What has been the reaction to permissioned distributed ledgers?

About 3 weeks ago I published the “Consensus as a service” report.  What has the fallout been over it?

The specific, public comments broadly fall into 3 groups:

  • those that think Bitcoin is the only blockchain that can and does matter and everything else is a worthless unholy “Frankenstein” ledger
  • those that think cryptocurrency systems as a whole are superior to non-cryptocurrency distributed ledger networks
  • those, like Nick Williamson, who are open to building technology for specific customers and use-cases

As of this writing, the majority of views on /r/bitcoin and Twitter seem to take the maximalist, one-size-fits-all approach: that Bitcoin is the only way, the truth and the light.

In contrast, the target audience for the report are decision makers and developers within the financial services industry.  These individuals, based on months of conversations, are more interested in permissioned ledgers for their business needs because all of the parties involved in the transactions are known, have real-world reputations to maintain, have responsibilities which are expressed in a terms-of-service that is contractually binding and are ultimately legally accountable for actions (or inaction).

Cryptocurrency networks like Bitcoin, a public good that purposefully lacks a terms of service or accountable validators, were specifically designed not to interface with these organizations and institutions — and intentionally created an expensive method to route around all entities (via proof-of-work).  Thus in practice, it makes some sense that financial institutions may not be interested in Bitcoin as-is.

This may be a problem to maximalists, who have come to create and control a narrative in which Bitcoin can and will disrupt anything and everything that deals with finance and have invested accordingly.  Perhaps it will, but then again, maybe it will not.

While there were a number of interesting comments elsewhere, I think the most objective was — independently — an interview earlier this week in Institutional Investor with Blythe Masters (formerly JPMorgan, now over at DAH):

Q: Everyone talks about the enormous potential of alternative currencies and their underlying technology.  But the whold world of Bitcoin and other currencies was set up to resist centralization and intermediation.  It didn’t want to be part of the organized financial industry; it was openly scornful of it, and there’s still a strong libertarian, antibank strain to much of the sector today. Do you think these worlds want to be bridged?

Blythe Masters: I would say that your general characterization of some in the space is correct. But if you had a really good idea about how to build a better tire for an automobile, you would probably be really interested in talking to the auto companies because they are the people that ultimately are going to make use of your technology. You could think that maybe, because of the power of your tire, there might emerge a whole new brand of auto companies that supplant the General Motors of the world because the incumbents never really got the whole concept of what a good tire should be all about. But I’m not sure that would be a good move.

Why do I think this tire analogy is apt?

Because each month at conferences, Bitprophets claim that financial institutions in New York, London and other global centers where capital resides, will fall to the wayside very soon.

Perhaps this prophecy will come true, but it is unlikely for the reason Masters points out: most of the funded Bitcoin companies thus far seem to act like tire companies.

A few entrepreneurs are hoping that newer, different car companies will not only adopt their tires but simultaneously replace older car companies that already provide the same product lines.  While these startups are likely capable of providing utility and usefulness to someone, this overall narrative is probably wishful thinking.  Why would Toyota or General Motors disappear and be completely replaced by new automobile companies in the coming years because someone created a new tire?  Perhaps these existing car manufacturers will indeed disappear due to changes in consumer preferences or safety concerns but probably not because of a new tire.

Furthermore, characterizing the 8 different projects discussed in the report as Frankenstein ledgers is funny as those writing the comments seem to have forgotten how tech iteration works.

For instance, according to Gwern Branwen, the key moving parts that Bitcoin uses are actually a bit old:

  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

Would projects like git, which use a few of these parts, be considered “Frankenchains”?

The reaction that a few have had the past couple of weeks makes one wonder as to how they would initially react if alternative airplanes, automobiles and boats were invented: “But a monoplane cannot work as it is missing essential features from the original biplane!”

Taking a step back, calling one of the 8 projects in the report “Frankenledgers” would be like calling:

  • non-Mercedes vehicles, Frankencars
  • non-Wright Brothers heavier-than-air contraptions, Frankeplanes
  • any non-Unix operating system, FrankenOSes (which is ironic since Unix was itself a FrankenOS relative to Multics)
  • any non-Motorola cell phone, Frankenphones

Maybe none of the projects in the report will ultimately succeed.  Maybe in five or six years they fail to gain traction.  Maybe future ledgers and projects add additional “moving parts” to whatever they ultimately call their chain.

Yet we cannot command customer-driven technology to follow one specific narrative anymore than the previous pioneers of technology.  Just ask Alfred Nobel or other inventors over the past few centuries.  Furthermore, building ever larger quantities of a product without figuring out if there is a product-market fit seems to be how the Bitcoin community has attempted to operate over the past several years.  Perhaps this “marketing myopia” will pay-off, maybe the Kevin Costner syndrome (build it and hope they come) will be avoided.  Or maybe not.

Owning coins without disclosing they do

“It’s about the coin, you cannot downplay the coin!” was another common response.

To me the question of coins or no-coins is a red herring.  Perhaps organizations find them useful or maybe not.  Ultimately however, the target market for the report were organizations who need products that:

1) Create additional financial controls (removing the ability for one administrator to abuse the system because the information and state is distributed and shared)

2) Provide additional transparency for their risk management and capital management teams (such as reducing duplicative effort in Transaction Reporting)

Or in short, this variation of shared, replicated ledgers helps financial institutions to securely reduce costs.  That may sound mundane and unsexy, but reducing IT costs at some banks can mean tens of millions in savings.  As a result, some financial institutions (and likely other industries), are looking to take parts of the toolkit, portions of the 10 moving parts above and develop a new developer stack, just as LAMP did 15 years ago.1

How do validators fit in with this again?

The tl;dr of the report is that permissioned ledgers use known validators whereas permissionless ledgers intentionally use pseudonymous validators.  They each have different cost structures and are targeting two different groups of customers.

Why are known validators important?  Because in the event a chain forks, is censored or transactions are double-spent, there is no legal way to hold pseudonymous validators accountable because there is no terms of service or contractual obligation.  Or more to the point, as a public good, who is responsible for when a block reorg take place?  Apparently no one is.  This is problematic for financial institutions that want to be able to reliably transfer large amounts of value.

If pseudonymous validating nodes and mining pools are required to doxx themselves (or the current euphemism, “trusted transparency”), they lose the advantage of being censorship resistant.  Users might just as well use a permissioned ledger.


In the event such a fork, censored transaction or double-spending occurs with permissioned ledgers, the validator can be held legally accountable because they are known.  Proof-of-work is no longer needed and entities that are doing the validating are held accountable to specific TOS/EULA.

The main reason that block reorgs do not occur more frequently, like what happened in March 2013, is that it is just not worth the effort right now relative to the amount of value being transacted on the Bitcoin network.  Yet if there were billions or trillions USD in financial instruments like derivatives moving across the network, there would be an more incentives to attack and reverse transactions (this is one of the problems with watermarked coins as they create a disproportional reward delta).  No financial institution is going to put this type of value on a permissionless chain if they cannot claim damages in the event of censorship or reversal.

bitcoin is not useful

Source: Matt Corallo

“But you cannot have a secure ledger without coins,” is a common response.  Isn’t owning bitcoins the most important part of this equation?

