:

On Monday, the first full day of the conference, the price of Bitcoin jumped by more than two dollars, to $36, and on Tuesday it rose by more than four dollars — its sharpest rise in months — to over $40. On Wednesday, when everyone flew home, Blodget put up a glowing item on his heavily read website, Business Insider, mentioning what he’d witnessed (though not specifying where exactly he’d been, or whom he’d talked to)” (page 184)

The Henry Blodget article in question appeared on March 6: Suddenly, Everyone’s Talking About Bitcoin…

Why were they talking about it?

To prove how easy this all was, Wences asked Blodget to take out his phone and helped him create an empty Bitcoin wallet. Once it was up, and Wences had Blodget’s new Bitcoin address, Wences used the wallet on his own phone to send Blodget $250,000, or some 6,400 Bitcoins. The money was then passed to the phones of other people around the table once they had set up wallets. Anyone could have run off with Wence’s $250,000, but that wasn’t a risk with this particular crowd. Instead, as the money went around, Wences saw the guests’ laughter and wide-eyed amazement at what they were watching. (page 183)

It would be interesting to do some blockchain forensics (such as Total Output Volume and Bitcoin Days Destroyed) to see if we can identify a blob of 6,400 bitcoins moving around on March 3-5 maybe five to ten different times (it is unclear from the story how many people it was sent to).

And finally a little more whale action to round out the month:

The prices certainly suggested certainly suggested that someone with lots of money was buying. In California, Wences Casares knew that no small part of the new demand was coming from the millionaires whom he had gotten excited about Bitcoin earlier in the month and who were now getting their accounts opened and buying significant quantities of the virtual currency. They helped push the price to over $90 in the last week of March. At that price, the value of all existing coins, what was referred to as the market capitalization, was nearing $1 billion. (page 198)

The following month, in April,  during the run-up on Mt. Gox which later stalled and crashed under the strain of traffic:

The day after the crash, the Winklevoss twins finally went public in the New York Times with their now significant stake in Bitcoin — worth some $10 million. (page 211)


The twins didn’t want to buy coins while the price was still dropping, but when they saw it begin to stabilize, Cameron, who had done most fo the trading, began placing $100,000 orders on Bitstamp, the Slovenian Bitcoin exchange. Cameron compared the moment to a brief time warp that allowed them to go back and buy at a a lower price. They had almost $1 million in cash sitting with Bitstamp for exactly this sort of situation, and Cameron now intended to use it all.” (page 251)

Prices were around $110 – $130 each so they may have picked up an additional ~9,000 bitcoins or so.

Interestingly enough, Popper wrote the same New York Times article (cited above) that discussed the Winklevoss holdings.  In the same article he also noted another active large buyer during the same month:

A Maltese company, Exante, started a hedge fund that the company says has bought up about 82,000 bitcoins — or about $10 million as of Thursday — with money from wealthy investors. A founder of the fund, Anatoli Knyazev, said his main concern was hackers and government regulators, who have so far mostly left the currency alone.

The tl;dr of this information is that between January through March 2013, at least a dozen or so high-net-worth individuals collectively bought tens of millions of dollars worth of bitcoin.  The demand of which resulted in a rapid increase in market prices.  This had nothing to do with the block reward halving, just a coincidence.


Interwoven amount the story line are examples illustrating the trials and tribulations of securing bearer assets with new financial institutions that lack clear (if any) financial controls including Bitomat (which lost 17,000 bitcoins) and MyBitcoin (at least 25,000 bitcoins were stolen from).

It also discussed some internal dialogue at both Google and Microsoft.

According to Popper, Google, WellsFargo, PayPal, Microsoft all had high level individuals and teams looking at Bitcoin in early 2013.  On page 101, Osama Abedier from Google, spoke with Mike Hearn and said, “I would never admit it outside this room, but this is how payments probably should work.”

Popper cites a paper that Charlie Songhurst, head of corporate strategy at Microsoft, wrote after the Ritz Carlton event, channeling Casares’s arguments:

“We foresee a real possibility that all currencies go digital, and competition eliminates all currencies from noneffective governments. The power of friction-free transactions over the Internet will unleash the typical forces of consolidation and globalization, and we will end up with six digital currencies: US Dollar, euro, Yen, Pound, Renminbi and Bitcoin.”

Some politics:

I didn’t keep track of the phrase “digital gold” but I believe it only appeared twice.  Unsurprisingly, this phrase came about via some of the ideological characters he looked at.

In Wences’ view:

 “Unlike gold, it could be easily and quickly transferred anywhere in the world, while still having the qualities of divisibility and verifiability that had made gold a successful currency for so many years.” (Page 109)


Unlike gold, which was universal but difficult to acquire and hold, Bitcoins could be bought, held, and transferred by anyone with an internet connection, with the click of a mouse.

“Bitcoin is the first time in five thousands years that we have something better than gold, ” he said. “And its not a little bit better, it’s significantly better. It’s much more scarce. More divisible, more durable. It’s much more transportable. It’s just simply better.”  (p. 165)

The specific trade-offs between precious metals and cryptocurrencies is not fully fleshed out, but that probably would have detracted from the overall narrative.  Of maybe not.

Meet and greet:

“The Bitcoin forum was full of people talking about their experiences visiting Zuccotti Park and other Occupy encampments around the country to advertise the role that a decentralized currency could play in bringing down the banks.” (p. 111)

Who isn’t meddling?

“Few things occupied the common ground of this new political territory better than Bitcoin, which put power in the hands of the people using the technology, potentially obviating overpaid executives and meddling bureaucrats.” (p. 112)

I thought that was a tad distracting, it’s never really discussed what “overpaid” or “meddling” are.  Perhaps if there is a second edition, in addition to clarifying those we can have a chance to look at some of the sock puppets that a variety of these characters may have been operating too.

Public goods problem:

Many libertarians and anarchists argued that the good in humans, or in the market, could do the job of regulators, ensuring that bad companies did not survive. But the Bitcoin experience suggested that the penalties meted out by the market are often imposed only after the bad deeds were done and do not serve as a deterrent. (p. 114)

That last quote reminded me of an interview with Bitcoin Magazine last year with Vinay Gupta: ‘Bitcoin is Teaching Realism to Libertarians’

About Argentina:

“You don’t have to battling all of the government’s problems, you aren’t going to buy bread with it, but it’ll save you if you have a stash of stable currency that tends to appreciate in value,” twenty-two-year-old Emmanuel Ortiz told the newspaper (page 241)

There is no real discussion between the trade-offs of rebasing a currency to maintain purchasing power and its unclear why Ortiz thinks that an asset that fluctuates 10% or more each month is considered stable.


It’s unclear how many of the salacious stories were left on the cutting board, but there is always Brian Eha’s upcoming book.

In the meantime, avoiding the Product Trap:

It turned out that Charlie’s willingness to throw things at the wall, to see if they would stick, was not a bad thing at this point. The idealists who had been driving the Bitcoin world often got caught up in what they wanted the world to look like, rather than figuring out how to provide the world with something it would want. (page 129)

Hacking for fun and profit.  How secure is the code?  On page 154:

After quietly watching and playing with it for some time, Wences gave $100,000 of his own money to two high-level hackers he knew in eastern Europe and asked them to do their best to hack the Bitcoin protocol.  He was especially curious about whether they could counterfeit Bitcoins or spend the coins held in other people’s wallets — the most damaging possible flaw. At the end of the summer, the hackers asked Wences for more time and money. Wences ended up giving them $150,000 more, sent in Bitcoins. In October they concluded that the basic Bitcoin protocol was unbreakable, even if some of the big companies holding Bitcoins were not.

I’m sure we would all like to see more of the study, especially Tony Arcieri who wrote a lengthy essay a couple days ago on some potential issues with cryptographic curves/methods used in Bitcoin.

A little irony on page 162:

For Wences, Bitcoin seemed to address many of the problems that he’d long wanted to solve, providing a financial account that could be opened anywhere, by anyone, without requiring permission from any authority. He also saw an infant technology that he believed he could help grow to dimensions greater than anything he had previously achieved.

Permissionless systems seems to be everyone’s goal, yet everyone keeps making trusted third parties which inevitably need to VC funding to scale and with it, regulatory compliance which then creates a gated, permission-based process.

Altruism on the part of BTC Guild during the fork/non-fork issue in March 2013:

The developers on the chat channel thanks him, recognizing that he was sacrificing for the greater good. When he finally had everything moved about an hour later, Eleuthria took stock on his own costs  (page 195)

Trusted trustlessness?

 “The network had not had to rely on some central authority to wake up to the problem and come up with a solution. Everyone online had been able to respond in real time, as was supposed to happen with open source software, and the user had settled on a response after a debate that tapped the knowledge of all of them — even when it meant going against the recommendation of the lead developer, Gavin.” (page 195)

Origins of Xapo:

They started by putting all their private keys on a laptop, with no connection to the Internet, thus cutting off access for potential hackers. After David Marcus, Pete Briger, and Micky Malka put their private keys on the same offline laptop, the men paid for a safe-deposit box in a bank to store the computer more securely. In case the computer gave out, they also put a USB drive with all the private keys in the safe-deposit box. (page 201)


First, they encrypted all the information on the laptop so that if someone got hold of the laptop that person still wouldn’t be able to get the secret keys. They put the keys for decrypting the laptop in a bank near Feede in Buenos Aires. Then they moved the laptop from a safe-deposit box to a secure data center in Kansas City. By this time, the laptop was holding the coins of Wences, Fede, David Marcus, Pete Briger, and several other friends. The private keys on the laptop were worth tens of millions of dollars. (page 281)

I heard a similar story regarding the origins of BitGo, that Mike Belshe used to walk around with a USB drive on his key chain that had privkey’s to certain individual accounts.  This is before the large upsurge in market value.  When the prices began to rise he realized he needed a better solution.  Perhaps this story is more apocryphal than real, but I suspect there have been others whose operational security was not the equivalent of Fort Knox prior to 2013.

Alex Waters

An unnamed Alex Waters appears twice:

“The new lead developer called for the entire site to be taken down and rebuilt. But there wasn’t time as a new customers were pouring money into the site. The new staff members were jammed into every corner of the small offices Charlie and Erik had moved into the previous summer.” (page 202)

And again:

“But as problems became more evident, they talked with Charlie’s chief programmer about replacing Charlie as CEO. When Charlie learned about the potential palace coup he was furious and began showing up for work less and less.” (page 221)

For those unfamiliar with Alex, he was the CTO of BitInstant who went on to co-found CoinValidation and then currently, & Coinapex.

Last week I had a chance to meet with him in NYC.

alex waters

Alex Waters (CEO, Sarah Tyre (COO, Isaac Bergman, myself

Yesterday I reached out to Alex about the two quotes above related to BitInstant and this is what he sent (quoted with permission):

“It was sad to see Bitinstant take such a drastic turn after the San Jose conference. It was as if we built a gold mine and couldn’t stop someone from taking dynamite into it. A lot of good people worked at Bitinstant (like 25 people) and the 2.0 product we wanted to launch was outstanding. It’s frustrating that some poor decisions early in the company’s history put pressure on such an important moment. A lot of us who worked there worked really hard with sleepless nights for months on a relaunch that never made it to the public. Those people didn’t list Bitinstant on their resume after the collapse as it was so clearly tainted. The quality of those people’s work was outstanding, and they had no part or knowledge of anything illegal. Our compliance standards were beyond reproach for the industry.”

Coinbase compliance

Just two months ago Coinbase was in the news due to some issues with their pitch deck (pdf) as it related to marketing Bitcoin as a method for bypassing country specific sanctions.

However two years ago they ran into a slightly different issue:

In order to stay on top of anti-money laundering laws, the bank had to review every single transaction, and these reviews cost the bank more money than Coinbase was brining in. The bank imposed more restrictions on Coinbase than on other customers because Bitcoin inherently made it easier to launder money. (page 203)


Coinbase had to repeatedly convince Silicon Valley Bank that it knew where the Bitcoins leaving Coinbase were going.  Even with all these steps, on several days in March Coinbase hit up against transaction limits set by Silicon Valley Bank and had to shut down until the next day. (page 204)

Not quite accurate

In looking at my notes in the margin I didn’t find many inaccuracies.  Two small ones that stood out:

In early December Roger used some of his Bitcoin holdings, which had gone up in value thousands of times, to make a $1 million donation to the Electronic Frontier Foundation, an organization that had been started by a former Cypherpunk to defend online privacy, among other things. (page 270)

Actually, Ver donated $1 million worth of bitcoins to FEE, the Foundation for Economic Education not EFF.

But over time the two Vals kept more and more of the computers for themselves and put them in data centers spread around the world, in places that offered cheap energy, including the Republic of Georgia and Iceland. These operations were literally minting money. Val Nebesny was so valuable that Bitfury did not disclose where he lived, though he was rumored to have moved from Ukraine to Spain. And Bitfury was so good that it soon threatened to represent more than 50 percent of the total mining power in the world; this would give it commanding power over the functioning of the network. The company managed to assuage concerns, somewhat, only when it promised never to go above 40 percent of the mining power online at any time. Bitfury, of course, had an interest in doing this because if people lost faith in the network, the Bitcoins being mind by the company would become worthless. (page 330)

While the two Val’s did create Bitfury, I am fairly certain the scenario that is described above is that of the mining pool (managed by during the early summer of 2014.  At one point in mid-June 2014, the GHash pool was regularly winning 40% or more of the blocks on several days.  Subsequently the CIO attempted to assuage concerns by stating they will make sure their own pool doesn’t go above a self-imposed threshold of 40%.

Probably overhyped:

I spent some time discussing this use-case in the previous review:

On Patrcik Murck: “But he was able to cogently explain his vision of how the blockchain technology could make it easier for poor immigrants to transfer money back home and allow people with no access to a bank account or credit card to take part in the Internet economy.” (page 235)

I think Yakov Kofner’s piece last month outlines the difficult challenges facing “rebittance” companies many of whom are ignoring the long term customer acquisition and compliance costs (not to mention the cash-in/cash-out hurdles).2 That’s not to say they will not be overcome, but it is probably not the slam dunk that Bitprophets claim it is.

The notion that Bitcoin could provide a new payment network was not terribly new. This is what Charlie Shrem had been talking about back in 2012, and BitPay was already using the network to charge lower transaction fees than the credit card networks.” (page 272)

Temporarily.  The problem is, after all the glitzy free PR splash in 2014, there was almost no real uptake.  So the sales and business development teams at payment processors now have a difficult time showing actual traction to future clients so that they too will begin using the payment processors.  See for instance, BitPay’s numbers.

For example, on page 352 the author notes that:

It might have just been the exhaustion, but Wences was sourly dismissive of all the talk about Bitcoin’s potential as a new payment system. He was an investor in Bitpay but he said that fewer than one hundred thousand individuals had actually purchased anything using Bitpay.

“There is no payment volume, ” he scoffed. “It’s a sideshow.”

Payments again:

“But in interviews he emphasized the more practical reasons for any company to make the move: no more paying the credit card companies 2.5 percent for each transaction (the company helping Overstock take Bitcoin, Coinbase, charged Overstock 1 percent)…”

“This was attractive to merchants because BitPay charged around 1 percent for its service while credit card networks generally charged between 2 and 3 percent per transaction.” p. 134

While I have no inside knowledge of their specific arrangement, I believe the promotional pitch is 0% for the first $1 million processed and 1% thereafter.  Overstock processed about $3 million last year.  And the BitPay fee appears to be unsustainable (see my previous book review on The Age of Cryptocurrency as well as the BitPay number’s breakdown).

Probably not true:

The potential advantages of Bitcoin over the existing system were underscored in late December, when it was revealed that hackers had breached the payment systems of the retail giant Target and made off with the credit card information of some 70 million Americans, from every bank and credit card issuer in the country. This brought attention to an issue that Bitcoiners had long been talking about: the relative lack of privacy afforded by traditional payment systems. When Target customers swiped their credit cards at a register, they handed over their account number and expiration date. For online purchases Target also had to gather the addresses and ZIP codes of customers, to verify transactions. If the customers had been using Bitcoin, they could have sent along their payments without giving Target any personal information at all. (page 289)

In theory, yes, if users control their own privkey on their own devices.  In practice, since most users use trusted third parties like Coinbase, Xapo and Circe, a hacker could potentially retrieve the same personal information from them; furthermore, because some merchants collect and require KYC then they are also vulnerable to identity theft.

For instance,

What’s more, Coinbase customers didn’t have to download the somewhat complicated Bitcoin software and thew hole blockchain, with its history of all bitcoin transactions. This helped turn Coinbase into the go-to-company for Americans looking to acquire Bitcoins and helped expand the audience for the technology. (page 237)

That’s a silo-coin.  Useful and helpful to on-ramping people.  But effectively a bank in practice.  Why not just use a real bank instead?

The more you know:

  • I thought the short explanation of hashcash on page 18 was good.
  • Was a little surprised that Eric Hughes was mentioned, but not Tim May.
  • On page 296, Xapo raised $40 million at a $100 million valuation in less than a couple months and on page 306, was banked by Silicon Valley Bank (which Coinbase also uses).
  • The Dread Pirate Roberts / Silk Road storyline that Popper discusses is upstaged by recent events that did not have a chance to make it into the book.  This includes the arrest of a DEA agent and Secret Service agent who previously worked on the Silk Road case for their respective agencies.
  • In addition, ArsTechnica recently published an interesting op-ed on the whole trial: Silk Road film unintentionally shows what’s wrong with the “Free Ross” crowd.

