What’s the deal with DAOs?

[Disclaimer: I do not own any cryptocurrencies nor have I participated in any DAO crowdfunding.]

This post will look at the difference between a decentralized autonomous organization (DAO) and a project called The DAO.

Brief explanation

The wikipedia entry on DAOs is not very helpful.  However, Chapters 2 through 5 may be of some use (although it is dated information).

In terms of the uber hyped blockchain world, at its most basic kernel, a DAO is a bit of code — sometimes called a “smart contract” (a wretched name) — that enables a multitude of parties including other DAOs to send cryptographically verifiable instructions (such as a digitally signed vote) in order to execute the terms and conditions of the cloud-based code in a manner that is difficult to censor.

One way to think of a simple DAO: it is an automated escrow agent that lives on a decentralized cloud where it can only distribute funds (e.g., issue a dividend, disperse payroll) upon on receiving or even not receiving a digital signal that a task has been completed or is incomplete.

For instance, let us assume that a small non-profit aid organization whose staff primarily work in economically and politically unstable regions with strict capital controls, set up a DAO — an escrow agent — on a decentralized cloud to distribute payroll each month.

This cloud-based escrow agent was coded such that it would only distribute the funds once a threshold of digital signatures had signed an on-chain contract — not just by staff members — but also from independent on-the-ground individuals who observed that the staff members were indeed doing their job.  Some might call these independent observers as oracles, but that is a topic for a different post.1

Once enough signatures had been used to sign an on-chain contract, the escrow agent would automatically release the funds to the appropriate individuals (or rather, to a public address that an individual controls via private key).  The terms in which the agent operated could also be amended with a predetermined number of votes, just like corporate board’s and shareholder’s vote to change charters and contracts today.

The purported utility that decentralization brings to this situation is that it makes censoring transactions by third parties more difficult than if the funds flowed through a centralized rail.  There are trade-offs to these logistics but that is beyond the scope of this post.

The reason the DAO acronym includes the “organization” part is that the end-goal by its promoters is for it to provide services beyond these simple escrow characteristics such as handling most if not all administrative tasks such as hiring and firing.

Watch out Zenefits, the cryptocurrency world is going to eat your lunch!  Oh wait.

A short history

It is really easy to get caught up in the euphoria of a shiny new toy.  And the original goal of a DAO sounds like something out of science fiction —  but these undertones probably do it a disservice.

Prior to 2014 there had been several small discussions around the topic of autonomous “agents” as it related to Bitcoin.

For instance, in August 2013, Mike Hearn gave a presentation at Turing Festival (see above), describing what was effectively a series of decentralized agents that operated logistical companies such as an autonomous car service.

Several months later, Vitalik Buterin published the Ethereum white paper which dove into the details of how to build a network — in this case a public blockchain — which natively supported code that could perform complex on-chain tasks: or what he dubbed as a decentralized autonomous organization.

Timing

The impetus and timing for this post is based on an ongoing crowdsale / crowdfunding activity for the confusingly named “The DAO” that has drawn a lot of media attention.

Over the past year, a group of developers, some of whom are affiliated with the Ethereum Foundation and others affiliated with a company called Slock.it have created what is marketed as the first living and breathing DAO on the Ethereum network.

The organizers kicked off a month long token sale and at the time of this writing just over 10 million ether (the native currency of the Ethereum blockchain) — or approximately 13% of all mined ether — has been sent to The DAO.  This is roughly equivalent to over $100 million based on the current market price of ether (ETH).

In return for sending ether to The DAO, users receive an asset called a DAO Token which can be used in the future to vote on projects that The DAO wants to fund.2 It is a process that Swarm failed at doing.

An investment fund or a Kickstarter project?

I would argue that, while from a technical standpoint it is possible to successfully set up a DAO in the manner that The DAO team did, that there really isn’t much utility to do so in an environment in which censorship or the theft of funds by third parties will probably not occur.

That is to say, just as I have argued before that permissioned-on-permissionless is a shortsighted idea, The DAO as it is currently set up, is probably a solution to a problem that no one really has.3

Or in short, if you “invested” in The DAO crowdsale thinking you’re going to make money back from the projects via dividends, you might be better off investing in Disney dollars.

Why?

Putting aside securities regulations and regulators such as the SEC for a moment, most of the crowdsale “investors” probably don’t realize that:

  1. crowdfunding in general has a checkered track record of return-on-investment4
  2. crowdfunding in the cryptocurrency world almost always relies on the future appreciation of token prices in order to break-even and not through the actual creation of new features or tools (e.g., see Mastercoin/Omni which effectively flopped)
  3. that the funds, when dispersed to Slock.it and other “products,” could take years, if ever to return a dividend

Why would this pool of capital provide any better expected return-on-investment than others?

Or as Nick Zeeb explained to me:

My sense about The DAO is that it’s a fascinating experiment that I do not want to be part of. I also do not think that a committee of over 1,000 strangers will make wise investment decisions. Most good investment decisions are taken by courageous individuals in my opinion. Anything that can get past a big committee will probably not be the next Google. Imagine this pitch: “Hi I’m Larry and this is Sergey and we want to build the world’s 35th search engine.”

While it probably wasn’t the 35th search engine, tor those unfamiliar with the history of Google, Larry Page and Sergey Brin are the co-founders who created a search engine in what was then though a very crowded market.

So why the excitement?

I think part of it is quite simply: if you own a bunch of ether, there really isn’t much you can do with it right now.  This is a problem that plagues the entire cryptocurrency ecosystem.

Despite all the back-patting at conferences, the market is already filled with lots of different tokens. There is a glut of tokens which do not currently provide many useful things that you couldn’t already do with existing cash systems.5

Part of it also is that most probably think they will some become rich quick through dividends, but that probably won’t happen anytime soon, if at all.

With The DAO, only the development teams of projects that are voted and approved by The DAO (e.g., the thousands of users with DAO Tokens), will see any short term gains through a steady paycheck.  And it is only after they build, ship and sell a product that the original investors may begin seeing some kind of return.

Or in other words: over the past several weeks, the pooling of capital has taken place for The DAO.  In the future there will be various votes as to where that capital goes.  Shortly thereafter, some capital is deployed and later KPI’s will be assessed in order to determine whether or not funding should continue.  All the while some type of profit is sought and dividend returned.

Why, I asked another friend, would this pool of capital offer any better risk adjusted return-on-investment than other asset classes?

In his view:

The return might be high but so is the risk. Always adjust for risk. I think The DAO is better compared to a distributed venture capital firm. Whether that’s better or worse I don’t know — I mean you have the crowd deciding on investments. Or more realistically: nerds who know how to obtain ether (ETH) get to decide on investments.

Does that make them better VCs? Probably not. However, The DAO can decide to hire people with actual credentials to manage and select the investments, admitting its own weakness which would then turn into a strength. I think this can go either way but given the regulator is not prepared for any of this it will probably not work out in the short term.

Does the ‘design-by-giant-nerd-committee’ process work?

Over the past year we have already seen the thousands, probably tens-of-thousands of man-hours dropped into the gravity well that is known as the “block size debate.”  In which hundreds of passionate developers have seemingly argued non-stop on Slack, Twitter, reddit, IRC, conferences and so forth without really coming to an amicable decision any one group really likes.

So if block size-design-by-committee hasn’t worked out terribly well, will the thousands of investors in The DAO take to social media to influence and lobby one another in the future?  And if so, how productive is that versus alternative investment vehicles?

Redistributing the monetary base

Assuming Ethereum has an economy (which it probably doesn’t by most conventional measures), will The DAO create a deflationary effect on the Ethereum economy?

For instance, at its current rate, The DAO could absorb about 20% of the ether (ETH) monetary base.

Does that mean it permanently removes some of the monetary base?  Probably not.

For example, we know that there will be some disbursements to projects such as Slock.it, so there will be some liquidity from this on-chain entity.  And that future DAOs will spend their ether on expenses and development like a normal organization.

But we also know that there is a disconnect between what The DAO is, an investment fund, with what many people see it as: a large vault filled with gold laying in Challenger Deep that will somehow appreciate in value and they will be able to somehow extract that value.

Sure, we will all be able to observe that the funds exist at the bottom of the trench, but someone somewhere has to actually create value with the DAO Tokens and/or ether.

For the same reason that most incubators, accelerators and VC funds fail, that entrepreneur-reliant math doesn’t change for The DAO.  Not only does The DAO need to have a large volume of deal flow, but The DAO needs to attract legitimate projects that — as my friend point out above — have a better risk adjusted return-on-investment than other asset classes.

Will the return-on-investment of the DAO as an asset class be positive in the “early days”?  What happens when the operators and recipients of DAO funds eventually confront the problem of securities regulation?

So far, most of the proposals that appear to be geared up for funding are reminiscent to hype cycles we have all seen over the past couple of years.

Let’s build a product…

  • 2014: But with Bitcoin
  • 2015: But with Blockchain
  • 2016: But with DAO

Maybe the funds will not all be vaporized, but if a non-trivial amount of ETH ends up being held in this DAO or others, it could be the case that with sluggish deal flow, a large portion of the funds could remain inert.  And since this ether would not touching any financial flows; it would be equivalent to storing a large fraction of M0 in your basement safe, siloed off from liquid capital markets.

