Explaining trading volumes in China

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

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

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

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

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

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

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

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

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

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

A taste of quotes

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

On first-movers and fads:

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

On the externalizing the costs of mining:

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

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

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

On his use of imagery:

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

On putting the theft at Mt. Gox into perspective:

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

Regarding the hype of adoption and ATMs in Canada:

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

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

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

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

On the odds that Bitcoin will supplant the state:

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

More on whether or not it will supplant the state:

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

On volatility:

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

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

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

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

Is it similar to how the internet evolved?

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

On hype and irrational exuberance:

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

On the wisdom of trying to short exuberance:

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

On the difficulty of creating other derivative products:

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

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

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

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

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

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

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Cryptocurrency in the news #28

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

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

In the meantime, other stories this past week:

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The Continued Existence of Altcoins, Appcoins and Commodity coins

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

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

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False analogies in Bitcoinland plus Alibaba

Saw two analogies used today that are inaccurate.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

The case of Alibaba

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

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

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

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

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Why do prices fluctuate #2?

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

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

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

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

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

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

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Cryptocurrency in the news #27

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

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

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

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

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Cryptocurrency in the news #26

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

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

Link is not an endorsement of service or coin.

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Cryptocurrency in the news #25

Closing tabs.

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

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

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Does Smart Contracts == Trustless Multiparty Monetary Computation?

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

In his view:

Here is my proposal.

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

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

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

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

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

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

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Cryptocurrency in the news #24

Closing tabs.

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

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

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

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A panel on smart contracts with industry developers and educators

Earlier today I participated in a virtual panel covering smart contracts called, “Let’s Talk Smart Contracts.”

The panel included: Adam Krellenstein (Counterparty), Oleg Andreev (CoreBitcoin), Pamela Morgan (Empowered Law), Stefan Thomas (Codius, Ripple Labs), Stephan Tual (Ethereum), Tim Swanson (Of Numbers), Yurii Rashkovskii (Trustatom) and it was moderated by Roman Snitko with Straight.

Below are some transcribed notes of my own statements.

Introduction starting at 09:06:

Hey guys, great to be here.  Thanks for the invite, thanks for organizing this.  So I’m here because you guys needed another white guy from Europe or something like that (that’s a joke).  So the definition I have of smart contracts, I have written a couple books in this space, and the definition I use is a smart contract is “a proposed tool to automate human interactions: it is a computer protocol – an algorithm – that can self-execute, self-enforce, self-verify, and self-constrain the performance of a contract.”  I think I got most of that definition from Nick Szabo’s work.  For those of you who are familiar with him, look up some of his past writings.  I think that the primary work he is known for is the paper, “Formalizing and Securing Relationships on Public Networks.”  And he is basically considered the [intellectual] grandfather of this space.  I’m here basically to provide education and maybe some trolling.

From 22:02 -> 24:15

I think I see eye-to-eye with Adam here.  Basically the idea of how we have a system that is open to interpretation, you do have reversibility, you do have nebulousness.   These are things that Nick Szabo actually discussed in an article of his called “Wet code and dry” back in 2008.  If you look back at some of the earlier works of these “cypherpunks” back in the ’90s, they talked about some of these core issues that Oleg talked about in terms of being able to mitigate these trusted parties.  In fact, if you look at the Bitcoin whitepaper alone, the first section has the word “reverse” or “reversibility” around 5 times and the word “trust” or “trusted” appears 11 times in the body of the work.  This was something that whoever created Bitcoin was really interested in trying to mitigate the need for any kind of centralized or third party involved in the process of transactions to reduce the mediation costs and so forth.

But I suppose my biggest criticism in this space, it is not pointed to anyone here in particular, is how we have a lot of “cryptocurrency cosplay.”  Like Mary Sue Bitcoin.  I’m not sure if you guys are familiar with who Mary Sue is: she is this archetype who is this kind of idealized type of super hero in a sense.  So what happens with Bitcoin and smart contracts is that you have this “Golden Age” [of Comics] where you had the limited ideas of what it could do.  Like Superman for example, when he first came out he could only jump over a building and later he was pushed to be able to fly because it looks better in a cartoon.  You have only a limited amount of space [time] and it takes too long to jump across the map.  So that’s kind of what I see with Bitcoin and smart contracts.  We can talk about that a little bit later, just how they have evolved to encompass these attributes that they’re probably not particularly good at.  Not because of lack of trying but just because of the mechanisms of how they work in terms of incentives for running mining equipment and so on.  So, again we can talk about that later but I think Adam and Oleg have already mentioned the things that are pretty important at this point.

