What did bitcoin movements look like in 2015?

[Note: opinions expressed below are solely my own and do not represent the views of my employer or any company I advise.]

Last April, May and August I wrote three posts that attempted to look at the flow of funds: where bitcoins move to throughout the ecosystem.

Thanks to the team at Chainalysis we can now have a more granular view into specific  transfer corridors and movements (not necessarily holdings) between miners, exchanges, darknet markets, payment processors and coin mixers.

The first three charts are backwards looking.

Bitcoin PieAbove is a simplified, color coded version of a tool that Chainalysis provides to its customers such as compliance teams at exchanges.  The thickness of a band accurately represents the volume of that corridor, it is drawn to scale.

What is the method used to generate the plot?

The chord-plot shows all bitcoin transactions in 2015 traced down all the way back to a known entity. This means that the connection between the entities can be any number of hops away.

So for instance, for the exchanges it will include direct arbitrage, but also the modus operandi for bitcoin: individuals buying bitcoins at an exchange and then doing peer-to-peer transfers.  Again this can be any number of hops and then perhaps later end at an exchange again where someone is cashing out.

According to Chainalysis, by hiding all the intermediate steps we can begin to learn how most of the Bitcoin ecosystem is put together (e.g., can it be split into sub systems?, is there a dark and a lit economy?, and what is bitcoin actually used for?).

Legend:

  • Blue: virtual currency exchanges
  • Red: darknet markets
  • Pink: coin mixers
  • Green: mining pools
  • Yellow: payment processors

Altogether there are 14 major exchanges tracked in blue including (in alphabetical order): Bitfinex, Bitreserve (now Uphold), Bitstamp, BitVC (subsidiary of Huobi), BTCC (formerly BTC China), BTC-e, Circle, Coinbase (most), Huobi, itBit, Kraken, LocalBitcoins, OKCoin and Xapo.

The identity of 12 exchanges were removed with the exception of BTC-e and LocalBitcoins.

  • BTC-e was founded in July 2011 and is one of the oldest operating exchanges still around.  It does not require users to provide KYC documentation nor has it implemented AML processes.  This has made it an attractive exchange for those wanting to remain anonymous.
  • LocalBitcoins was founded in June 2012 and is a combination of Craigslist and Uber for bitcoin transfers.  It enables users to post trade requests on its site and provides escrow and reputation services for the facilitation of those trades.  Like BTC-e, it does not require users to provide KYC documentation nor has it implemented AML processes.  As a result it is a popular service for those wanting to trade bitcoins anonymously.

sharedcoinSharedCoin (depicted in pink above) is a product / service from Blockchain.info that allows users to mix their coins together with other users.  It is one of about a dozen services that attempt to — depending who you talk to — delink the history or provenance of a bitcoin.

agoraFounded in the spring of 2013, Agora (depicted in red above) was the largest known darknet market operating in 2015.

Forward Tracing

For each of the entities labeled on the charts below there is a ‘send to self’ characteristic which in fact are the UTXOs that originate from that entity and ends in unspent funds without first hitting another service.  So it can be both cold storage owned by the service or someone hoarding (“hodling”) coins using that service.

Interestingly enough, the deposits held at one VC-backed intermediary almost all stay cold.

forward looking localbitcoinsAbove is LocalBitcoins.

forward looking btceAbove is BTC-e.

forward looking sharedcoinAbove is SharedCoin.

Questions and Answers

I also spoke with the Chainalysis team about how their clustering algorithm worked.

Q: What about all the transactions that did not go between central parties and intermediaries?  For instance, if I used my wallet and sent you some bitcoins to your wallet, how much is that in terms of total activity?

A: The analysis above is intended to isolate sub-economies, not to see who is directly trading with who. The Chainalysis team previously did a Chord of that roughly a year ago which shows the all-time history (so early days will be overrepresented) and it was based only on one hop away transactions and normalized to what the team can ascribe to a known service.

The new chord above is different as it continues searching backwards until it locates an identified entity – this means it could have passed through an other either unidentified or less perfectly described service – but as it is same for everything and we have the law of large numbers it will still give a pretty accurate picture of what subeconomies exist.  It was made to identify if the Bitcoin network had a dark economy and a lit economy (e.g. if the same coins were moving in circles e.g. dark-market->btc-e->localbitcoin->dark-market and what amount of that loop would include the regulated markets too).