Ten observations

  1. Since the crowdsale / crowdfund began on April 30, the market price of ETH has increased ~30%; is that a coincidence or is there new demand being generated due to The DAO crowdsale?
  2. A small bug has been discovered in terms of the ETH to DAO Token conversion time table
  3. The DAO surpassed the Ethereum Foundation to become the largest single holder of ether (note: the linked article is already outdated)
  4. In terms of concentration of wealth: according to Etherscan, the top 50 DAO Token holders collectively “own” 38.49% of The DAO
  5. The top 500 DAO Token holders collectively “own” 71.39% of The DAO
  6. As of this writing there are over 15,000 entities (not necessarily individuals) that “own” some amount of a DAO Token
  7. Why is “own” in quotation marks? Because it is still unclear if controlling access to these private keys is the same thing as owning them.  See also: Watermarked Tokens as well as The Law of Bitcoin
  8. Gatecoin, which facilitated the crowdsale of both The DAO and DigixDAO was recently hacked and an estimated $2 million in bitcoins and ether were stolen
  9. Yesterday Gavin Wood, a co-founder of Ethereum, announced that he is stepping down as a “curator” for The DAO.  Curators, according to him, are effectively just individuals who identify whether someone is who they say they are — and have no other duties, responsibilities or authority.
  10. Three days ago, the Slock.it dev team — some of whom also worked on creating The DAO — did a live Q/A session that was videotaped and attempted to answer some difficult questions, like how many DAO Tokens they individually own.

Conclusion

About 17 months ago I put together a list of token crowdsales.  It would be interesting to revisit these at some point later this year to see what the return has been for those holders and how many failed.

For instance, there hasn’t really been any qualitative analysis of crowdsales or ICOs in beyond looking at price appreciation.6 What other utility was ultimately created with the issuance of say, factoids (Factom tokens) or REP (Augur tokens)?

Similarly, no one has really probed Bitcoin mining (and all POW mining) through the lens of a crowdsale on network security. Is every 10 minutes an ICO? After all, the scratch-off contest ties up capital seeking rents on seigniorage and in the long run, assuming a competitive market, that seigniorage is bid away to what Robert Sams has pointed out to where the marginal cost equals the marginal value of a token. So you end up with this relatively large capital base — divorced from the real world — that actually doesn’t produce goods or services beyond the need to be circularly protected via capital-intensive infrastructure.

Other questions to explore in the future include:

  • what are the benefits, if any, of using a centralized autonomous organization (CAO) versus decentralized autonomous organization (DAO) for regulated institutions?
  • how can a party or parties sue a decentralized autonomous organization? 7
  • what are the legal implications of conducting a 51% attack on a network with legally recognized DAOs residing on a public blockchain?8
  • will the continued concentration of ether and/or DAO Tokens create a 51% voting problem identified in the “Curator” section?

Still don’t fully understand what The DAO is?  Earlier this week CoinDesk published a pretty good overview of it.

[Special thanks to Raffael Danielli, Robert Sams and Nick Zeeb for their thoughts]

Endnotes

  1. Note: for the purposes of The DAO, “curators” are effectively identity oracles. []
  2. It appears that currently, once a quorum is achieved, a relatively small proportion of token holders can vote “yes” to a proposal to trigger a large payout. []
  3. The current line-up of goods and services are not based around solving for problems in which censorship is a threat, such as those facing an aid worker in a politically unstable region. []
  4. That is not to say that they all fail. In fact according to one statistic from Kickstarter, there was a 9% failure rate on its platform. Thus, it depends on the platform and what the reward is. []
  5. CoinGecko is tracking several hundred tokens. []
  6. ICO stands for “initial coin offering” — it is slight twist to the term IPO as it relates to securities. []
  7. An added wrinkle to identifying liable parties is: what happens when systems like Zcash launch? []
  8. This presupposes that a DAO will gain legal recognition and/or a public blockchain gains legal standing as an actual legal record. []
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Book Review: The Business Blockchain

[Disclaimer: The views expressed below are solely my own and do not necessarily represent the views of my employer or any organization I advise.]

William Mougayar is an angel investor who has been investigating the cryptocurrency and broader distributed ledger ecosystem over the past several years.

He recently published a book that looks at how enterprises and organizations should look at distributed ledgers and specifically, blockchains.

While it is better than “Blockchain Revolution” from the Tapscott’s, it still has multiple errors and unproven conjectures that prevent me from recommending it.  For instance, it does not really distinguish one blockchain from another, or the key differences between a distributed ledger and a blockchain.

Note: all transcription errors below are my own.

Introduction

On p. xxii he writes:

“These are necessary but not sufficient conditions or properties; blockchains are also greater than the sum of their parts.”

I agree with this and wrote something very similar two years ago in Chapter 2:

While the underlying mathematics and cryptographic concepts took decades to develop and mature, the technical parts and mechanisms of the ledger (or blockchain) are greater than the sum of the ledger’s parts.

On p. xxiv he writes:

“Just like we cannot double spend digital money anymore (thanks to Satoshi Nakamoto’s invention), we will not be able to double copy or forge official certificates once they are certified on a blockchain.”

There are two problems with this:

  1. Double-spending can and does still occur, each month someone posts on social media how they managed to beat a retailer/merchant that accepted zero-confirmation transactions
  2. Double-spending can and is prevented in centralized architectures today, you don’t need a blockchain to prevent double-spending if you are willing to trust a party

Chapter 1

[Note: recommend that future editions should include labeled diagrams/tables/figures]

On p. 11 he writes:

“Solving that problem consists in mitigating any attempts by a small number of unethical Generals who would otherwise become traitors, and lie about coordinating their attack to guarantee victory.”

It could probably be written slightly different: how do you coordinate geographically dispersed actors to solve a problem in which one or more actor could be malicious and attempt to change the plan?  See also Lamport et al. explanation.

On p.13 he writes compares a database with a blockchain which he calls a “ledger.”

I don’t think this is an accurate comparison.

For instance, a ledger, as Robert Sams has noted, assumes ties to legal infrastructure.  Some blockchains, such as Bitcoin, were intentionally designed not to interface with legal infrastructure, thus they may not necessarily be an actual ledger.

To quote Sams:

I think the confusion comes from thinking of cryptocurrency chains as ledgers at all. A cryptocurrency blockchain is (an attempt at) a decentralised solution to the double spending problem for a digital, extra-legal bearer asset. That’s not a ledger, that’s a log.

That was the point I was trying to make all along when I introduced the permissioned/permissionless terminology!  Notice, I never used the phrase “permissionless ledger” — Permissionless’ness is a property of the consensus mechanism.

With a bearer asset, possession of some instrument (a private key in the cryptocurrency world) means ownership of the asset. With a registered asset, ownership is determined by valid entry in a registry mapping an off-chain identity to the asset. The bitcoin blockchain is a public log of proofs of instrument possession by anonymous parties. Calling this a ledger is the same as calling it “bearer asset ledger”, which is an oxymoron, like calling someone a “married bachelor”, because bearer assets by definition do not record their owners in a registry!

This taxonomy that includes the cryptocurrency stuff in our space (“a public blockchain is a permissionless distributed ledger of cryptocurrency”) causes so much pointless discussion.

I should also mention that the DLT space should really should be using the phrase “registry” instead of “ledger”. The latter is about accounts, and it is one ambition too far at the moment to speak of unifying everyone’s accounts on a distributed ledger.

Is this pedantic?  Maybe not, as the authors of The Law of Bitcoin also wrestle with the buckets an anarchic cryptocurrency fall under.

On p. 14 he writes about bank accounts:

“In reality, they provided you the illusion of access and activity visibility on it.  Every time you want to move money, pay someone or deposit money, the bank is giving you explicit access because you gave them implicit trust over your affairs.  But that “access” is also another illusion.  It is really an access to a database record that says you have such amount of money.  Again, they fooled you by giving you the illusion that you “own” that money.”

This is needless inflammatory.  Commercial law and bankruptcy proceedings will determine who owns what and what tranche/seniority your claims fall under.  It is unclear what the illusion is.

On p. 14 he writes:

“A user can send money to another, via a special wallet, and the blockchain network does the authentication, validation and transfer, typically within 10 minutes, with or without a cryptocurrency exchange in the middle.”

Which blockchain is he talking about?  If it is not digital fiat, how does the cash-in/cash-out work?  To my knowledge, no bank has implemented an end-to-end production system with other banks as described above.  Perhaps that will change in the future.

On p. 18 he writes:

“Sometimes it is represented by a token, which is another form of related representation of an underlying cryptocurrency.”

This isn’t very well-defined.  The reason I went to great lengths in November to explain what a “token” is and isn’t is because of the confusion caused by the initial usage of a cryptographic token, a hardware device from companies like RSA.  This is not what a “token” in cryptocurrency usage means. (Note: later on p. 91 he adds a very brief explanation)

On p. 18 he cites Robert Sams who is quoting Nick Szabo, but didn’t provide a source.  It is found in Seigniorage Shares.

On p. 18 he also writes:

“As cryptocurrency gains more acceptance and understanding, its future will be less uncertain, resulting in a more stable and gradual adoption curve.”

This is empirically not true and actually misses the crux of Sams’ argument related to expectations.

On p. 20 he writes:

“As of 2016, the Bitcoin blockchain was far from these numbers, hovering at 5-7 TPS, but with prospects of largely exceeding it due to advances in sidechain technology and expected increases in the Bitcoin block size.”

This isn’t quite correct.  On a given day over the past year, the average TPS is around 2 TPS and Tradeblock estimates by the end of 2016 that with the current block size it will hover around just over 3 TPS.

What is a sidechain?  It is left undefined in that immediate section.  One potential definition is that it is a sofa.