Under Meher Roy’s classification chart, this is only true if hyperbitcoinization takes place, which it probably will not (recall: that which can be asserted without evidence, can be dismissed without evidence).

Then why is this continually promoted?  Probably because the company they work for or their personal portfolio includes bitcoins as part of their retirement plan and hope the demand for bitcoins by financial institutions and other organizations launches the price to the moon.  This is not to say that Bitcoin is bad or worthless as a network (or as an asset, it may even have another black swan or two upwards), but neither the UTXO or network (as-is) is a solution to a problem most banks have.

Maybe as Matt Corallo (who shared the picture above) is right: perhaps in the long-run historians will look back at these permissioned, distributed ledgers and declare them non-blockchains.  Maybe they will be called something else?  However, as it stands right now, even with cryptocurrencies, Bitcoin is not the only way to skin a cat.  The wheels (or tires) comprising Bitcoin and its nascent ecosystem can and will be interchanged and removed due to their open source nature and differing business requirements for each organization.

Keeping fees or be altruistic?

Are there any recent examples of doxxing of validators?  Yesterday a bitcoin user (someone who controls a privkey) made a mistake and accidentally sent 85 bitcoins to a miner in the form of a fee.  At ~$228 per BTC (at the time it was sent) this amounted to a $19,380 fee.  After several hours of debugging and troubleshooting, the problem was identified and fixed.

Along the way, the block maker (the pool) was also identified and notified, in this case it was Bitmain (which operates AntPool) based in China who said they would return the fee.

tx fees in USDThe chart above covers the time frame over the past two years, between April 2013 – April 2015.  It visualizes the fees paid to miners denominated in USD.

As we can see, in addition to the large fee yesterday, there are several outliers that have occurred.  One that is publicly known took place on August 28, 2013 when someone sent a 200 bitcoin fee that was collected by ASICMiner.  At the time the market value was $117.59 per BTC, which meant this was a $23,518 fee.  It is unclear who originally sent the fee.

This raises a couple of questions.

The network was originally designed in such a way that validators (block makers) were pseudonymous and identification by outside participants was unintended and difficult to do.  If users can now contact validators, known actors, why not just use a distributed ledger system that already identifies validators from the get go?  What use is proof-of-work at all?

Yet a trend that has actually occurred over the past four years is self-identification.

For instance, I reached out to Andrew Geyl from Organ of Corti and he provided two lists.

Below is a list of the first time a pool publicly claimed a block:

Pool  |  Height
1:  Slush  97838
2:  bitcoinPool 110156
3:  DeepBit 110322
4:  Eligius 120630
5:  BTC Guild 122608
6:  MTRed 123034
7:  EclipseMC 129314
8:  Polmine 131299
9:  Triplemining 134362
10: BitMinter 134500

And a list of the first time a pool signed a coinbase transaction:

Pool  |  Height
1:  Eligius 130635
2:  BitMinter 152246
3:  BTC Guild 152700
4:  Nmcbit.com 153343
5:   YourBTC 154967
6:   simplecoin.us 158291
7:   Ass Penny pool 161432
8:   btcserv.net 163672
9:   Slush 163970
10:  BitLC 166462

A little history: Slush began publicly operating at the end of November 2010.  Eligius was announced on April 27, 2011.  DeepBit publicly launched on February 26, 2011 and at one point was the most popular pool, reaching for a short period in July 2011, more than 50% of the network hashrate.

Why did they begin to identify themselves and sign coinbase transactions?  Geyl thinks they initially did so to help with miner book keeping and that community pressure towards transparency did not happen until later.  And as shown by the roughly ~20% of unknown block creators on any given day, if a block maker wants to remain unknown, it is not hard to do so.

The other question this raises is that of terms of service.  As noted above, since the Bitcoin network is a public good (no one owns it) there is no terms of service or end-user license agreement.  Coupled with a bearer instrument and pseudonomity it is unclear why pools should feel obligated to refund a fee; Bitmain did not steal it and in fact, did nothing wrong.  The user on the other hand made a mistake with a bearer instrument.

This type of altruism actually could set a nebulous precedent: once block rewards are reduced and fees begin to represent a larger percentage of miner revenue, it will no longer be an “easy” decision to “refund” the user.  If Bitmain did not send a “refund” it would serve as a powerful warning to future users to try and not make mistakes.

In addition, why do elements in the community think that 85 BTC is considered refundable but are unconcerned with any fee sent above 0.0001 BTC (0.0001 BTC is considered the “default” fee to miners)?  This seems arbitrary.

And this is a problem with public goods, there are few mechanisms besides social pressure and arbitrary decision making to ration resources.  As described by David Evans, since miners are the sole labor force, they create the economic outputs (BTC) and security it is unclear why they are under any expectation to return fees.

This is probably not the last time this will occur.


Public goods are hard to fund as they typically fall victim to tragedy of the commons.  And development, maintenance and security of Bitcoin is no exception.

While it did end up dominating the embedded systems space, despite similar rhetoric 20 years ago by passionate FOSS developers, Microsoft was not killed by Linux.2  Prophetic claims that desktop Linux would bankrupt incumbents and a GNU (and GPL “maximalism”) world order would take over the software industry never materialized: the fact of the matter is desktop Linux became a niche with no more than 1% of marketshare.  Incidentally, some vocal promoters insisted each year, that 200X would be the year of mass adoption for desktop Linux (it even saw a funding boom-bust such as the VA Linux IPO).3

Instead, many of the ideas and libraries were forked and integrated by enterprises such as IBM into other organizations and institutions, such as banks.  The only multi-billion dollar open source company that arose from this time period was Red Hat, yet even the inroads it made with Linux and FOSS is arguably overshadowed by the biggest kernel user: Android, another corporate sponsored “distro.”45

While past performance does not guarantee future results, IBM is once again back and has been looking into blockchain tech (through ADEPT), many of the major tech companies that arose in the ’90s (such as Amazon and Google) have payment solutions and customer usage of Bitcoin — like desktop Linux before it, despite enormous awareness and interest — still remains very niche, perhaps roughly 300,000 that actually control a privkey.

Maybe this will change over time.  Or maybe the buzz with this hot space will cool down in a few years and all the Young Turks will find something new to work on, leaving Bitcoin to fend for itself like Gnu Privacy Guard and many other forgotten public goods.6  Maybe they will move on to permissioned distributed ledgers which have known use-cases and customers, or maybe onto something else entirely.