So, for example, the transfers going between the regulated exchanges, many will be multihop transfers, but they start and end in regulated exchanges and as such could be described as being part of the lit economy.

Q: What specific exchange activity can you actually identify?

A: It varies per service but Chainalysis (and others) have access to some “full wallets” from clients.  Also newer deposits are often not known so the balance in a wallet will be underestimated due to how the current algorithms work.

Further, some services require special attention and special analytics to be well represented due to their way of transacting – this includes some of the regional dark markets and Coinbase (due to how the company splits and pools deposits, see below).  By looking at all the known entities and how many addresses they contain as a percentage of all addresses ever used for bitcoin in all time, Chainalysis has significant coverage and these are responsible for more than half of all transactions ever happened.

Q: And what was the motivation behind building this?

A: The initial purpose of the plot was to identify subsystems and pain points in the ecosystem – the team was at first uncertain of the possibility that every Bitcoin user simply bought bitcoins from exchanges to buy drugs but that does not seem to be the case.  Most drug buyers use LocalBitcoins and sellers cash-in via mixers on LocalBitcoins or BTC-e (for the larger amounts).

Q: How large is SharedCoin and other mixers?

A: SharedCoin is currently around 8 million addresses and Bitcoin Fog is 200,000 addresses; they are the two largest.1

Additional analysis

Based on the charts above, what observations can be seen?

  • With a forward tracing graph we can see where all the unspent bitcoins come from (or are stored).  One observation is that intermediaries, in this case exchanges, are holding on to large quantities of deposits.  That is to say that many users (likely traders) — despite the quantifiable known risks of trusting exchanges — still prefer to store bitcoins on virtual currency exchanges.  Or to look at it another way: exchanges end up with many stagnant bitcoins and what this likely means is that users are buying lots of bitcoins from that exchange and not moving them and/or the exchange itself is holding a lot of bitcoins (perhaps collected via transaction fees or forfeited accounts).2

  • A lot of the activity between exchanges (as depicted in blue lines) is probably based on arbitrage.  Arbitrage means if Exchange A is selling bitcoins for a higher price than Exchange B, Alice will buy bitcoins on Exchange B and transfer them to Exchange A where they are sold for a profit.
  • Despite the amount of purported wash trading and internal bot trading that several Chinese exchanges are believed to operate, there is still a lot of on-chain flows into and out of Chinese-based exchanges, most likely due to arbitrage.
  • An unknown amount of users are using bitcoin for peer-to-peer transactions.  This may sound like a truism (after all, that’s what the whitepaper pitches in its title), but what this looks like above is that people go to exchanges to transfer fiat currencies for virtual currencies.  Then users, using the P2P mechanic of bitcoin (or other virtual currencies), transfer their coins to someone else.  We can see this by counting hops between the exchanges.

A potential caveat

Because of how certain architectures obfuscate transactions — such as Coinbase and others — it can be difficult for accurate external data analysis.  However with their latest clustering algorithm, Chainalysis’s coverage of Coinbase now extends to roughly the same size of the size of Mt. Gox at its height.3

Why can this be a challenge?  Coinbase’s current design can make it difficult for many data analytics efforts to clearly distinguish bitcoins moving between addresses.  For instance, when Bob deposits bitcoins into one Coinbase address he can withdraw the deposit from that same address up to a limit.  After about two bitcoins are withdrawn, Bob then automatically begins to draw out of a central depository pool making it harder to look at the flow granularly.

Other secondary information also makes it unclear how much activity takes place internally.  For instance, in a recent interview with Wired magazine, Coinbase provided the following information:

According to Coinbase, the Silicon Valley startup that operates digital bitcoin wallets for over 2.8 million people across the globe, about 20 percent of the transactions on its network involve payments or other tasks where bitcoin is used as a currency. The other 80 percent of those transactions are mere speculation, where bitcoin is traded as a commodity in search of a profit.

In a subsequent interview with New York Business Journal, Coinbase stated that it “has served 2.9 million people with $3 billion worth of bitcoin transactions.”

It is unclear at this time if all of those transactions are just an aggregation of trades taking place via the custodial wallet or if it also includes the spot exchange it launched last January.

Future research

Publishing cumulative bitcoin balances and the number of addresses for different entities such as exchanges could help compliance teams and researchers better understand the flows between specific exchanges.  For instance, a chart that shows what percentage of the 15 million existing bitcoins everyone holds at a given moment over different time intervals.