On p. 20 he writes:

“Private blockchains are even faster because they have less security requirements, and we are seeing 1,000-10,000 TPS in 2016, going up to 2,000-15,000 TPS in 2017, and potentially an unlimited ceiling beyond 2019.”

This is untrue.  “Private blockchains” do not have “less” security requirements, they have different security requirements since they involve known, trusted participants.  I am also unaware of any production distributed ledger system that hits 10,000 TPS.  Lastly, it is unclear where the “unlimited ceiling” prediction comes from.

On p. 20 he writes:

“In 2014, I made the strong assertion that the blockchain is the new database, and warned developers to get ready to rewrite everything.”

Where did you warn people?  Link?

On p. 21 he writes:

“For developers, a blockchain is first and foremost a set of software technologies.”

I would argue that it is first and foremost a network.

On p. 22 he writes:

“The fact that blockchain software is open source is a powerful feature. The more open the core of a blockchain is, the stronger the ecosystem around it will become.”

Some, but not all companies building blockchain-related technology, open source the libraries and tools.  Also, this conflates the difference between code and who can validate transactions on the network.  A “private blockchain” can be open sourced and secure, but only permit certain entities to validate transactions.

On p. 24 he writes:

“State machines are a good fit for implementing distributed systems that have to be fault-tolerant.”

Why?

On p. 25 he writes:

“Bitcoin initiated the Proof-of-Work (POW) consensus method, and it can be regarded as the granddaddy of these algorithms. POW rests on the popular Practical Byzantine Fault Tolerant algorithm that allows transactions to be safely committed according to a given state.”

There are at least two problems with this statement:

  • The proof-of-work mechanism used in Bitcoin is apocryphally linked to Hashcash from Adam Back; however this does not quite jive with Mougayar’s statement above. Historically, this type of proof-of-work predates Back’s contribution, all the way to 1992.  See Pricing via Processing or Combatting Junk Mail by Dwork and Naor
  • Practical Byzantine Fault Tolerance is the name of a specific algorithm published in 1999 by Castro and Liskov; it is unrelated to Bitcoin.

On p. 26 he writes:

“One of the drawbacks of the Proof-of-Work algorithm is that it is not environmentally friendly, because it requires large amounts of processing power from specialized machines that generate excessive energy.”

This is a design feature: to make it economically costly to change history.  It wasn’t that Satoshi conjured up a consensus method to be environmentally friendly, rather it is the hashrate war and attempt to seek rents on seigniorage that incentivizes the expenditure of capital, in this case energy.  If the market price of a cryptocurrency such as bitcoin declined, so too would the amount of energy used to secure it.

Chapter 2

On p. 29 he writes:

“Reaching consensus is at the heart of a blockchain’s operations.  But the blockchain does it in a decentralized way that breaks the old paradigm of centralized consensus, when one central database used to rule transaction validity.”

Which blockchain is he talking about?  They are not a commodity, there are several different unique types.  Furthermore, distributed consensus is an academic research field that has existed for more than two decades.

On p. 29 he writes:

“A decentralized scheme (which the blockchain is based on) transfers authority and trust to a decentralized network and enables its nodes to continuously and sequentially record their transactions on a public “block,” creating a unique” chain” – the blockchain.”

Mougayar describes the etymology of the word “blockchain” specific to Bitcoin itself.

Note: a block actually is more akin to a “batch” or “bucket” in the sense that transactions are bundled together into a bucket and then propagated.  His definition of what a blockchain is is not inclusive enough in this chapter though because it is unclear what decentralization can mean (1 node, 100 nodes, 10,000 nodes?).  Also, it is important to note that not all distributed ledgers are blockchains.

On p. 31 he writes:

“Credit card companies charge us 23% in interest, even when the prime rate is only at 1%”

Which credit card companies are charging 23%?  Who is being charged this?  Also, even if this were the case, how does a blockchain of some kind change that?

On p. 32 he writes:

“Blockchains offer truth and transparency as a base layer. But most trusted institutions do not offer transparency or truth. It will be an interesting encounter.”

This is just a broad sweeping generalization.  What does truth and transparency mean here?  Which blockchains?  Which institutions?  Cannot existing institutions build or use some kind of distributed ledger to provide the “truth” and “transparency” that he advocates?

On p. 33 he writes:

“The blockchain challenges the roles of some existing trust players and reassigns some of their responsibilities, sometimes weakening their authority.”

Typo: should be “trusted” not “trust.”

On p. 34 he writes:

“There is a lesson from Airbnb, which has mastered the art of allowing strangers to sleep in your house without fear.”

This is not true, there are many examples of Airbnb houses that have been trashed and vandalized.

On p. 34, just as the Tapscott’s did in their book, Mougayar talks about how Airbnb could use a blockchain for identity and reputation.  Sure, but what are the advantages of doing that versus a database or other existing technology?

On p. 37 he writes:

“Enterprises are the ones asking, because the benefits are not necessarily obvious to them.  For large companies, the blockchain presented itself as a headache initially. It was something they had not planned for.”

First off, which blockchain?  And which enterprises had a headache from it?

On p. 39 he writes: “Prior to the Bitcoin invention…”

He should probably flip that to read “the invention of Bitcoin”

On p. 40 he writes:

“… it did not make sense to have money as a digital asset, because the double-spend (or double-send) problem was not solved yet, which meant that fraud could have dominated.”

This is empirically untrue.  Centralized systems prevent double-spending each and every day.  There is a double-spending problem when you are using a pseudonymous, decentralized network and it is partially resolved (but not permanently solved) in Bitcoin by making it expensive, but not impossible, to double-spend.

On p. 41 he writes:

“They will be no less revolutionary than the invention of the HTML markup language that allowed information o be openly published and linked on the Web.”

This is a little redundant and should probably be rewritten as “the invention of the hypertext markup language (HTML).”

On p. 43 he writes:

“Smart contracts are ideal for interacting with real-world assets, smart property, Internet of Things (IoT) and financial services instruments.”

Why are smart contracts ideal for that?

On p. 46 he writes: “Time-stamping” and in other areas he writes it without a dash.

On p. 46 he writes:

“And blockchains are typically censorship resistant, due to the decentralized nature of data storage, encryption, and peer controls at the edge of the network.”

Which blockchains?  Not all blockchains in the market are censorship resistant.  Why and why not?

On p. 48 he mentions “BitIID” – this is a typo for “BitID”

On p. 51 he writes:

“Enter the blockchain and decentralized applications based on it. Their advent brings potential solutions to data security because cryptographically-secured encryption becomes a standard part of blockchain applications, especially pertaining to the data parts. By default, everything is encrypted.”

This is untrue.  Bitcoin does not encrypt anything nor does Ethereum.  A user could encrypt data first, take a hash of it and then send that hash to a mining pool to be added to a block, but the network itself provides no encryption ability.

On p. 52 he writes:

“Consensus in public blockchains is done publicly, and is theoretically subject to the proverbial Sybil attacks (although it has not happened yet).”

Actually, it has on altcoins.  One notable occurrence impacted Feathercoin during June 2013.

On p. 54 he writes:

“The blockchain can help, because too many Web companies centralized and hijacked what could have been a more decentralized set of services.”

This is the same meme in the Tapscott book.  There are many reasons for why specific companies and organizations have large users bases but it is hard to see how they hijacked anyone; but that is a different conversation altogether.

On p. 54 he writes:

“We can also think of blockchains as shared infrastructure that is like a utility. If you think about how the current Internet infrastructure is being paid for, we subsidize it by paying monthly fees to Internet service providers.  As public blockchains proliferate and we start running millions of smart contacts and verification services on them, we might be also subsidizing their operation, by paying via micro transactions, in the form of transaction fees, smart contract tolls, donation buttons, or pay-per-use schemes.”

This is a very liberal use of the word subsidize.  What Mougayar is describing above is actually more of a tax than a charitable donation.

The design behind Bitcoin was intended to make it such that there was a Nash equilibrium model between various actors.  That miners would not need to rely on charity to continue to secure the network because as block rewards decline, the fees themselves would in the long run provide enough compensation to pay for their security services.

It could be argued that this will not happen, that fees will not increase to offset the decline in block rewards but that is for a different article.

As an aside, Mougayar’s statement above then intersects with public policy: which blockchains should receive that subsidy or donation?  All altcoins too?  And who should pay this?

Continuing:

“Blockchains are like a virtual computer somewhere in a distributed cloud that is virtual and does not require server setups. Whoever opens a blockchain node runs the server, but not users or developers.”

This is untrue.  The ~6,400 nodes on the Bitcoin network are all servers that require setup and maintenance to run.  The same for Ethereum and any other blockchain.

On p. 58 he writes:

“It is almost unimaginable to think that when Satoshi Nakamoto released the code for the first Bitcoin blockchain in 2009, it consisted of just two computers and a token.”

A couple issues:

  1. There is a typo – “first” should be removed (unless there was another Bitcoin network before Bitcoin?)
  2. Timo Hanke and Sergio Lerner have hypothesized that Satoshi probably used multiple computers, perhaps more than a dozen.

On p. 58 he writes:

“One of the primary differences between a public and private blockchain is that public blockchains typically have a generic purpose and are generally cheaper to use, whereas private blockchains have a more specific usage, and they are more expensive to set up because the cost is born by fewer owners.”

This is not true.  From a capital and operation expenditure perspective, public blockchains are several orders of magnitude more expensive to own and maintain than a private blockchain.  Why?  Because there is no proof-of-work involved and therefore private blockchain operators do not need to spend $400 million a year, which is roughly the cost of maintaining the Bitcoin network today.