40:18 -> 41:43

I’m the token cynic, huh?  So actually before I say anything, I would like to mention to the audience other projects that you might be interested in looking at: BitHalo; NotaryChains is a new project that encompasses some of these ideas of Proof of Existence created by Manuel Araoz, he is the one who did POE.  NotaryChains is a new project I think that sits on top of Mastercoin.  The issue that people should consider is that proof of existence/proof of signature: these are just really hi-tech forms of certification.  Whether or not they’re smart contracts I guess is a matter of debate.

There is another project: Pebble, Hyperledger, Tezos, Tendermint, Nimblecoin.  With Dogethereum their project is called Eris which apparently is the first DAO ever.  A DAO for the audience is a decentralized autonomous organization, it’s a thing apparently. SKUChain is a start-up in Palo Alto, I talk about them in chapter 16.  They have this interesting idea of what they call a PurchaseChain which is a real use-case for kind of updating the process from getting a Letter of Credit to a Bill of Lading and trying to cut out time and mediation costs in that process.  There are a few others in stealth mode.  So I really don’t have a whole lot to add with cynicism at this point, we can go on and come back to me in a little bit.

59:41 -> 1:02:35

The go to deficiency guy, huh?  They’re not really saying anything particularly controversial, these things are fundamentally — at least from an engineering perspective — could be done.  The problem though I think runs into is what Richard Boase discussed in — if listeners are interested — he went to Kenya and he did a podcast a few weeks ago on Let’s Talk Bitcoin #133.  I really recommend people listen to it.  In it he basically talks about all of these real world issues that run into this idealized system that the developers are building.  And as a result, he ended up seeing all of these adoption hurdles, whether it was education or for example tablets: people were taking these tablets with bitcoin, and they could just simply resell it on a market, the tablet itself was worth more than they make in a year basically; significant more money.  He talked about a few issues like P2P giving, lending and charity and how that doesn’t probably work like we think it does.

I guess the biggest issue that is facing this space, if you want issues, is just the cost benefit analysis of running these systems.  There is a cost somewhere to run this stuff on many different servers, there is different ways to come up with consensus for this: for example, Ripple, Stellar, Hyperledger, they’re all using consensus ledgers which require a lot less capital expenditures.  But when you end up building something that requires some kind of mining process itself, that costs money.  So I think fundamentally in the long-run it won’t be so much what it can do but what can it economically do.

So when you hear this mantra of let’s decentralize everything, sure that’s fine and dandy but that’s kind of like Solutionism: a solution looking for a problem.  Let’s decentralize my hair — proof of follicle — there is a certain reductio ad absurdum which you come to with this decentralization.  Do you want to actually make something that people are actually going to use in a way that is cheaper than an existing system or we just going to make it and throw it out there and think they’re going to use it because we designed [wanted] it that way.  So I think education is going to be an issue and there are some people doing that right now: Primavera De Fiillipi, she’s over at Harvard’s Berkman Center — she’s got something called the Common Accord program.  And also Mike Hearn; listeners if you’re interested he’s made about 7 or 8 use-cases using the existing Bitcoin blockchain including assurance contracts — not insurance contracts — assurance contracts.  And he’s got a program called Lighthouse which hopes to build this onto the actual chain itself.  So there are things to keep in mind, I’m sure I’ll get yelled at in a minute here.

1:23:58 -> 1:28:10

Anyone listening to this wanting to get involved with smart contracts: hire a lawyer, that’s my immediate advice.  I will preface by saying I don’t necessarily agree with policies that exist and so on; I don’t personally like the status quo but there is no reason to be a martyr for some crusade led by guys in IRC, in their little caves and stuff like that.  That’s not towards anyone here in this particular chat but you see this a lot with “we’re going to destroy The Fed” or “destroy the state” and the reality is that’s probably not going to happen.  But not because of lack of trying but because that’s not how reality works.

Cases right now are for example: DPR, Shavers with the SEC, Shrem now with the federal government, Karpeles [Mt. Gox] went bankrupt.  What’s ended up happening is in 2009, with Bitcoin for example, you started with a system that obviated the need of having trusted third parties but as users started adopting it you ended up having scams, stolen coins, people losing coins so you ended up having an organic growth of people wanting to have insurance or some way to mediate these transactions or some way to make these things more efficient.  And I think that it will probably happen — since we’re guessing, this is speculative — I think that this will kind of happen with smart contracts too.  That’s not to say smart contracts will fail or anything like that.  I’m just saying that there will probably just be a few niche cases initially especially since we don’t have much today, aside I guess from Bitcoin — if you want to call it a smart contract.