On Roger Ver potentially selling his stake in

“Roger was constantly getting entreaties from venture capitalists who wanted to pay millions for some of his 80 percent stake in the company. “(p. 330)

In October 2014, after the book was completed, announced that it had closed a $30.5 million round, half of which was raised in bitcoins.

Germane citation:

An academic study in 2013 had found that 45 percent of the Bitcoin exchanges that had taken money had gone under, several taking the money of their customers with them (page 317)

The citation comes from an interesting paper, Beware the Middleman: Empirical Analysis of Bitcoin-Exchange Risk by Tyler Moore and Nicolas Christin

Federated blockchain:

This JPMorgan group began secretly working with the other major banks in the country, all of which are part of an organization known as The Clearing House, on a bold experimental effort to create a new blockchain that would be jointly run by the computers of the largest banks and serve as the backbone for a new, instant payment system that might replace Visa, MasterCard, and wire transfers. Such a blockchain would not need to rely on the anonymous miners powering the Bitcoin blockchain. But it could ensure there would no longer be a single point of failure in the payment network. If Visa’s system came under attack, all the stores using Visa were screwed. But if one bank maintaining a blockchain came under attack, all the other banks could keep the blockchain going.

While the The Clearing House is not secretive, the project to create an experimental blockchain was; this is the first I had heard of it.

Concluding remarks:

I had a chance to meet Nathaniel Popper about 14 months ago during the final day of Coinsummit.  We chatted a bit about what was happening in China and potential angles for how and why the mainland mattered to the overall Bitcoin narrative.

There is only so much you can include in a book and if I had my druthers I would have liked to add perhaps some more on the immediate history pre-Bitcoin: projects such as the now-defunct Liberty Reserve (which BitInstant was allegedly laundering money for) and the various dark net markets and online poker sites that were shut down prior to the creation of Bitcoin yet whose customer base would go on to eventually adopt the cryptocurrency for payments and bets (making up some of the clientele for SatoshiDice and other Bitcoin casinos).

Similarly, I would have liked to have looked at a few of the early civil lawsuits in which some of the early adopters were part of.  For instance, the Bitcoinica lawsuit is believed to be the first Bitcoin-related lawsuit (filed in August 2012) and includes several names that appeared throughout the book: plaintiffs: Brian Cartmell, Jed McCaleb, Jesse Powell and Roger Ver; defendants: Donald Norman, Patrick Strateman and Amir Taaki.  The near collapse of the Bitcoin Foundation and many of its founders would make an interesting tale in a second edition, particularly Peter Vessenes (former chairman of the board) whose ill-fated Coinlab and now-bankrupt Alydian mining project are worth closer inspection.

Overall I think this was an easy, enjoyable read.  I learned a number of new things (especially related to the amount of large purchases in early 2013) and think its worth looking at irrespective of your interest in internet fun bux.

End notes:

  1. See What is the “real” price of bitcoin? []
  2. See also: The Rise and Rise of Lipservice: Viral Western Union Ad Debunked []
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Book review: The Age of Cryptocurrency

age of cryptocurrencyOn my trip to Singapore two weeks ago I read through a new book The Age of Cryptocurrency, written by Michael Casey and Paul Vigna — two journalists with The Wall Street Journal.

Let’s start with the good.  I think Chapter 2 is probably the best chapter in the book and the information mid-chapter is some of the best historical look on the topic of previous electronic currency initiatives.  I also think their writing style is quite good.  Sentences and ideas flow without any sharp disconnects.  They also have a number of endnotes in the back for in-depth reading on certain sub-topics.

In this review I look at each chapter and provide some counterpoints to a number of the claims made.


[Note: I manually typed the quotes from the book, all transcription errors are my own and should not reflect on the book itself.]

The book starts by discussing a company now called bitLanders which pays content creators in bitcoin.  The authors introduce us to Francesco Rulli who pays his bloggers in bitcoin and tries to forbid them from cashing out in fiat, so that they create a circular flow of income.1 One blogger they focus on is Parisa Ahmadi, a young Afghani woman who lacks access to the payment channels and platforms that we take for granted.  It is a nice feel good story that hits all the high notes.

Unfortunately the experience that individuals like Ahmadi, are not fully reflective of what takes place in practice (and this is not the fault of bitLanders).  For instance, the authors state on p. 2 that: “Bitcoins are stored in digital bank accounts or “wallets” that can be set up at home by anyone with Internet access.  There is no trip to the bank to set up an account, no need for documentation or proof that you’re a man.”

This is untrue in practice.  Nearly all venture capital (VC) funded hosted “wallets” and exchanges now require not only Know-Your-Customer (KYC) but in order for any type of fiat conversion, bank accounts.  Thus there is a paradox: how can unbanked individuals connect a bank account they do not have to a platform that requires it?  This question is never answered in the book yet it represents the single most difficult aspect to the on-boarding experience today.

Starting on page 3, the authors use the term “digital currency” to refer to bitcoins, a practice done throughout the remainder of the book.  This contrasts with the term “virtual currency” which they only use 12 times — 11 of which are quotes from regulators.  The sole time “virtual currency” is not used by a regulator to describe bitcoins is from David Larimer from Invictus (Bitshares).  It is unclear if this was an oversight.

Is there a difference between a “digital currency” and “virtual currency”?  Yes.  And I have made the same mistake before.

Cryptocurrencies such as bitcoin are not digital currencies.  Digital currencies are legal tender, as of this writing, bitcoins are not.  This may seem like splitting hairs but the reason regulators use the term “virtual currency” still in 2015 is because no jurisdiction recognizes bitcoins as legal tender.  In contrast, there are already dozens of digital currencies — nearly every dollar that is spent on any given day in the US is electronic and digital and has been for over a decade.  This issue also runs into the discussion on nemo dat described a couple weeks ago.

On page 4 the authors very briefly describe the origination of currency exchange which dates back to the Medici family during the Florentine Renaissance.  Yet not once in the book is the term “bearer asset” mentioned.  Cryptocurrencies such as bitcoin are virtual bearer instruments and as shown in practice, a mega pain to safely secure.  500 years ago bearer assets were also just as difficult to secure and consequently individuals outsourced the security of it to what we now call banks.  And this same behavior has once again occurred as large quantities — perhaps the majority — of bitcoins now are stored in trusted third party depositories such as Coinbase and Xapo.

Why is this important?

Again recall that the term “trusted third party” was used 11 times (in the body, 13 times altogether) in the original Nakamoto whitepaper; whoever created Bitcoin was laser focused on building a mechanism to route around trusted third parties due to the additional “mediation and transaction costs” (section 1) these create.  Note: that later on page 29 they briefly mentioned legal tender laws and coins (as it related to the Roman Empire).

On page 8 the authors describe the current world as “tyranny of centralized trust” and on page 10 that “Bitcoin promises to take at least some of that power away from governments and hand it to the people.”

While that may be a popular narrative on social media, not everyone involved with Bitcoin (or the umbrella “blockchain” world) holds the same view.  Nor do the authors describe some kind of blue print for how this is done.  Recall that in order to obtain bitcoins in the first place a user can do one of three things:

  1. mine bitcoins
  2. purchase bitcoins from some kind of exchange
  3. receive them for payments (e.g., merchant activity)

In practice mining is out of the hands of “the people” due to economies of scale which have trended towards warehouse mining – it is unlikely that embedded ASICs such as from 21 inc, will change that dynamic much, if any.  Why?  Because for every device added to the network a corresponding amount of difficulty is also added, diluting the revenue to below dust levels.  Remember how Tom Sawyer convinced kids to whitewash a fence and they did so eagerly without question?  What if he asked you to mine bitcoins for him for free?  A trojan botnet?  While none of the products have been announced and changes could occur, from the press release that seems to be the underlying assumption of the 21 inc business model.

In terms of the second point, nearly all VC funded exchanges require KYC and bank accounts.  The ironic aspect is that “unbanked” and “underbanked” individuals often lack the necessary “valid” credentials that can be used by cheaper automated KYC technology (from Jumio) and thus expensive manual processing is done, costs that must be borne by someone.  These same credential-less individuals typically lack a bank account (hence the name “unbanked”).

Lastly with the third point, while there are any number of merchants that now accept bitcoin, in practice very few actually do receive bitcoins on any given day.  Several weeks ago I broke down the numbers that BitPay reported and the verdict is payment processing is stagnant for now.

Why is this last point important to what the authors refer to as “the people”?

Ten days after Ripple Labs was fined by FinCEN for not appropriately enforcing AML/KYC regulations, Xapo  — a VC funded hosted wallet startup — moved off-shore, uprooting itself from Palo Alto to Switzerland.  While the stated reason is “privacy” concerns, it is likely due to regulatory concerns of a different nature.

In his interview with CoinDesk last week, Wences Casares, the CEO and founder of Xapo noted that:

Still, Casares indicated that Xapo’s customers are most often using its accounts primarily for storage and security. He noted that many of its clientele have “never made a bitcoin payment”, meaning its holdings are primarily long-term bets of high net-worth customers and family offices.

“Ninety-six percent of the coins that we hold in custody are in the hands of people who are keeping those coins as an investment,” Casares continued.

96% of the coins held in custody by Xapo are inert.  According to a dated presentation, the same phenomenon takes place with Coinbase users too.

Perhaps this behavior will change in the future, though, if not it seems unclear how this particular “to the people” narrative can take place when few large holders of a static money supply are willing to part with their virtual collectibles.  But this dovetails into differences of opinion on rebasing money supplies and that is a topic for a different post.

On page 11 the authors describe five stages of psychologically accepting Bitcoin.  In stage one they note that:

Stage One: Disdain.  Not even denial, but disdain.  Here’s this thing, it’s supposed to be money, but it doesn’t have any of the characteristics of money with which we’re familiar.

I think this is unnecessarily biased.  While I cannot speak for other “skeptics,” I actually started out very enthusiastic — I even mined for over a year — and never went through this strange five step process.  Replace the word “Bitcoin” with any particular exciting technology or philosophy from the past 200 years and the five stage process seems half-baked at best.

On page 13 they state, “Public anxiety over such risks could prompt an excessive response from regulators, strangling the project in its infancy.”  Similarly on page 118 regarding the proposed New York BitLicense, “It seemed farm more draconian than expected and prompted an immediate backlash from a suddenly well-organized bitcoin community.”

This is a fairly alarmist statement.  It could be argued that due to its anarchic code-as-law coupled with its intended decentralized topology, that it could not be strangled.  If a certain amount of block creating processors (miners) was co-opted by organizations like a government, then a fork would likely occur and participants with differing politics would likely diverge.  A KYC chain versus an anarchic chain (which is what we see in practice with altchains such as Monero and Dash).  Similarly, since there are no real self-regulating organizations (SRO) or efforts to expunge the numerous bad actors in the ecosystem, what did the enthusiasts and authors expect would occur when regulators are faced with complaints?

With that said — and I am likely in a small minority here — I do not think the responses thus far from US regulators (among many others) has been anywhere near “excessive,” but that’s my subjective view.  Excessive to me would be explicitly outlawing usage, ownership and mining of cryptocurrencies.  Instead what has occurred is numerous fact finding missions, hearings and even appearances by regulators at events.

On page 13 the authors state that “Cryptocurrency’s rapid development is in some ways a quirk of history: launched in the throes of the 2008 financial crisis, bitcoin offered an alternative to a system — the existing financial system — that was blowing itself up and threatening to take a few billion people down with it.”

This is retcon.  Satoshi Nakamoto, if he is to be believed, stated that he began coding the project in mid-2007.  It is more of a coincidence than anything else that this project was completed around the same time that global stock indices were at their lowest in decades.

Chapter 1:

On page 21 the authors state that, “Bitcoin seeks to address this challenge by offering users a system of trust based not on human being but on the inviolable laws of mathematics.”

While the first part is true, it is a bit cliche to throw in the “maths” reason.  There are numerous projects in the financial world alone that are run by programs that use math.  In fact, all computer programs and networks use some type of math at their foundation, yet no one claims that the NYSE, pace-makers, traffic intersections or airplanes are run by “math-based logic” (or on page 66, “”inviolable-algorithm-based system”).  A more accurate description is that Bitcoin’s monetary system is rule-based, using a static perfectly inelastic supply in contrast to either the dynamic or discretionary world humans live in.  Whether this is desirable or not is a different topic.

On page 26 they describe the Chartalist school of thought, the view that money is political, that “looks past the thing of currency and focuses instead on the credit and trust relationships between the individual and society at large that currency embodies” […] “currency is merely the token or symbol around which this complex system is arranged.”

This is in contrast to the ‘metallist’ mindset of some others in the Bitcoin community, such as Wences Casares and Jon Matonis (perhaps there is a distinct third group for “barterists”?).

I thought this section was well-written and balanced (e.g., appropriate citation of David Graeber on page 28; and description of what “seigniorage” is on page 30 and again on page 133).

On page 27 the authors write, “Yet many other cryptocurrency believers, including a cross section of techies and businessmen who see a chance to disrupt the bank centric payments system are de facto charatalists.  They describe bitcoin not as a currency but as a payments protocol.”

Perhaps this is true.  Yet from the original Nakamoto whitepaper, perhaps he too was a chartalist?  Stating in section 1:

Commerce on the Internet has come to rely almost exclusively on financial institutions serving as trusted third parties to process electronic payments. While the system works well enough for most transactions, it still suffers from the inherent weaknesses of the trust based model. Completely non-reversible transactions are not really possible, since financial institutions cannot avoid mediating disputes. The cost of mediation increases transaction costs, limiting the minimum practical transaction size and cutting off the possibility for small casual transactions, and there is a broader cost in the loss of ability to make non-reversible payments for non-reversible services. With the possibility of reversal, the need for trust spreads. Merchants must be wary of their customers, hassling them for more information than they would otherwise need. A certain percentage of fraud is accepted as unavoidable. These costs and payment uncertainties can be avoided in person by using physical currency, but no mechanism exists to make payments over a communications channel without a trusted party.

A payments rail, a currency, perhaps both?

Fun fact: the word “payment” appears 12 times in the whole white paper, just one time less than the word “trust” appears.

On page 29 they cite the Code of Hammurabi.  I too think this is a good reference, having made a similar reference to the Code in Chapter 2 of my book last year.

On page 31 they write, “Today, China grapples with competition to its sovereign currency, the yuan, due both to its citizens’ demand for foreign national currencies such as the dollar and to a fledgling but potentially important threat from private, digital currencies such as bitcoin.”

That is a bit of a stretch.  While Chinese policy makers do likely sweat over the creative ways residents breach and maneuver around capital controls, it is highly unlikely that bitcoin is even on the radar as a high level “threat.”  There is no bitcoin merchant economy in China.  The vast majority of activity continues to be related to mining and trading on exchanges, most of which is inflated by internal market making bots (e.g., the top three exchanges each run bots that dramatically inflate the volume via tape painting).  And due to how WeChat and other social media apps in China frictionlessly connect residents with their mainland bank accounts, it is unlikely that bitcoin will make inroads in the near future.

On page 36 they write, “By 1973, once every country had taken its currency off the dollar peg, the pact was dead, a radical change.”

In point of fact, there are 23 countries that still peg their currency to the US dollar.  Post-1973 saw a number of flexible and managed exchange rate regimes as well as notable events such as the Plaza Accord and Asian Financial Crisis (that impacted the local pegs).

On page 39 they write, “By that score, bitcoin has something to offer: a remarkable capacity to facilitate low-cost, near-instant transfer of value anywhere in the world.”

The point of contention here is the “low-cost” — something that the authors never really discuss the logistics of.  They are aware of “seigniorage” and inflationary “block rewards” yet they do not describe the actual costs of maintaining the network which in the long run, the marginal costs equal the marginal value (MC=MV).

This is an issue that I tried to bring up with them at the Google Author Talk last month (I asked them both questions during the Q&A):

The problem for Vigna’s view, (starting around 59m) is that if the value of a bitcoin fell to $30, not only would the network collectively “be cheaper” to maintain, but also to attack.

On paper, the cost to successfully attack the network today by obtaining more than 50% of the hashrate at this $30 price point would be $2,250 per hour (roughly 0.5 x MC) or roughly an order of magnitude less than it does at today’s market price (although in practice it is a lot less due to centralization).  Recall that the security of bitcoin was purposefully designed around proportionalism, that in the long run it costs a bitcoin to secure a bitcoin.  We will talk about fees later at the end of next chapter.

Chapter 2:

On page 43, in the note at the bottom related to Ray Dillinger’s characterization that bitcoin is “highly inflationary” — Dillinger is correct in the short run.  The money supply will increase by 11% alone this year.  And while in the long run the network is deflationary (via block reward halving), the fact that the credentials to the bearer assets (bitcoins) are lost and destroyed each year results in a non-negligible amount of deflation.

For instance, in chapter 12 I noted some research: in terms of losing bitcoins, the chart below illustrates what the money supply looks like with an annual loss of 5% (blue), 1% (red) and 0.1% (green) of all mined bitcoins.

lost coins

Source: Kay Hamacher and Stefan Katzenbeisser

In December 2011, German researchers Kay Hamacher and Stefan Katzenbeisser presented research about the impact of losing the private key to a bitcoin. The chart above shows the asymptote of the money supply (Y-axis) over time (X-axis).

According to Hamacher:

So to get rid of inflation, they designed the protocol that over time, there is this creation of new bitcoins – that this goes up and saturates at some level which is 21 million bitcoins in the end.