In contrast, depending on how a private blockchain (or distributed ledger) is set up, it could simply be run by a handful of nodes on several different cloud providers – a marginal cost.

Chapter 3

On p. 68 he writes:

“Taken as an extreme case, just about any software application could be rewritten with some blockchain and decentralization flavor into it, but that does not mean it’s a good idea to do so.”

Yes, fully agreed!

On p. 68 he writes:

“By mid-2016, there were approximately 5,000 developers dedicated to writing software for cryptocurrency, Bitcoin or blockchains in general. Perhaps another 20,000 had dabbled with some of that technology, or written front-end applications that connect to a blockchain, one way or the other.”

Mougayar cites his survey of the landscape for this.

I would dispute this though, it’s probably an order of magnitude less.

The only way this number is 5,000 is if you liberally count attendees at meetups or all the various altcoins people have touched over the year, and so forth.  Even the headcount of all the VC funded “bitcoin and blockchain” companies is probably not even 5,000 as of May 2016.

On p. 71 he writes:

“Scaling blockchains will not be different than the way we have continued to scale the Internet, conceptually speaking.  There are plenty of smart engineers, scientists, researchers, and designers who are up to the challenge and will tackle it.”

This is a little too hand-wavy.  One of the top topics that invariably any conversation dovetails into at technical working groups continues to be “how to scale” while keeping privacy requirements and non-functional requirements intact.  Perhaps this will be resolved, but it cannot be assumed that it will be.

On p. 72 he writes:

“Large organizations, especially banks, have not been particularly interested in adopting public blockchains for their internal needs, citing potential security issues. The technical argument against the full security of public blockchains can easily be made the minute you introduce a shadow of a doubt on a potential scenario that might wreak havoc with the finality of a transaction.  That alone is enough fear to form a deterring factor for staying away from public blockchain, although the argument could be made in favor of their security.”

This is a confusing passage.  The bottom line is that public blockchains were not designed with the specific requirements that regulated financial institutions have.  If they did, perhaps they would be used.  But in order to modify a public blockchain to provide those features and characteristics, it would be akin to turning an aircraft carrier into a submarine.  Sure it might be possible, but it would just be easier and safer to build a submarine instead.

Also, why would an organization use a public blockchain for their internal needs?  What does that mean?

On p. 78 he writes:

“Targeting Bitcoin primarily, several governments did not feel comfortable with a currency that was not backed by a sovereign country’s institutions.”

Actually, what made law enforcement and regulators uncomfortable was a lack of compliance for existing AML/KYC regulations.  The headlines and hearings in 2011-2013 revolved around illicit activities that could be accomplished as there were no tools or ability to link on-chain activity with real world identities.

Chapter 4

On p. 87 he writes:

“The reality is that customers are not going to the branch as often (or at all), and they are not licking as many stamps to pay their bills.  Meanwhile, FinTech growth is happening: it was a total response to banks’ lack of radical innovation.”

There are a couple issues going on here.

Banks have had to cut back on all spending due to cost cutting efforts as a whole and because their spending has had to go towards building reporting and compliance systems, neither of which has been categorized as “radical innovation.”

Also, to be balanced, manyh of the promises around “fintech” innovation still has yet to germinate due to the fact that many of the startups involved eventually need to incorporate and create the same cost structures that banks previously had to have.  See for instance, financial controls in marketplace lending – specifically Lending Club.

On p. 88 he writes:

“If you talk to any banker in the world, they will admit that ApplePay and PayPal are vexing examples of competition that simply eats into their margins, and they could not prevent their onslaught.”

Any banker will say that?  While a couple of business lines may change, which banks are being displaced by either of those two services right now?

On p. 89 he writes:

“Blockchains will not signal the end of banks, but innovation must permeate faster than the Internet did in 1995-2000.”

Why?  Why must it permeate faster?  What does that even mean?

On p. 89 he writes:

“This is a tricky question, because Bitcoin’s philosophy is about decentralization, whereas a bank is everything about centrally managed relationships.”

What does this mean?  If anything, the Bitcoin economy is even more concentrated than the global banking world, with only about a dozen exchanges globally that handle virtually all of the trading volume of all cryptocurrencies.

On p. 89 he writes:

“A local cryptocurrency wallet skirts some of the legalities that existing banks and bank look-alikes (cryptocurrency exchanges) need to adhere to, but without breaking any laws. You take “your bank” with you wherever you travel, and as long as that wallet has local onramps and bridges into the non-cryptocurrency terrestrial world, then you have a version of a global bank in your pocket.”

This is untrue.  There are many local and international laws that have been and continue to be broken involving money transmission, AML/KYC compliance and taxes.  Ignoring those though, fundamentally there are probably more claims on bitcoins – due to encumbrances – than bitcoins themselves.  This is a big problem that still hasn’t been dealt with as of May 2016.

On p. 95 he writes:

“The decentralization of banking is here. It just has not been evenly distributed yet.”

This is probably inspired by William Gibson who said: ‘The future is already here — it’s just not very evenly distributed.’

On p. 95 he writes:

“The default state and starting position for innovation is to be permissionless. Consequently, permissioned and private blockchain implementations will have a muted innovation potential.  At least in the true sense of the word, not for technical reasons, but for regulatory ones, because these two aspect are tie together.”

This is not a priori true, how can he claim this?  Empirically we know that permissioned blockchains are designed for different environments than something like Bitcoin.  How can he measure the amount of potential “innovation” either one has?

On p. 95 he writes:

“We are seeing the first such case unfold within the financial services sector, that seems to be embracing the blockchain fully; but they are embracing it according to their own interpretation of it, which is to make it live within the regulatory constraints they have to live with. What they are really talking about is “applying innovation,” and not creating it. So, the end-result will be a dialed down version of innovation.”

This is effectively an ad hominem attack on those working with regulated institutions who do not have the luxury of being able to ignore laws and regulations in multiple jurisdictions.  There are large fines and even jail time for ignoring or failing to comply with certain regulations.

On p. 95 he writes:

“That is a fact, and I am calling this situation the “Being Regulated Dilemma,” a pun on the innovator’s dilemma. Like the innovator’s dilemma, regulated companies have a tough time extricating themselves from the current regulations they have to operate within.  So, when they see technology, all they can do is to implement it within the satisfaction zones of regulators. Despite the blockchain’s revolutionary prognosis, the banks cannot outdo themselves, so they risk only guiding the blockchain to live within their constrained, regulated world.”

“It is a lot easier to start innovating outside the regulatory boxes, both figuratively and explicitly. Few banks will do this because it is more difficult.”

“Simon Taylor, head of the blockchain innovation group at Barclays, sums it up: “I do not disagree the best use cases will be outside regulated financial services. Much like the best users of cloud and big data are not the incumbent blue chip organizations.  Still their curioisity is valuable for funding and driving forward the entire space.” I strongly agree; there is hope some banks will contribute to the innovation potential of the blockchain in significant ways as they mature their understanding and experiences with this next technology.

An ending note to banks is that radical innovation can be a competitive advantage, but only if it is seen that way. Otherwise innovation will be dialed down to fit their own reality, which is typically painted in restrictive colors.

It would be useful to see banks succeed with the blockchain, but they need to push themselves further in terms of understanding what the blockchain can do. They need to figure out how they will serve their customers better, and not just how they will serve themselves better. Banks should innovate more by dreaming up use cases that we have not though about yet, preferably in the non-obvious category.

The fundamental problem with his statement is this: banks are heavily regulated, they cannot simply ignore the regulations because someone says they should.  If they fail to maintain compliance, they can be fined.

But that doesn’t mean they cannot still be innovative, or that the technology they are investigating now isn’t useful or helpful to their business lines.

In effect, this statement is divorced from the reality that regulated financial institutions operate in.  [Note: some of his content such as the diagram originated from his blog post]

On p. 102 he writes:

“Banks will be required to apply rigorous thinking to flush out their plans and positions vis-à-vis each one of these major blockchain parameters. They cannot ignore what happens when their core is being threatened.”

While this could be true, it is an over generalization: what type of business lines at banks are being threatened?  What part of “their” core is under attack?

On p. 103 he writes:

“More than 200 regulatory bodies exist in 150 countries, and many of them have been eyeing the blockchain and pondering regulatory updates pertaining to it.”

Surely that is a typo, there are probably 200 regulatory bodies alone in the US itself.

On p. 105 he writes:

“Banks will need to decide if they see the blockchain as a series of Band-Aids, or if they are willing to find the new patches of opportunity.  That is why I have been advocating that they should embrace (or buy) the new cryptocurrency exchanges, not because these enable Bitcoin trades, but because they are a new generation of financial networks that has figured out how to transfer assets, financial instruments, or digital assets swiftly and reliably, in essence circumventing the network towers and expense bridges that the current financial services industry relies upon.”

This is a confusing passage.

Nearly all of the popular cryptocurrency exchanges in developed countries require KYC/AML compliance in order for users to cash-in and out of their fiat holdings.  How do cryptocurrency exchanges provide any utility to banks who are already used to transferring and trading foreign exchange?

In terms of percentages, cryptocurrency exchanges are still very easy to compromise versus banks; what utility do banks obtain by acquiring exchanges with poor financial controls?

And, in order to fund their internal operations, cryptocurrency exchanges invariably end up with the same type of cost structures regulated financial institutions have; the advantage that they once had effectively involved non-compliance – that is where some of the cost savings was.  And banks cannot simply ignore regulations because people on social media want them to; these cryptocurrency sites require money to operate, hence the reason why many of them charge transaction fees on all withdrawals and some trades.