What has ironically happened, is that we have created — in order to get rid of the middlemen it looks like you’ve got to reintroduce middlemen.  I’m not saying it will always be the case.  In empirical counter-factual it looks like that’s where things are heading and again obviously not everyone will agree with me on that and they’ll call me a shill and so on.  But that’s kind of where I see things heading.

I have a whole chapter in a book, chapter 17.  I interviewed 4 or 5 lawyers including Pamela [Morgan] of different reasons why this could take place.  For example, accredited investor — for those who are unfamiliar just look up ‘accredited investor.’  If you’re in the US, in order to buy certain securities that are public, you need to have gone through certain procedure to be considered a ‘sophisticated investor.’  This is one of the reasons why people do crowdsales outside of the US — Ethereum — because you don’t want to have to interact with the current legal system in the US.  The reason I mention that is because you end up opening yourselves to lawsuit because chains — like SWARM — cannot necessarily indemnify users.  That’s legal terminology for being able to protect your users from lawsuits from third parties; they just do not have the money, the revenue to support that kind of legal defense.  Unlicensed practice of law (UPL) is another issue.  If you end up putting up contracts on a network one of the issues could be, at least in the US, are bar associations.  Bar associations want to protect their monopoly so they go after people who practice law without a license.  I’m not saying it will happen but it could happen.

My point with this is, users, anyone listening to this should definitely do your due diligence, do your education.  If you plan to get involved with this space either as an investor or developer or so on, definitely at least talk to a lawyer that has some inkling of of an idea [on this].  The ones I recommend, in addition to Pamela here are: Ryan Straus, he is a Seattle-based attorney with Riddell Williams; Austin Brister and James Duchenne they’re with a program called Satoshi Legal; and then Preston Byrne, who’s out in London and he’s with Norton Rose Fulbright.

1:52:20 -> 1:54:43

Guys look, I understand that sounds cool in theory and it’s great to have everything in the background, but the reason you have to see these “shrink wrapped” EULAs [end user license agreements] and TOSs [terms of service] is because people were hiding stuff inside those agreements.  So if you hide what’s actually taking place in the contract you end up making someone liable for something they might not actually agree to.  So I’m not sure, I think it’s completely debatable at this point.  If we’re trying to be transparent, then you’re going to have to be transparent with the terms of agreement.

I should point out by the way, check out Mintchalk.com, it’s run by guys named James and Aaron in Palo Alto, they’re doing contract building.  ACTUS is a program from the Stevens Institute, they’re trying to come with codified language for contracts.  Mark S. Miller, he’s got a program over at Google, he does something with e-rights.

I mention all of this because, we already have a form of “polycentric law” if you will in terms of internationally with 200 different jurisdictions vying for basically jurisdiction arbitrage.  Ireland and the Netherlands have a tax agreement that Facebook, Google, Pfizer they take advantage of.  It’s this Double Irish With a Dutch Sandwich.  In fact my own corporation is incorporated in Delaware because of the legal arbitrage [opportunities].  Obviously smart contracts might add some sort of new wrinkle to that, but people who are listening to this, don’t expect to be living in some Galt’s Gulch tomorrow or something like that.

For example, when you have something that is stolen, there is something called Coinprism which is a colored coin project.  They can issue dividends on stock.  The cool thing with that is, “hey, you get to decentralize that.”  The double-edged side of that is if that when that get’s stolen: people steal stuff like bitcoins and so forth, what happens to the performance of that dividend?  If the company continues paying that dividend in knowing that the person had been stolen from: if somebody stole from me and I tell the company, “hey, it was stolen” and they continue paying, then I can sue them for continuing to pay a thief.  If they stop paying then it defeats the purpose of decentralization because anonymity is given up, identity has taken place.  Obviously this moves into another area called “nemo dat” it’s another legal term talking about what can be returned to the rightful owner, that’s where the term “bona fide” comes from.  Anyways, I wanted to get that out there.  Be wary of disappearing EULAs, those have a purpose because people were being sued for hiding stuff in there.

2:10:05 -> 2:12:23

So I think everybody and all these projects are well-intentioned and have noble goals but they’re probably over-hyped in the short-run, just like the Segway was.  It eventually leads to some kind of burnout, or over-promise and under-delivering.  I’m not saying this will happen, I’m just saying it could happen.  I actually think the immediate future will be relatively mundane, such as wills and trusts kind of like Pamela was talking about.

One particular program is in Kenya there is something called Wagenitech which is run by Robin Nyaosi and he is wanting to help farmers move, manage and track produce to market to bypass the middleman.  That doesn’t seem like something really “sexy,” that doesn’t seem like the “Singularity” kind of thing that everyone likes to talk about.  But that is needed for maybe that particular area and I think we might see more of that along with PurchaseChain, NotaryChains, some of these things that we already do with a lot of the paperwork.