This leads to the second area: rebittance, a portmanteau of remittance and bitcoin.  Last year it was supposed to be the “killer app” for cryptocurrencies but has failed to materialize due in part, to some of the reasons outlined by Save on Send.4 Further research could help identify how much of the flows between exchanges and the peer-to-peer economy is related to cross-border value transfer as it relates to rebittance activity.

And as the market for data analysis grows in this market — which now includes multiple competitors including Coinalytics, Blockseer, Elliptic and Scorechain — it may be worth revisiting other topics that we have looked at before including payment processors, long-chains and darknet markets and see how their clustering algorithms and coverage are comparable.

Conclusions

For compliance teams it appears that the continued flow between illicit corridors (darknet markets) is largely contingent on liquidity from two specific exchanges: BTC-e and LocalBitcoins.  In addition, coin mixing is still a popular activity: from this general birds-eye view it appears as if half of the known mixing is directly related to darknet market activity and the motivation behind the other half is unknown.

Based on the information above other economic activity is still dwarfed by arbitrage and peer-to-peer transactions. And lastly, based on current estimates it appears that several million bitcoins are being stored on the intermediaries above.

[Note: special thanks to Michael Gronager and the Chainalysis team for their assistance and feedback on this post.]

  1. There are many regional smaller projects in, for example, smaller European countries whose flows may be underrepresented as they are less known in part because they do not use commonly used languages. However most are likely a part of the long tail of coin distribution. []
  2. There is a spectrum of intermediaries in which bitcoins are stagnant (or active).  For instance, in an interview last May, Wences Casares, founder and CEO of Xapo stated:

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

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

  3. See also The missing MtGox bitcoins from WizSec []
  4. There are notable exceptions that have gained regional traction including: BitX, Coins.ph and Align Commerce. []
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Designing a Global Fabric for Finance (G3F)

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

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

Homework

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

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

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

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

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

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

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

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

What are we doing then?

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

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

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

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

What about specific use-cases?

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

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

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

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

What does that mean?

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

Growth

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

standards

Source: XKCD

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

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

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

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

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

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Cryptocurrency KYSF: Know Your Source of Funds part 2

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

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

Below are my unabbreviated comments:

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

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

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

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

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

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

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

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

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

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

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

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

dark net market volume

Source: Soska and Christin

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

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

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

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

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

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

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

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

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

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

So Buzzfeed, but with bitcoins.

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

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

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

A couple days ago, on Monday, I was on a panel hosted at Stanford University as part of the “Blockchain Global Impact” conference.  The panel covered remittances, unbanked residents and financial inclusion.

Below is a presentation I put together based on research for Melotic, for SKBI in Singapore and in preparation for the panel.

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While we wait for another Bitcoin black swan event

I was interviewed and quoted a few times in the past couple weeks:

Is Bitcoin Stalling? at Technology Review:

The design of Bitcoin and the blockchain, its public transaction ledger, make it challenging to distinguish specific types of transactions. Nonetheless, researchers from the U.S. Federal Reserve determined in a recent analysis that the currency is “still barely used for payments for goods and services.” Last week, nearly 200,000 bitcoins changed hands each day, on average. But fewer than 5,000 bitcoins per day (worth roughly $1.2 million) are being used for retail transactions, according to estimates by Tim Swanson, head of business development at Melotic, a Hong Kong-based cryptocurrency technology company. After some growth in 2013, retail volume in 2014 was mostly flat, says Swanson.

After the Bitcoin Gold Rush at The New Republic:

“Some of the New York Bitcoin Center guys are pretty religious,” says Tim Swanson, who has written two e-books on cryptocurrencies in the past year, most recently The Anatomy of a Money-like Informational Commodity: A Study of Bitcoin. Before that, while living in China, he built his own graphics-chip miners. (Some of his miners have since been re-purposed as gaming systems.) Swanson has grown increasingly skeptical that Bitcoin will unsettle the existing finance megaliths. “You have centralization without the benefits of centralization,” he says. Bitcoin’s promise of frictionless finance is drowning in the ever more immense cost of mining, user-friendly infrastructure, and appeasing regulators.

“Being your own bank sounds cool in theory,” Swanson says, “but it’s a pain in reality.”

Beyond Bitcoin, episode #27: An Architecture For The Internet Of Money at Let’s Talk Bitcoin.