Update: be sure to see some critical feedback from Peter Todd

End notes:

  1. According to L.M. Goodman, who created Tezos, a better example would be HTTP, not LAMP: “The value of distributed ledgers is in protocols and networks, not software or “stacks”.” []
  2. Linux certainly did change the infrastructure landscape.  Embedded Linux now pretty much dominates inside many devices (e.g. routers, switches), while it also dominates much of the Internet server ecosystem. The key to both of these was that it solved very specific commercial problems; the adoption was frictionless.  In embedded systems Linux was up against quite expensive proprietary RTOS and embedded OS designs.  The smaller ones were not as feature rich, while the larger ones could not compete in markets where gross margins became very tight. In the server space commercial Unix and Windows servers had expensive OS software and Linux could run on smaller, resource constrained, systems very effectively.  Early adopters could often get their hands on hardware but not the software and startups could readily tweak the software for special purposes. Now Linux dominates these spaces because it is actually really efficient for building things like network servers (they can run better on Linux in many cases).  Thanks to Dave Hudson for this insight. []
  3. Mike Hearn made a similar observation a year ago during a presentation: Mike Hearn, Bitcoin Core Developer NBC2014 from Bitcoin Congress.  See also: What Killed the Linux Desktop by Miguel de Icaza, Linus Torvalds on the Linux desktop’s popularity problems from ZDNet, Desktop Linux: The Dream Is Dead from PCWorld and Windows’ Endgame. Desktop Linux’s Failure from ZDNet []
  4. Google has purposefully avoided using almost all other Linux software and particularly GPL’d software. The entire application framework for Android is different than other distributions like Fedora. They only adopted the kernel possibly because of onerous GPL requirements. []
  5. Incidentally parts of Mac OS X are based off of FreeBSD. []
  6. I would like to thank Christopher Allen for this analogy. []
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The flow of funds on the Bitcoin network in 2015

Over the past several months, there has been a number of useful, simplified flow charts that show the general demand and supply for bitcoins.

chain participants

Source: Chain

The diagram above was created this past fall by Adam Ludwin, co-founder of Chain.com.  Subsequently, there have been a variety of similar charts from others describing the flows in an easy-to-understand way.  I think these are helpful and look forward to seeing more.

However, based on blockchain data, what do the specific flows look like?

After consulting with a number of industry experts, I constructed a rough, but more granular flow of funds based on actual user behavior.  This is not to say that these trends or activities will stay the same, but rather this is a visual aid to better understanding where the supply and demand of both “coins” and fiat are within the current ecosystem.

bitcoinland april 2015

Bitcoinland flow chart

The legend

  • The term “BTC” is in reference to unspent transaction outputs (UTXO), because “coins” do not actually exist1
  • The orange buckets and arrows involve mining farms, manufacturers and pools.
  • The brown buckets involve exchanges, ATMs, financial intermediaries, custodians and payment processors which have access to fiat (“early adopters” may also be on the sell side).
  • The green buckets represent fiat, this can be in the form of bank accounts or in the case of Localtrader, Localbitcoins.com, #bitcoin-otc (an IRC room) and “human” ATMs actual physical cash.
  • The champagne arrows involve the sale of BTC and block rewards.
  • The red arrows involve the purchase and buying of BTC.
  • The purple buckets and arrows involve illicit activity including darknet markets, scams, ransomeware, gambling, laundering and mixing of BTC.
  • The black arrows involve the sending of BTC to another hop or address.
  • And the blue buckets and arrows have no real commonality but are important in terms of the flow of funds.
  • Technically wallets do not exist at all, they are just a mental analogy to abstractly describe addresses as UTXO labels (not all wallets are “burner” as that would imply an increase in anonymity and requires knowledge of intent; they all can be effectively “temporary”).
  • In terms of mixing, certain altcoins are now a popular method for mixing.  For instance, litecoin (LTC) is one of the most liquid altcoins.  This typically looks like convert BTC at exchange A to LTC.   Then send LTC to exchange B and convert back to BTC.  Darkcoin (now called Dash) is another popular coin due to its specific “anonymity” features.  See also ring signatures from Monero.

[Note: I used Creately to prototype it and am releasing it as usual under a CC Attribution license]

The good with the bad

If a bitcoin is eventually deemed legally property, does this new flow chart imply that the current Bitcoin blockchain is a public, near-real-time record of contraband?  Maybe not.  Cryptocontraband would only really apply if you indeed were able to show the provenance of the property that you are talking about.2  For many of the use cases it is actually very difficult to show the provenance of individual currency units.   Perhaps this will change in the future, no one knows.

What is observable?  In addition to roughly 1 million bitcoins moving on a daily basis (more on that later), in the last four years we have seen several dozen high profile cases of individuals and companies whose bitcoins were lost, stolen or accidentally destroyed due to improper operational security.  By one account there are more than a million bitcoins that are no longer with their legal owner.345 Consequently, in terms of venture funding, the 2nd largest vertical that has received funds over the past 18 months is hosted wallet companies (“depository institutions”) such as Xapo and Coinbase which provide cold storage (“vaults”) and some type of insurance.

What has been the motivation to do so?  Because in practice, bearer assets are very hard to secure hence the reason for the emergence of banking intermediaries 500 years ago and again today in the era of virtual assets.

And this type of mercurial bearer ownership is not relegated to just the above-board economy.  For instance, about 16 months ago Sheep Marketplace, a darknet market, was “hacked” and 96,000 bitcoins were stolen (this was worth around $40 million at the time).  The purported owner of Sheep Marketplace was arrested last month.  A month ago, another darknet market, Evolution, lost at least 43,000 bitcoins (~$10 million) after two of the administrators stole them.

At a combined valuation of $50 million, this is roughly what BitPay processed in 2014 once mining and precious metals are removed from itemization.6

What about the “ransomware” subheading, what is “ransomware”?  It is a type of software, or malware precisely, that prevents users from using their computer unless the user pays the malware creator some kind of “ransom.”  In this case, bitcoins.

malware secureworks

“SecureWorks’ chart showing the correlation between Bitcoin’s price increases and the creation of new Bitcoin-targeting malware.” Source: Forbes

As noted in Chapter 12, 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.  And as shown by the chart above, there were as of February 2014, 146 different families of “Bitcoin-stealing malware.”   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, last month the network for Swedesboro-Woolwich School District in New Jersey was held hostage for a 500 bitcoin ransom.  And earlier this month, the Tewksbury Police Department system in Massachusetts became just one of many public organizations that has paid similar ransoms in bitcoin.

The case of the unknown volume

We know from public reports above of some on-chain activity, but not all.

Current total output volume is around 1 million bitcoins per day.  That is to say that on any given day (over the past year), approximately 1 million bitcoins have moved somewhere on the blockchain.  Knowing this and taking the categorization from Slicing Data, let us make a low, conservative assumption that 80% of the remaining volume is “change” being swept into change addresses, faucet outputs (a potential candidate for “long-chains”) and mining payouts.

And as established last week, we know that about $1,000,000 a day is from payment processing and above-board merchant activity, this amounts to less than 5,000 bitcoins per day.

Where is the rest of the volume coming from?

For instance, has the volume of Counterparty transactions increased?

counterparty transaction history

Source: Blockscan

As illustrated in the chart above, transaction volume for Counterparty has stayed roughly the same over the past 9 months or so.  A typical transaction requires about 0.0001 BTC (as a watermark) and about 0.0001 fee to miners.  Thus on any given day the total amount of bitcoins used by Counterparty is a handful, maybe even just 3 or 4 bitcoins.

What about P2SH?

weekly volume p2sh

Source: P2SH.info

As of this writing, about 8.63% of all bitcoins are stored using P2SH.  And while the last several months have each seen more than 1 million bitcoins move into P2SH, this still does not tell the whole story because that is per month and not per day, which we are observing (e.g., roughly 100,000 or so bitcoins per day move into P2SH).