But that is rather a naïve picture. Probably you have as bad luck I have, I have had several hard drive crashes in my lifetime, and what happens when your wallet where your bitcoins are stored and your private key vanish? Then your bitcoins are probably still in the system so to speak, so they are somewhat identifiable in all the transactions but they are not accessible so they are of no economic value anymore. You cannot exchange them because you cannot access them. Or think more in the future, someone dies but his family doesn’t know the password – no economic value in those bitcoins anymore. They cannot be used for any exchange anymore. And that is the amount of bitcoins when just a fraction per year vanish for different fractions. So the blue curve is 5% of all the bitcoins per year vanish by whatever means there could be other mechanisms.

It is unclear exactly how many bitcoins can be categorized in such a manner today or what the decay rate is.

On page 45 the authors write, “Some immediately homed in on a criticism of bitcoin that would become common: the energy it would take to harvest “bitbux” would cost more than they were worth, not to mention be environmentally disastrous.”

While I am unaware of anyone who states that it would cost more than what they’re worth, as stated in Appendix B and in Chapter 3 (among many other places), the network was intentionally designed to be expensive, otherwise it would be “cheap to attack.”  And those costs scale in proportion to the token value.

As noted a few weeks ago:

For instance, last year O’Dwyer and Malone found that Bitcoin mining consumes roughly the same amount of energy as Ireland does annually.  It is likely that their estimate was too high and based on Dave Hudson’s calculations closer to 10% of Ireland’s energy consumption.23 Furthermore, it has likely declined since their study because, as previously explored in Appendix B, this scales in proportion with the value of the token which has declined over the past year.

The previous post looked at bitcoin payments processed by BitPay and found that as an aggregate the above-board activity on the Bitcoin network was likely around $350 million a year.  Ireland’s nominal GDP is expected to reach around $252 billion this year.  Thus, once Hudson’s estimates are integrated into it, above-board commercial bitcoin activity appears to be about two orders of magnitude less than what Ireland produces for the same amount of energy.

Or in other words, the original responses to Nakamoto six and a half years ago empirically was correct.  It is expensive and resource intensive to maintain and it was designed to be so, otherwise it would be easy to attack, censor and modify the history of votes.

Starting on page 56 they describe Mondex, Secure Electronic Transaction (SET), Electronic Monetary System, Citi’s e-cash model and a variety of other digital dollar systems that were developed during the 1990s.  Very interesting from a historical perspective and it would be curious to know what more of these developers now think of cryptocurrency systems.  My own view, is that the middle half of Chapter 2 is the best part of the book: very well researched and well distilled.

On page 64 they write:

[T]hat Nakamoto launched his project with a reminder that his new currency would require no government, no banks and no financial intermediaries, “no trusted third party.”

In theory this may be true, but in practice, the Bitcoin network does not natively provide any of the services banks do beyond a lock box.  There is a difference between money and the cornucopia of financial instruments that now exist and are natively unavailable to Bitcoin users without the use of intermediaries (such as lending).

On page 66 they write, “He knew that the ever-thinning supply of bitcoins would eventually require an alternative carrot to keep miners engaged, so he incorporated a system of modest transaction fees to compensate them for the resources they contributed.  These fees would kick in as time went on and as the payoff for miners decreased.”

That’s the theory and the popular narrative.

However, what does it look like in practice?

Above is a chart visualizing fees to miners denominated in USD from January 2009 to May 17, 2015.  Perhaps the fees will indeed increase to replace block rewards, or conversely, maybe as VC funding declines in the coming years, the companies that are willing and able to pay fees for each transaction declines.

On page 67, the authors introduce us to Laszlo Hanyecz, a computer programmer in Florida who according to the brief history of Bitcoin lore, purchased two Papa John’s pizzas for 10,000 bitcoins on May 22, 2010 (almost five years ago to the day).  He is said to have sold 40,000 bitcoins in this manner and generated all of the bitcoins through mining.  He claims to be the first person to do GPU mining, ramping up to “over 800 times” of a CPU; and during this time “he was getting about half of all the bitcoins mined.”  According to him, he originally used a Nvidia 9800 GTX+ and later switched to 2 AMD Radeon 5970s.  It is unclear how long he mined or when he stopped.

In looking at the index of his server, there are indeed relevant OpenCL software files.  If this is true, then he beat ArtForz to GPU mining by at least two months.

solar pizza

Source: Laszlo Hanyecz personal server

On page 77 they write, “Anybody can go on the Web, download the code for no cost, and start running it as a miner.”

While technically this is true, that you can indeed download the Satoshi Bitcoin core client for free, restated in 2015 it is not viable for hoi polloi.  In practice you will not generate any bitcoins solo-mining on a desktop machine unless you do pooled mining circa 2011.  Today, even pooled mining with the best Xeon processors will be unprofitable.  Instead, the only way to generate enough funds to cover both the capital expenditures and operating expenditures is through the purchase of single-use hardware known as an ASIC miner, which is a depreciating capital good.  Mining has been beyond the breakeven reach of most non-savvy home users for two years now, not to mention those who live in developing countries with poor electrical infrastructure or uncompetitive energy rates.  It is unlikely that embedded mining devices will change that equation due to the fact that every additional device increases the difficultly level whilst the device hashrate remains static.

This ties in with what the authors also wrote on page 77, “You don’t buy bitcoin’s software as you would other products, which means you’re not just a customer.  What’s more, there’s no owner of the software — unlike, say, PayPal, which is part of eBay.”

This is a bit misleading.  In order to use the Bitcoin network, users must obtain bitcoins somehow.  And in practice that usually occurs through trusted third parties such as Coinbase or Xapo which need to identify you via KYC/AML processes.  So while in 2009 their quote could have been true, in practice today that is largely untrue for most new participants — someone probably owns the software and your personal data.  In fact, a germane quote on reddit last week stated, “Why don’t you try using Bitcoin instead of Coinbase.”

Furthermore, the lack of “ownership” of Bitcoin is dual-edged as there are a number of public goods problems with maintaining development that will be discussed later.

On page 87 they describe as a “high-profile wallet and analytics firm.”  I will come back to “wallets” later.  Note: most of these “wallets” are likely throwaway, temp wallets used to move funds to obfuscate provenance through the use of Shared Coin (one of the ways generates revenue is by operating a mixer).

Overall Chapter 3 was also fairly informative.  The one additional quibble I have is that Austin and Beccy Craig (the story at the end) were really only able to travel the globe and live off bitcoins for 101 days because they had a big cushion: they had held a fundraiser that raised $72,995 of additional capital.  That is enough money to feed and house a family in a big city for a whole year, let alone go globe trotting for a few months.

Chapter 4:

On page 99 they describe seven different entities that have access to credit card information when you pay for a coffee at Starbucks manually.  Yet they do not describe the various entities that end up with the personal information when signing up for services such as Coinbase, ChangeTip, Circle and Xapo or what these depository institutions ultimately do with the data (see also Richard Brown’s description of the payment card system).

When describing cash back rewards that card issuers provide to customers, on page 100 they write, “Still it’s an illusion to think you are not paying for any of this.  The costs are folded into various bank charges: card issuance fees, ATM fees, checking fees, and, of course, the interest charged on the millions of customers who don’t pay their balances in full each month.”

Again, to be even handed they should also point out all the fees that Coinbase charges, Bitcoin ATMs charge and so forth.  Do any of these companies provide interest-bearing accounts or cash-back rewards?

On page 100 they also stated that, “Add in the cost of fraud, and you can see how this “sand in the cogs” of the global payment system represents a hindrance to growth, efficiency, and progress.”

That seems a bit biased here.  And my statement is not defending incumbents: global payment systems are decentralized yet many provide fraud protection and insurance — the very same services that Bitcoin companies are now trying to provide (such as FDIC insurance on fiat deposits) which are also not free.

On page 100 they also write, “We need these middlemen because the world economy still depends on a system in which it is impossible to digitally send money from one person to another without turning to an independent third party to verify the identity of the customer and confirm his or her right to call on the funds in the account.”

Again, in practice, this is now true for Bitcoin too because of how most adoption continues to take place on the edges in trusted third parties such as Coinbase and Circle.

On page 101 they write:

In letting the existing system develop, we’ve allowed Visa and MasterCard to form a de facto duopoly, which gives them and their banking partners power to manipulate the market, says Gil Luria, an analyst covering payment systems at Wedbush Securities.  Those card-network firms “not only get to extract very significant fees for themselves but have also created a marketplace in which banks can charge their own excessive fees,” he says.

Why is it wrong to charge fees for a service?  What is excessive?  I am certainly not defending incumbents or regulatory favoritism but it is unclear how Bitcoin institutions in practice — not theory — actually are any different.

And, the cost per transaction for Bitcoin is actually quite high (see chart below) relative to these other systems due to the fact that Bitcoin also tries to be a seigniorage system, something that neither Visa or MasterCard do.

cost per transaction

Source: Markos05

On page 102 when talking about MasterCard they state, “But as we’ve seen, that cumbersome system, as it is currently designed, is tightly interwoven into the traditional banking system, which always demands a cut.”

The whole page actually is a series of apples-and-oranges comparisons.  Aside from settlement, the Bitcoin network does not provide any of the services that they are comparing it to.  There is nothing in the current network that provides credit/lending services whereas the existing “cumbersome” system was not intentionally designed to be cumbersome, but rather is intertwined and evolved over decades so that customers can have access to a variety of otherwise siloed services.  Again, this is not to say the situation cannot be improved but as it currently exists, Bitcoin does not provide a solution to this “cumbersome” system because it doesn’t provide similar services.

On page 102 and 103 they write about payment processors such as BitPay and Coinbase, “These firms touted a new model to break the paradigm of merchants’ dependence on the bank-centric payment system described above.  These services charged monthly fees that amounted to significantly lower transaction costs for merchants than those charged in credit-card transactions and delivered swift, efficient payments online or on-site.”

Except this is not really true.  The only reason that both BitPay and Coinbase are charging less than other payment processors is that VC funding is subsidizing it.  These companies still have to pay for customer service support and fraud protection because customer behavior in aggregate is the same.  And as we have seen with BitPay numbers, it is likely that BitPay’s business model is a losing proposition and unsustainable.

On page 103 they mention some adoption metrics, “The good news is found in the steady expansion in the adoption of digital wallets, the software needed to send and receive bitcoins, with Blockchain and Coinbase, the two biggest providers of those, on track to top 2 million unique users each at the time of the writing.”

This is at least the third time they talk about wallets this way and is important because it is misleading, I will discuss in-depth later.

Continuing they write that:

Blockchain cofounder Peter Smith says that a surprisingly large majority of its accounts — “many more than you would think,” he says cryptically — are characterized as “active.”

This is just untrue and should have been pressed by the authors.  Spokesman from continue to publish highly inflated numbers.  For instance in late February 2015, claimed that “over $270 million in bitcoin transactions occurred via its wallets over the past seven days.”

This is factually untrue.  As I mentioned three months ago:

Organ of Corti pointed out that the 7 day average was indeed ~720,000 bitcoins in total output volume (thus making) the weekly volume would be about “5e06 btc for the network.”

Is it valid to multiply the total output volume by USD (or euros or yen)?  No.

Why not?  Because most of this activity is probably a combination of wallet shuffling, laundering and mixing of coins (e.g., use of SharedSend and burner wallets) or any number of superfluous activity.  It was not $270 million of economic trade.’s press release seems to be implying that economic trade is taking place, in which all transactions are (probably) transactions to new individuals when in reality it could simply be a lot of “change” address movement.  And more to the point, the actual internal volume looks roughly the same as has been the past few months (why issue a press release now?).

Continuing on page 103 they write, “For the first eight months months of 2014, around $50 million per day was passing thought the bitcoin network (some of which was just “change” that bitcoin transactions create as an accounting measure)…”

There is a small typo above (in bold) but the important part is the estimate of volume.  There is no public research showing a detailed break down of average volume of economic activity.  Based on a working paper I published four months ago, it is fairly clear that this figure is probably in the low millions USD at most.  Perhaps this will change in the future.

On page 106 they write about Circle and Xapo:

For now, these firms make no charge to cover costs of insurance and security, betting that enough customers will be drawn to them and pay fees elsewhere — for buying and selling bitcoins, for example — or that their growing popularity will allow them to develop profitable merchant-payment services as well.  But over all, these undertaking must add costs back into the bitcoin economy, not to mention a certain dependence on “trusted third parties.”  It’s one of many areas of bitcoin development — another is regulation — where some businessmen are advocating a pragmatic approach to bolstering public confidence, one that would necessitate compromises on some of the philosophical principles behind a model of decentralization.  Naturally, this doesn’t sit well with bitcoin purists.

While Paul Vigna may not have written this, he did say something very similar at the Google Author Talk event (above in the video).

The problem with this view is that it is a red herring: this has nothing to do with purism or non-purism.

The problem is that Bitcoin’s designer attempted to create a ‘permissionless’ system to accommodate pseudonymous actors.  The entire cost structure and threat model are tied to this.  If actors are no longer pseudonymous, then there is no need to have this cost structure, or to use proof-of-work at all.  In fact, I would argue that if KYC/KYM (Know Your Miner) are required then a user might just as well use a database or permissioned system.  And that is okay, there are businesses that will be built around that.

This again has nothing to do with purism and everything to do with the costs of creating a reliable record of truth on a public network involving unknown, untrusted actors.  If any of those variables changes — such as adding real-world identity, then from a cost perspective it makes little sense to continue using the modified network due to the intentionally expensive proof-of-work.

On page 107 they talk about bitcoin price volatility discussing the movements of gasoline.  The problem with this analogy is that no one is trying to use gasoline as money.  In practice consumers prefer purchasing power stability and there is no mechanism within the Bitcoin network that can provide this.

For instance:

volatility 1volatility 2volatility 3The three slides above are from a recent presentation from Robert Sams.  Sams previously wrote a short paper on “Seigniorage Shares” — an endogenous way to rebase for purchasing power stability within a cryptocurrency.

Bitcoin’s money supply is perfectly inelastic therefore the only way to reflect changes in demand is through changes in price.  And anytime there are future expectations of increased or decreased utility, this is reflected in prices via volatility.

Oddly however, on page 110, they write, “A case can be made that bitcoin’s volatility is unavoidable for the time being.”

Yet they do not provide any evidence — aside from feel good “Honey Badger” statements — for how bitcoin will somehow stabilize.  This is something the journalists should have drilled down on, talking to commodity traders or some experts on fuel hedging strategies (which is something airline companies spend a great deal of time and resources with).

Instead they cite Bobby Lee, CEO of BTC China and Gil Luria once again.  Lee states that “Once its prices has risen far enough and bitcoin has proven itself as a store of value, then people will start to use it as a currency.”

This is a collective action problem.  Because all participants each have different time preferences and horizons — and are decentralized — this type of activity is actually impossible to coordinate, just ask Josh Garza and the $20 Paycoin floor.  This also reminds me of one of my favorite comments on reddit: “Bitcoin will stabilize in price then go to the moon.”

The writers then note that, “Gil Luria, the Wedbush analyst, even argues that volatility is a good thing, on the grounds that it draws profit-seeking traders into the marketplace.”

But just because you have profit-seeking traders in the market place does not mean volatility disappears.

trading view

Credit: George Samman

For instance, in the chart above we can see how bitcoin trades relative to commodities over the past year:

  • Yellow is DBC
  • Red is OIL
  • Bars are DXY which is a dollar index
  • And candlesticks are BTCUSD
DBC is a commodities index and the top 10 Holdings (85.39% of Total Assets):
  • Brent Crude Futr May12 N/A 13.83
  • Gasoline Rbob Fut Dec12 N/A 13.71
  • Wti Crude Future Jul12 N/A 13.56
  • Heating Oil Futr Jun12 N/A 13.20
  • Gold 100 Oz Futr Dec 12 N/A 7.49
  • Sugar #11(World) Jul12 N/A 5.50
  • Corn Future Dec12 N/A 5.01
  • Lme Copper Future Mar13 N/A 4.55
  • Soybean Future Nov12 N/A 4.38
  • Lme Zinc Future Jul12

It bears mentioning that Ferdinando Ametrano has also described this issue in depth most recently in a presentation starting on slide 15.

Continuing on page 111, the writers note that:

Over time, the expansion of these desks, and the development of more and more sophisticated trading tools, delivered so much liquidity that exchange rates became relatively stable.  Luria is imagining a similar trajectory for bitcoin.  He says bitcoiners should be “embracing volatility,” since it will help “create the payment network infrastructure and monetary base” that bitcoin will need in the future.

There are two problems with Luria’s argument:

1) As noted above, this does not happen with any other commodity and historically nothing with a perfectly inelastic supply

2) Empirically, as described by Wences Casares above, nearly all the bitcoins held at Xapo (and likely other “hosted wallets”) are being held as investments.  This reduces liquidity which translates into volatility due to once again the inability to slowly adjust the supply relative to the shifts in demand.  This ties into a number of issues discussed in, What is the “real price” of bitcoin? that are worth revisiting.

Also on page 111, they write that “the exchange rate itself doesn’t matter.”

Actually it does.  It directly impacts two things:

1) outside perception on the health of Bitcoin and therefore investor interest (just talk to Buttercoin);

2) on a ten-minute basis it impacts the bottom line of miners.  If prices decline, so to is the incentive to generate proof-of-work.  Bankruptcy, as CoinTerra faces, is a real phenomenon and if prices decline very quickly then the security of the network can also be reduced due to less proof-of-work being generated

Continuing on page 111, “It’s expected that the mirror version of this will in time be set up for consumers to convert their dollars into bitcoins, which will then immediately be sent to the merchant.  Eventually, we could all be blind to these bitcoin conversions happening in the middle of all our transactions.”