Again, blockchains and distributed ledgers are pretty good at certain things, but not everything.  It has real limitations that vocal adopters on the subreddit of Bitcoin like to project their own philosophical views onto it and I think that it does it a very big disservice to this technology long-term.  For example, LEGO’s can be used to make a car but you wouldn’t want to go driving around in one.  A laptop could be used as a paper weight but it’s not particularly cost effective to do that.  And so what I think we’ll end up running into a tautology with smart contracts, it’s going to be used by people who need to use them.  Just like bitcoin is.  So what we’re going to have is a divergence between what can happen, this “Superman” version of Bitcoin and smart contracts, versus the actual reality.

So for example, people say it’s [Bitcoin] going to end war.  You had the War of Spanish Succession, there was a Battle of Denain, a quarter million people fought that in 1712 and it was gold-based [financed by specie].  Everyone that says bitcoin is going to destroy fiat, if the state exists as it does today there’s always going to be these institutions and types of aggression.  I do think smart contracts do add collateral and arbitration competition and it does take away the problem of having trust in the system itself, but the edges are the kryptonite.  And always will be.  So we need to focus on education and creating solutions to real actual problems today with the actual technology and not just some hypothetical “Type 2″ civilization where we are using [harvesting] the Sun for all of our energy.

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Cryptocurrency in the news #23

Closing tabs.

A few interesting stories, the first of which is from The Economist, “The dollar’s sterling work.”  One notable passage from the article is, “people exaggerate the importance of the yuan. Just $0.3 trillion of Chinese assets are open to foreign investors, compared to $56 trillion of American ones. That makes the yuan a poor candidate for a global reserve currency.”

As I explored in chapter 13, Bitcoin adopters who continue to claim bitcoin will become a reserve currency usually do not understand how or what foreign currency reserves are.  The Chinese RMB, not bitcoins, has a more probable future as a reserve currency and as discussed by The Economist and others cited in chapter 13 (such as Patrick Chovanec), this is not going to happen anytime soon for the RMB, if ever.

I also recommend reading through “Inside Visa’s Data Center” published last year to give you an idea of the quality and security of their network.  Significantly different (42 firewalls, mirrored center in Midwest) than the cartoon caricature that some vocal “decentralize the worlders” claim it as.

Thanks to Izabella Kaminska and others for a couple of the links.

 

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Some costs and pictures of Bitcoin mining in China

Jake Smith has another good article / overview of a large Bitcoin mining operation in China, “Inside one of the world’s largest bitcoin mines.”

The article states that this operation’s output is roughly 5% of the entire network hashrate and the electrical costs for it are about $1 million per month.

A couple guys on reddit did the math and came up with these other two numbers:

  • $1 million electric bill per month = $33000 per day/$500(price of btc) so they need to mine 66 btc/perday just to cover electricity.
  • If they have 5% of the network, then it’s 3600*0.05 = 180 bitcoin per day, or about $90k.

So they are generating $90,000 in revenue per day yet fully 1/3 of the costs are soaked up by electricity.  Note: Last month, the  bottom line price at a farm like this, to “create” a bitcoin was 2700 RMB ($444).

What this means is that if this is the most efficient set up possible (economies of scale via low labor costs, quick installation from manufacturer, relatively cheap land prices, relatively competitive electrical rates) then to power the rest of the Bitcoin network with similar data warehouses, the global cost for electricity alone would be around $240 million a year.  Obviously this may not be the case as each geographic region and jurisdiction have several variables that could impact and move this final amount up or down, yet that is probably a relevant range.

Similarly, the hardware costs would likely double, triple or perhaps quadruple the costs as well.  Add on costs of maintenance (things break), rent, etc. and this pushes the world wide costs of bitcoin mining upwards into the $1 – $2 billion per year range, which as copiously detailed in Chapter 3, is what theory predicts (MV=MC).  This does not also take into account all the various exceptions to the rule of miners mining at losses to get “virgin” coins, or researchers externalizing costs onto government run computers, etc.

This dynamic could change as market prices for bitcoins fluctuate, see further discussion from Dave Hudson on this.

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Dave Hudson explains Bitcoin mining hash rate statistics

Over the past several months I have had a number of conversations with Dave Hudson, proprietor of HashingIt.com; some of these quotes ended up in the book.  A couple months ago he became the VP of software development over at PeerNova; he also has a strong background in both chip design and network graph analysis.

Last week he gave a presentation at the Bitcoin Dev meetup in San Francisco (special thanks to Taariq Lewis for hosting it) where he explains, in minute detail, how to differentiate between noise and signal when analyzing changes in hash rate.