What else comprises this gap?

If actual transactions represent 20% of the total output volume, or 200,000 bitcoins, what else could fit the bill?  Payment processors collectively would account for 2.5%, P2SH would account for 50% (although technically P2SH is not commercial activity), Counterparty less than 1%, gift cards less than 1%.

What about crowdsales?  The largest one right occurring right now is Factom.  Over the past three weeks approximately 2,180 transactions containing 1,955 bitcoins have been sent to the fundraising address; or about 104 transactions per day.

Now lets assume the international payments and remittance market is at least the same size as the merchant economy (it may be lower, based on anecdotally having talked to about 10 different exchanges overseas the past couple of months); so that is about another 5,000 bitcoins per day or 2.5%.

That means that we are still missing around 80,000 bitcoins per day if not more.  And based on address clusters at WalletExplorer, a large portion appears to come from movement in between exchanges and hosted wallets, as well as gambling services and darknet markets.

Recall that at its height in the spring and summer of 2012, nearly half of all transaction volume on the Bitcoin network were related to SatoshiDice.7 Once it blocked US-based IP addresses, its popularity waned.

Over the past two years, since May 13, 2013, there have been 946,261 bitcoins worth of wagers at Primedice, or roughly 1,350 bitcoins per day.

prime dice betting

Source: Dicesites

The chart above visualizes the activity on Primedice since January 1, 2015 – April 18, 2015.  Based on this cluser, there is is roughly as much transactional volume passing through Primedice as BitPay does each day.

A few other notable publicly known dice sites tracked by Dicesites:

  • Pocket Rocket Casino has about 440 bitcoins / day in wagers
  • BitDice has about 240 bitcoins / day in wagers
  • Dicenow has about 70 bitcoins / day in wagers

For perspective, prior to emptying its wallet (the first time), on its then-summer 2012 height, Silk Road’s public address contained 5% of all mined bitcoins at that point.8  In early November 2014, Operation Onymous — an international law enforcement action targeting darknet markets, closed down 414 sites.  Left unaffected were several of the larger DNMs, including Agora, Evolution and Andromeda, each of which actively sell illicit wares denominated in bitcoin.  Evolution, as noted above, suffered a large theft which will be looked at below.

Evolution DNM

Last week we looked at some charts from Coinalytics in relation to BitPay.  Coinalytics specializes in building data intelligence tools to analyze activities on the blockchain.  Using labels from WalletExplorer.com (which identifies reused addresses of a number of different services), the team was able to create visual aides covering Evolution.

Two things to keep in mind:

1) as a Swiss-based bot recently discovered, not everything sold on a DNM like Evolution are necessarily illegal (though a lot probably is)

2) we cannot have 100% confidence on the data since it may be missing some address clusters.  For instance, last week, the 500,000 BitPay transactions identified by WalletExplorer were 10% less than what BitPay officially reported during the same time frame (2014).  Thus, there may be a similar margin of error for the following data.

Evolution was officially launched on January 14, 2014 and its administrators pulled an “exit scam” with a large portion of the funds on March 18, 2015, effectively shutting down its operations.

Evolution Market Number of TransactionsThe chart above visualizes the time period between January 16, 2014 – March 18, 2015.  The average number of transactions per day was 1,004 and average bitcoins per day was 562.  However, as shown in the chart above it was not until the fall of 2014 that Evolution hit its stride.

For the six months between September 18, 2014 – March 18, 2015 saw traction.  During this time frame they processed 2,025 transactions and 1,260 bitcoins per day.

Evolution Market v Bitpay BtcAnother way of looking at that same trend is the comparison above: 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).

evolution market volume log scaleThe log chart above measures the value of incoming market volume between BTC and USD.

In terms of USD, the average value sent to Evolution between March 18 2014 – March 18 2015 was $190,179 per day.  As it achieved traction, between September 18 2014 – March 18, 2015 the average value sent was $353,669 per day.

For comparison recall that based on the stats released last week by BitPay, on average BitPay processed 1,544 transactions worth $435,068 per day in 2014.

USD Evolution MarketThe final chart above may be of interest to those wondering what the “exit scam” looked like in USD denominated value.  The time frame above is between January 16, 2014 – March 18, 2015.  As shown at the end, in March, the administrators “exited” with a large portion of coins valued at a range between $10-12 million USD (the full amount varies based on media outlet and is not fully captured in the chart above).

A question of ownership

Throughout this post the word “owner” has been used a few times.  Why is this important when looking at economic activity and flows of funds?

In an exchange with Amor Sexton, an Australian attorney that represents cryptocurrency companies, she noted that:

It seems like the preferred legal approach in many jurisdictions is that bitcoin is a form of digital property, and not money. This means that bitcoin would lack the negotiability of money. It is an important distinction in light of the concerns about the volume of fraud and theft.

If the statistics are correct, a significant amount of people may not have good title to the bitcoin that they hold. Of course, this is all theoretical, as it is arguably nearly impossible to prove title to bitcoin and satisfy the nemo dat principle.

However, you can’t merely ignore the issue. The law doesn’t cease to exist because you ignore it. For example, as Pamela Morgan points out, when you build a website, you get a default font without needing to specify any font. If you want to change the font, you need to write code to change it. The law has default positions that are implied into every situation. To change the default position, you have to actively create a new position that takes precedence over the default position.

The default position for property (and bitcoin if it is deemed property) is that the nemo dat rule applies. Ignoring the problem doesn’t fix it. The only thing that can fix it is by creating a new default position – either by law (declaring bitcoin to have the same negotiability as fiat currency) or by private agreement.

Nemo dat (short for nemo dat quod non habet) boils down to clean titles.  If you buy property from someone who does not have ownership right of the property, then the new purchaser does not have a legitimate title to this property (e.g., you cannot sell what is not yours).

Sexton is not the only practicing attorney with this view.

I spoke with Ryan Straus, an attorney at Riddell Williams in Seattle.  According to him:

I think there is a great deal of confusion around the property/currency distinction.  This confusion was magnified by FinCEN’s classification of Bitcoin as “virtual currency” for the purposes of the Bank Secrecy Act.  Shortly after FinCEN’s March 2013 interpretive guidance, people started to use the term “digital currency” rather than “virtual currency.”9

Bitcoin is not currency in digital or virtual form.  Rather, Bitcoin is virtually, or almost, currency.  Why is this important?  Currency can be thought of as property imbued, by the sovereign, with a special power.  Specifically, the legal tender status of currency allows it to be transferred free and clear of, rather than subject to, all claims and defenses.

In other words, currency is the only unconditional exception to nemo dat quod non habet, or the general rule that one can never transfer a better interest than one has.  There are other conditional exceptions to nemo dat that apply to certain types of property (goods, negotiable instruments and security entitlements) if certain conditions are met (property is transferred “for value” and in “good faith”).  If Bitcoin is not currency and does not fit within one of the statutory exceptions to nemo dat, nemo dat applies.  At this point in the conversation, the issue of fungibility inevitably comes up. However, fungibility isn’t a solution; it is merely an evidentiary issue.