It’s unfortunate that they do not explain how this will be done without a trusted third party, or why this process is needed.  What is the advantage of going from USD-> paying a conversion fee -> BTC -> conversion fee -> back into USD?  Why not just spend USD and cut out the Bitcoin middleman?

Lastly on page 111, “Still, someone will have to absorb the exchange-rate risk, if not the payment processors, then the investors with which they trade.”

The problem with this is that its generally not in the mandate or scope of most VC firms to purchase commodities or currencies directly.  In fact, they may even need some kind of license to do so depending on the jurisdiction (because it is a foreign exchange play).  Yet expecting the payment processors to shoulder the volatility is probably a losing proposition: in the event of a protracted bear market how many bitcoins at BitPay — underwater or not — will need to be liquidated to pay for operating costs?4

On page 112 they write, ‘Bitcoin has features from all of them, but none in entirety.  So, while it might seem unsatisfying, our best answer to the question of whether cryptocurrency can challenge the Visa and MasterCard duopoly is, “maybe, maybe not.”

On the face of it, it is a safe answer.  But upon deeper inspection we can probably say, maybe not.  Why?  Because for Bitcoin, once again, there is no native method for issuing credit (which is what Visa/MasterCard do with what are essentially micro-loans).

For example, in order to natively add some kind of lending facility within the Bitcoin network a new “identity” system would need to be built and integrated (to enable credit checks) — yet by including real-world “identity” it would remove the pseudonymity of Bitcoin while simultaneously maintaining the same costly proof-of-work Sybil protection.  This is again, an unnecessary cost structure entirely and positions Bitcoin as a jack-of-all-trades-but-master-of-none.  Why?  Again recall that the cost structure is built around Dynamic Membership Multi-Party Signature (DMMS); if the signing validators are static and known you might as well use a database or permissioned ledgers.

Or as Robert Sams recently explained, if censorship resistance is co-opted then the reason for proof-of-work falls to the wayside:

Now, I am sure that the advocates of putting property titles on the bitcoin blockchain will object at this point. They will say that through meta protocols and multi-key signatures, third party authentication of transaction parties can be built-in, and we can create a registered asset system on top of bitcoin. This is true. But what’s the point of doing it that way? In one fell swoop a setup like that completely nullifies the censorship resistance offered by the bitcoin protocol, which is the whole raison d’etre of proof-of-work in the first place! These designs create a centralised transaction censoring system that imports the enormous costs of a decentralised one built for censorship-resistance, the worst of both worlds.

If you are prepared to use trusted third parties for authentication of the counterparts to a transaction, I can see no compelling reason for not also requiring identity authentication of the transaction validators as well. By doing that, you can ditch the gross inefficiencies of proof-of-work and use a consensus algorithm of the one-node-one-vote variety instead that is not only thousands of times more efficient, but also places a governance structure over the validators that is far more resistant to attackers than proof-of-work can ever be.

On page 113, they write, “the government might be able to take money out of your local bank account, but it couldn’t touch your bitcoin.  The Cyprus crisis sparked a stampede of money into bitcoin, which was now seen as a safe haven from the generalized threat of government confiscation everywhere.”

In theory this may be true, but in practice, it is likely that a significant minority — if not majority — of bitcoins are now held in custody at depository institutions such as Xapo, Coinbase and Circle.  And these are not off-limits to social engineering.  For instance, last week an international joint-task force confiscated $80,000 in bitcoins from dark web operators.  The largest known seizure in history were 144,000 bitcoins from Ross Ulbricht (Dread Pirate Roberts) laptop.

Similarly, while it probably is beyond the scope of their book, it would have been interesting to see a survey from Casey and Vigna covering the speculators during this early 2013 time frame.  Were the majority of people buying bitcoins during the “Cyprus event” actually worried about confiscation or is this just something that is assumed?  Fun fact: the largest transaction to BitPay of all time was on March 25, 2013 during the Cyprus event, amounting to 28,790 bitcoins.

On page 114, the writers for the first time (unless I missed it elsewhere), use the term “virtual currency.”  Actually, they quote FinCEN director Jennifer Calvery who says that FincCEN, “recognizes the innovation virtual currencies provide , and the benefits they might offer society.”

Again recall that most fiat currencies today are already digitized in some format — and they are legal tender.  In contrast, cryptocurrencies such as bitcoin are not legal tender and are thus more accurately classified as virtual currencies.  Perhaps that will change in the future.

On page 118 they note that, “More and more people opened wallets (more than 5 million as of this writing).”

I will get to this later.  Note that on p. 123 they say Coupa Cafe has a “digital wallet” a term used throughout the entire book.

Chapter 5:

On page 124, “Bitcoins exist only insofar as they assign value to a bitcoin address, a mini, one-off account with which people and firms send and receive the currency to and from other people’s firms’ addresses.”

This is actually a pretty concise description of best-practices.  In reality however, many individuals and organizations (such as exchanges and payment processors) reuse addresses.

Continuing on page 124, “This is an important distinction because it means there’s no actual currency file or document that can be copied or lost.”

This is untrue.  In terms of security, the hardest and most expensive part in practice is securing the credentials — the private key that controls the UTXOs.  As Stefan Thomas, Jason Whelan (p. 139) and countless other people on /r/sorryforyourloss have discovered, this can be permanently lost.  Bearer assets are a pain to secure, hence the re-sprouting of trusted third parties in Bitcoinland.

One small nitpick in the note at the bottom of page 125, “Sometimes the structure of the bitcoin address network is such that the wallet often can’t send the right amount in one go…” — note that this ‘change‘ is intentional (and very inconvenient to the average user).

Another nitpick on page 128, “Each mining node or computer gathers this information and reduces it into an encrypted alphanumeric string of characters known as a hash.”

There is actually no encryption used in Bitcoin, rather there are some cryptographic primitives that are used such as key signing but this is not technically called encryption (the two are different).

On page 130, I thought it was good that they explained where the term nonce was first used — from Lewis Carroll who created the word “frabjous” and described it as a nonce word.

On page 132, in describing proof-of-work, “While that seems like a mammoth task, these are high-powered computers; it’s not nearly as taxing as the nonce-creating game and can be done relatively quickly and easily.”

They are correct in that something as simple as a Pi computer can and is used as the actual transaction validating machine.  Yet, at one point in 2009, this bifurcation did not exist: a full-node was both a miner and a hasher.  Today that is not the case and we technically have about a dozen or so actual miners on the network, the rest of the machines in “farms” just hash midstates.

On page 132, regarding payment processors accepting zero-confirmation transactions, “They do this because non-confirmations — or the double-spending actions that lead to them — are very rare.”

True they are very rare today in part because there are very few incentives to actually try and double-spend.  Perhaps that will change in the future with new incentives to say, double-spend watermarked coins from NASDAQ.

And if payment processors are accepting zero confirmations, why bother using proof-of-work and confirmations at all?  Just because a UTXO is broadcast does not mean it will not be double-spent let alone confirmed and packaged into a block.  See also replace-by-fee proposal.

Small note on page 132, “the bitcoin protocol won’t let it use those bitcoins in a payment until a total of ninety-nine additional blocks have been built on top its block.”

Sometimes it depends on the client and may be up to 120 blocks altogether, not just 100.

On page 133 they write, “Anyone can become a miner and is free to use whatever computing equipment he or she can come up with to participate.”

This may have been the case in 2009 but not true today.  In order to reduce payout variance, the means of production as it were, have gravitated towards large pools of capital in the form of hashing farms.  See also: The Gambler’s Guide to Bitcoin Mining.

On page 135 they write, “Some cryptocurrency designers have created nonprofit foundations and charged them with distributing the coins based on certain criteria — to eligible charities, for example. But that requires the involvement of an identifiable and trusted founder to create the foundation.”

The FinCEN enforcement action and fine on Ripple Labs may put a kibosh on this in the future.  Why?  If organizations that hand out or sell coins are deemed under the purview of the Bank Secrecy Act (BSA) it is clear that most, if not all, crowdfunding or initial coin offerings (ICO) are violating this by not implementing KYC/AML requirements on participants or filing SARs.

On page 136 they write, “Both seigniorage and transaction fees represent a transfer of value to those running the network. Still, in the grand scheme of things, these costs are far lower than anything found in the old system.”

This is untrue and an inaccurate comparison.  We know that at the current bitcoin price of $240 it costs roughly $315 million to operate the network for the entire year.  If bitcoin-based consumer spending patterns hold up and reflect last years trends seen by BitPay, then roughly $350 million will be spent through payment processors, nearly half of which includes mining payouts.

Or in other words, for roughly every dollar spent on commerce another dollar is spent securing it.  This is massive oversecurity relative to the commerce involve.  Neither Saudi Arabia or even North Korea spend half of, let alone 100% of their GDP on military expenditures (yet).

Chapter 6:

Small nitpick on page 140, Butterfly Labs is based in Leawood, Kansas not Missouri (Leawood is on the west side of the dividing line).

I think the story of Jason Whelan is illuminating and could help serve as a warning guide to anyone wanting to splurge on mining hardware.

For instance on page 141, “And right from the start Whelan face the mathematical reality that his static hashrate was shrinking as a proportion of the ever-expanding network, whose computing power was by then almost doubling every month.”

Not only was this well-written but it does summarize the problem most new miners have when they plan out their capital expenditures.  It is impossible to know what the network difficulty will be in 3 months yet what is known is that even if you are willing to tweak the hardware and risk burning out some part of your board, your hashrate could be diluted by faster more efficient machines.  And Whelan found out the hard way that he might as well bought and held onto bitcoins than mine.  In fact, Whelan did just about everything the wrong way, including buying hashing contracts with cloud miners from “” (a non-functioning url).

On page 144 the authors discussed the mining farms managed by now-defunct CoinTerra:

With three in-built high-powered fans running at top speed to cool the rig while its internal chi races through calculations, each unit consumes two kilowatts per hour, enough power to run an ordinary laptop for a month. That makes for 20 kWh per tower, about ten times the electricity used for the same space by the neighboring server of more orthodox e-commerce firms.

As noted in Chapter 2 above, this electricity has to be “wasted.”  Bitcoin was designed to be “inefficient” otherwise it would be easy to attack and censor.  And in the future, it cannot become more “efficient” — there is no free lunch when it comes to protecting it.  It also bears mentioning that CoinTerra was sued by its utility company in part for the $12,000 a day in electrical costs that were not being paid for.

On page 145 they wrote that as of June 2014, “By that time, the network, which was then producing 88,000 trillion hashes every second, had a computing power six thousand times the combined power of the world’s top five hundred supercomputers.”

This is not a fair comparison.  ASIC miners can do one sole function, they are unable to do anything aside from reorganize a few fields (such as date and nonce) with the aim of generating a new number below a target number.  They cannot run MS Office, Mozilla Firefox and more sobering: they cannot even run a Bitcoin client (the Pi computer run by the pool runs the client).

In contrast, in order to be recognized as a Top 500 computer, only general purpose machines capable of running LINXPACK are considered eligible.  The entire comparison is apples-to-oranges.

On page 147 the authors described a study from Guy Lane who used inaccurate energy consumption data from  And then they noted that, “So although the total consumption is significantly higher than the seven-thousand-home estimate, we’re a long way from bitcoin’s adding an entire country’s worth of power consumption to the world.”

This is not quite true.  As noted above in the notes of Chapter 2 above, based on Dave Hudson’s calculations the current Bitcoin network consumes the equivalent of about 10% of Ireland’s annual energy usage yet produces two orders of magnitude less economic activity.  If the price of bitcoin increases so to does the amount of energy miners are willing to expend to chase after the seigniorage.  See also Appendix B.

On page 148 they write that:

For one, power consumption must be measured against the value of validating transactions in a payment system, a social service that gold mining has never provided.  Second, the costs must be weighed against the high energy costs of the alternative, traditional payment system, with its bank branches, armored cars, and security systems. And finally, there’s the overriding incentive for efficiency that the profit motive delivers to innovators, which is why we’ve seen such giant reductions in power consumption for the new mining machines. If power costs make mining unprofitable, it will stop.

First of all, validation is cheap and easy, as noted above it is typically done with something like a Pi computer.  Second, they could have looked into how much real commerce is taking place on the chain relative to the costs of securing it so the “social service” argument probably falls flat at this time.

Thirdly, the above “armored cars and security systems” is not an apples-to-apples comparison.  Bitcoin does not provide any banking service beyond a lock box, it does not provide for home mortgages, small business loans or mezzanine financing.  The costs for maintaining those services in the traditional world do not equate to MC=MV as described at the end of Chapter 1 notes.

Fourthly, they ignore the Red Queen effect.  If a new hashing machine is invented and consumes half as much energy as before then the farm owner will just double the amount of machines and the net effect is the same as before.  This happens in practice, not just in theory, hence the reason why electrical consumption has gone up in aggregate and not down.

On page 149 they write, “But the genius of the consensus-building in the bitcoin system means such forks shouldn’t be allowed to go on for long. That’s because the mining community works on the assumption that the longest chain is the one that constitutes consensus.”

That’s not quite accurate.  Each miner has different incentives.  And, as shown empirically with other altcoins, forks can reoccur frequently without incentives that align.  For now, some incentives apparently do.  But that does not mean that in the future, if say watermarked coins become more common place, that there will not be more frequent forks as certain miners attempt to double-spend or censor such metacoins.

Ironically on page 151 the authors describe the fork situation of March 2013 and describe the fix in which a few core developers convince Mark Karpeles (who ran Mt. Gox) to unilaterally adopt one specific fork.  This is not trustless.

On page 151 they write, “That’s come to be known as a 51 percent attack.  Nakamoto’s original paper stated that the bitcoin mining network could be guaranteed to treat everyone’s transactions fairly and honestly so long as no single miner or mining group owned more than 50 percent of the hashing power.”

And continuing on page 153, “So, the open-source development community is now looking for added protections against selfish mining and 51 percent attacks.”

While they do a good job explaining the issue, they don’t really discuss how it is resolved.  And it cannot be without gatekeepers or trusted hardware.  For instance, three weeks ago there was a good reddit thread discussing one of the problems of Andreas Antonopolous’  slippery slope view that you could just kick the attackers off the network.  First, there is no quick method for doing so; second, by blacklisting them you introduce a new problem of having the ability to censor miners which would be self-defeating for such a network as it introduces a form of trust into an expensive cost structure of trust minimization.

On page 152 they cite a Coinometrics number, “in the summer of 2014 the cost of the mining equipment and electricity required for a 51 percent attack stood at $913 million.”

This is a measurement of maximum costs based on hashrate brute force — a Maginot Line attack.  In practice it is cheaper to do via out of band attacks (e.g., rubber hose cryptanalysis).  There are many other, cheaper ways, to attack the P2P network itself (such as Eclipse attacks).

On page 154 when discussing wealth disparity in Bitcoin they write, “First, some perspective.  As a wealth-gap measure, this is a lousy one.  For one, addresses are not wallets.  The total number of wallets cannot be known, but they are by definition considerably fewer than the address tally, even though many people hold more than one.”

Finally.  So the past several chapters I have mentioned I will discuss wallets at some length.  Again, the authors for some reason uncritically cite the “wallet numbers” from, Coinbase and others as actual digital wallets.  Yet here they explain that these metrics are bupkis.  And they are.  It costs nothing to generate a wallet and there are scripts you can run to auto generate them.  In fact, Zipzap and many others used to give every new user a wallet por gratis.

And this is problematic because press releases from Xapo and continually cite a number that is wholly inaccurate and distorting.  For instance Wences Casares said in a presentation a couple months ago that there were 7 million users.  Where did that number come from?  Are these on-chain privkey holders?  Why are journalists not questioning these claims?  See also: A brief history of Bitcoin “wallet” growth.

On page 154 they write, “These elites have an outsize impact on the bitcoin economy. They have a great interest in seeing the currency succeed and are both willing and able to make payments that others might not, simply to encourage adoption.”

Perhaps this is true, but until there is a systematic study of the conspicuous consumption that takes place, it could also be the case that some of these same individuals just have an interest in seeing the price of bitcoin rise and not necessarily be widely adopted.  The two are not mutually exclusive.

On page 155 and 156 they describe the bitsat project, to launch a full node into space which is aimed “at making the mining network less concentrated.”

Unfortunately these types of full nodes are not block makers.  Thus they do not actually make the network less concentrated, but only add more propagating nodes.  The two are not the same.

On page 156 they describe some of the altcoin projects, “They claim to take the good aspects of bitcoin’s decentralized structure but to get ride of its negative elements, such as the hashing-power arms race, the excessive use of electricity, and the concentration of industrialized mining power.”

I am well aware of the dozens various coin projects out there due to work with a digital asset exchange over the past year.  Yet fundamentally all of the proof-of-work based coins end up along the same trend line, if they become popular and reach a certain level of “market cap” (an inaccurate term) specialized chips are designed to hash it.  And the term “excessive” energy related to proof-of-work is a bit of a non-starter.  Ignoring proof-of-stake systems, if it becomes less energy intensive to hash via POW, then it also becomes cheaper to attack.  Either miners will add more equipment or the price has dropped for the asset and it is therefore cheaper to attack.

On page 157 regarding Litecoin they write that, “Miners still have an incentive to chase coin rewards, but the arms race and the electricity usage aren’t as intense.”