The deck of the presentation is here.  I think his discussion covered on slides 26-30 provide a very cogent argument for what I discussed on page 32; if I update the book I’ll be sure to include his analysis because it is the most probably explanation.

I highly recommend the entire hour long lecture because it is probably the best single source of non-partisan analysis of what mining as a statistical process looks like and why it has evolved to look the way it does today (especially around 43:00m regarding incentives for pooled mining).  His proposed solution, by staggering a hard fork over a period of time to increase block confirmation times by 5x is also interesting because it looks like it may be incentive compatible for current miners, farms and pools to implement.

Below are some transcribed portions starting around 12:00m regarding an explanation for hash rate estimations (slide 26 and 27):

So the other thing that is interesting of course about a logarithmic plot is that if you actually plot a straight line on a logarithmic plot you can actually see if you are seeing an exponential expansion.  There was a period of time where that was almost a straight line.  In fact if you look at the statistics from the end of last year and the early part of this year it was pretty much a straight line; we were seeing a straight logarithmic expansion.  But now in fact, that is slowing down, so in fact there is actual slow down in the hash rate.  And that is likely to continue until there is a significant change in the technology of that is implementing the hashing.

So we’ve reached the limit pretty much in terms of process technology for ASICs.  There are a couple of nodes left that, I have not talked about it in this but there is some stuff on the blog.  We are in 28 nanometers now there is some room to go in 28nm but it is not a huge amount.  The reality is we can get to state-of-the-art around 14 to 16 nanometers and then we are just waiting on the fabs to be able to move to something better than that.  So the amount that we can actually gain from just process technology is diminishing significantly.

The other problem is that from a power efficiency perspective, the power efficiency just doesn’t improving at the same rate it was before.  When you can jump and leverage many years of the process improvements in the course of one generation of ASICs and go from 130 to 65 to 28 then you can see dramatic improvements and dramatic improvements in the power efficiency.  That’s just not possible when you start getting out to 28.  So yes, you can put more capacity online but the amount of power that it is likely to take will go up much more dramatically then what we’ve seen in previous generations.  So this is leading to a slow down.

The other thing of course is you can look at the block mining reward and say ‘well most of the funding for this sort of hash rate expansion has to come from the block mining rewards.’  And given that there isn’t a massive spike in bitcoin price which is driving the ability to pay for more hardware then you’re not going to see those sorts of huge increases.  There is certainly the capacity to do that, if the price of bitcoin were to go up by a factor of 5 then there is a lot more money available for people to throw at hardware and throw at operational costs.  So there is scope for that.  But while things are actually relatively static then things are going to slow down, so we’ll see some slow down.

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A month later, what is happening with cryptocurrency mining in China?

I am not one to continually update books, but, since this space is very dynamic I reached out to one of the experts in China, “Bob,” who helped me with chapter 5.  Bob works with large Bitcoin mining farms, specifically helping them source energy but also helps procure mining equipment too.

Here are some of his comments:

I think the value per gigahash is difficult to define. Chip Maker. Assembly. Operator. Electricity Provider. Pool.  Those are five distinct industries. I believe the hashing contracts that you hear about includes one year of electricity and all of the above.  Whereas most mining businesses quote mining solutions to operators who need to buy the machines.  I think it’s not easy to lay out the relationship to a new reader, but at the same time you have to avoid confusing different segments of the mining industries who are normally just concerned with their one segment. A tough middle road.

For instance, earlier today, Guy Corem, CEO of Spondoolies Tech, an Israeli-based Bitcoin mining manufacturer posted several comments on Bitcoin Talk:

We do have large customers. The real threat is that one self-mining ASIC provider will be able to produce a killer ASIC.
Everyone of them are trying. Buying from them help their deployment and R&D efforts. As I wrote short-term gain, scarifying the long-term.

Continuing Corem states:

Spondoolies-Tech have clear technological advantage now. We have much more impressive 3rd and 4th gen under development.
I think that if we wanted to raise funds for mega farms, BitFury style, we could have done that.
KNC is doing that right now for example. So are other players.
BitFury doesn’t need to do that, but fortunately, they are very delayed with their next gens.

I don’t think it’s good for the Bitcoin ecosystem at all.

KNC has proven track record of treating the ecosystem as a retirement fund.
CoinTerra switched to self mining (and selling unprofitable cloud contracts) and exchanges to fiat heavily on the open exchanges, exactly like KNC.
BitFury at least has the sense not to exchange in the exchanges (selling at 5% markup for high net-worth individuals who wants newly mined coins), but BitFury have unclear past and are partly responsible for the CEX.IO fiasco. I don’t think they can be trusted not to harm the ecosystem.