Chapter 5

On p. 115 he mentions La’Zooz and Maidsafe, neither of which – after several years of development, actually work.  Perhaps that changes in the future.

On p.118 he writes:

“There is another potential application of DIY Government 2.0. Suppose a country’s real government is failing, concerned citizens could create a shadow blockchain governance that is more fair, decentralized and accountable. There are at least 50 failed, fragile, or corrupt states that could benefit from an improve blockchain governance.”

Perhaps this is true, that there could be utility gain from some kind of blockchain.  But this misses a larger challenge: many of these same countries lack private property rights, the rule of law and speedy courts.

On p. 119 he writes about healthcare use cases:

“Carrying a secure wallet with our full electronic medical record in it, or our stored DNA, and allowing its access, in case of emergency.”

What advantage do customers gain from carrying this around in a secure wallet?  Perhaps they do, but it isn’t clear in this chapter.

On p. 126-127 he makes the case for organizations to have a “blockchain czar” but an alternative way to pitch this without all the pomp is simply to have someone be tasked with becoming a subject-matter expert on the topic.

On p. 131 he writes:

“Transactions are actually recorded in sequential data blocks (hence the word blockchain), so there is a historical, append-only log of these transaction that is continuously maintained and updated.  A fallacy is that the blockchain is a distributed ledger.”

It is not a fallacy.

Chapter 7

On p. 149 he writes: “What happened to the Web being a public good?”

Costs.  Websites have real costs.  Content on those websites have real costs.  And so forth.  Public goods are hard to sustain because no one wants to pay for them but everyone wants to use them.  Eventually commercial entities found a way to build and maintain websites that did not involve external subsidization.

On p. 150 he writes:

“Indeed, not only was the Web hijacked with too many central choke points, regulators supposedly continue to centralize controls in order to lower risk, whereas the opposite should be done.”

This conflicts with the “Internet is decentralized” meme that was discussed throughout the book.  So if aspects of the Internet are regulated, and Mougayar disagrees with those regulations, doesn’t this come down to disagreements over public policy?

On p. 153 he writes:

“Money is a form of value.  But not all value is money. We could argue that value has higher hierarchy than money. In the digital realm, a cryptocurrency is the perfect digital money.  The blockchain is a perfect exchange platform for digital value, and it rides on the Internet, the largest connected network on the planet.”

Why are cryptocurrencies perfect?  Perhaps they are, but it is not discussed here.

On p. 153 he also talks about the “programmability” of cryptocurrencies but doesn’t mention that if fiat currencies were digitally issued by central banks, they too could have the same programmable abilities.

On p. 160 he predicts:

“There will be dozens of commonly used, global virtual currencies that will be considered mainstream, and their total market value will exceed $5 trillion, and represent 5% of the world’s $100 trillion economy in 2025.”

Perhaps that occurs, but why?  And are virtual currencies now different than digital currencies?  Or are they the same?  None of these questions are really addressed.

Conclusion

This book is quick read but unfortunately is weighed down by many opinions that are not supported by evidence and consequently, very few practical applications for enterprises are explained in detail.

For regulated businesses such as financial institutions, there are several questions that need to be answered such as: what are the specific cost savings for using or integrating with some kind of blockchain?  What are the specific new business lines that could be created?  And unfortunately the first edition of this book did not answer these types of questions.  Let us look again at a future version.

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Book review: Blockchain Revolution

[Disclaimer: The views expressed below are solely my own and do not necessarily represent the views of my employer or any organization I advise.]

A couple weeks ago I joked that while containment is impossible, it would be nice to know who patient-zero was for using the term “blockchain” without an article preceding it.  The mystery of who exactly removed the “a” before “blockchain” is probably residing on the same island that Yeti, Sasquatch, and the New England Patriot’s equipment team are now located.

The Tapscott’s, a Canada-based father-son duo, co-authored a new book that not only suffers from this grammatical faux pas but has several dozen errors and unproven assertions which are detailed in this review.

Below is a chapter-by-chapter look into a book that should have baked in the oven for a bit more time.  Note: all transcription errors are my own.

Chapter 1

On p. 5 the authors write:

“A decade later in 2009, the global financial industry crashed. Perhaps propitiously, a pseudonymous person or persons named Satoshi Nakamoto outlined a new protocol for a peer-to-peer electronic cash system using a cryptocurrency called bitcoin.”

Ignoring the current drama surrounding Craig Wright — the Australian who claims to be Satoshi — during the initial threads on Metzdowd, Satoshi mentioned he had been working on this project for 18 months prior; roughly mid-2007.  So it was more coincidental timing than intentional.

And much like other books on the same topic, the authors do not clarify that there are more than one type of blockchain in existence and that some are a type of distributed ledger.

For instance, on p. 6 they write:

“At its most basic, it is an open source code: anyone can download it for free, run it, and use it to develop new tools for managing transactions online.”

With the ‘it’ being a ‘blockchain.’  The problem with this grammatical issue is that we know empirically that there many different types of distributed ledgers and blockchains currently under development and not all of them are open sourced.  Nor does being open source automagically qualify something as a blockchain.

On p. 6 they write:

“However, the most important and far-reaching blockchains are based on Satoshi’s bitcoin model.”

That’s an opinion that the authors really don’t back up with facts later on.

In addition, on the same page they make the “encryption” error that also plagues books in this space: the Bitcoin blockchain does not use encryption.

For example, on page 6 they write:

“And the blockchain is encrypted: it uses heavy-duty encryption involving public and private keys (rather like the two-key system to access a safety deposit box) to maintain virtual security.”

Incorrect.  Bitcoin employs a couple different cryptographic processes, but it doesn’t use encryption.  Furthermore, the example of a ‘two-key system’ actually illustrates multisig, not public-private key pairs.

On p. 8 they write:

“Bankers love the idea of secure, frictionless, and instant transactions, but some flinch at the idea of openness, decentralization and new forms of currency.  The financial services industry has already rebranded and privatized blockchain technology, referring to it as distributed ledger technology, in an attempt to reconcile the best of bitcoin — security, speed, and cost — with an entirely closed system that requires a bank or financial institution’s permission to use.”

There is a lot of assumptions in here:

(1) it is unclear which “bankers” they are speaking about, is it every person who works at a bank?

(2) the term ‘openness’ is not very well defined, does that mean that people at banks do not want to have cryptographically proven provenance?

In addition, in order for something to be privatized it must have been public at first.  Claiming that the “blockchain” toolkit of ideas and libraries was privatized away from Bitcoin is misleading.  The moving pieces of Bitcoin itself are comprised of no less than 6 discrete elements that previously existed in the cryptography and distributed systems communities.

The Bitcoin network itself is not being privatized by financial institutions.  In fact, if anything, empirically Bitcoin itself is being carved away by entities and efforts largely financed by venture capital — but that is a topic for another article.  Furthermore, research into distributed computing and distributed consensus techniques long predates Bitcoin itself, by more than a decade.

Lastly, and this is why it helps to clearly define words at the beginning of a book, it is important to note that some blockchains are a type of distributed ledger but not all distributed ledgers are blockchains.

On page 9 they write that:

“In 2014 and 2015 alone more than $1 billion of venture capital flooded into the emerging blockchain ecosystem, and the rate of investment is almost doubling annually.”

This is only true if you conflate cryptocurrency systems with non-cryptocurrency systems.  The two are separate and have completely different business models.  See my December presentation for more details about the divergence.

On p. 9 they write:

“A 2013 study showed that 937 people owned half of all bitcoin, although that is changing today.”

First off, this is a typo because the original article the authors cite, actually says the number is 927 not 937.  And the ‘study’ showed that about half of all bitcoins resided on addresses controlled by 937 on-chain entities.  Addresses does not mean individuals.  It is likely that some of these addresses (or rather, UTXOs) are controlled and operated by early adopters (like Roger Ver) as well as exchanges (like Bitstamp and Coinbase).

Furthermore, it is unclear from the rest of the book how that concentration of wealth is changing — where is that data?

On p. 18 they write about Airbnb, but with a blockchain.  It is unclear from their explanation what the technical advantage is of using a blockchain versus a database or other existing technology.

On p. 20 they write:

“Abra and other companies are building payment networks using the blockchain. Abra’s goal is to turn every one of its users into a teller. The whole process — from the funds leaving one country to their arriving in another — takes an hour rather than a week and costs 2 percent versus 7 percent or higher.  Abra wants its payment network to outnumber all physical ATMs in the world.  It took Western Union 150 years to get to 500,000 agents worldwide.  Abra will have that many tellers in its first years.”

There are at least 3 problems with this statement:

  1.  the authors conflate a blockchain with all blockchains; empirically there is no “the” blockchain
  2.  Abra’s sales pitch relies on the ability to convince regulators that the company itself just make software and doesn’t participate in money transmission or movement of financial products (which it does by hedging)
  3.  Abra was first publicly announced in March 2015 and then formally launched in the Philippines in October 2015.

Fast forward to May 2016 and according to the Google Play Store and Abra has only been downloaded about 5,000 times.

Perhaps it will eventually reach 500,000 and even displace Western Union, but the authors’ predictions that this will occur in one year is probably not going to happen at the current rate.

Furthermore, on p. 186 they write that “Abra takes a 25-basis-point fee on conversion.”

Will this require a payment processing license in each jurisdiction the conversion takes place?