In this episode, Meher Roy does a fantastic job explaining what a neutral, agnostic protocol actually is and why the current allotment of cryptocurrency “protocols” are not real protocols.  Many thanks to Arthur Falls for his time, patience and great questions.  We will all miss the show.

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Is the adoption of blockchains and consensus ledgers a foregone conclusion?

Earlier this evening I gave a new presentation to the Sim Kee Boon Institute (SKBI) for Financial Economics at Singapore Management University (where I am a new research fellow).

Covered a lot of ground over 2 hours, I am not sure if there is a recording but will post it if one surfaces.  Below is the deck that I used.  Many thanks to David Lee, Ernie Teo, William Mougayar, Mikkel Larsen, Taulant Ramabaja, Taariq Lewis, Dan O’Prey, Bobby Ong, Meher Roy, Richard Brown, Sidney Zhang, Dave Hudson, Jonathan Levin and Robert Sams for their feedback.

Abstract: 
For the past two years, many entrepreneurs, developers, investors and enthusiasts have promoted the view that blockchains and in particular, Bitcoin will eventually be adopted as a universal value transfer mechanism — a type of global payment rail fit for a cornucopia of use-cases. Empirically this does not seem to be the case as over the past year and specifically the past 6 months, multiple startups have been created that specialize in areas that Bitcoin is not particularly well suited for. Whether any of these succeed is another matter entirely, but it is not a foregone conclusion that any one blockchain will be the “one to rule them all” based on their competitive (dis)advantages. This presentation outlines a number of vendors that have either announced or are working on solutions for the broader “Fintech” space as well as incumbent institutions in the existing ecosystem.
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Slicing data: what comprises blockchain transactions?

[Note: a PDF version of this is available]

Over the past month we have seen nominal transaction volume on the Bitcoin network reach several all-time highs. Enthusiasts on social media have proposed any number of theories including a rise in retail payments or commercial volume.

Yet upon further inspection, there does not appear to be a silver bullet answer.

We know, for example, that these transactions can originate or be comprised of faucet outputs, mining rewards, coin mixing, gambling, movement to ‘change’ addresses and simple wallet shuffling. 1 So with this type of identification problem, how can analysts distinguish the signal from the noise? Or as Peter Todd and others explained last month, for a few hundred dollars a day, it is possible to inflate the transaction volume by an entire order of magnitude.2

For instance, questions have arisen over a series of what some call “long chains.” Last month several commentators on a popular thread on Hacker News identified thousands of small transactions originating from a single source.3 The source was continually sending transactions and paid transaction fees for each of them. The reason this struck many as odd as a rational actor would simply bundle the transactions together to save on transaction fees.

While there are likely different motivations for doing so, one reason for why this was occurring was that the originating source was attempting to delink or otherwise mix and tumble coins to make it difficult to “dox” or identify the originating source. But it could also be a faucet and at one point even pools paid out miners using chained transactions, perhaps some still do.

What does this look like? Below is a chart created by user “FatalLogic” in that thread:

hackernews

Source: Hacker News

The green line identifies the overall transaction volume on the Bitcoin blockchain, whereas the red line follows the rule, the heuristic that removes these “long chains.”

Is there a definition of long chains?

Two weeks ago Blockchain.info published several similar charts excluding “Long Chains.”

According to Jonathan Levin, formerly of Coinometrics:4

Blockchain.info have implemented a heuristic to identify high velocity activity that is probably unrelated to real world commerce. Every day the internal counter resets and counts how many times transaction outputs were spent on the same day. So if a wallet paid someone 1 btc in one transaction output and they then transferred that to cold storage that would be a chain of two. However there are some chains where the chain of spent outputs of a given day exceeds 1000. Each day, on average, the sample size is 144 blocks. Therefore, for chains of more than 144, the chain of transactions involve zero confirmation transactions (i.e., are not relying on the blockchain for their security). In other words, it is a measure of velocity.

These long chains show that there are some parts of the economy that are flipping outputs almost 10 times a block with chains of over 1000 in a day. This may not relate to real world commerce or security processes, probably more likely to be gambling or mixing. In Satoshi Dice often the bettor just takes their winnings and gambles again with everything being done with 0 confirmations. Likewise with mixing there is little need to wait for confirmations and the priority is obscuring the origin of the transaction outputs. Finally this is unlikely to capture a lot of activity run by the centralised services since their objective is fee minimisation.