And another notable comment:

Not desperate at all. Just analysed and know all the known competition cost.

The trend is clear if you remove BitFury 2 last DCs (June and August): http://bitcoin.sipa.be/growth.png
At current BTC price and their machine cost, they’re almost loosing money at Georgia and Iceland.

btw: They didn’t need the $20M they raised. I can’t elaborate more.

BitmainTech margins are very, very low.

ASICMiner is selling almost at cost to recoup their $6M wafers gen3 investment.

Cointerra is also probably loosing money on their 1st gen. Their 2nd gen won’t arrive until Q2

Should I continue ?

Please quote this message one month from now. Let see how the growth graph will look.

For comparison, I reached out to Bob and asked him his thoughts on what Corem was stating.  According to Bob, in terms of Chinese manufacturers switching to self-mining:

They’ve already been doing that for the past two months. But not mining themselves, they’re all into coop mode now. The manufacturers issue the machines. The site operators invest on the sites. They split the income between them.

Spoondoolies is no bitmain tech nor bitfury. But those guys have a good chance of being no.2 if either of these guys slip up. Their chip design is highly competitive, they just need a strong hook up to a manufacturing partner in shenzhen.

A lot of the claims in the thread are exagerrated. It is fair play though I think. The fud points I see there are the centralization claims and the mining is more profitable than selling. Retail consistently overestimates the production value which means that as long as your pricing strategy is good, your machines often never ROI. Would you rather sell something that doesn’t ROI or have your capital locked up for the next 6 months?

Spoondoolies is a rare case in that they still have a lot of clout to rely primarily on pre-selling their gear, which means their product might still be quite profitable for the buyer when it comes out. So to them it seems like it is more profitable to self mine, but the fact of the matter remains that without cheap pre-orders, they don’t have the money to start a production run.

And for perspective, to give you an idea of how important this space is in China, be sure to see this new summary, “The 2nd Private Meeting of Bitcoin Mining Industry in China” from Bitell.  It will be interesting to see how many manufacturers and farms can stay afloat while market price hover above cost of production for more than just a few months.

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Cryptocurrency in the news #22

Closing tabs.

Two things:

1) I contacted Wedbush Securities about their new report and asked them what their citation for their first point regarding payments was.  They responded by saying they used the Blockchain.info transactional volume chart.  The reason this is interesting is because based on the past 8 months, that chart does not actually support their argument.  Perhaps this will change in the future, but it may not.

2) I have a short article about the unseen costs/subsidies in the mining space, it is mostly a rehash of chapter 3.  I suspect that once we have “Peak Hashrate” prior to the next block reward halving in 2016, some of the hand waivers will begin to realize what the real costs of securing and transacting is: How many bitcoins does it cost to maintain the Bitcoin network?

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Jae Kwon on other economic attack challenges

Apropos the responses of BINO and the other responses to Downplaying Risks, Jae Kwon (author of the Tendermint protocol) pointed to an interesting thread on Reddit:

How to double spend PoW coins for fun and profit.

You don’t even need major pools to subvert the security of the blockchain and double spend.

Let’s say that you want to doublespend a transaction that was included at height H. Simply put out a bounty for more than the mining reward for the first miner to mine an alternative block at height H. Then, you reward the (traitor) miner on the existing blockchain. As long as the instigator is trustworthy, rational greedy miners would switch because the expected reward is higher. Then you do the same for height H+1 and so on, until the fork wins.

Jae also had some more comments related to blockchain forks and he gave me permission to have them reposted:

I actually wrote a prototype of an exchange engine, and the hardest part was dealing with logic pertaining to block chain forks.  It’s just so easy to get wrong, and it’s not even clear when a transaction should be deemed “irreversibly committed”.  So I ended up having to write tricky edge cases, where, I can imagine bugs can emerge.  This isn’t something that will connect with most users, so I doubt that people will even “get it”, but my assessment is that Bitcoin has these fundamental design issues that may end up hurting its adoption rate compared to other designs..

Another thought is that we probably want  to see a multi-coin future where no single coin has global dominance.  If you want a future with many multiple competing cryptocurrencies, then you probably want to get away from a consensus algorithm that relies on energy.

And in terms of the speculation surrounding the Ethereum team working together with the BitShares team and potentially using Delegated Proof of Stake (DPOS), Jae thinks that:

I don’t know enough about BitShare’s DPOS scheme to list specific vulnerabilities, but here’s a rule of thumb that I use to evaluate consensus algorithms:

The amount of value at stake that is lost in the event of a fork is roughly the amount of security afforded.