On page 24 they write:

“Other critics point to the massive amount of energy consumed to reach consensus in just the bitcoin network: What happens when thousands or perhaps millions of interconnected blockchains are each processing billions of transactions a day?  Are the incentives great enough for people to participate and behave safely over time, and not try to overpower the network? Is blockchain technology the worst job killer ever?”

There are multiple problems with this statement:

  1.  on a proof-of-work blockchain, the amount of energy consumed is not connected with the amount of transactions being processed.  Miners consume energy to generate proofs-of-work irrespective of the number of transactions waiting in the memory pool.  Transaction processing itself is handled by a different entity entirely called a block maker or mining pool.
  2.  as of May 2016, it is unclear why there would be millions of interconnected proof-of-work blockchains.  There are perhaps a couple hundred altcoins, at least 100 of which are dead, but privately run blockchains do not need to use proof-of-work — thus the question surrounding incentives is a non sequitur.
  3.  while blockchains however defined may displace workers of some kind at some point, the authors never really zero in on what “job killing” blockchains actually do?

On p. 25 they write:

“The blockchain and cryptocurrencies, particularly bitcoin, already have massive momentum, but we’re not predicting whether or not all this will succeed, and if it does, how fast it will occur.”

Nowhere do the authors actually cite empirical data showing traction.  If there was indeed massive momentum, we should be able to see that from data somewhere, but so far that is not happening.  Perhaps that changes in the future.

The closing paragraph of Chapter 1 states that:

“Everyone should stop fighting it and take the right steps to get on board. Let’s harness this force not for the immediate benefit of the few but for the lasting benefit of the many.”

Who is fighting what?  They are presumably talking about a blockchain, but which one?  And why should people stop what they are doing to get on board with something that is ill-defined?

Chapter 2

On p. 30 they write that:

“Satoshi leveraged an existing distributed peer-to-peer network and a bit of clever cryptography to create a consensus mechanism that could solve the double-spend problem as well as, if not better than, a trusted third party.”

The word “trust” or variation thereof appears 11 times in the main body of the original Satoshi whitepaper.  Routing around trusted third parties was the aim of the project as this would then allow for pseudonymous interaction.  That was in October 2008.

What we empirically see in 2016 though is an increasingly doxxed environment in which it could be argued that ‘trusted’ parties could do the same job — movement of payments — in a less expensive manner.  But that is a topic for another article.

On p. 33 they write:

“So important are the processes of mining — assembling a block of transactions, spending some resource, solving the problem, reaching consensus, maintaining a copy of the full ledger — that some have called the bitcoin blockchain a public utility like the Internet, a utility that requires public support. Paul Brody of Ernst & Young thinks that all our appliances should donate their processing power to upkeep of a blockchain: “Your lawnmower or dishwasher is going to come with a CPU that is probably a thousand times more powerful than it actually needs, and so why not have it mine? Not for the purpose of making you money, but to maintain your share of the blockchain,” he said.  Regardless of the consensus mechanism, the blockchain ensures integrity through clever code rather than through human beings who choose to do the right thing.”

Let’s dissect this:

  1.  the process of mining, as we have looked at before, involves a division of labor between the entities that generate proofs-of-work – colloquially referred to as miners, and those that package transactions into blocks, called blockmakers.  Miners themselves do not actually maintain a copy of a blockchain, pools do.
  2.  while public blockchains like Bitcoin are a ‘public good,’ it doesn’t follow how or why anyone should be compelled to subsidize them, at least the reasons why are not revealed to readers.
  3.  the only reason proof-of-work was used for Bitcoin is because it was a way to prevent Sybil attacks on the network because participants were unknown and untrusted.  Why should a washing machine vendor integrate an expensive chip to do calculations that do not help in the washing process?  See Appendix B for why they shouldn’t.
  4.  because proof-of-work is used in a public blockchain and public blockchains are a public good, how does anyone actually have a “share” of a blockchain? What does that legally mean?

On p. 34 they write:

“The blockchain resides everywhere. Volunteers maintain it by keeping their copy of the blockchain up to date and lending their spare computer processing units for mining. No backdoor dealing.”

There are multiple problems with this:

  1.  to some degree entities that run a fully validating node could be seen as volunteering for a charity, but most do not lend spare computer cycles because they do not have the proper equipment to do so (ASIC hardware)
  2.  to my knowledge, none of the professional mining farms that exist have stated they are donating or lending their mining power; instead they calculate the costs to generate proofs-of-work versus what the market value of a bitcoin is worth and entering and exiting the market based on the result.
  3.  this is a contentious issue, but because of the concentration and centralization of both mining and development work, there have been multiple non-public events in which mining pools, mining farms and developers get together to discuss roadmaps and policy. Is that backdoor dealing?

On p. 35 they write:

“Nothing passes through a central third party; nothing is stored on a central server.”

This may have been true a few years ago, but only superficially true today.  Most mining pools connect to the Bitcoin Relay Network, a centralized network that allows miners to propagate blocks faster than they would if they used the decentralized network itself to do so (it lowers the amount of orphan blocks).

On p. 37 they write:

“The paradox of these consensus schemes is that by acting in one’s self-interest, one is serving the peer-to-peer (P2P) network, and that in turn affects one’s reputation as a member of the economic set.”

Regarding cryptocurrencies, there is currently no built-in mechanism for tracking or maintaining reputation on their internal P2P network.  There are projects like OpenBazaar which are trying to do this, but an on-chain Bitcoin user does not have a reputation because there is no linkage real world identity (on purpose).

On p. 38 they write:

“Trolls need not apply”

Counterfactually, there are many trolls in the overall blockchain-related world, especially on social media in part because there is no identity system that links pseudonymous entities to real world, legal identities.

On p. 39 the authors list a number of high profile data breaches and identity thefts that took place over the past year, but do not mention the amount of breaches and thefts that take place in the cryptocurrency world each year.

On p. 41 they write:

“Past schemes failed because they lacked incentive, and people never appreciated privacy as incentive enough to secure those systems,” Andreas Antonopoulos said. The bitcoin blockchain solves nearly all these problem by providing the incentive for wide adoption of PKI for all transaction of value, not only through the use of bitcoin but also in the shared bitcoin protocols.  We needn’t worry about weak firewalls, thieving employees, or insurance hackers. If we’re both using bitcoin, if we can store and exchange bitcoin securely, then we can store and exchange highly confidential information and digital assets securely on the blockchain.”

There are multiple problems with this statement:

  1.  it is overly broad and sweeping to say that every past PKI system has not only failed, but that they all failed because of incentives; neither is empirically true
  2.  Bitcoin does not solve for connecting real world legal identities that still will exist with our without the existence of Bitcoin
  3.  there are many other ways to securely transmit information and digital assets that does not involve the use of Bitcoin; and the Bitcoin ecosystem itself is still plagued by thieving employees and hackers

On p. 41 they write:

“Hill, who works with cryptographer Adam Back at Blockstream, expressed concern over cryptocurrencies that don’t use proof of work. “I don’t think proof of stake ultimately works. To me, it’s a system where the rich get richer, where people who have tokens get to decide what the consensus is, whereas proof of works ultimately is a system rooted in physics. I really like that because it’s very similar to the system for gold.”

There are multiple problems with this as well:

  1.  people that own bitcoins typically try to decide what the social consensus of Bitcoin is — by holding conferences and meetings in order to decide what the roadmap should or should not be and who should and should not be administrators
  2.  the debate over whether or not a gold-based economy is good or not is a topic that is probably settled, but either way, it is probably irrelevant to creating Sybil resistance.

On p. 42 they write:

“Satoshi installed no identity requirement for the network layer itself, meaning that no one had to provide a name, e-mail address, or any other personal data in order to download and use the bitcoin software. The blockchain doesn’t need to know who anybody is.”

The authors again conflate the Bitcoin blockchain with all blockchains in general:

  1.  there are projects underway that integrate a legal identity and KYC-layer into customized distributed ledgers including one literally called KYC-Chain (not an endorsement)
  2.  empirically public blockchains like Bitcoin have trended towards being able to trace and track asset movement back to legal entities; there are a decreasing amount of non-KYC’ed methods to enter and exit the network

On p. 43 they write:

“The blockchain offers a platform for doing some very flexible forms of selective and anonymous attestation. Austin Hill likened it to the Internet. “A TCP/IP address is not identified to a public ID. The network layer itself doesn’t know. Anyone can join the Internet, get an IP address, and start sending and receiving packets freely around the world. As a society, we’ve seen an incredible benefit allowing that level of pseudonymity… Bitcoin operates almost exactly like this. The network itself does not enforce identity. That’s a good thing for society and for proper network design.”

This is problematic in a few areas:

  1.  it is empirically untrue that anyone can just “join the Internet” because the Internet is just an amalgamation of intranets (ISPs) that connect to one another via peering agreements.  These ISPs can and do obtain KYC information and routinely kick people off for violating terms of service.  ISPs also work with law enforcement to link IP addresses with legal identities; in fact on the next page the authors note that as well.
  2.  in order to use the Bitcoin network a user must obtain bitcoins somehow, almost always — as of 2016 — through some KYC’ed manner.  Furthermore, there are multiple projects to integrate identity into distributed ledger networks today.  Perhaps they won’t be adopted, but regulated institutions are looking for ways to streamline the KYC/AML process and baking in identity is something many of them are looking at.

On p. 44 they write:

“So governments can subpoena ISPs and exchanges for this type of user data.  But they can’t subpoena the blockchain.”

That is not quite true.  There are about 10 companies that provide data analytics to law enforcement in order to track down illicit activity involving cryptocurrencies all the way to coin generation itself.