That’s untrue.  Scrypt (which is used instead of Hashcash) is just as energy intensive.  Miners will deploy and utilize energy in the same patterns, directly in proportion to the token price.  The difference is memory usage (Litecoin was designed to be more memory intensive) but that is unrelated to electrical consumption.

Continuing, “Litecoin’s main weakness is the corollary of its strength: because it’s cheaper to mine litecoins and because scrypt-based rigs can be used to mine other scrypt-based altcoins such as dogecoin, miners are less heavily invested in permanently working its blockchain.”

This is untrue.  Again, Litecoin miners will in general only mine up to the point where it costs a litecoin to make a litecoin.  Obviously there are exceptions to it, but in percentage terms the energy usage is the same.

Continuing, “Some also worry that scrypt-based mining is more insecure, with a less rigorous proof of work, in theory allowing false transactions to get through with incorrect confirmations.”

This is not true.  The two difference in security are the difficulty rating and block intervals.  The higher the difficulty rating, the more energy is being used to bury blocks and in theory, the more secure the blocks are from reversal.  The question is then, is 2.5 minutes of proof-of-work as secure as burying blocks every 10 minutes?  Jonathan Levin, among others, has written about this before.

cthuluSmall nitpick on page 157, fairly certain that nextcoin should be referred to as NXT.

On page 158 they write:

If bitcoin is to scale up, it must be upgraded sot hat nodes, currently limited to one megabyte of data per ten-minute block, are free to process a much larger set of information.  That’s not technically difficult; but it would require miners to hash much larger blocks of transactions without big improvements in their compensation.  Developers are currently exploring a transaction-fee model that would provide fairer compensation for miners if the amount of data becomes excessive.

This is not quite right.  There is a difference between block makers (pools) and hashers (mining farms).  The costs for larger blocks would impact block makers not hashers, as they would need to upgrade their network facilities and local hard drive.  This may seem trivial and unimportant, but Jonathan Levin’s research, as well as others suggest that block sizes does in fact impact orphan rates.5 It also impacts the amount of decentralization within the network as larger blocks become more expensive to propagate you will likely have fewer nodes.  This has been the topic of immense debate over the past several weeks on social media.

Also on page 158 they write:

The laboratory used by cryptocurrency developers, by contrast, is potentially as big as the world itself, the breadth of humanity that their projects seek to encompass. No company rulebook or top-down set of managerial instructions keeps people’s choice in line with a common corporate objective. Guiding people to optimal behavior in cryptocurrencies is entirely up to how the software is designed to affect human thinking, how effectively its incentive systems encourage that desired behavior

This is wishful thinking and probably unrealistic considering that Bitcoin development permanently suffers from the tragedy of the commons.  There is no CEO which is both good and bad.

For example, directions for where development goes is largely based on two things:

  1. how many upvotes your comment has on reddit (or how many retweets it gets on Twitter)
  2. your status is largely a function of how many times Satoshi Nakamoto responded to you in email or on the Bitcointalk forum creating a permanent clique of “early adopters” whose opinions are the only valid ones (see False narratives)

This is no way to build a financial product.  Yet this type of lobbying is effectively how the community believes it will usurp well-capitalized private entities in the payments space.

Several months ago a user, BitttBurger, made a similar observation:

I’ve said it before and I will say it again. There is a reason why Developers should not be in control of product development priorities, naming, feature lists, or planning for a product. That is the job of the sales, marketing, and product development teams who actually interface with the customer. They are the ones who do the research and know what’s needed for a product. They are the ones who are supposed to decide what things are called, what features come next, and how quickly shit gets out the door.

Bitcoin has none of that. You’ve got a Financial product, being created for a financial market, by a bunch of developers with no experience in finance, and (more importantly) absolutely no way for the market to have any input or control over what gets done, or what it’s called. That is crazy to me.

Luke is a perfect example of why you don’t give developers control over anything other than the structure of the code.

They are not supposed to be making product development decisions. They are not supposed to be naming anything. And they definitely are not supposed to be deciding “what comes next” or how quickly things get done. In any other company, this process would be considered suicide.

Yet for some reason this is considered to be a feature rather than a bug (e.g., “what is your Web of Trust (WoT) number?”).

On page 159 they write, “The vital thing to remember is that the collective brainpower applied to all the challenges facing bitcoin and other cryptocurrencies is enormous.  Under the open-source, decentralized model, these technologies are not hindered by the same constraints that bureaucracies and stodgy corporations face.”

So, what is the Terms of Service for Bitcoin?  What is the customer support line?  There isn’t one.  Caveat emptor is pretty much the marketing slogan and that is perfectly fine for some participants yet expecting global adoption without a “stodgy” “bureaucracy” that helps coordinate customer service seems a bit of a stretch.

And just because there is some avid interest from a number of skilled programmers around the world does not mean public goods problems surrounding development will be resolved.  For reference: there were over 5000 co-authors on a recent physics paper but that doesn’t mean their collective brain power will quickly resolve all the open questions and unsolved problems in physics.

Chapter 7:

Small nitpick on page 160, “Bitcoin was born out of a crypto-anarchist vision of a decentralized government-free society, a sort of encrypted, networked utopia.”

As noted above, there is actually no encryption used in Bitcoin.

On page 162 they write, “Before we get too carried away, understand this is still early days.”

That may be the case.  Perhaps decentralized cryptocurrencies like Bitcoin are not actually the internet in the early 1990s like many investors claim but rather the internet in the 1980s when there were almost no real use-cases and it is difficult to use.  Or 1970s.  The problem is no one can actually know the answer ahead of time.

And when you try to get put some milestone down on the ground, the most ardent of enthusiasts move the goal posts — no comparisons with existing tech companies are allowed unless it is to the benefit of Bitcoin somehow.  I saw this a lot last summer when I discussed the traction that M-Pesa and Venmo had.

A more recent example is “rebittance” (a portmanteau of “bitcoin” and “remittance”).  A couple weeks ago Yakov Kofner, founder of Save On Send, published a really good piece comparing money transmitter operators with bitcoin-related companies noting that there currently is not much meat to the hype.  The reaction on reddit was unsurprisingly fist-shaking Bitcoin rules, everyone else drools.

yakov breakfast

With Yakov Kofner (CEO Save On Send)

When I was in NYC last week I had a chance to meet with him twice.  It turns out that he is actually quite interested in Bitcoin and even scoped out a project with a VC-funded Bitcoin company last year for a consumer remittances product.

But they decided not to build and release it for a few reasons: 1) in practice, many consumers are not sensitive enough to a few percentage savings because of brand trust/loyalty/habit; 2) lacking smartphones and reliable internet infrastructure, the cash-in, cash-out aspect is still the main friction facing most remittance corridors in developing countries, bitcoin does not solve that; 3) it boils down to an execution race and it will be hard to compete against incumbents let alone well-funded MTO startups (like TransferWise).

That’s not to say these rebittance products are not good and will not find success in niches.

For instance, I also spoke with Marwan Forzley (below), CEO of Align Commerce last week.  Based on our conversation, in terms of volume his B2B product appears to have more traction than BitPay and it’s less than a year old.  What is one of the reasons why?  Because the cryptocurrency aspect is fully abstracted away from customers.

marwan p2p

Raja Ramachandran (R3CEV), Dan O’Prey (Hyperledger), Daniel Feichtinger (Hyperledger), Marwan Forzley (Align Commerce)

In addition, both BitX and — based on my conversations in Singapore two weeks ago with their teams — seem to be gaining traction in a couple corridors in part because they are focusing on solving actual problems (automating the cash-in/cash-out process) and abstracting away the tech so that the average user is oblivious of what is going on behind the scenes.

singapore ron

Markus Gnirck (StartupBootCamp), Antony Lewis (itBit) and Ron Hose ( at the DBS Hackathon event

On page 162 and 163 the authors write about the Bay Area including 20Mission and Digital Tangible.  There is a joke in this space that every year in cryptoland is accelerated like dog years.  While 20Mission, the communal housing venue, still exists, the co-working space shut down late last year.  Similarly, Digital Tangible has rebranded as Serica and broadened from just precious metals and into securities.  In addition, Dan Held (page 164) left and is now at ChangeTip.

On page 164 they write, “But people attending would go on to become big names in the bitcoin world: Among them were Brian Armstrong and Fred Ehrsam, the founders of Coinbase, which is second only to Blockchain as a leader in digital-wallet services and one of the biggest processors of bitcoin payments for businesses.”

10 pages before this they said how useless digital wallet metrics are.  It would have been nice to press both Armstrong and Ehrsam to find out what their actual KYC’ed active users to see if the numbers are any different than the dated presentation.

On page 165 they write:

“It’s a very specific type of brain that’s obsessed with bitcoin,” says Adam Draper, the fourth-generation venture capitalist…”

I hear this often but what does that mean?  Is investing genetic?  If so, surely there are more studies on it?

For instance, later on page 176 they write, “The youngest Draper, who tells visitors to his personal web site that his life’s ambition is to assist int he creation of an iron-man suit, has clearly inherited his family’s entrepreneurial drive.”

Perhaps Adam Draper is indeed both a bonafide investor and entrepreneur, but it does not seem to be the case that either can be or is necessarily inheritable.

On page 167, “The only option was to “turn into a fractional-reserve bank,” he said jokingly, referring tot he bank model that allows banks to lend out deposits while holding a fraction of those funds in reserve.  “They call it a Ponzi scheme unless you have a banking license.”

Why is this statement not challenged?  I am not defending rehypothecation or the current banking model, but fractional reserve banking as it is employed in the US is not a Ponzi scheme.

Also on page 167 they write, “First, he had trouble with his payments processor, Dwolla which he later sued for $2 million over what Tradehill claimed were undue chargebacks.”

A snarky thing would be to say he should have used bitcoin, no chargebacks.  But the issue here, one that the authors should have pressed is that Tradehill, like Coinbase and Xapo, are effectively behaving like banks.  It’s unclear why this irony is not discussed once in the book.

For instance, several pages later on page 170 they once again talk about wallets:

The word wallet is thrown around a lot in bitcoin circles, and it’s an evocative description, but it’s just a user application that allows you to send and receive bitcoins over the bitcoin network. You can download software to create your own wallet — if you really want to be your own bank — but most people go through a wallet provider such as Coinbase or Blockchain, which melded them into user-friendly Web sites and smart phone apps.

I am not sure if it is intentional but the authors clearly understand that holding a private key is the equivalent of being a bank.  But rather than say Coinbase is a bank (because they too control private keys), they call them a wallet provider.  I have no inside track into how regulators view this but the euphemism of “wallet provider” is thin gruel.  On the other hand does not hold custody of keys but instead provide a user interface — at no point do they touch a privkey (though that does not mean they could not via a man-in-the-middle-attack or scripting errors like the one last December).

On page 171 they talk about Nathan Lands:

The thirty-year-old high school dropout is the cofounder of QuickCoin, the maker of a wallet that’s aimed directly at finding the fastest easiest route to mass adoption.  The idea, which he dreamed up with fellow bitcoiner Marshall Hayner one night over a dinner at Ramen Underground, is to give nontechnical bitcoin newcomers access to an easy-to-use mobile wallet viat familiar tools of social media.

Unfortunately this is not how it happened.  More in a moment.

Continuing the authors write, “His successes allowed Lands to raise $10 million for one company, Gamestreamer.”

Actually it was Gamify he raised money for (part of the confusion may be due to how it is phrased on his LinkedIn profile).

Next the authors state: “He started buying coins online, where her ran into his eventual business partner, Hayner (with whom he later had a falling-out, and whose stake he bought).”

One of the biggest problems I had with this book is that the authors take claims at face value.  To be fair, I probably did a bit too much myself with GCON.

On this point, I checked with Marshall Hayner who noted that this narrative was untrue:  “Nathan never bought my stake, nor was I notified of any such exchange.”

While the co-founder dispute deserves its own article or two, the rough timeline is that in late 2013 Hayner created QuickCoin and then several months later on brought Lands on to be the CEO.  After a soft launch in May 2014 (which my wife and I attended, see below) Lands maneuvered and got the other employees to first reduce the equity that Hayner had and then fired him so they could open up the cap table to other investors.


QuickCoin launch party with Marshall Hayner, Jackson Palmer (Dogecoin), and my wife

With Hayner out, QuickCoin quickly faded due to the fact that the team had no ties to the local cryptocurrency community.  Hayner went on to join Stellar and is now the co-founder of Trees.  QuickCoin folded by the end of the year and Lands started Blockai.

On page 174 they discuss VCs involved in funding Bitcoin-related startups:

Jerry Yang, who created the first successful search engine, Yahoo, put money from his AME Ventures into a $30 million funding round for processor BitPay and into one of two $20 million rounds raised by depository and wallet provider Xapo, which offers insurance to depositors and call itself a “bitcoin vault.”

While they likely couldn’t have put it in this section, I think it would have been good for the authors to discuss the debate surrounding what hosted wallets actually are because regulators and courts may not agree with the marketing-speak of these startups.6

On page 177 they write about Boost VC which is run by Adam Draper, “He’d moved first and emerged as the leader in the filed, which meant his start-ups could draw in money from the bigger guys when it came time for larger funding rounds.”

It would be interesting to see the clusters of what VCs do and do not co-invest with others.  Perhaps in a few years we can look back and see that indeed, Boost VC did lead the pack.  However while there are numerous incubated startups that went on to close seed rounds (Blockcypher, Align Commerce, Hedgy, Bitpagos) as of this writing there is only one incubated company in Boost that has closed a Series A round and that is Mirror (Coinbase, which did receive funding from Adam Draper, was not in Boost).  Maybe this is not a good measure for success, perhaps this will change in the future and maybe more have done so privately.

On page 179-180 the discussion as to what Plug and Play Tech Center does and its history was well written.

On page 184 they write:

With every facet of our economy now dependent on the kinds of software developed and funded in the Bay Area, and with the Valley’s well-heeled communities becoming a vital fishing ground for political donations and patronage, we’re witnessing a migration of the political and economic power base away from Wall Street to this region.

I have heard variations of this for the past couple of years.  Most recently I heard a VC claim that Andreessen Horrowitz (a16z) was the White House of the West Coast and that bankers in New York do not understand this tech.  Perhaps it is and perhaps bankers do not understand what a blockchain is.

Either way we should be able to see the consequences to this empirically at some point.  Where is the evidence presented by the authors?


Source: finviz

Fast forwarding several chapters, on page 287 they write, “Visa, MasterCard, and Western Union combined – to name just three players whose businesses could be significantly reformed — had twenty-seven thousand employees in 2013.”

Perhaps these figures will dramatically change soon, however, the above image are the market caps over the past 5 years of four incumbents: JP Morgan (the largest bank in the US), MasterCard and Visa (the largest card payment providers) and Western Union, the world’s largest money transfer operator.

Will their labor force dramatically change because of cryptocurrencies?  That is an open question.  Although it is unclear why the labor force at these companies would necessarily shrink because of the existence of Bitcoin rather than expand in the event that these companies integrated parts of the tech (e.g., a distributed ledger) thereby reducing costs and increasing new types of services.

On page 185 they write, “Those unimaginable possibilities exist with bitcoin, Dixon says, because “extensible software platforms that allow anyone to build on top of them are incredibly powerful and have all these unexpected uses. The stuff about fixing the existing payment system is interesting, but what’s superexciting is that you have this new platform on which you can move money and property and potentially build new areas of businesses.”

Maybe this is true.  It is unclear from these statements as to what Chris Dixon views as broken about the current payment system.  Perhaps it is “broken” in that not everyone on the planet has access to secure, near-instant methods of global value transer.  However it is worth noting that cryptocurrencies are not the only competitors in the payments space.

According to AngelList as of this writing:

Chapter 8:

This chapter discussed “The Unbanked” and how Bitcoin supposedly can be a solution to banking these individuals.

On page 188 they discuss a startup called 37coins:

“It uses people in the region lucky enough to afford Android smartphones as “gateways” to transmit the messages.  In return, these gateways receive a small fee, which provides the corollary benefit of giving locals the opportunity to create a little business for themselves moving traffic.”

This is a pretty neat idea, both HelloBit and Abra are doing something a little similar.  The question however is, why bitcoin?  Why do users need to go out of fiat, into bitcoin and back out to fiat?  If the end goal is to provide users in developing countries a method to transmit value, why is this extra friction part of the game plan?

Last month I heard of another supposed cryptocurrency “killer app”: smart metering prepaid via bitcoin and how it is supposed to be amazing for the unbanked.  The unbanked, they are going to pay for smart metering with money they don’t have for cars they don’t own.  There seems to be a disconnect when it comes to financial inclusion as it is sometimes superficially treated in the cryptocurrency world.  Many Bitleaders and enthusiasts seem to want to pat themselves on the back for a job that has not been accomplished.  How can the cryptocurrency community bring the potential back down to real world situations without overinflating, overhyping or over promising?

If Mercedes or Yamaha held a press conference to talk about the “under-cared” or “under-motorcycled” they would likely face a backlash on social media.  Bitcoin the bearer instrument, is treated like a luxury good and expecting under-electrified, under-plumbed, under-interneted people living in subsistence to buy and use it today without the ability to secure the privkey without a trusted third party, seems far fetched (“the under bitcoined!”).  Is there a blue print to help all individuals globally move up Maslow’s Hierarchy of Financial Wants & Needs?

On page 189 they write:

“But in the developing world, where the costs of an ineffectual financial system and the burdens of transferring funds are all too clear, cryptocurrencies have a much more compelling pitch to make.”

The problem is actually at the institutional level, institutions which do not disappear because of the Bitcoin blockchain.  Nor does Bitcoin solve the identity issue: users still need real-world identity for credit ratings so they can take out loans and obtain investment to build companies.