In the PoW vulnerability that I mentioned, what is at stake is the electricity spent mining blocks.  Large transactions need to be vetted by waiting a proportional amount of confirmations, potentially much longer than the original 6 confirmations as cited in Satoshi’s paper for transactions over hundreds of BTC.

In any delegated PoS model, if Carl can delegate his stake to someone without the risk of losing that stake, then Carl can be bribed by Malory to delegate his stake to Malory’s puppet account.  On the other hand if Carl can lose his stake in the event that the delegated signer does something bad (e.g. enable a double spend by forking the blockchain), then Carl probably wouldn’t want to delegate his stake to anyone, and instead would opt out of the consensus process or become a validator himself.  For this reason I don’t find delegation models to be very interesting.  It may provide some utility as long as delegated coins are “at stake”, but the foundational consensus algorithm (minus the delegation part) must be secure first.  Delegation cannot fix a broken algorithm.

Lastly, Peter Todd suggested that I emphasize that there is a difference between hard forks, soft forks and SPV soft forks.  Last fall Todd wrote an overview on this titled On soft-forks and hard-forks.

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Robert Sams on rehypothecation, deflation, inelastic money supply and altcoins

The Bitcoin Foundation held a conference in Amsterdam back on May 15-17.  The video of the events was not uploaded until recently.  The one below covers the panel on economic theory.

Panel: Robert Sams (Founder, Cryptonomics) Robin Teigland (Associate Professor, Stockholm School of Economics) Peter Surda (Economist, Economicsofbitcoin.com) Konrad Graf (Author & Investment Research Translator) and moderator Jon Matonis (Executive director of the Bitcoin Foundation)

Over the past several months, Robert Sams has helped act as a non-partisan sounding board to discuss these issues as I did research on these topics.  He also recently launched a start-up in this space called Swiss Coin Group which acts as a liquidity counterparty (see also SCG’s announcement video from Coinsummit last month).

I finally had a chance to watch the panel on economic theory of Bitcoin (above) and below are some transcribed portions of comments by Robert Sams.

Regarding the ‘regression theorem‘:

The idea that something needs to have some underlying use value before it can gain liquidity and become a medium of exchange, first of all it has always struck me as not a derivation of logic and therefore not a theorem but an empirical hypothesis and one that I think that the very existence of Bitcoin has conclusively falsified.

On competing altcoins being sorted out:

I think eventually there is only room for a handful, 3, 4, 5, maybe ten competing cryptocurrencies.  Each filling a niche that satisfies some area of demand, some might have a richer scripting function for smart contracts, one might be embedded in a different kind of protocol.  So there is definitely room for multiple currencies but the very nature of hash-based proof of work, where the security of the network is arrived at by people literally burning money is one that can’t be evenly distributed over a large number of alternative cryptocurrencies.  It’s what you see, eventually most of the altcoins will fail and people will stop mining them, they won’t have any exchange value.  But there will still be room for quite a few.  And you already see it in the distribution of the market capitalization of these things, they follow a power law and I would expect that to continue.

What about altcoins in local communities?

That’s an interesting question.  I think the more local the currency becomes the harder I think it is to use hash-based proof of work as a solution.  Although other types of distributed consensus mechanisms could be used.  Because if as a community currency the overall monetary value of that thing is going to be much much lower, so the amount of seigniorage that comes from the mining award to reward the miners is much lower, so the amount of electricity that is spent securing it, it is something that will be alot easier for someone on the outside to attack it if they wanted to.  On the other hand, the incentive of attacking some small community currency might not be there, so not much of an issue.  So it’s an open question.

Thoughts on fractional reserve banking with bitcoin:

I don’t think it is actually possible to construct fractional reserve banking within Bitcoin.  Because fractional reserve banking, especially in the modern era, it’s one of the great scandals of modern finance is based on an illusion — this 1:1 fungibility between bank deposits and cash.  And you can do that in the conventional analog world because you have this whole institutional framework of deposit insurance, lender of last resort function of the central bank, you can bail out the banks if they fail in order to maintain this illusion that a loan to the bank — an unsecured loan to the bank which is basically what a bank deposit is — is the same thing as cash, and they are not.  And there is not anyway within the crypto space to express such an arrangement.  Sure there will be lending done in Bitcoin, I was talking to a guy last night who is doing just that, that’s fantastic.  But the relationship between the lender and the borrower isn’t one of “well I had some ownership of a pool of loans to people” — that’s something that has a floating net asset value.  It is not treated as a cash equivalent, I can’t use it as a medium of exchange or maybe I could but it would be a medium of exchange that trades like a credit instrument rather than risk free cash.  So I don’t think its even possible to express fractional reserve banking in bitcoin and I think that’s a good thing.