The Financial Times, recently covered similar legal analysis by George Fogg, an attorney at Perkins Coie.  According to Fogg, “under the United States’ UCC code (uniform commercial code) as long as bitcoins are treated as general intangibles, no high value investor can be sure that an angry Tony Soprano won’t show up one day to claim that the bitcoins they thought they received in a completely unencumbered manner are actually his.”

Based on this insight the Times noted that:

Indeed, given the high volume of fraud and default in the bitcoin network, chances are most bitcoins have competing claims over them by now. Put another way, there are probably more people with legitimate claims over bitcoins than there are bitcoins. And if they can prove the trail, they can make a legal case for reclamation.

This contrasts considerably with government cash. In the eyes of the UCC code, cash doesn’t take its claim history with it upon transfer. To the contrary, anyone who acquires cash starts off with a clean slate as far as previous claims are concerned. It is assumed, basically, that previous claims on cash are untraceable throughout the system. Though, liens it must be stressed can still be exercised over bank accounts or people.

According to Fogg there is currently only one way to mitigate this sort of outstanding bitcoin claim risk in the eyes of US law. Rather than treating cryptocurrency as a general intangible, Fogg argues, investors could transform bitcoins into financial assets in line with Article 8 of the UCC. By doing this bitcoins would be absolved from their cumbersome claim history.

The catch: the only way to do that is to deposit the bitcoin in a formal (a.k.a licensed) custodial or broker-dealer agent account.

Whether or not a court will agree with this view depends on the jurisdiction that future defendants/plaintiffs are located.  US law seems pretty clear when it comes to property.

And as it is encoded today, there is no technical means for the Bitcoin network to enforce  off-chain asset rights based on terms-of-service (smart contract or otherwise); although there may be technical methods for integrating a terms-of-service into contracts transacted on the network.  However that is a topic for a different post.


As the Bitcoinland flow chart above showed, over the past six-and-nearly-a-half years, a visible division can now been seen between a KYC economy and non-KYC economy.  And while readers will likely find different parts of interest, to me a few of the takeaways are:

  1. In terms of activity, it is still difficult to tell what each category consumes specific amounts of transaction volume (e.g., “change” addresses, above-board merchant volume, gambling and so forth)
  2. Where the fiat leakage is occurring, where people take bitcoins out of circulation and purchase them with dollars or euros; how will this change in the coming months?
  3. The fact that value is actually being transferred: for all its warts some people still use it to transfer value often without intermediaries involved

Bitcoin and most other cryptocurrencies today, were intentionally designed not to interface with the current financial infrastructure.  Satoshi Nakamoto purposefully designed the network so that on-chain activity would route around trusted third parties and this came at a capital intensive cost (e.g., proof-of-work).  The decentralized, pseudonymous nature of these networks are a dual-edged sword: it provides advantages that can and will be used by both good and bad actors alike.  It will be interesting to look again at how this flow chart evolves over the coming years.

energy consumption bitcoin

Bitcoin network power usage from O’Dwyer and Malone

Future researchers may also be interested in breaking down the energy costs for maintaining each segment or bucket in the flows above.

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.1011
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.

If this is the case, is there a way to determine how much energy is being consumed to transfer and secure: the KYC activities as well as the non-KYC’ed activities?  One constraint to consider too for this research is that if it somehow becomes cheaper to secure the network, it is also cheaper to attack the network — and this can impact both currency and non-currency applications of the network.

[Thanks to Fabio Federici, Andrew Geyl (Organ of Corti), Dave Hudson, Jonathan Levin, Amor Sexton and Ryan Straus for their feedback and insights.]

  1. For one explanation why, see Bitcoin: New Plumbing for Financial Services by Jonathan Levin []
  2. The first person I am aware of that used the term “cryptocontraband” is Robert Sams. []
  3. 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 []
  4. The inability to enforce a contract and retrieve losses in the event of fraud is not just a challenge for Bitcoin, but other cryptocurrency systems such as Dogecoin. For instance, Dogeparty asset “DOGEDIGGERS” was used by someone mid-November 2014 to sell shares in their “mining operation.” The individual(s) behind it managed to extract a few million dogecoin before people caught on and started asking questions, identifying it as a scam and put an end to it — the social media sites that the scammers were using to make the scam look legitimate were taken down. Restitution, if there is any, will take place off-chain where contract enforcement actually exists. See also Meet Moolah, the company that has Dogecoin by the collar from The Daily Dot []
  5. While the verdict is still out on Mt. Gox, new data analysis suggests that hundreds of thousands of bitcoins were systematically stolen from Mt. Gox over a period of two years, many of which were sold on other exchanges including Mt. Gox.  See The missing MtGox bitcoins from Wizsec []
  6. Some other examples include: Neo & Bee, Bitcoin Trader, Moolah from Alex Green/Ryan Kennedy, GAW/PayCoin from Josh Garza, BFL, MyCoin and at least 192 others, more likely hundreds more.  A number of the buckets probably deserve their own flow chart, especially since stolen bitcoins can be observed being split apart, onion style (e.g., the criminal peel off UTXOs little by little). See: Investigating the allinvain heist by GraphLab and An Analysis of Anonymity in the Bitcoin System by Fergal Reid and Martin Harrigan []
  7. On May 4, 2012 Stephen Gornick calculated that of the 42,152 total transaction on the blockchain, 21,076 transactions were wagers related to Satoshi Dice. This volume doubled within four days, as Gornick posted an update that 94,706 total transactions on the blockchain, 47,353 were wagers.  In September 2013, Rick Falkvinge made the following analogy: “Money in gambling – at least instant gambling – is not in a lockdown cycle and does not contribute to the minimum size of the money supply. This becomes important as we look at the different economies making up bitcoin today. There are about 11.7 million bitcoin in circulation today. Out of these, a staggering 2 million bitcoin are gambled every year on the SatoshiDice site alone, and another, PrimeDice, 1.5 million. To put these numbers in perspective, if translated to the global economy, it would mean that people bet the entire production of the USA at one single betting site, and the entire production of Europe on another. But as we have seen, these numbers do not contribute to the money supply pool in any meaningful way in a functioning economy.” See Bitcoin’s Vast Overvaluation Appears Partially Caused By (Usually) Illegal Price-Fixing by Rick Falkvinge []
  8. See A Fistful of Bitcoins: Characterizing Payments Among Men with No Names by Meiklejohn et al. []
  9. FinCEN Issues Guidance on Virtual Currencies and Regulatory Responsibilities from FinCEN []
  10. See also Megawatts Of Mining by Dave Hudson []
  11. 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. []
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A gift card economy: breaking down BitPay’s numbers

Two days ago BitPay, the largest payment processor in the cryptocurrency space, published a new infographic filled with a number of new stats.

BitPay claims that in 2014:

  • $158,800,000 total value processed (an increase from $107 million in 2013)
  • 563,568 total number of transactions (an increase from 209,420 in 2013)
  • $281 average order value (a decline from $513 in 2013)

They also state that there is a reason for the decline in average order value:

This number is dropping as adoption increases and Bitcoin moves from an investment commodity to a payment method.