For instance on page 190 the authors mention the costs of transferring funds to and from Argentina, the Philippines, India and Pakistan.  One of the reasons for the high costs is due to institutional problems which is not solved by Bitcoin.

In fact, the authors write, “Banks won’t service these people for various reasons. It’s partly because the poor don’t offer as fat profits as the rich, and it’s partly because they live in places where there isn’t the infrastructure and security needed for banks to build physical branches. But mostly it’s because of weak legal institutions and underdeveloped titling laws.”

This is true, but Bitcoin does not solve this.  If local courts or governments do not recognize the land titles that are hashed on the blockchain it does the local residents no good to use Proof of Existence or BlockSign.

They do not clarify this problem through the rest of the chapter.  In fact the opposite takes place, as they double down on the reddit narrative:

“Bitcoin, as we know, doesn’t care who you are. It doesn’t care how much money you are willing to save, send, or spend. You, your identity and your credit history are irrelevant. […] If you are living on $50 a week, the $5 you will save will matter a great deal.”

This helps nobody. The people labeled as “unbanked” want to have access to capital markets and need a credit history so they can borrow money to create a companies and build homes.  Bitcoin as it currently exists, does not solve those problems.

Furthermore, how do these people get bitcoins in the first place?  That challenge is not discussed in the chapter.  Nor is the volatility issue, one swift movement that can wipe out the savings of someone living in subsistence, broached.  Again, what part of the network does lending on-chain?

On page 192 they write, “They lack access to banks not because they are uneducated, but because of the persistent structural and systemic obstacles confronting people of limited means there: undeveloped systems of documentation and property titling, excessive bureaucracy, cultural snobbery, and corruption. The banking system makes demands that poor people simply can’t meet.”

This is very true.  The Singapore conference I attended two weeks ago is just one of many conferences held throughout this year that talked about financial inclusion.  Yet Bitcoin does not solve any of these problems.  You do not need a proof-of-work blockchain to solve these issues.  Perhaps new database or permissioned ledgers can help, but these are social engineering challenges — wet code — that technology qua technology does not necessarily resolve.

Also on page 192 they write, “People who have suffered waves of financial crises are used to volatility. People who have spent years trusting expensive middlemen and flipping back and forth between dollars and their home currency are probably more likely to understand bitcoin’s advantages and weather its flaws.”

This is probably wishful thinking too.  Residents of Argentina and Ukraine may be used to volatility but it does not mean it is something they want to adopt.  Why would they want to trade one volatile asset for another?  Perhaps they will but the authors do not provide any data for actual usage or adoption in these countries, or explain why the residents prefer bitcoin instead of something more global and stable such as the US dollar.

On page 193 they write that, “In many cases, these countries virtually skip over legacy technology, going straight to high-tech fiber-optic cables.”

While there is indeed a number of legacy systems used on any given day in the US, it is not like Bitcoin itself is shiny new tech.  While the libraries and BIPS may be new, the components within the consensus critical tech almost all dates back to the 20th century.

For instance, according to Gwern Branwen, the key moving parts that Bitcoin uses:

  1. 2001: SHA-256 finalized
  2. 1999-present: Byzantine fault tolerance (PBFT etc.)
  3. 1999-present: P2P networks (excluding early networks like Usenet or FidoNet; MojoNation & BitTorrent, Napster, Gnutella, eDonkey, Freenet, etc.)
  4. 1998: Wei Dai, B-money5
  5. 19986: Nick Szabo, Bit Gold
  6. 1997: HashCash
  7. 1992-1993: Proof-of-work for spam7
  8. 1991: cryptographic timestamps
  9. 1980: public key cryptography8
  10. 1979: Hash tree

That’s not to say that Bitcoin is bad, old or that other systems are not old or bad but rather the term “legacy” is pretty relative and undefined in that passage.

On page 194 they discuss China and bitcoin, “With bitcoin, the theory goes, people could bypass that unjust banking system and get their money out of China at low cost.”

This is bad legal advice, just look at the problems this caused Coinbase with regulators a couple months ago.  And while you could probably do it low-scale, it then competes with laundering via art sales and Macau junkets and thus expecting this to be the killer use-case for adoption in China is fairly naive.

On page 195 they write “Bitcoin in China is purely a speculator’s game, a way to gamble on its price, either through one of a number of mainland exchanges or by mining it. It is popular — Chinese trading volumes outstrip those seen anywhere else in the world.”

Two months ago Goldman Sachs published a widely circulated report which stated that “80% of bitcoin volume is now exchanged into and out of Chinese yuan.”

This is untrue though as it is solely based on self-reporting metrics from all of the exchanges (via Bitcoinity).  As mentioned in chapter 1 notes above, the top 3 exchanges in China run market-making bots which dramatically inflate trading volume by 50-70% each day.  While they likely still process a number of legitimate trades, it cannot be said that 80% of bitcoin volume is traded into and out of RMB.  The authors of both the report and the book should have investigated this in more depth.

On page 196 they write, “This service, as well as e-marketplace Alibaba’s competing Alipay offering, is helping turn China into the world’s most dynamic e-commerce economy. How is bitcoin to compete with that?”

Great question and the answer is it probably won’t.  See Understanding value transfers to and from China.

Next on page 196 they write, “But what about the potential to get around the controls the government puts on cross-border fund transfers?”

By-passing capital controls was discussed two pages before and will likely cause problems for any VC or PE-backed firm in China, the US and other jurisdictions.  I am not defending the current policies just being practical: if you are reading their book and plan to do this type of business, be sure to talk to a legal professional first.

On page 197 they discuss a scenario for bitcoin adoption in China: bank crisis.  The problem with this is that in the history of banking crisis’ thus far, savers typically flock to other assets, such as US dollars or euros.  The authors do not explain why this would change.  Now obviously it could or in the words of the authors, the Chinese “may warm to bitcoin.”  But this is just idle speculation — where are the surveys or research that clarify this position?  Why is it that many killer use-cases for bitcoin typically assumes an economy or two crashes first?

On page 198 they write, “The West Indies even band together to form one international cricket team when they play England, Australia, and other members of the Commonwealth. What they don’t have, however, is a common currency that could improve interisland commerce.”

More idle speculation.  Bitcoin will probably not be used as a common currency because policy makers typically want to have discretion via elastic money supplies.  In addition, one of the problems that a “common currency” could have is what has plagued the eurozone: differing financial conditions in each country motivate policy makers in each country to lobby for specific monetary agendas (e.g., tightening, loosening).  Bitcoin in its current form, cannot be rebased to reflect the changes that policy makers could like to make.  While many Bitcoin enthusiasts like this, unless the authors of the book have evidence to the contrary, it is unlikely that the policy makers in the West Indies find this desirable.

On page 199 they write, “A Caribbean dollar remains a pipe dream.”

It is unclear why having a unified global or regional currency is a goal for the authors?  Furthermore, there is continued regional integration to remove some frictions, for instance, the ECACH (Eastern Caribbean Automated Clearing House) has been launched and is now live in all 8 member countries.

On page 203 they spoke to Patrick Byrne from about ways Bitcoin supposedly saves merchants money.  They note that, “A few weeks later, Byrne announced he would not only be paying bitcoin-accepting vendors one week early, but that he’d also pay his employee bonuses in bitcoin.”

Except so far this whole effort has been a flop for  According to Overstock, in 2014 approximately 11,100 customers paid with bitcoin at both its US and international websites.  Altogether this represented roughly $3 million in sales which when coupled with low margin products (based on the top 10 list of things sold on Overstock) is an initiative that Stone Street Advisors labeled “distracting” (see slides 21, 32, 33, 37, 58).

This continues onto page 204, “As a group of businesses in one region begins adopting the currency, it will become more appealing to others with whom they do business. Once such a network of intertwined businesses builds up, no one wants to be excluded from it. Or so the theory goes.”  Byrne then goes on to describe network effects and fax machines, suggesting that this is what will happen with bitcoin.

In other words, a circular flow of income.  The challenge however goes back to the fact that the time preferences of individuals is different and has not lended towards the theory of spending.  As a whole, very few people spend and suppliers typically cash out to reduce their exposure to volatility.  Perhaps this will change, but there is no evidence that it has so far.

On page 206 they talk to Rulli from Film Annex (who was introduced in the introduction):

With bitcoin, “you can clearly break down the value of every single stroke on the keyboard, he says.

And you cannot with fiat?

Continuing the authors talk about Rulli:

He wanted the exchange to be solely in bitcoin for other digital currencies, with no option to buy rupees or dollars: “The belief I have is that if you lock these people into this new economy, they will make that new economy as efficient as possible.”

What about volatility?  Why are marginalized people being expected to hold onto an asset that fluctuates in value by more than 10% each month?  Rulli has a desire to turn the Film Annex Web site “into its own self enclosed bitcoin economy.”  There is a term for this: autarky or closed economy.

Continuing Rulli states, ‘If you start giving people opportunities to get out of the economy, they will just cut it down, whereas if the only way for you to enrich yourself is by trading bitcoins for litecoins and dogecoins, you are going to become an expert in that… you will become the best trader in Pakistan.”

This seems to be a questionable strategy: are these users on bitLanders supposed to be artisans or day traders?  Why are marginalized people expected to compete with world-class professional traders?

On page 210 the second time the term “virtual currency” is mentioned, this time by the Argentinian central bank.

On page 213 they write, “With bitcoin, it is possible to sen money via a mobile phone, directly between two parties, to bypass that entire cumbersome, expensive system for international transfers.”

What an updated version to the book should include is an actual study for the roundtrip costs of doing international payments and remittances.  This is not to defend the incumbents, but rebittance companies and enthusiasts on reddit grossly overstate the savings in many corridors.7 And it still does not do away with the required cash-in / cash-out steps that people in these countries still want and need.

On page 216 they write about the research of Hernando de Soto who discusses the impediments of economic development including the need to document ownership of property.  Unfortunately Bitcoin does not currently solve this because ultimately the recognition of a hash of a document on a blockchain comes down to recognition from the same institutions that some of these developing countries lack.

Continuing on page 217 they write that, “Well, the blockchain, if taken to the extent that a new wave of bitcoin innovators believe possible, could replace many of those institutions with a decentralized authority for proving people’s legal obligations and status. In doing so, it could dramatically widen the net of inclusion.”

How?  How is this done?  Without recognized title transfers, hashing documents onto a chain does not help these people.  This is an institutional issue, not one of technology.  Human corruption does not disappear because of the existence of Bitcoin.

Chapter 9:

On page 219 they write, “Like everything else in the cryptocurrency world, the goal is to decentralize, to take power out of the hands of the middleman.”

By recreating the same middleman, depository institutions, yet without robust financial controls.

On page 220 and 221 they mention “basic encryption process” and “standard encryption models” — I believe that it is more accurately stated as cryptographic processes and cryptographic models.

On page 222 they define “Bitcoin 2.0” / “Blockchain 2.0” and put SatoshiDice into that bucket.  Ignoring the labels for a moment, I don’t think SatoshiDice or any of the other on-chain casino games are “2.0” — they use the network without coloring any asset.

One quibble with Mike Hearn’s explanation on page 223 is when he says, “But bitcoin has no intermediaries.”  This is only true if you control and secure the privkey by yourself.  In practice, many “users” do not.

On page 225 they write, “Yet they are run by Wall Street banks and are written and litigated by high-powered lawyers pulling down six- or seven-figure retainers.”

Is it a crime to be able to charge what the market bears for a service?  Perhaps some of this technology will eventually reduce the need for certain legal services, but it is unclear what the pay rate of attorneys in NYC has in relation with Bitcoin.

Also on page 225 a small typo: “International Derivatives and Swaps Association (ISDA)” — need to flip Derivatives and Swaps.

On page 226, 227, 229 and 244: nextcoin should be called NXT.

On page 227 they write, “Theses are tradable for bitcoins and other cryptocurrencies on special altcoin exchanges such as Cryptsy, where their value is expected to rise and fall according to the success or failure of the protocol to which they belong.”

There is a disconnect between the utility of a chain and the speculative activity around the token.  For instance, most day traders likely do not care about the actual decentralization of a network, for if they did, it would be reflected in prices of each chain.  There are technically more miners (block makers) on dozens of alternative proof-of-work chains than there in either bitcoin or litecoin yet market prices are (currently) not higher for more decentralized chains.

On page 228 they write that:

“Under their model, the underlying bitcoin transactions are usually of small value — as low as a “Satoshi” (BTC0.00000001).  That’s because the bitcoin value is essentially irrelevant versus the more important purpose of conveying the decentralized application’s critical metadata across the network, even though some value exchange is needed to make the communication of information happen.”

Actually in practice the limit for watermarked coins typically resides around 0.0001 BTC.  If it goes beneath 546 satoshi, then it is considered dust and not included into a block.  Watermarked coins also make the network top heavy and probably insecure.8

On page 209, the third time “virtual currency” is used and comes from Daniel Larimer, but without quotes.

On page 230 they discuss an idea from Daniel Larimer to do blockchain-based voting.  While it sounds neat in theory, in practice it still would require identity which again, Bitcoin doesn’t solve.  Also, it is unclear from the example in the book as to why it is any more effective/superior than an E2E system such as Helios.

On page 238 they write, “It gets back to the seigniorage problem we discussed in chapter 5 and which Nakamoto chose to tackle through the competition for bitcoins.”

I am not sure I would classify it as a problem per se, it is by design one method for rewarding security and distributing tokens.  There may be other ways to do it in a decentralized manner but that is beyond the scope of this review.

On page 239 they discuss MaidSafe and describe the “ecological disaster” that awaits data-center-based storage.  This seems a bit alarmist because just in terms of physics, centralized warehouses of storage space and compute will be more efficient than a decentralized topology (and faster too).  This is discussed in Chapter 3 (under “Another facsimile”).

Continuing they quote the following statement from David Irvine, founder of MaidSafe: “Data centers, he says, are an enormous waste of electricity because they store vast amounts of underutilized computing power in huge warehouse that need air-condition and expensive maintenance.”

Or in other words: #bitcoin

On page 242 they mention Realcoin whose name has since been changed to Tether.  It is worth pointing out that Tether does not reduce counterparty risk, users are still reliant on the exchange (in this case Bitfinex) from not being hacked or shut down via social engineering.

On page 244, again to illustrate how fast this space moves, Swarm has now pivoted from offering cryptocurrency-denominated investment vehicles into voting applications and Open-Transactions has hit a bit of a rough patch, its CTO, Chris Odom stepped down in March and the project has not had any public announcements since then.

Chapter 10:

If you missed it, the last few weeks on social media have involved a large debate around blockchain stability with respect to increasing block sizes.  During one specific exchange, several developers debated as to “who was in charge,” with Mike Hearn insisting that Satoshi left Gavin in charge and Greg Maxwell stating that this is incorrect.

gavin mike hearn

Source: Reddit

This ties in with the beginning of page 247, the authors write about Gavin Andresen, “A week earlier he had cleared out his office at the home he shares with his wife, Michele – a geology professor at the University of Massachusetts — and two kids. He’d decided that a man essentially if not titularly in charge of running an $8 billion economy needed something more than a home office.”

Who is in charge of Bitcoin?  Enthusiasts on reddit and at conferences claim no one is.  The Bitcoin Foundation claims five people are (those with commit access).  Occasionally mainstream media sites claim the Bitcoin CEO or CFO is fired/jailed/dead/bankrupt.

The truth of the matter is that it is the miners who decide what code to update and use and for some reason they are pretty quiet during all of this hub bub.  Beyond that, there is a public goods problem and as shown in the image above, it devolves into various parties lobbying for one particular view over another.

The authors wrote about this on page 247, “The foundation pays him to coordinate the input of the hundreds of far-flung techies who tinker away at the open-licensed software. Right now, the bitcoin community needed answers and in the absence of a CEO, a CTO, or any central authority to turn to, Andresen was their best hope.”

It is unclear how this will evolve but is a ripe topic of study.  Perhaps the second edition will include other thoughts on how this role has changed over time.

On page 251 they write, “Probably ten thousand of the best developers in the world are working on this project,” says Chris Dixon, a partner at venture capital firm Andreessen Horowitz.

How does he know this?  There are not 10,000 users making changes to Bitcoin core libraries on github or 10,000 subscribers to the bitcoin development mailing list or IRC rooms.  I doubt that if you added up all of the employees of every venture-backed company in the overall Bitcoin world, that the amount would equate to 2,000 let alone 10,000 developers.  Perhaps it will by the end of this year but this number seems to be a bit of an exaggeration.

Continuing Dixon states, “You read these criticisms that ‘bitcoin has this flaw and bitcoin has that flaw,’ and we’re like ‘Well, great. Bitcoin has ten thousand people working hard on that.”

This is not true.  There is a public goods problem and coordination problem.  Each developer and clique of developers has their own priorities and potential agenda for what to build and deploy.  It cannot be said that they’re all working towards one specific area.  How many are working on the Lightning Network?  Or on transaction malleability (which is still not “fixed”)?  How many are working on these CVE?

On page 254 they discuss Paul Baran’s paper “On Distributed Communications Networks,” the image of which has been used over the years and I actually used for my paper last month.

On page 255 the fourth usage of “virtual currency” appears regarding once more, FinCEN director Jennifer Shasky.  Followed by page 256 with another use of “virtual currency.”  On page 257 Benjamin Lawsky was quoted using “virtual currency.”  Page 259 the term “virtual currency” appears when the European Banking Authority is quoted.  Page 260 and 261 sees “virtual currency” being used in relation with NYDFS and Lawsky once more.  On page 264 another use of “virtual currency” is used and this time in relation with Canadian regulations from June 2014.