Furthermore, according to the description on Blockchain.info’s site, “A chart showing the total number of bitcoin transactions per day excluding those part of long chain transaction chains. There are many legitimate reasons to create long transaction chains however they may also be caused by coin mixing or possible attempts to manipulate transaction volume.”

The first chart below is the original unmodified chart of total transactions on the Bitcoin blockchain:5 blockchaininfo unmodified

Using the same Y-o-Y time frame, below is the newly modified chart, using the Blockchain.info heuristic that removes these “chains” longer than 10:6

blockchaininfo modified

As we can tell above, by removing these “long chains” the volume decreases by 3x, yet there does appear to be an upward trend over the past several months.

I spoke with Atif Nazir, the CEO and co-founder of Block.io. In his view:7

The term “longest chain” is vague – it would be misleading to say it is just coin mixing. The volume could be a series of transactions where the user cannot spend to the desired destinations in the same transaction. This could be a limitation of their wallet software’s user interface, or the backend of the software itself.

For instance, if a faucet is built on Block.io, the owner spends coins rapidly, sometimes breaking them into a couple transactions if they are efficient, and at other times into hundreds of transactions that spend unconfirmed change in rapid succession. We have seen chains of unconfirmed spends as long as 1,000 transactions, and they could be longer if blocks are not found.

In general, achieving provable privacy through coin mixing and coin shuffling is hard as long as you stay on the same Blockchain. With the current methods, you can look at a destination address and say, with some certainty, “hey, this guy is the one who stole the Bitstamp coins.”8

In the absence of a definite, no-non-sense way to look at “long chains” of transactions, the safest assumption would be to consider them as unconfirmed chain spends, where the user wants to spend transactions very quickly deliberately or due to their software’s limitation.

Another potential source is even smaller.

For instance, Sidney Zhang, co-founder of HelloBlock has noticed that:9

Another interesting thing is people are sending dust transactions on the network as advertisements for high-yield investment program (HYIP).10

This transaction, 92aa, is an example of an ad (and the message was removed by blockchain.info).11

What they do is they will look for transactions happening on the blockchain, pick a collection of addresses and then send 1 satoshi to them and then they will attach a “public note” on blockchain.info. The message is normally like earn 7% per day at xyz.com. The public note in this case was removed, probably reported as spam

The second, 1cca, is an example of a faucet. If you look at the tag “win free bitcoins every hour!” it is the address for freebitco.in.12

It is unlikely the long chains come directly from consumers because consumers don’t spend money rapidly.

A more likely scenario is it is a ‘shared’ hot wallet operated by a service (e.g., Coinbase, Circle). A possible explanation then emerges – off-chain gambling sites such as Primedice / Moneypot / Betcoin casino and others operate hot wallets.

In terms of scale, very small casinos may receive approximately 30+ deposits a day. A larger casino easily operate with 1000s of deposits a day and hundreds of withdrawals.

One interesting behavior is that, bitcoin gamblers never keep funds in a casino. They tend to deposit, play and then immediately withdraw without leaving funds there overnight. That could create a huge amount of activities from the same hot wallet. Thus creating a large chain.

Last year Ken Shirriff also pointed out a few of the notable pieces of “spam” that permanently reside on the blockchain including images.13

What does this look like altogether?

For additional analysis I reached out to Organ of Corti who plotted out these differences onto two different charts.14

organ weekly transactions

As shown above, these match up with the heuristic used by the original Hacker News post as well as that of Blockchain.info. In Organ’s view:

If long chains of transactions are used by entities of a very different nature to single transactions or short chains of transactions, then we might expect to see differences in transaction rates and transaction rate cycles between the short and long chain groups.

Starting with a visual comparison of the two groups, the most significant difference between the longer and shorter chain groups is variance. This is to be expected since one long chain of transactions increases transactions rates more than a single, unchained transaction.

Does the yellow line at the bottom represent the actual “real” volume? Perhaps, but maybe not.

In addition, Organ put together a spectrogram to analyze this weekly cycle that is visually apparent in all the charts:

organ spectrogram

Another way to look at it is through a spectral density chart, according to him:

Perhaps a more useful test is to check for periodicity in the data. We know from previous work that currently transactions show a daily and a weekly cycle. I’m using Blockchain.info’s data which is daily, so a spectrogram will only reveal a weekly cycle.