Furthermore, companies like Coinbase and Circle are routinely subpoenaed by law enforcement.  So while the network itself cannot be physically subpoenaed, there are many other entities in the ecosystem that can be.

On p. 46 they write:

“Combined with PKI, the blockchain not only prevents a double spend but also confirms ownership of every coin in circulation, and each transaction is immutable and irrevocable.”

The public-private key technology being used in Bitcoin does not confirm ownership, only control.  Ownership implies property rights and a legal system, neither of which currently exist in the anarchic world of Bitcoin.

Furthermore, while it is not currently possible to reverse the hashes (hence the immutability characteristic), blocks can and have been reorganized which makes the Bitcoin blockchain itself revocable.

On p. 47 they write:

“No central authority or third party can revoke it, no one can override the consensus of the network. That’s a new concept in both law and finance. The bitcoin system provides a very high degree of certainty as to the outcome of a contract.”

This is empirically untrue: CLS and national real-time gross settlement (RTGS) systems are typically non-reversible.  And the usage of the word contract here implies some legal standing, which does not exist in Bitcoin; there is currently no bridge between contracts issued on a public blockchain with that of real world.

On p. 50 they write:

“That was part of Satoshi’s vision. He understood that, for people in developing economies, the situation was worse.  When corrupt or incompetent bureaucrats in failed states need funding to run the government, their central banks and treasuries simply print more currency and then profit from the difference between the cost of manufacturing and the face value of the currency. That’s seigniorage. The increase in the money supply debases the currency.”

First off, they provide no evidence that Satoshi was actually concerned about developing countries and their residents.  In addition, they mix up the difference between seigniorage and inflation – they are not the same thing.

In fact, to illustrate with Bitcoin: seigniorage is the marginal value of a bitcoin versus the marginal cost of creating that bitcoin.  As a consequence, miners effectively bid up such that in the long run the cost equals the value; although some miners have larger margins than others.  In contrast, the increase in the money supply (inflation) for Bitcoin tapers off every four years.  The inflation or deflation rate is fully independent of the seigniorage.

Chapter 3

On p. 56 they quote Erik Vorhees who says:

“It is faster to mail an anvil to China than it is to send money through the banking system to China. That’s crazy!  Money is already digital, it’s not like they’re shipping palletes of cash when you do a wire.”

This is empirically untrue, according to SaveOnSend.com a user could send $1,000 from the US to China in 24 hours using TransFast. In addition:

  1.  today most money in developed countries is electronic, not digital; there is no central bank digital cash yet
  2.  if new distributed ledgers are built connecting financial institutions, not only could cross-border payments be done during the same day, but it could also involve actual digital cash

On p. 59 they write:

“Other blockchain networks are even faster, and new innovations such as the Bitcoin Lightning Network, aim to dramatically scale the capacity of the bitcoin blockchain while dropping settlement and clearing times to a fraction of a second.”

This is problematic in that it is never defined what clearing and settlement means.  And, the Bitcoin network can only — at most — provide some type of probabilistic settlement for bitcoins and no other asset.

On p. 67 they write:

“Private blockchains also prevent the network effects that enable a technology to scale rapidly. Intentionally limiting certain freedoms by creating new rules can inhibit neutrality. Finally, with no open value innovation, the technology is more likely to stagnate and become vulnerable.”

Not all private blockchains or distributed ledgers are the same, nor do they all have the same terms of service. The common theme has to do with knowing all the participants involved in a transaction (KYC/KYCC) and only certain known entities can validate a transaction.

Furthermore, the authors do not provide any supporting evidence for why this technology will stagnate or become vulnerable.

On p. 70 they write:

“The financial utility of the future could be a walled and well-groomed garden, harvested by a cabal of influential stakeholders, or it could be an organic and spacious ecosystem, where people’s economic fortunes grow wherever there is light.  The debate rages on, but if the experience of the first generation of the Internet has taught us anything, it’s that open systems scale more easily than closed ones.”

The authors do not really define what open and closed means here.  Fulfilling KYC requirements through terms of service at ISPs and governance structures like ICANN did not prevent the Internet from coming into existence.  It is possible to have vibrant innovation on top of platforms that require linkage to legal identification.

On p. 72 the authors quote Stephen Pair stating:

“Not only can you issue these assets on the blockchain, but you can create systems where I can have an instantaneous atomic transaction where I might have Apple stock in my wallet and I want to buy something or you.  But you want dollars.  With this platform I can enter a single atomic transaction (i.e., all or none) and use my Apple stock to send you dollars.”

This is currently not possible with Bitcoin without changing the legal system.  Furthermore:

  1.  this is probably not safe to do with Bitcoin due to how colored coin schemes distort the mining incentive scheme
  2.  from a technological point of view, there is nothing inherently unique about Bitcoin that would enable this type of atomic swapping that several other technology platforms could do as well

On p. 73 they write:

“Not so easy.  Banks, despite their enthusiasms for blockchain, have been wary of these companies, arguing blockchain businesses are “high-risk” merchants.”

Once again this shows how the authors conflate “blockchain” with “Bitcoin.”  The passage they spoke about Circle, a custodian of bitcoins that has tried to find banks to partner with for exchanging fiat to bitcoins and vice versa.  This is money transfer.  This type of activity is different than what a “blockchain” company does, most of whom aren’t exchanging cryptocurrencies.

On p. 74 they write:

“Third, new rules such as Sarbanes-Oxley have done little to curb accounting fraud. If anything, the growing complexity of companies, more multifaceted transactions, and the speed of modern commerce create new ways to hide wrongdoing.”

This may be true, but what are the stats or examples of people violating Sarbanes-Oxley, and how do “blockchains” help with this specifically?

On p. 78 they write:

“The blockchain returns power to shareholders. Imagine that a token representing a claim on an asset, a “bitshare,” could come with a vote or many votes, each colored to a particular corporate decision.  People could vote their proxies instantly from anywhere, thereby making the voting process for major corporate actions more response, more inclusive, and less subject to manipulation.”

First off, which blockchain?  And how does a specific blockchain provide that kind of power that couldn’t otherwise be done with existing non-blockchain technology?

On p. 80 they quote Marc Andreessen who says:

“PayPal can do a real-time credit score in milliseconds, based on your eBay purchase history — and it turns out that’s a better source of information than the stuff used to generate your FICO score.”

But what if you do not use eBay?  And why do you need a blockchain to track or generate a credit rating?

On p. 81:

“This model has proven to work.  BTCjam is a peer-to-peer lending platform that uses reputation as the basis for extending credit.”

BTCjam appears to have plateaued. They currently have a low churn rate on the available loans and they exited the US market 2 months ago.

On p. 83 they write:

“The blockchain IPO takes the concept further. Now, companies can raise funds “on the blockchain” by issuing tokens, or cryptosecurities, of some value in the company. They can represent equity, bonds, or, in the case of Augur, market-maker seats on the platform, granting owners the right to decide which prediction markets the company will open.”

From a technical perspective this may be possible, but from a legal and regulatory perspective, it may not be yet. Overstock has been given permission by the SEC to experiment with issuance.

On p. 86 they write:

“Bitcoin cannot have bail-ins, bank holidays, currency controls, balance freezes, withdrawal limits, banking hours,” said Andreas Antonopoulos.

That’s not quite true.  Miners can and will continue to meet at their own goals and they have the power to hard fork to change any of these policies including arbitrarily increasing or decreasing the issuance as well as changing fees for faster inclusion.  They also have the ability to censor transactions altogether and potentially — if the social value on the network increases — “hold up” transactions altogether.

Also, this doesn’t count the subsidies that miners receive from the utilities.

On p. 98 they write:

“To this last characteristic, Antonopoulos notes: “If there is enough financial incentive to preserve this blockchain into the future, the possibility of it existing for tens, hundreds, or even thousands of years cannot be discounted.”

It can arguably be discounted.  What evidence is presented to back up the claim that any infrastructure will last for hundreds of years?

On p. 100 they write:

“And just imagine how the Uniform Commercial Code might look on the blockchain.”

Does this mean actually embedding the code as text onto a blockchain?  Or does this mean modifying the UCC to incorporate the design characteristics of a specific blockchain?

On p. 102 they write:

“What interests Andreas about the blockchain is that we can execute this financial obligation in a decentralized technological environment with a built-in settlement system. “That’s really cool,” he said, “because I could actually pay you for the pen right now, you would see the money instantly, you would put the pen in the mail, and I could get a verification of that. It’s much more likely that we can do business.”

I assume that they are talking about the Bitcoin blockchain:

  1.  there is no on-chain settlement of fiat currencies, which is the actual money people are settling with on the edges of the network
  2.  since it is not fiat currency, it does not settle instantly.  In fact, users still have a counterparty risk involving delivery of the pen versus the payment.
  3.  if a central bank issued a digital currency, then there could be on-chain settlement of cash.

On p. 103 they write:

“If partners spends more time up front determining the terms of an agreement, the monitoring, enforcement, and settlement costs drop significantly, perhaps to zero.  Further, settlement can occur in real time, possibly in microseconds throughout the day depending on that deal.”

The DTCC published a white paper in January that explains they can already do near real-time settlement, but T+3 exists due to laws and other market structures.

On p. 105 they write that:

“Multisig authentication is growing in popularity. A start-up called Hedgy is using multisig technology to create futures contracts: parties agree on a price of bitcoin that will be traded in the future, only ever exchanging the price difference.”

As an aside, Hedgy is now dead.  Also, there are other ways to illustrate multisig utility as a financial control to prevent abuse.