At best that is just a guess.  While it is neat that BitPay is one of a very few companies in this space willing to publicly release some numbers, we cannot determine what the actual cause for this trend with the available information.  Correlation (drop in prices or average order value) does not mean the real cause is payment adoption.


Source: XKCD

According to Jonathan Levin, head of business development at Chainalysis:

The fall in the average order value seems likely to be attributed to the increase in difficulty and the fall in the number of home miners.

Unless they publish weekly or monthly bar charts (which they used to), or what merchants are their largest by volume each week, it is unclear what could be skewing that number (e.g., large block sales from miners in 2013 and 2014?).

For instance, in December 2013, the chart below was published on the official BitPay blog (it has since been removed):

bitpay 2013The spike in transactions during November 2013 is probably related to two things:

  1. the Bitcoin Black Friday marketing event
  2. simultaneous run-up in prices during the contemporary bubble that early adopters / miners were likely able to capitalize off of by exiting positions

Are there any other numbers?

bitpay 2014Above is the last known public chart of BitPay transaction volume.  The dates on the chart corresponds with April 2013 – March 2014 and the image comes from the Cryptolina conference held in August 2014.

Although the quality is a little fuzzy, transaction volume appears to have reached around 70,000 in March 2014.  Token prices during March ranged from approximately $450 – $650 which they likely weighted and multiplied by the total amount of bitcoins received each day to come up with a figure of $1 million processed each day (note: at the end of May 2014, BitPay announced it was processing $1 million in bitcoins a day).

Yet as we shall see, in terms of fiat transaction equivalent, there is less than half as much today as there was last year.

bitpay chartThe chart above is part of the original BitPay infographic released on Wednesday.

In terms of transaction volume, bitcoin mining alone accounts for the next 4 largest segments combined.  For those who believe this will change in the future, recall that if mining somehow becomes cheaper then it is also cheaper to attack the network.  So as long as there are rents to be extracted, miners will continue to fight for and bid up the slivers of seigniorage up to where the marginal cost eventually reaches the marginal value of the token; and that translates into continuous streams of mining revenue (not necessarily economic profit) that are converted into fiat to pay for land, labor, taxes and electricity.

Furthemore, because bitcoin mining is not on the top 5 list of in terms of number of transactions this likely means that the miners that do use BitPay likely sell large blocks and are therefore large manufacturers or farms or both (and of those miners, most probably come from large entities such as BFL and KnC paying their utility bills).

The second chart to the right states that gift cards as a class represent the lion share for number of transactions processed.  This is actually kind of humorous and unhumorous.  What this means is that the majority of BitPay users (and probably bitcoin users in general) are not doing economic calculation in BTC (the unit of account) but instead some kind of fiat.  And to do so, they are going through a Rube Goldberg-like process to convert bitcoins into fiat-based utility.

This is mostly borne out through a roundabout process such as bitcoins sent to Gyft -> Gamestop -> ShellCard (the gas company).  Or Gyft->Amazon->Purse.io.

What are other motivations?  Some users, based on social media posts, claim to do this in order to reduce identification (KYC) paper trails so taxes will not have to be declared and sometimes to take part in illicit trade (e.g., sell these gift cards at a discount for actual cash for illicit wares).

Based on their chart, roughly $345,000 of merchant activity is processed on a daily basis.  Of that, $277,000 comes from precious metals and bitcoin mining.  The remaining  $68,000 is for unidentified e-commerce, IT services and travel.  Or in other words, nearly 80% of bitcoins processed by BitPay in 2014 went to paying for security (mining) and buying (or selling) gold and silver.

As I have written about previously, that for roughly every $1 spent on security (via mining), there was roughly $1 spent on actual retail commerce which translates into a quantitatively (not qualitatively) oversecured network.1 But based on this new data: more capital is probably being spent securing the network than retail commerce by a factor of at least 2x.2

Recall that bitcoin mining represents just under half of all transaction volume processed by BitPay, and BitPay itself has about 1/3 to 1/2 of the global market share for payment processing, so it is probably a good sample size of world wide non-darkmarket “activity.”

What about others?

The second largest payment processor is Coinbase.  And based on their self-reported transaction volume (below), the “off-chain” trend over the past year is similar to what BitPay processed:

coinbase chartAs described in Wallet Growth, approximately six months ago, in October 2014, Brian Armstrong and Fred Ehrsam, co-founders of Coinbase, did a reddit AMA.  At the 31:56 minute mark (video), Ehrsam 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.

Perhaps those volumes will change, but according to the chart above, that does not appear to be the case.

And as discussed in Slicing Data, the noticeable pattern of higher activity on weekdays versus the weekend is apparent irrespective of holidays with Coinbase too. Consequently, on most days these self-reported numbers comprise between 3-5% of the total transactions on the Bitcoin blockchain.  However, as Jonathan Levin, has pointed out, it is not clear from these numbers alone are or what they refer to: Coinbase user to user, user to merchant, and possible user wallet to user vault?

What does this mean for BitPay?

BitPay has three tiers of customer pricing.  The first plan is free, the second charges $300 for the first month and the third is for enterprise clients.  They claim that there are no transaction fees at all.

While they probably do sign up customers on their 2nd and 3rd tier, it is unclear how much.  Speculatively it may not be very much due to the low transaction volumes overall (e.g., why would Microsoft pay more in customer service than they generate in actual revenue?).  Thus their margins may be razor thin at ~1% which translates to roughly $1.5 million in annual revenue (it has to be below 2-3% otherwise merchants would not perceive an advantage for using their service).  BitPay also charges (collects) a spread through a process called the BitPay Best Bid (BBB) rate.

Based on the current head count of between 70-100 people (9 were probably laid off after the “Bitbowl“), it may be the case that the revenue generated annually covers the labor costs for just one or two months.  Perhaps this will change if prices rebound and/or if volume increases (recall that payment processors sometimes have to put coins on their books if they cannot find a counterparty to sell to in the time frame so in the likely event that BitPay holds coins on their books, they can gain or lose through forex movements).

bitpay twitterOn this point, four months ago I was involved in a mini-twitter debate with Jeff Garzik (a developer with BitPay) and Antonis Polemitis (an investor with Ledra Capital).  It partially centered around some of the findings that Jorge Stolfi (a computer science professor in Brazil) posted the previous month regarding BitPay’s transaction volume.

As discussed on Twitter, their burn rate on labor — as in almost all startups — is most certainly higher than the revenue they generate.  This should not be seen as “picking on BitPay” (because virtually every US-based VC-backed Bitcoin-related startup is in the same boat, see Buttercoin and probably ChangeTip) but they probably are not generating much additional revenue from “monthly SaaS subscriptions and payroll API customers.”

How do we know this?  Again, why would Demandware pay more for a SaaS subscription than they generate via revenue?  Altruism?  Perhaps a few do (like NewEgg or TigerDirect) but even if 1,000 customers paid $300 a month, that is still just $300,000 a month far less than the $1 million (speculatively) needed to cover labor alone.