The last plot shows the spectrograms for chains longer and shorter than 10, 100, 1000, or 10000. These show a periodicity similar to that for all transactions of one cycle per week.

We can also compare transaction of chains longer and shorter than 10, 100, 1000, or 10000 by calculating the cross correlation function. In each case the maximum correlation is at lag 0 and is much higher than the upper bound of the 99.9 confidence interval, so the periodicity of the transaction rates of each group (chains longer and shorter than 10, 100, 1000, or 10000) are similar to, also suggesting that time of use for shorter and longer chain transactions are similar.

Further, time series decomposition showed the same starting and finishing days of each weekly cycle.

I think that a working week cycle implies that the larger number uses of longer chain transactions are from businesses with a normal working week, and the correlation in the periodicity of the shorter and longer chains of transactions suggests the largest use of both longer and shorter chains of transactions are by entities with a work days and weekends.

Is there anything that explains the increase then?

Other sources

Earlier this month a new game called SaruTobi was approved for inclusion into the iOS store.15 The game tips its users bitcoin on the blockchain (in contrast, ChangeTip does so off-chain). During its debut week, before running out of coins, according to its first public address, SaruTobi sent out more than 5,000 transactions most of which during an 11-hour time period.16 Within its first two weeks it paid out roughly 6.4 bitcoins with more than 50,000 transactions.17

Another continual source of on-chain usage comes from Counterparty, a “2.0” platform that effectively sits on top of the Bitcoin blockchain and uses bitcoins for each counterparty transaction (e.g., it is an embedded consensus mechanism). Below is a visual of the daily transaction volume over the past year:18

counterparty blockscan

Source: Blockscan.com

The variation follows some of the daily (and weekend) patterns we have observed with Bitcoin in general (e.g., less activity on “Sundays”) but at certain days and times there are peak usages of up to 3% of the Bitcoin network.19 One explanation is that Counterparty is a popular platform for issuing tokens during crowdsales. For instance, the double peaks in December are most likely related to the Gems crowdsale, in which 2,633 BTC were exchanged for 38 million “GEMZ” (the native coin of the Gems system).20

As I briefly described last month, over the past year, a BitcoinTalk user, “dexX7” has been parsing other data, usually related to alt platforms such as Counterparty, Mastercoin, Colored coins and proof of existence.21 Recall that these ‘altcoins’ are actually in practice, just watermarked bitcoin transactions. In order to use these platforms, a user has to interact with the Bitcoin network (e.g., they are embedded consensus mechanisms). Below is a chart he recently sent me that dissects this composed parts:22

dexx7 meta transactions

  • Data captured at block height 340,018
  • There were at least 184,155 identifiable meta-transactions
  • There were 57,489,982 transactions in total
  • There were 16,511,696 unspent outputs

This only includes the transactions dexX7 was able to identify. Counterparty, Mastercoin and Chancecoin use almost entirely “bare multisig” scripts as medium to embed and transport data. In contrast, Proof of Existence, Open Assets, Coinspark and Block Sign use OP_RETURN (note: there is still an active discussion between using 40 bytes and 80 bytes).23 Open Assets and Coinspark are a type of colored coin implementation and both Proof of Existence and Block Sign are a type of notary service (previous charts are available in an album view).24

Some other analysis from dexX7:

Almost all Counterparty transactions carry data via bare multisig and there are about 5000 non-multisig Mastercoin transactions. There are furthermore 17620 unclassified, unspent multisig outputs and 6286 unclassified, spent multisig outputs.

Almost all of those unclassified multisig outputs were created by Wikileaks and actually carry some data too.25

Proof of Existence, Open Assets, Coin Spark and Block Sign account for 7363 OP_RETURN transactions. The total number of all OP_RETURN outputs, according to webbtc.com, is close to 11960, so more than 60 % can be mapped to those four.

Another slice of daily and weekly transactional volume comes from pay-to-script-hash, better known as P2SH. This was originally BIP 16 proposed by Gavin Andresen and incorporated into the protocol in 2012 to “let a spender create a pubkey script containing a hash of a second script, the redeem script.”26

p2sh transactions

Source: P2SH.info

This has replaced ‘bare’ multisig as a means for securing bitcoins. While its use and adoption started off very slow, more than 6% of all bitcoins are now stored in this manner including Bitstamp via its recent integration with BitGo:27

What about retail volume?