On p. 106 they wrote that:

“The trouble is that, in recent business history, many hierarchies have not been effective, to the point of ridicule. Exhibit A is The Dilbert Principle, most likely one of the best-selling management books of all time, by Scott Adams. Here’s Dilbert on blockchain technology from a recent cartoon…”

The problem is that the cartoon they are citing (above) was actually a parody created by Ken Tindell last year.

The original Scott Adam’s cartoon was poking fun of databases and is from November 17, 1995.

On p. 115 they write:

“But the providers of rooms receive only part of the value they create. International payments go through Western Union, which takes $10 of every transaction and big foreign exchange off the top.”

Western Union does not have a monopoly on international payments, in fact, in many popular corridors they have less than 25% of market share.  In addition, Western Union does not take a flat $10 off every transaction.  You can test this out by going to their price estimator.  For instance, sending $1,000 from the US to a bank account in China will cost $8.

On p. 117 they write about a fictional blockchain-based Airbnb called bAirbnb:

“You and the owner have now saved most of the 15 percent Airbnb fee. Settlements are assured and instant.  There are no foreign exchange fees for international contracts.  You need not worry about stolen identity. Local governments in oppressive regimes cannot subpoena bAirbnb for all its rental history data. This is the real sharing-of-value economy; both customers and service providers are the winner.”

The problem with their statement is that cash settlements, unless it is digital fiat, is not settled instantly.  Identities can still be stolen on the edges (from exchanges).  And, governments can still issue subpoenas and work with data analytics companies to track provenance and history.

On p. 119 they write:

“Along comes blockchain technology.  Anyone can upload a program onto this platform and leave it to self-execute with a strong cryptoeconomical guarantee that the program will continue to perform securely as it was intended.”

While that may have been the case when these cryptocurrency systems first launched, in order to acquire ether (for Ethereum) or bitcoin, users must typically exchange fiat first.  And in doing so, they usually dox themselves through the KYC requirements at exchanges.

On p.123-124 they write about a ‘Weather decentralized application’ but do not discuss how its infrastructure is maintained let alone the Q-o-S.

On p.127 they write:

“Using tokens, companies such as ConsenSys have already issued shares in their firms, staging public offerings without regulatory oversight.”

The legality of this is not mentioned.

On p. 128 they write:

“Could there be a self-propagating criminal or terrorist organizations?  Andreas Antonopolous is not concerned.  He believes that the network will manages such dangers. “Make this technology available to seven and a half billion people, 7.499 billion of those will use it for good and that good can deliver enormous benefit to society.”

How does he know this?  Furthermore, the Bitcoin network itself is already available to hundreds of millions, but many have chosen not to use it.  Why is this not factored into the prediction?

On p.131 they write:

“What if Wikipedia went on the blockchain — call it Blockpedia.”

The total article text of English Wikipedia is currently around 12 gigabytes.  If it is a public blockchain, then how would this fit on the actual blockchain itself?  Why not upload the English version onto the current Bitcoin blockchain as an experiment?  What utility is gained?

From p. 129-144 they imagine seven ideas that are pitched as business ideas, but in most instances it is unclear what the value proposition that a blockchain provides over existing technology.

Chapter 6

On p. 148 they write that:

“The Internet of Things cannot function without blockchain payment networks, where bitcoin is the universal transactional language.”

What does that mean?  Does that mean that there are multiple blockchains and that somehow bitcoin transactions control other blockchains too?

On p. 152 they write:

“Last is the overarching challenge of centralized database technology — it can’t handle trillions of real-time transactions without tremendous costs.”

What are those costs?  And what specifically prevents databases from doing so?

On p. 153 they write:

“Other examples are a music service, or an autonomous vehicle,” noted Dino Mark Angaritis, founder of Smartwallet, “each second that the music is playing or the car is driving it’s taking a fraction of a penny out of my balance. I don’t have a large payment up front and pay only for what I use.  The provider runs no risk of nonpayment. You can’t do these things with a traditional payment networks because the fees are too high for sending fractions of a penny off your credit card.”

Depositing first and having a card-on-file are types of solutions that currently exist.  “Microtipping” doesn’t really work for a number of reasons including the fact that consumers do not like to nickel and dime themselves.  This is one of the reasons that ChangeTip had difficulties growing.

Furthermore, the tangential market of machine-to-machine payments may not need a cryptocurrency for two reasons:

  • M2M payments could utilize existing electronic payment systems via pre-paid and card-on-file solutions
  • The friction of moving into and out of fiat to enter into the cryptocurrency market is an unnecessary leg, especially if and when central bank digital currency is issued.

On pages 156-169 nearly all of the examples could use a database as a solution, it is unclear what value a blockchain could provide in most cases.  Furthermore, on p. 159 they discuss documentation and record keeping but don’t discuss how these records tie into current legal infrastructure.

Chapter 7

On p. 172 they write:

“We’re talking billions of new customers, entrepreneurs, and owners of assets, on the ground and ready to be deployed. Remember, blockchain transactions can be tiny, fractions of pennies, and cost very little complete.”

Maybe some transactions on some blockchains cost fractions of pennies, but currently not Bitcoin transactions.

On p.177 they write that “David Birch, a cryptographer and blockchain theorist, summed it up: “Identity is the new money.”

David Birch is not a cryptographer.

On p. 179 they write:

“Financing a company is easier as you can access equity and debt capital on a global scale, and if you’re using a common denominator — like bitcoin — you need not worry about exchange rates and conversation rates.”

Unless everyone is using one currency, this is untrue.

On p.185 they write:

“Sending one bitcoin takes about 500 bits, or roughly one one-thousandth the data consumption of one second of video Skype!”

But users still need to cash out on the other side which requires different infrastructure than Skype, namely money transmitter licenses and bank accounts.

On p. 192 they write that:

“Second, it can mean better protection of women and children. Through smart contracts, funds can be donated into escrow accounts, accessible only by women, say, for accessing food, feminine products, health care, and other essentials.”

How can a smart contract itself detect what gender the user is?

On p.194 they write:

“In jurisdictions like Honduras where trust is low in public institutions and property rights systems are weak, the bitcoin blockchain could help to restore confidence and rebuild reputation.”

How does Bitcoin do that?  What are the specific ways it can?

Chapter 8

On p. 202 they write:

“People can register their copyrights, organize their meetings, and exchange messages privately and anonymously on the blockchain.”

Which blockchain does this?  There are external services like Ascribe.io that purportedly let creators take a hash of a document (such as a patent) and store it into a blockchain.  But the blockchain itself doesn’t have that feature.

On p.214 they write:

“But surely a more collaborative model of democracy — perhaps one of that rewards participation such as the mining function — could encourage citizens’ engagement and learning about issues, while at the same time invigorating the public sector with the keen reasoning the nation can collectively offer.”

How?

Chapter 10

On p. 255 they mention that Greek citizens during 2015 would’ve bought more bitcoins if they had better access to ATMs and exchanges.  But this is not true, empirically people typically try to acquire USD because it is more universal and liquid.  Perhaps that changes in the future, but not at this time.

On p. 260 they write:

“The cost for having no central authority is the cost of that energy,” said Eric Jennings, CEO of Filament, an industrial wireless sensor network. That’s one side of the argument. The energy is what it is, and it’s comparable to the cost incurred in securing fiat currency.”

Where is the citation?  The reason the costs of securing the Bitcoin network are currently around $400 million a year is because that is roughly the amount of capital and energy expended by miners to secure a network in which validators are unknown and untrusted.  If you know who the participants are, the costs of securing a network drop by several orders of magnitude.

On p. 261 they write about the BitFury Group, a large mining company:

“Its founder and CEO, Valery Vavilov, argued the view that machines and mining operations overall will continue to get more energy efficient and environmentally friendly.”

Actually what happens is that while the ASIC chips themselves become more energy efficient, miners in practice will simply add more equipment and maintain roughly the same energy costs as a whole.  That is to say, if a new chip is 2x as efficient as before, miners typically just double the acquisition of equipment — maintaining the same amount of energy consumption, while doubling the hashrate.  There is no “environmental friendliness” in proof-of-work blockchains due to the Red Queen Effect.

On p. 274 they write:

“There will be many attempts to control the network,” said Keonne Rodriguez of Blockchain. “Big companies and governments will be devoted to breaking down privacy. The National Security Agency must be actively analyzing data coming through the blockchain even now.”

With thousands of copies being replicated around the world, it’s unclear who actually is storing it, perhaps intelligence agencies are.  We do know that at least 10 companies are assisting compliance teams and law enforcement in tracking the provenance of cryptocurrency movements.

On p. 282 they write:

“Indeed, Mike Hearn, a prominent bitcoin core developer, caused a quite a stir in January 2015 when he wrote a farewell letter to the industry foretelling bitcoin’s imminent demise.”

Wrong year, it was in January 2016.

On p. 291 they write that:

“Licensed exchanges, such as Gemini, have gained ground perhaps because their institutional clientele know they’re now as regulated as banks.”

Actually, Gemini hasn’t gained ground and remains relatively flat over the past ~5 months.  Even adding ether to their list of assets didn’t move the dial.

Conclusion

Overall the book was published a little too early as there hasn’t been much real traction in the entire ecosystem.

The content and perspective is currently skewed towards telling the cryptocurrency narrative and seemingly downplays the important role that institutions and enterprises have played over the past year in the wider distributed ledger ecosystem.

If you are looking for just one book to read on the topic, I would pass on this and wait for a future edition to rectify the issues detailed above.

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