I contacted Fabio Federici, co-founder of Coinalytics which specializes in building data intelligence tools to analyze activities on the blockchain.  Using data from WalletExplorer.com (which identifies reused addresses of payment processors, pools, gambling services and such), his team was able to create visual aides covering BitPay.

It bears mentioning that there is a ~10% discrepancy between the WalletExplorer numbers and BitPay and this is likely a result of the clustering heuristic (by WalletExplorer) which will not give 100% coverage and is not dishonesty from BitPay (e.g., WalletExplorer data set identifies just over 600,000 transactions last year whereas BitPay cites roughly 650,000 transactions).

bitpay daily number of transactionsThe time frame for the chart above takes place between July 2, 2011 and April 13, 2015.  The chart visualizes the Daily Number of Transactions.  The green line is the important line as it represents the incoming transaction amount that BitPay receives each day.  It shows that aside from a brief outlier in the winter of 2014, volume has remained relatively flat at around 1,200 – 1,500 transactions per day for the past 15 months.Daily Volume Btc (2013-2015) [Log] xThe time frame for the log chart above is slightly shorter, between January 1, 2013 and February 28, 2015 (there is a strange drop starting in March that is likely a problem with the clustering heuristic, so it was removed).  The chart visualizes the Daily Volume of bitcoin that BitPay receives.  The green line is the important line as it represents the aggregate of how many bitcoins BitPay received each day.  While there are some days where the total reaches to 8,000 or even 9,000 bitcoins, these are outliers.  Conversely some slower days reach around 500 bitcoins per day.  On average, between January 1, 2013 and February 28, 2015, the daily amount is 1,138 bitcoins.

Other specific ranges:

  • Average February 2013 – February 2015 = 1,209 bitcoins daily
  • Average February 2014 – February 2015 = 850 bitcoins daily

One explanation for the discrepancy is that there is a large incoming transaction of 28,790 bitcoins on March 25, 2013 which skews the average in the first date range.  It the same day that the Cyprus international bailout was announced.  While this coincides with the ‘bull run’ in the spring of 2013, it is unclear from public data what this one sale may have been.  Looking at some other charts, at around that date roughly 52,694,515 bitcoin days were destroyed (BDD) and total output volume (TOV) was around 4 million (which is about 4x higher than today).  During this time frame fees to miners were also about 3x-4x higher than they are today.  And on this specific day, 159 bitcoins in fees were sent to miners, the fifth highest total ever.  While speculative it could have been an “early adopter” or even a company overseas cashing out (market price was around $73.60 per bitcoin on March 25, 2013).

Daily Number of Transactions (2013-2015) [Log] xThe log chart above visualizes the daily number of transactions for BitPay between January 1, 2013 and February 28, 2015.  The interesting phenomenon is the flip that occurred in the fall of 2014.  Whereas previously the number of outgoing transactions exceeded the internally held coins, in late September this appears to have changed.  It is unclear what the reason(s) for this is.  Perhaps more merchants decided to keep coins instead of exchanging for fiat.  Or perhaps due to the continued price decline, BitPay had to hold more coins on their balance sheet due to the inability to liquidate merchant requests fast enough (e.g., between August 1 – November 1, market prices declined from around $558 to $336 per bitcoin).

Other noticeable phenomenon on the green line above include a rapid run-up during the collapse of Mt. Gox in February 2014 and then later Bitcoin Black Friday followed by Cyber Monday in November 2014.

Why are there recognizable patterns for the green line in all of the charts?  Again, since the bulk of payments are related to mining, it is likely that miners sell blocks on a regular basis.  Denominated in USD, when paired up with bitcoin volume between February 2013 and February 2015, the plot would likely look like a left-modal bell curve.

Perspectives and conclusions

On average BitPay processed 1,544 transactions worth $435,068 per day in 2014.  Once mining and precious metals are removed, the BitPay “economy” involves $57.5 million per year.  Even if the full amount, $158 million, were classified as actual economic activity, it is less money than what Harvard Business School generates from selling case studies each year (~$200 million) or roughly the same amount that the University of Texas athletic department generates each year.

If Coinbase and the rest of the bitcoin-to-fiat merchant economy sees similar patterns of activity, that would mean that above-board economic “activity” may currently hover around $350 million a year.  This is just slightly more than venture capital was invested in the Bitcoin space last year (~$315 million) and roughly equivalent to the fund that Lux Capital raised last month for funding science-related startups.  For comparison, Guatemalan’s working abroad remitted more than $500 million back to their families in one month alone last year.

In terms of payments the competitive landscape for Bitcoinland is not just other cryptocurrencies but also incumbent payment providers and tech companies such as Google, Apple, Facebook and Microsoft (the latter has been collecting money transmitter licenses), each of which has launched or is planning to launch an integrated payments system.  Startups such as Venmo and Square, both of which were launched the same year as Bitcoin, have seen some actual traction.  For instance, in the forth quarter of 2014 Venmo payment volume came in just over $900 million, up from $700 million processed in the third quarter (Square Cash claims to have an annualized volume run rate of $1 billion).

And although it is not a completely fair comparison, Second Life from Linden Lab is still around “with 900,000 active users a month, who get payouts of $60 million in real-world money every year” (note: there is some debate over specific user numbers).

When mining payments are removed, Bitcoin, as an above-board economy, appears to generate less in return than the venture capital funds have gone into it (so far).  Perhaps this will change as more of the capital is deployed but it may be the case that Bitcoinland cannot securely grow exponentially (as the bullish narrative envisions) while maintaining a fixed amount of outputs.

In his recent conversation with International Business Times, Wouter Vonk, BitPay’s European marketing manager, described the trends from the infographic, stating:

As bitcoin becomes a more established technology, we expect to see more consumers using it. The investors are usually the first ones to hop on new technology, but as bitcoin circulates more, and as the amount of transactions increases, we should see bitcoin being used by more and more average consumers. We see bitcoin being used in emerging markets as a supplement to the current banking and monetary systems.  Bitcoin breaks down the barriers to financial tools that many people in emerging countries are facing.

Empirically, regarding “more consumer using it,” this does not seem to be true.  Nor is there evidence that bitcoin is circulating “more” — in fact, based on age of last use, more than 70% of coins have not moved in more than 6 months (slightly older figure).  And while cryptocurrencies may play a role in developing countries, so far there is little evidence this is actually occurring beyond talk at conferences.  Again, perhaps this will change as new data could reinforce Vonk’s narrative, but so far that is not the case.

For perspective I contacted Dave Hudson, proprietor of HashingIt, a leading network analysis site.  According to him:

One thing that I did notice is that their earlier “incoming” graphs all look highly correlated to the transaction volume in the Bitcoin network after long chains are removed.  This gets back to the usual Bitcoin transaction volume question of what’s really in a transaction and what’s change?  It seems their transaction volumes have really only crept up in the last 12 months, much slower than the rate of growth in transactions (or non-long-chain transactions) on the main network (increased competition?).

What does this look like?  The chart below measures Number of Transactions Excluding Chains Longer Than 10 between April 2013 – April 2015.

blockchain long chainsWhat are long chains again?  Rather than rehashing the entire paper, recall that in Slicing Data, it was observed that a significant fraction of total transaction volume on any given day was likely inflated through a variety of sources such as faucets, coin mixing and gambling.