As has become apparent, it cannot be said that an increase in transaction volume is (probably) due to any one specific variable. Yet, according to a popular narrative, the quadrupling of acceptance by merchants this past year (from ~20,000 to 82,000), may have led to increased spending by consumers and therefore account for the increase.28

Last month, Jorge Stolfi a computer science professor in Brazil analyzed the BitPay addresses (BitPay reuses addresses) based on the Walletexplorer dataset.29 Below is a visual of what BitPay has received over the past two years.stolfi bitpay

According to Stolfi:

The green line on this graph shows the number of BTC deposited each day into that wallet.30 This graph is rather strange since the number is practically constant since January 2013, about 500–1000 BTC/day, and shows no weekly pattern. And no Black Friday spike either.

In his analysis Stolfi also noticed two different types of orders processed by BitPay, what he labels “wholesale” versus “retail.” The “wholesale” coins are likely miners selling their block rewards in bulk whereas “retail” is consumer behavior (e.g., buying coffee, food, tickets).

Furthermore, if this wallet heuristic is valid, according to Stolfi:

  • BitPay now processes about 1000-1500 “retail” payments per day, averaging less than 1 BTC each;
  • The number of retail transactions processed by BitPay has grown 3x since mid-2013, and has been flat through most of 2014;
  • The amount of BTC processed by BitPay (including “retail” and “wholesale” payments) has been quite constant since Jan/2013, about 500-1000 BTC/day
  • In terms of dollar value, the amount processed by BitPay (including “retail” and “wholesale” payments) has increased a lot from 2013 to 2014, but has fallen 50% or more since February, as the BTC price fell.
  • Black Friday had a modest effect (2x to 3x) on the number of “retail” payments, but had no effect on the total BTC/day (which is dominated by the “wholesale” payments).

And what about off-chain retail transactions?

Below is a public chart from Coinbase that visualizes the off-chain activity that takes place on Coinbase’s platform.31

coinbase chart

Source: Coinbase.com

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

Fees

Another way of looking at whether or not transaction volume is increasing is through the “fees” to miner metric (recall that these are not real “fees” as they are not mandatory yet and may be more akin to “donations”).32 Maybe transaction volume based on the methods above does not fully capture hypothesized growth.

transaction fees organ

Above is a new chart from Organ of Corti which visualizes the transaction fees included with each block over the past 6 years.33 If on-chain retail commerce was increasing, it would likely in turn be paid for via some fee mechanism yet this is not apparent. This is not to say that utility has not increased for certain participants. Volume as a whole has clearly increased as shown by the second image – yet these are users who likely opt to send a fee-less transaction to the mempool (these transactions typically take several hours or perhaps a day to be included within a block).

What is another explanation?

It does illustrate that the other narrative – that fees replacing block rewards – has not yet begun to occur. Maybe it will not.

For instance, last year Robert Sams and Vitalik Buterin highlighted the economic costs that are being overlooked to maintain the infrastructure, that fees would unlikely be able to adequately compensate miners.34 And Dave Hudson independently explored what has actually occurred in practice, providing visualizations of the empirical data that highlights and reinforces their marginalized viewpoint.35

To put it another way, if more users were actively using the blockchain to transmit value, then it would likely be apparent via an aggregate increase in fees.

hudson miner rewards

Source: HashingIt.com

As shown above during a four year time span, miners, the actual labor force of the network, are not seeing the narrative play out as it is supposed to (block reward plus fees to miner). Denominated in bitcoin (the blue line), miners have not seen the increase in fees or revenue that many of the same social media promoters claim will happen. Whether this changes is unknown.

Again, recall the current narrative that in the end, transaction fees will purportedly replace the block reward.36 But the causality is the opposite direction than assumed by most: fees people are willing to pay determine the number of miners. Not the other way around. The takeaway is that simply put, fees may not rise to cover the current block reward amounts. It may be that the block reward falls and miners just drop out and net transaction fees never increase reducing the security of the network but this is a topic for another article.

What does this all mean?