Konrad makes a really interesting point about trusted fourth parties and trusted fifth parties.  You know, it’s not just about being fractional reserve banking, the bank deposit versus cash, it’s about all assets within the financial system: the clearing banks, custodians — also play a fractional reserve-like role.  Most people don’t realize that.  Securities that are on deposit with a custodian bank can be lent out to those who want to sell them short; bonds, the same thing happens.  So that something that is called rehypothecation, these assets get lent and relent and relent, they multiply throughout the system.  So like some particular bond that’s in the system, there might be $2 billion of it outstanding, but the actual quantity of people who own that bond on their balance sheet is like a factor of 10 times that.  It’s just like the multiplication of base money in the banking system and the whole thing creates a systemic instability because the lack of clarity about this relationship between the guy who is entrusted his assets for safe keeping in some clearing bank and exactly do what that clearing bank can do with it.  Now the theory you think that it is governed by the law and the like but when Lehman bankrupt, there were a lot of fund managers and hedge fund managers who didn’t actually realize that their clients money which was supposed to be in a segregated client account was actually rehypothecated and they had to queue up in the bankruptcy courts in order to recover that money.  And one of the things that crypto does is make the sure technical nature of the transference being done by digital signature means that there is no way that you can create these rehypothecation arrangements without making them explicit.  And I think that is great.

Would you take out a 5 year loan in bitcoin knowing you had to pay it back in bitcoin?

No.  Well, it depends, I guess if I were selling it short.  But no.  If there was a lending market in bitcoin its most likely to flourish initially as being something that’s denominated in fiat money rather than nominal bitcoin.  Unless the borrower is using it as a vehicle to speculate on a climb in the exchange rate.

On deflation:

I think the deflation criticism of Bitcoin is usually misguided, it usually comes from the economics profession.  The arguments that are made don’t really apply because, the arguments about sticky prices (good’s prices fall faster than wages), about balance sheet effects of debtors being punished because an increase in the purchasing power, none of those really apply in Bitcoin because bitcoin isn’t yet a unit of account.  Contracts and prices are still priced in the fiat currency and expressed in bitcoin by reference to some exchange rate.  So the traditional arguments like, “is deflation is a bad thing” don’t really apply in a bitcoin world.

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.

What about issuing coins after 21 million limit, that would be called Keynes coin?

I wouldn’t call it Keynes coin, not just because of the marketing but conceptually I don’t think it would be either.  This is controversial and difficult.  There are algorithmic, distributed ways of working within cryptocurrency protocol to change the money supply in proportion to the change in its exchange value.  And that can be done, it doesn’t require a central bank, it doesn’t require some cabal of guys deciding what the monetary policy can be, it can be done completely anarchic and distributed way and it would have the property of stabilizing the price of cryptocurrency.

I think the issue if should you have more elastic supply or not it just really comes down to the fact that if you have a fixed supply of something, the only way that changes in demand can be expressed is through the change in price.  And people have expectations of increased demand so that means those expectations, expectations of future demand get translated into present day prices.  And the inelastic supply creates volatility in the exchange rate which kind of undermines the long term objective of something like cryptocurrency ever becoming a unit of account.  And forever it will be a medium of exchange that’s parasitic on the unit of account function of national currencies.  So I do think the issue does need to be addressed.

Audience question on 100% reserve versus fractional banking:

There is a movement underway in the economics profession called limited purpose banking or 100% reserve banking.  It’s not just in the cryptocurrency world that we criticize fractional reserve.  Even Mervyn King before he left his chairmanship with the Bank of England he suggested that this is something that we should look into.  So yes, it is quite possible, there could be consensus — broad base consensus — around taking away the banks ability to create private money.  What do we use to replace that, one side of the argument is going to be that the banks should take the role of issuing the currency they just have to have 100% reserves and ‘gosh those things should be risk free government bonds.’  I think there is an alternative argument that can be made from the cryptocurrency space is that we don’t actually need the banking system to fulfill those functions at all.  And the demand for some medium of exchange in the absence of bank created money will be met spontaneously within the cryptocurrency space.

Audience question, does buying bitcoin and holding them benefit the community?

It’s an interesting question.  I don’t think so.  You could argue indirectly the fact that people buy and hold bitcoin, the price goes up and that attracts all the interest into this space and to some extent that’s true.  So yes, it does provide some investment.  But I think it doesn’t provide as much investment as would be the case in the alternative world where Satoshi implemented the exact same thing but had a different money supply rule.  My view counterfactual is that we would actually see a lot more underlying economic activity in the cryptocurrency space and a lot more investment.

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