As we can see above, while there is indeed an upward trend line over the past two years, it is clearly not growing exponentially but rather linearly, and particularly in spurts around “macro” events (e.g., bubble in late 2013 and collapse of Mt. Gox).

Based on the public data from address clustering, consumer adoption is empirically not growing near the same level as merchant adoption.  In fact, consumer adoption in terms of actual non-mining, retail-usage, has basically plateaued over the past year.  We know this is the case since merchants accepting bitcoin for payments has roughly quintupled over the same time frame (20,000 to 100,000) and includes several large marquis (such as Microsoft) yet without any surge in usage by bitcoin owners in aggregate.

Other companies that have actively promoted bitcoin for payments have likely also been impacted by sluggish sales.

For instance, in February 2015, Overstock.com (which has been using Coinbase as a payment processor for over a year) tried to obfuscate weak traction by using a strange method: measuring orders per 1 million residents.

overstock bitcoinThe top 3 were:

  • New Hampshire has a population of 1,326,813 and according to the chart above Overstock received 131 bitcoin orders per million residents.  This comes out to roughly 175 orders in 2014.
  • Utah has a population of 2,949,902 and according to the chart, Overstock received 89 bitcoin orders per million residents.  This comes out to roughly 270 orders in 2014.
  • Washington D.C. has a population of 658,893 and according tot he chart above Overstock received 85 bitcoin orders per million residents.  This comes out to roughly 56 orders in 2014 (although if the greater D.C. metro population was used, the order number would be about 9x larger).
  • Fighting for last place: Puerto Rico trounced Mississippi, which came in dead last.  Puerto Rico has a population of 3,667,084 and according to the report, Overstock received 12 bitcoin orders per million residents.  This comes out to about 44 orders in 2014.   In comparison, Mississippi, with a population of 2,994,079 had 8 order per million residents.  This comes to about 24 orders.

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).

In addition, since gift cards represent about 16% of all transactions processed by BitPay, they can be added to the list of non-negligible reasons for fluctuation in blockchain transaction volume.  That is to say, on any given day there are roughly 242 gift card related transactions through BitPay which should appears on the blockchain.  This is about the same amount of Counterparty transactions that may take place on a slow day.

Thus, as discussed in Slicing Data, the daily components of blockchain transactions are likely: faucet outputs (which may be “long chains”), mining rewards, some retail activity, coin mixing, gambling, watermarked assets (e.g., Counterparty, Mastercoin), P2SH, movement to ‘change’ addresses, wallet shuffling and now gift cards.

While their new infographic does not come to any direct conclusions as to macro growth of Bitcoinland it is likely that there are still only a few profitable businesses and projects in the ecosystem and most are unrelated to Bitcoin itself:

  • Fabrication plants such as TSMC and designers like Alchip
  • Utility companies (hydroelectric dams in Washington, coal power plants in Inner Mongolia)
  • Large mining farms with access to the newest ASIC batches reducing overall operating costs relative to marginal players (Bitfury in the Republic of Georgia)
  • Some mining pools (Organ sometimes has a break down of block makers)
  • Law firms (such as Perkins Coie)
  • Conference organizers such as Inside Bitcoins (but not The Bitcoin Foundation)
  • A handful of bitcoin-to-fiat exchanges (BTC-e, Bitfinex and a few others)
  • Scams (Moolah from Alex Green/Ryan Kennedy, GAW/PayCoin from Josh Garza, BFL, MyCoin and at least 42 others, more likely hundreds)
  • Botnet operators (botnet mining still exists, externalizing operating costs with “other people’s electricity”)
  • Ransomeware (CryptoLocker, KEYHolder, CryptoWall and a few dozen others)
  • Darknet Markets (Evolution “exit,” Sheep Marketplace “hack“; some low-hanging fruit exists for academics studying operators and providers that transitioned from Liberty Reserve to other DNMs, after it was shut down 2 years ago)

Perhaps all of this will change and this snapshot is “too early” as the bullish narrative claims.  Trends may change, no one has a crystal ball.

[Special thanks to CukeKing, Fabio Federici, Dave Hudson, Jonathan Levin and Pete Rizzo for their feedback and info]

  1. See Are there changes in the volume of retail transactions through Bitpay this past year?, Will colored coin extensibility throw a wrench into the automated information security costs of Bitcoin? and A brief history of Bitcoin “wallet” growth []
  2. In Chapter 14 in The Anatomy: “If the labor force of bitcoin is spending $10 million on protecting the network yet real commerce is only $30 million, this would be equivalent to a mall issuing 1 out of 3 customers a personal security detail to go shopping.  Or in other words it is, arguably, quantitatively oversecure (it is not qualitatively trustless as shown by the trifecta of DeepBit, BTC Guild and GHash.io).” []
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Consensus-as-a-service: a brief report on the emergence of permissioned, distributed ledger systems

I have spent the past month compiling research that took place between August and the present day.  This was much more of a collaborative process than my previous publications as I had to talk with not just 8 geographically dispersed teams to find out what their approach was in this nascent field but also find out who is working on ideas that are closely related to these projects (as seen in Appendix A).

The culmination of this process can be found in this report: Permissioned distributed ledgers

Fortunately I had the help of not just astute practitioners in the industry who did the intellectual heavy lifting, but the resources and experience of the R3 CEV team where I am an advisor.

I think the three strongest areas are:

  • Richard Brown’s and Jo Lang’s description and visualization of smart contracts.  I loathe the term smart contracts (I prefer “banana” and Preston Byrne prefers “marmot”) and fortunately they distilled it to a level where many professionals can probably begin to understand it
  • Meher Roy’s excellent OSI-model for an “internet of money”
  • Robert Sams mental model of the core attributes of a permissioned distributed ledger

I think the weakest part is in the beginning of Section 8 regarding TCP/IP.  That is reflective of the fact that there is no perfect analogy because Bitcoin was designed to do many things that no other system does right now so there probably is no single apple’s to apple’s comparison.

While you do not need special internetcoins or fun buxx to use the internet (as it were), there is still a cost to someone to connect to the net.  So perhaps, the frictional differences between obtaining and securing an internet connection versus obtaining and securing a bitcoin at this time is probably something that should be highlighted more if the report is updated.

Wither Bitcoin?

For cryptocurrencies such as Bitcoin to do what it does best on its own terms, its competitive advantage lays with the native token and not representing real-world assets: its community needs to come to terms about what it is and is not good for.  Because of its inability to control off-chain assets its developers should stop promising that bitcoins — or metacoins and watermarked-coins that use Bitcoin as a transportation layer — as a panacea for managing off-chain assets, assets the network cannot control.  At most Bitcoin’s code base and node network operates as its own legal system for non-watermarked bitcoins.

Consequently, the advantage a cryptocurrency system has is endogenous enforcement of contractual terms — or as Taulant Ramabaja calls it: “fully blockchain endogenous state transition without any external dependencies.”  Or on-chain, dry code to dry code.

I wonder if someone in the future will call themselves a full “dry code” stack developer?

Consensus-as-a-service: a brief report on the emergence of permissioned, distributed ledger systems

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