On page 265 they mention “After the People’s Bank of China’s antibitcoin directives…”

I am not sure the directives were necessarily anti-bitcoin per se.  Rather they prohibited financial institutions like banks and payment processors from directly handling cryptocurrencies such as bitcoins.  The regulatory framework is still quite nebulous but again, going back to “excessive” in the introduction above, it is unclear why this is deemed “anti-bitcoin” when mining and trading activity is still allowed to take place.  Inconsistent and unhelpful, yes.  Anti?  Maybe, maybe not.

Also on page 265 they mention Temasek Holdings, a sovereign wealth fund in Singapore that allegedly has bitcoins in its portfolio.  When I was visiting there, I spoke with a managing director from Temasek two weeks ago and he said they are not invested in any Bitcoin companies and the lunchroom experiment with bitcoins has ended.

On page 268 the authors discuss “wallets” once more this time in relation with Mt.Gox: “All the bitcoins were controlled by the exchange in its own wallets” and “Reuters reported that only Karpeles knew the passwords to the Mt. Gox wallets and that he refused a 2012 request from employees to expand access in the event that he became incapacitated.”

Chapter 11:

On page 275 the authors use a good nonce, “übercentralization.”

On page 277 they write, “While no self-respecting bitcoiner would ever describe Google or Facebook as decentralized institutions, not with their corporate-controlled servers and vast databases of customers’ personal information, these giant Internet firms of our day got there by encouraging peer-to-peer and middleman-free activities.”

In the notes on the margin I wrote “huh?”  And I am still confused because each of these companies attempts to build a moat around their property.  Google has tried 47 different ways to create a social network even going so far as to cutting off its nose (Google Reader, RIP) to spite its face all with the goal of keeping traffic, clicks and eyeballs on platforms it owns.  And this is understandable.  Similarly Coinbase and other “universal hosted wallets” are also trying to build a walled garden of apps with the aim of stickiness — finding something that will keep users on their platform.

On page 277 they also wrote that, “Perhaps these trends can continue to coexist if the decentralizing movements remains limited to areas of the economy that don’t bleed into the larger sectors that Big Business dominates.”

What about Big Bitcoin?   The joke is that there are 300,027 advocacy groups in Bitcoinland: 300,000 privkey holders who invested in bitcoin and 27 actual organizations that actively promote Bitcoin.  There is probably only one quasi self-regulating organization (SRO), DATA.  And the advocacy groups are well funded by VC-backed companies and investors, just look at CoinCenter’s rolodex.

On page 280 they write, “Embracing a cryptoccurency-like view of finance, it has started an investment program that allows people invest directly in the company, buying notes backed by specific hard assets, such as individual stores, trucks, even mattress pads. No investment bank is involved, no intermediary. Investors are simply lending U-Haul money, peer-to-peer, and in return getting a promissory note with fixed interested payments, underwritten by the company’s assets.”

This sounds a lot like a security as defined by the Howey test.  Again, before participating in such an activity be sure to talk with a legal professional.9

On page 281 they use the term “virtual currencies” for the 11th time, this time in reference to MasterCard’s lobbying efforts in DC for Congress.

On page 283 a small typo, “But here’s the rub: because they are tapped” — (should be trapped).

On page 283 they write, “By comparison, bitcoin processors such as BitPay, Coinbase, and GoCoin say they’ve been profitable more or less from day one, given their low overheads and the comparatively tiny fees charged by miners on the blockchain.”

This is probably false.  I would challenge this view, and that none of them are currently breaking even on merchant processing fees alone.

In fact, they likely have the same user acquisition costs and compliance costs as all payment processors do.

For instance, in October 2014, Brian Armstrong and Fred Ehrsam, co-founders of Coinbase, did a reddit AMA.  At the 21:12 minute mark (video):

Q: Is Coinbase profitable or not, if not, when?

A: It’s happened to be profitable at times, at the moment it’s not; we’re not burning too much cash.  I think that the basic idea here is to grow and by us growing we help the entire ecosystem grow — without dying.  So not at the moment but not far.

It’s pretty clear from BitPay’s numbers that unless they’ve been operating a high volume exchange, they are likely unprofitable.

Why?  Because, in part of the high burn rate.  What does this mean?

Last week Moe Levin, former Director of European Business Development at BitPay, was interviewed by deBitcoin, below is one detailed exchange starting at 1:57m:

Q: There was a lot of stories in the press about BitPay laying off people, can you comment on that?

A: Yea, what happened was we had a high burn rate and the company necessarily needed to scale back a little bit on how many people we hired, how many people we had on board, how much we sponsored things.  I mean things were getting a little bit out of hand with sponsorships, football games and expansion — more care needed to be put on how and where we spent the money.

Q: Can you elaborate on the burn rate?  Tim Swanson wrote a piece on BitPay in April, published this piece about the economy, the BitPay economy. Posted this piece on the burn rate and actual figures, have you read that piece?  Can you comment on that?

A: Yes, it is especially hard for a company to build traction when they start off.  Any start up is difficult to build traction.  It’s doubly hard, the hardness is amplified when a company enters a market with competitors that have near unlimited resources because the other companies can either blow you out of the water or have better marketing strategies or they can do a ton of different things to make your startup more irrelevant.  Standard in any company but it is doubly difficult when you enter a market like that.  In the payments industry, forget about Bitcoin for a second, in the payments industry and the mobile commerce, ecommerce, company-to-company payments industry there are massive players with investments and venture backed companies in the billions.  Competing at that stage is tricky and it necessarily requires a burn rate that is much higher than the average startup because of how you need to compete in this space.  What is also important is that the regulation costs a lot of money for the startups in the Bitcoin economy.  It’s the perfect storm of how a startup will be hit with a ton of expenses early on and that can hurt the growth of a company.  Even though a lot of the money that went into it was growth capital it takes a while to get the balance right between spending and growing.

On page 284 they write, “That leads us to one important question: What happens to banks as credit providers if that age arrives? Any threat to this role could be a negotiating chip for banks in their marketing battle with the new technology.”

This is a good question and it dovetails with the “Fedcoin” discussion over the past 6 months.10

On page 285 they write, “With paper money they can purchase arms, launch wars, raise debt to finance those conflicts, and then demand tax payments in that same currency to repay those debts.”

This is a common misconception, one involving lots of passionate Youtube videos, that before central banks were established or fiat currencies were issued, that there was no war or “less war.”  On page 309 they quote Roger Ver at a Bitcoin conference saying, “they’ll no longer be able to fund these giant war machines that are killing people around the world. So I see bitcoin as a lever that I can use to move the world in a more peaceful direction.”

Cryptocurrencies such as Bitcoin will not end wars for the same reason that precious metals did not prevent wars: the privkey has no control over the “wet code” on the edges.  Wars have occurred since time immemorial due to conflicts between humans and will likely continue to occur into the future (I am sure this statement will be misconstrued on reddit to say that I am in support of genocide and war).

On page 286 they write, “Gil Luria, an analyst at Wedbush Securities who has done some of the most in-depth analysis of cryptocurrency’s potential, argues that 21 percent of U.S. GDP is based in “trust” industries, those that perform middlemen tasks that blockchain can digitize and automate.”

In looking at the endnote citation (pdf) it is clear that Luria and his team is incorrect in just about all of the analysis that month as they rely on unfounded assumptions to both adoption and the price of bitcoin.  That’s not to say some type of black swan events cannot or will not occur, but probably not for the reasons laid out by the Wedbush team.  The metrics and probabilities are entirely arbitrary.

For instance, the Wedbush analysts state, “Our conversation with bitcoin traders (and  Wall Street traders trading bitcoin lead us to believe they see opportunity in a market that has frequent disruptive news flow  and large movements that reflect that news flow.”

Who are these traders?  Are they disinterested and objective parties?

For instance, a year ago (in February 2014), Founders Grid asked 50 Bitcoin “experts” what their bitcoin price predictions were over the next year.  The end result — all but a couple were completely, very wrong (see this spreadsheet for a line-by-line itemization).  Later, in May 2014, CoinTelegraph asked (video) more than 30 Bitcoin “experts” as to what their bitcoin predictions were for the end of 2014.  Once again, all but a couple were completely, very wrong.

Or in short, no one has a very good track record of predicting either prices or adoption.  Thus it is unclear from their statements why a cryptocurrency such as Bitcoin will automatically begin performing the tasks that comprise 21% of US economic output based on “trust.”

On page 288 they write, “So expect a backlash once banks start shutting back-office administrative centers in midtown Manhattan or London’s Canary Wharf when their merchant customers start booking more customer sales via cryptocurrency systems to avoid the 3 percent transaction fees.”

I think there is a lot of conflation here.  For starters, back-offices could be reformed with the integration of distributed ledgers, but probably not cryptocurrency systems (why would a trusted network need proof-of-work?).  Secondly, the empirical data thus far suggests that it doesn’t matter how many merchants adopt cryptocurrencies as payments, what matters is consumer adoption — and thus far the former out paces the latter by several an enormous margin.  Third, that 3% is broken down and paid to a variety of other participants not just Visa or MasterCard.  Fourth, the US economy (like that of Europe and many other regions) is consumer driven — supply does not necessarily create its own demand.

There is one more point, but first the authors quote Chris Dixon from Andreessen Horowitz, “On the one hand you have the bank person who loses their job, and everyone feels bad about that person, and on the other hand, everyone else saves three percent, which economically can have a huge impact because it means small businesses widen their profit margins.”

This myth of “3%” savings is probably just a myth.  At the end of the day Coinbase, BitPay and other payment processors will likely absorb the same cost structures as existing payment processors in terms of user acquisition, customer support, insurance, compliance and so forth.  While the overhead may be lean, non-negligible operating costs still exist.

There are two reasons for why it could be temporarily cheaper to use Coinbase:

1) VC funding and exchange activity subsidizes the “loss-leader” of payment processing;

2) because Coinbase outsources the actual transaction verification to a third party (miners), they are dependent on fees to miners staying low or non-existent.  At some point the fees will have to increase and those fees will then either need to be absorbed by Coinbase or passed on to customers.

On page 290 they quote Larry Summers, “So it seems to me that the people who confidently reject all the innovation here [in blockchain-based payment and monetary systems] are on the wrong side of history.”

Who are these people?  Even Jeffrey Robinson finds parts of the overall tech of interest.  I see this claim often on social media but it seems like a strawman.  Skepticism about extraordinary claims that lack extraordinary proof does not seem unwarranted or unjustified.

On page 292 they write, “But, to borrow an idea from an editor of ours, such utopian projects often end up like Ultimate Frisbee competitions, which by design have no referees — only “observers” who arbitrate calls — and where disputes over rule violations often devolve into shouting matches that are won by whichever player yells the loudest, takes the most uncompromising stance, and persuades the observer.”

This is the exact description of how Bitcoin development works via reddit, Twitter, Bitcoin Talk, the Bitcoin Dev mailing list, IRC and so forth.  This is not a rational way to build a financial product.  Increasing block sizes that impact a multi-billion dollar asset class should not be determined by how many Likes you get on Facebook or how often you get to sit on panels at conferences.

Final chapter (conclusion):

On page 292 they write, “Nobody’s fully studied how much business merchants are doing with bitcoin and cryptocurrencies, but actual and anecdotal reports tend to peg it at a low number, about 1 percent of total sales for the few that accept them.”

My one quibble is that they as journalists were in a position to ask payment processors for these numbers.

Fortunately we have a transparent, public record that serves as Plan B: reused addresses on the Bitcoin blockchain.

Evolution Market v Bitpay BtcAs described in detail a couple weeks ago, the chart above is a log scale measuring the amount of bitcoins that both BitPay (in green) and Evolution (in red) received starting January 16, 2014.  The drop off at the end in March 2015 is related to the exit scam that Evolution underwent (and the drop off for BitPay is related to a limitation in WalletExplorer’s data).

As we can see here, based on the clusters labeled by WalletExplorer, on any given day BitPay processes about 1,200 bitcoins (the actual number is probably about 10% higher).

coinbase transactions

Source: Coinbase

The chart above are self-reported transaction numbers from Coinbase.  While it is unclear what each transaction can or do represent, in aggregate it appears to be relatively flat over the past year.11 Perhaps that will change in the future.

On page 295 they write, “Volatility in bitcoin’s price will also eventually decline as more traders enter the market and exchanges become more sophisticated.”

As Christopher Hitchens once remarked, that which can be asserted without evidence, can be dismissed without evidence.  Those making a positive claim (that volatility will decline) are the party that needs to prove this and they do not in this book.  Perhaps volatility will somehow disappear, but not for the non-technical reasons they describe.

At the bottom of page 295 they write, “Even so, we will go out on a limb here and argue that encryption-based, decentralized digital currencies do have a future.”

Again, there is no encryption in cryptocurrencies, only cryptographic primitives.  Also, as described in the introductory notes above, virtual currencies are not synonymous with digital currencies.

Also on page 295 they write, “Far more important, it solves some big problems that are impossible to address within the underlying payment infrastructure.”

Yes, there are indeed problems with identity and fraud but it is unclear from this book what Bitcoin actually solves.  No one double-spends on the Visa network.  No one has, publicly, hacked the Visa Network (which has 42 firewalls and a moat).  The vulnerabilities and hacks that take place are almost always at the edges, in retailers such as Home Depot and Target (which is unfortunately named).  This is not to say that payment rails and access to them cannot be improved or made more accessible, but that case is not made in this book.

On page 296 they write, “Imagine how much wider the use of cyptocurrency would be if a major retailer such as Walmart switched to a blockchain-based payment network in order to cut tens of billions of dollars in transaction costs off the $350 billion it sends annually to tens of thousands of suppliers worldwide.”

Again this is conflating several things.  Walmart does not need a proof-of-work blockchain when it sends value to trusted third parties.  All the participants are doxxed and KCY’ed.  Nor does it need to convert fiat -> into a cryptocurrency -> into fiat to pay retailers.  Instead, Walmart in theory, could use some type of distributed ledger system like SKUChain to track the provenance of items, but again, proof-of-work used by Bitcoin are unneeded for this utility because parties are known.

Also, while the authors recognize that bitcoins currently represent a small fraction of payments processed by most retailers, one of the reasons for why they may not have seen a dramatic improvement in their bottom line because people — as shown with the Wence Casares citation above (assuming the 96% figure is accurate) — do not typically purchase bitcoins in order to spend them but rather invest and permanently hold them.  Perhaps that may change in the future.

On page 297 they write, “But now bitcoin offers an alternative, one that is significantly more useful than gold.”

That’s an unfounded claim.  The two have different sets of utility and different trade-offs We know precious metals have some use-value beyond ornamentation, what are the industrial usages of bitcoin?  In terms of security vulnerabilities there are trade-offs of owning either one.  While gold can be confiscated and stolen, to some degree the same challenge holds true with cryptocurrencies due to its bearer nature (over a million bitcoins have been lost, stolen, seized and destroyed).12 One advantage that bitcoin seems to have is cheaper transportation costs but that is largely dependent on subsidized transaction fees (through block rewards) and the lack of incentives to attack high-value transactions thus far.

On page 300 they write, “As you’ll know from having read this book, a bitcoin-dominant world would have far more sweeping implications: for one, both banks and governments would have less power.”

That was not proven in this book.  In fact, the typical scenarios involved the success of trusted third parties like Coinbase and Xapo, which are banks by any other name.  And it is unclear why governments would have less power.  Maybe they will but that was not fleshed out.

On page 301 they write, “In that case, cryptocurrency protocols and blockchain-based systems for confirming transactions would replace the cumbersome payment system that’s currently run by banks, credit-card companies, payment processors and foreign-exchange traders.”

The authors use the word cumbersome too liberally.  To a consumer and even a merchant, the average swipeable (nonce!) credit card and debit card transaction is abstracted away and invisible.  In place of these institutions reviled by the authors are, in practice, the very same entities: banks (Coinbase, Xapo), credit-card companies (Snapcard, Freshpay), payment processors (BitPay, GoCoin) and foreign-exchange traders (a hundred different cryptocurrency exchanges).  Perhaps this will change in the future or maybe not.

On page 305 they write about a “Digital dollar.”  Stating, “Central banks could, for example, set negative interest rates on bank deposits, since savers would no longer be able to flee into cash and avoid the penalty.”

This is an interesting thought experiment, one raised by Miles Kimball several months ago and one that intersects with what Richard Brown and Robert Sams have discussed in relation to a Fedcoin.

On page 306 they write about currency reserves, “we doubt officials in Paris or Beijing are conceiving of such things  right now, but if cryptocurrency technology lives up to its potential, they may have to think about it.”

This is wishful thinking at best.  As described in Chapter 13, most proponents of a “Bitcoin reserve currency” are missing some fundamental understanding of what a reserve currency is or how a currency becomes one.

Because there is an enormous amount of confusion in the Bitcoin community as to what reserve currencies are and how they are used, it is recommended that readers peruse what Patrick Chovanec wrote several years ago – perhaps the most concise explanation – as it relates to China (RMB), the United Kingdom (the pound) and the United States (the dollar):

There are four main factors that set the Pound and the Dollar apart as viable and attractive reserve currencies. Each was necessary. They were liquid. They were available. And they were perceived as safe. I’m going to run through each of these conditions in turn. I will consider how they applied to the Pound and the Dollar, and to what extent they are satisfied by China’s Renminbi.

(1) Necessity. The fundamental purpose of a reserve currency is to settle external obligations. The greater quantity and variety of obligations a particular currency can settle, the more useful it is as a reserve currency. The currency of a country that produces little of note and lacks funds to lend or invest is not nearly as useful as one whose home economy produces many goods and services desired around the world, serves as an important source of capital, and has many commercial partners who also find its currency relevant to meeting their own obligations. This idea — that the dominant reserve currency derives its status from its connection with the dominant national economy in an interconnected world – is what underlies Roubini’s reasoning that the Renminbi may be next in line to replace the Dollar.

But this conclusion misses something important. A reserve currency must not only be capable of settling obligations in connection with a heavy-weight economy. It must be required to. Because if you can settle those obligations, as sizeable and important as they may be, using your own currency — or the currency of another leading economy — there is no reason to hold that country’s currency as a reserve. That is precisely the case today with China.

It is unclear how or why some Bitcoin advocates can suggest that bitcoins will ever be used as a reserve currency when there is no demand for the currency to meet external trading obligations let alone in the magnitude that these other currencies do (RMB, USD, GBP).

On page 307 they write:

Under this imagined Bretton Woods II, perhaps the IMF would create its own cryptocurrency, with nodes for managing the blockchain situated in proportionate numbers within all the member countries, where none could ever have veto power, to avoid a state-run 51 percent attack.

Proof-of-work mining on a trusted network is entirely unnecessary yet this type of scenario is propagated by a number of people in the Bitcoin space including Adam Ludwin (CEO of and Antonis Polemitis (investor at Ledra Capital).  Two months ago on a panel at the Stanford Blockchain event, Ludwin predicted that in the future governments would subsidize mining.  Again, the sole purpose of mining on a proof-of-work blockchain is because the actors cannot trust one another.  Yet on a government-run network, there are no unverified actors (Polemitis has proposed a similar proof-of-work solution for Fedcoin).

Again, there is no reason for the Fed, or any bank for that matter, to use a Bitcoin-like system because all parties are known.  Proof-of-work is only useful and necessary when actors are unknown and untrusted.  The incentive and cost structure for maintaining a proof-of-work network is entirely unnecessary for financial services institutions.  Furthermore, maintaining anonymous validators while simultaneously requiring KYC/AML on end users is a bit nonsensical (which is what the Bitcoin community has done actually).  Not only do you have the cost structures of both worlds but you have none of the benefits.  If validators are known, then they can be held legally responsible for say, double spending or censoring transactions.

Robert Sams recently noted the absurdity of this hydra, why permissionless systems are a poor method for managing off-chain assets:

The financial system and its regulators go to great lengths to ensure that something called settlement finality takes place. There is a point in time in which a trade brings about the transfer of ownership–definitively. At some point settlement instructions are irrevocable and transactions are irreversible. This is a core design principle of the financial system because ambiguity about settlement finality is a systemic risk. Imagine if the line items of financial institution’s balance sheet were only probabilistic. You own … of … with 97.5% probability. That is, effectively, what a proof-of-work based distributed ledger gives you. Except that you don’t know what the probabilities are because the attack vectors are based not on provable results from computers science but economic models. Do you want to build a settlement system on that edifice?

Though as shown by the NASDAQ annoucement, this will likely not stop people from trial by fire.

Concluding remarks

Bertha Benz, wife of Karl Benz, is perhaps best known for her August 1886 jaunt through present day Baden-Württemberg in which she became the first person to travel “cross-country” in an automobile — a distance of 106 kilometers.

It is unclear what will become of Bitcoin or cryptocurrencies, but if the enthusiasm of the 19th century German countryside echoed similar excitement as reddit sock puppets do about magic internet money, they must have been very disappointed by the long adoption process for horseless carriages to overtake horses as the primary mode of transportation.  For instance, despite depictions of a widely motorized Wehrmacht, during World War II the Teutonic Heer army depended largely on horses to move its divisions across the battlefields of Europe: 80% of its entire transportation was equestrian.  Or maybe as the popular narrative states: cryptocurrencies are like social networks and one or two will be adopted quickly, by everyone.

So is this book the equivalent to a premature The Age of Automobile?  Or The New Age of Trusted Third Parties?

Its strength is in simplicity and concision.  Yet it sacrifices some technical accuracy to achieve this. While it may appear that I hated the book or that each page was riddled with errors, it bears mentioning that there were many things they did a good job with in a fast-moving fluid industry.  They probably got more right than wrong and if someone is wholly unfamiliar with the topic this book would probably serve as a decent primer.

Furthermore, a number of the incredulous comments that are discussed above relate more towards the people they interviewed than the authors themselves and you cannot really blame them if the interviewees are speaking on topics they are not experts on (such as volatility).  It is also worth pointing out that this book appears to have been completed around sometime last August and the space has evolved a bit since then and of which we have the benefit of hindsight to utilize.

You cannot please everyone 

For me, I would have preferred more data.  VC funding is not necessarily a good metric for productive working capital (see the Cleantech boom and bust).  Furthermore, VCs can and often are wrong on their bets (hence the reason not all of them outperform the market).13 Notable venture-backed flops: Fab, Clinkle, DigiCash, and Beenz.  I think we all miss the heady days of

Only two charts related to Bitcoin were used: 1) historical prices, 2) historical network hashrate.  In terms of balance, they only cited one actual “skeptic” and that was Mark Williams’ testimony — not from him personally.  For comparison, it had a different look and feel than Robinson’s “BitCon” (here’s my mini review).

Both Michael and Paul were gracious to sign my book and answer my questions at Google and I think they genuinely mean well with their investigatory endeavor.  Furthermore, the decentralized/distributed ledger tent is big enough for a wide-array of views and disagreement.  While I am unaware of any future editions, I look forward to reading their articles that tackle some of the challenges I proposed above.  Or as is often unironically stated on reddit: you just strengthened (sic) my argument.


  1. Note: I contacted Rulli who mentioned that the project has been ongoing for about 10 years — they have been distributing value since 2005 and adopted bitcoin due to what he calls a “better payment solution.”  They have 500,000 registered users and all compete for the same pot of bitcoins each month. []
  2. See also Megawatts Of Mining by Dave Hudson []
  3. Additional calculations from Dave Hudson:
    – Current Bitcoin network capacity: approximately 320 PH/s (320 x 10^15)
    – Best case power efficiency (shipping today): approximately 0.5 J/GH (0.5 x 10^-9 J/H)
    Likely power efficiency: approximately 1.0 J/GH (1 x 10^-9 J/H) = 2 x best case
    – Best case power usage (sustained): 320 x 10^15 x 0.5 x 10^-9 = 160 x 10^6 W = 160 MW
    Likely power efficiency: 160 x 2 = 320 MW
    – Best case power usage per day: 160 x 24 = 3840 MWh = 3.84 GWh
    Likely power usage per day: 320 x 24 = 7680 MWh = 7.68 GWh
    – Best case power usage per year: 3.84 x 365 = 1401.6 GWh = 1.4 TWh
    Likely power usage per year: 7.68 x 365 = 2803.2 GWh = 2.8 TWh
    The best case example would represent the entire Bitcoin network using the best possible hardware and doesn’t account for any cooling or any other computers used in the Bitcoin network. As such it represents an impossible best version of a network of this size. The likely example is probably closer as there is older hardware still in use and most data centers need cooling of some sort.
    The US Energy Information Administration estimated the US power generation capacity for 2012 at 1051 GW so the 320 MW number would represent 0.03% of the total electricity supply for the US. Assuming that we take the 320 MW figure then that would put Bitcoin at about 10% of Ireland’s electricity supply. []
  4. See: How do Bitcoin payment processors work? []
  5. See What is the blockchain hard fork “missile crisis?” []
  6. See Distributed Oversight: Custodians and Intermediaries []
  7. See also: The Rise and Rise of Lipservice: Viral Western Union Ad Debunked []
  8. See Can Bitcoin’s internal economy securely grow relative to its outputs? and Will colored coin extensibility throw a wrench into the automated information security costs of Bitcoin? []
  9. See Mitigating the Legal Risks of Issuing Securities on a Cryptoledger []
  10. See Fedcoin by JP Koning, Fedcoin: On the Desirability of a Government Cryptocurrency by David Andolfatto, A Central Bank “cryptocurrency”? An interesting idea, but maybe not for the reason we think by Richard Brown and Which Fedcoin? by Robert Sams []
  11. See Slicing Data []
  12. Tabulating publicly reported bitcoins that were lost, stolen, seized, scammed and accidentally destroyed between August 2010 and March 2014 amounts to 966,531 bitcoins. See p. 196 in The Anatomy of a Money-like Informational Commodity by Tim Swanson. See also: Bitcoin Self-Defense, Part I: Wallet Protection by Vitalik Buterin []
  13. See Venture Capitalists Get Paid Well to Lose Money from Harvard Business Review and Ouch: Ten-year venture returns still lag the broader markets from Pando Daily []
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What’s happening in the Singapore fintech arena?

About a week ago I attended two back-to-back events: the Sim Kee Boon Institute’s conference and the DBS blockchain hackathon.

SKBI, where I am a visiting research fellow, is a seven year old institute which is part of Singapore Management University, one of the youngest universities in Singapore. This was its fifth annual event to cover digital banking and its scope has expanded to impact investing and financial inclusion.

While both events took place over the entire week, the conference was a two and a half day event that included panelists, moderators and audience members from around the globe including parts of Europe, both Americas and all across Asia.

The first full day included several keynotes from industry gurus including Piyush Gupta, the CEO of DBS bank, one of the largest banks in Southeast Asia and others such as Omidyar Network, a investment fund focused on social impact investing primarily in developing countries. The second day was entirely conducted in Chinese and among others included speakers from SF Express and VCredit.

Prior to the event a private roundtable took place over a three hour period and included members from policy making and research bodies.  Both Chris Skinner and myself independently gave presentations covering the future of fintech (incidentally a few of our slides were even similar). Some of the feedback and comments discussed the sustainability, or rather the unsustainability of several P2P lending projects such as those in the UK and in China.  For example, some of the problems in this segment include a lack of credit ratings, financial controls and arbitrary quotas (e.g., incentives to approve loans in order to hit specific arbitrary numbers).

The following day, on the first day of the public conference, Professor Rui Meng from CEIBS explained how there are now 1,700 P2P lending platforms in China and that there were at least 7 reasons for why this number has rapidly increased over the past five years including financial “repression” (the dearth of financial instruments by which investors can diversify into).

rui meng

Professor Rui Meng

For some more stats related to China see: Understanding value transfers to and from China.

What was the overall takeaway of the conference?

My thoughts echo Todd McDonald’s, based on my two trips to Singapore over the past 6 months its policy makers seem to be positioning the country (via Smart Nation) as a testbed for a variety of innovations in the overall “fintech” arena. The Minister of Water Resources & Smart Nation, Vivian Balakrishnan, even gave a roughly 3 minute overview of what blockchains are to the conference dinner after the first day of the event.

Conversations on and off chain throughout the remainder of the week seemed to support the notion that key decision makers at institutions across the country were increasingly interested in potential use-cases that blockchains (or derivations thereof) could solve especially those surrounding trade finance and identity/authentication. And this makes sense.  Singapore became a wealthy developed country in part because of its ports (recall that it sits the cross roads of both regional and international maritime trade prior to even the British colonial era).

Trade finance – smart contracts

One of the conversations I had with a banking administrator was that if you took a port manager or bank manager from the late 19th century and brought them to the present day they would likely not see too many differences in how the trade finance system worked in terms of letters of credit and bill of lading. It still involves a number of frictions (manual, heavily trust-based interactions) that are over a century year old, if not longer, yet are a multi-trillion dollar segment that the revolutions in digitization and automation seem to have forgotten.

It’s a chicken-and-egg problem, a little like fax machines and airports (I am trying not to use the overused cliche phrase “network effect”).  A fax machine which cannot connect to other machines is about as useful as a paper weight and a solitary airport that has no connecting flights is effectively a parking lot.

Can distributed ledgers (or whatever we end up calling non-Nakamoto blockchains) reduce the costs and provide transparency to this seemingly anachronistic trade finance system?  Can smart contracts be used to act as custodians of collateral or property titles in the movement of goods?  Or is this all just wishful thinking? There are two startups that have a “trade piece” related to this, including Mountain View-based PurchaseChain (part of the SKUChain project). Readers: if you are working on a replicated ledger project in this area, Singapore is definitely the place to go to test its utility.

Perhaps the second most widely discussed area that came up in conversations with members of the Singapore financial industry was that of identity and authentication. Like the rest of the world, each local bank has its own KYC/AML procedures that creates frictions when transferring value and adds to the already expensive customer acquisition and on-boarding costs.  For instance, one stat that stood out was that the costs for customer on-boarding at a traditional bank branch can reach upwards of $1,500 or more (once marketing is factored in).


Credit: Amar Banwait and Optirate

Ideally, so the conversations went, something akin to SingPass or Estonia’s e-identity initiative is an idea that seems to be worth its weight in gold as it could not only lower the costs but also the potential fraud and identity theft that currently takes place (among other benefits).

While it is just my opinion, I found the two most interesting presentations to be from the Fidor bank team (Frank Schwab and Matthias Kröner)  and Daniel Epstein from the Unreasonable Group.

I moderated a panel that included Chris Skinner, Frank Schwab, David Shin (from Paywise) and Todd McDonald (from R3).  The videos are supposed to be uploaded soon.

I also enjoyed hanging out with Albert Chu, who was a moderator and also a SKBI visiting research fellow.  His diverse experience in investing, advising and mentoring.  His views are grounded and did not involve the evangelical hype of the typical Silicon Valley investor.  Anju Patwardhan from Standard Chartered also had many interesting comments and insights throughout the event involving financial inclusion, P2P lending and trade finance.  I would like to also thank professor David Lee for his time, effort and enthusiasm as well as Ernie Teo and Priscilla Cheng from the SKBI team for hosting me.  More photos on Twitter #SKBI.

Some other coverage of the conference:

skbi dinner

SKBI Conference participants


Panel 1 on Day 1 of SKBI conference


Between Friday and Saturday, 18 teams comprised of 3-4 people each (hailing from a variety of countries) participated in the DBS hackathon, competing for $33,000 SGD in prize money as well as a spot at the DBS / Startupbootcamp (SBC) accelerator.

I took a number of photos with commentary that were posted on Twitter #dbshackathon.

Both CoinGecko and Bitcoin Magazine posted an overview with a few of the teams from the event including the winners and David Moskowitz has a short reddit thread on it as well.

The hackathon itself was fairly straight forward.  Held on the third floor of Block 79 called BASH (where the Startupbootcamp facility is), 18 teams initially worked in one large room and there are several adjoining rooms that were also used as meeting spaces.  Throughout the day a group of mentors (of which I was one of) spoke with and provided assistance and consultation to the teams.  Some of the mentors (and later judges) helped a few of the teams walk through the ideation phase.  The self-organized teams themselves were fairly diverse, comprised of individuals whose skillset typically involved a engineering background but also business development.

In addition to creating a three-minute presentation, there were a number of criteria the projects would be judged on including a technical code review.  While some participants arrived earlier in the week and had a chance to brainstorm, the teams themselves only had two days to bring it all together and pitch the product to six judges.  DBS was the main sponsor of the event and more than 10 individuals from the bank were on-hand throughout the event to provide feedback as to how the ideas could be used in a fintech context.  In addition to the three winners covered in the two articles above, three additional startups that participated in the event were recently accepted into SBC for their new batch.

Aside from the top 3 projects, I thought the 4th place was especially of interest.  DBB is similar to Hyperledger and Stellar but is unique in that users individually run their own ledger and validating node yet there is no global consensus or state.  One of its creators is Pavel Kravchenko who is currently chief cryptographer at Tembusu and previously worked at Stellar.

The atmosphere was friendly, informative and competitive.  Some of the teams were laser focused at winning the competition while others were more relaxed, preferring to focus on team building and becoming more proficient with the tech.  A few had not worked with a decentralized ledger before and Blockstrap was on-site to help provide support for everyone.  Overall it was probably a helpful event for both startups and banks as it led to a cross pollination of ideas and professions.

It was good catching up with the active startup scene there:  Anson Zeall from CoinPip; David Moskowitz from CoinRepublic (who led the tech auditing team for the hackathon); Yusho Liu from CoinHako (which got 3rd place), Antony Lewis (and his baby son) from itBit; TM Lee and Bobby Ong from CoinGecko, Pavel Kravchenko and Andras Kristoff from Tembusu (Pavel independently worked on a new project and got 4th place); Adam Giles and Mark Smalley from Blockstrap; Marcus Swanepoel from BitX; Taulant Ramabaja (founder of Pactum but who flew in and was part of the 1st place team); Ayoub Naciri from Artabit; Virgil Griffith (independent); Lilia Vershinina from Kraken; Markus Gnirck from StartupBootcamp; and Ron Hose from

They all have, as my British friends say, heaps of passion and it appears as if Singapore is positioning itself to be an important integral role in the future of fintech innovation.

Special thanks to Mikkel Larsen and Cade Tan from DBS for organizing the event and taking the time to discuss their views on trends in this space.


Blockstrap and team NuBank (which won 2nd place at the DBS hackathon)


Antony Lewis (itBit), Taulant Ramabaja (Pactum) and a future stuntman


Ernie Teo (SKBI), Todd McDonald (R3CEV) and Albert Chu at the Economic Society of Singapore’s annual dinner

dbs hackathon day 1

DBS Hackathon Day 1

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