For perspective I spoke with Ernie Teo, a research fellow at the Sim Kee Boon Institute for Financial Economics (which hosted a cryptocurrency conference in November).37 According to his team:

We observe similar trends to what has been mentioned in your article. We see a large increase in the one satoshi (or less) addresses over time. This could also be due to the long chain “spammer” you have described above. A few more things we can note from our upcoming analysis on the distribution of bitcoins over time:

  • 50 coin addresses, these are the only addresses in the very beginning due there being only miners on the network. However we see that this does not fluctuate a lot overtime and it indicates that most miners tend to cash out once they mined.
  • Large increase in number of addresses with less than 1 bitcoin. This indicates more “retail” type buyers.
  • Not much change or fluctuations to the large addresses.

I think it is probably true that not a very large proportion of the transactions are retail transactions. In the long run, it doesn’t help the network. We can only wait for the next big innovative app that can boost retail-type usage.

How else can this be visualized?

John Ratcliff recently published several new charts describing “the State of the Blockchain Address(es)“ in which he delves into token movements and in particular “zombie” addresses (addresses that have not been active in 3 or more years).38 They are illuminating and we both disagree on conclusions that can be drawn from them.

For instance, he updated one chart that I previously described as showing more than 70% of coins have not moved in more than 6 months:39

ratcliff distribution age

Source: John Ratcliff

What does the chart above illustrate? If it is velocity then what the color bands reinforce my explanation from two months ago: that the majority of coin holders that were purchased in the November / December 2013 bubble are now underwater.40 We see the transition over the year, in which these coin holders, rather than spending and realizing a loss, hold on to them throughout the months. Hence, why we likely see another uptick to an “older” band starting in mid-November 2014 – the anniversary of the beginning of the most recent bubble.

This explanation is further reinforced by the demographics of bitcoin holders: mostly middle to upper-middle class residents of developed countries – most of whom have “low time preference” (e.g., speculators) and therefore do not need or want to spend bitcoins immediately because they have other means of payment (e.g., credit cards) and can therefore hold onto their coins longer than someone with “higher time preference” (e.g., less affluent individuals living paycheck to paycheck who in theory would have to continually, immediately spend bitcoins). Another potential explanation is the disposition effect, but this is also a topic for a different article.41

badev chen velocity

The chart above (originally Figure 15) was published this past month by two researchers at the Federal Reserve.42 They independently used a similar methodology that Ratcliff has undertaken. In their view:

Figure 15 examines the degree of activity for the addresses in the network. For each date we partition the volume of addresses with positive balances according to their last activity. For example, the addresses that have transacted in the last week are likely to be frequently used (shown with the strip in the bottom). On the other hand, some of the addresses have not been active in the past 52 weeks. Those are likely to serve saving or investment purposes and much less so for transacting. From Figure 15 we can see that the volume of “investment” addresses (not used in the last year) has been steadily decreasing. Still, however, around 75 percent of the addresses in operation with positive balances have not been used in a transaction in the last four months.

While the rest of their report is illuminating, in their concluding remarks, they also do not see retail transactions as comprising more than a marginal amount of volume:

Broadly speaking, our empirical exercise documents general patterns of Bitcoin usage, and examines the use of Bitcoin for investment and payment purposes. We find that while the number of daily users may have doubled every eight months, the transaction volume is negligible compared to the domestic volume of U.S. payment systems. Our analysis of data from the Bitcoin system further suggests that Bitcoin is still barely used for payments for goods and services. In addition, the patterns of circulations of bitcoins and the dynamics of the bitcoin exchange rate are consistent with low usage of Bitcoin for retail payment transactions. Finally, we provide evidence that the exchange rates between bitcoin and other currencies are not well aligned, which we interpret as a lack of depth of the exchange markets and as costly exchange rather than unexploited arbitrage opportunities.

Perhaps these trends will change. Maybe, as some claim, retail volume will increase. But as shown above and through Total Output Volume we know what the maximum “purchasing power volume” of transactions is, this has not been a mystery.43

While merchant adoption continues to increase, consumer adoption for retail purchases appears to be flat (as shown by both BitPay and Coinbase numbers). Future analysis may need to look at correlating these trends for brick and mortar merchants. Without regular use at the register and point-of-sale, there are a number of anecdotal stories of retraining and fumbling that will go on with floor employees with respect to accepting bitcoin.44

Perhaps again, this will change in the future (e.g. Impulse),45 but going forward a full traffic analysis such as the type created by Sarah Meiklejohn et al. two years ago would help the industry as a whole determine what consumer behavior looks like with greater accuracy.46 And this is important for a project whose white paper promotes itself as a payment network for online commerce (see section 1).

So what conclusions can be drawn from this?

As noted at the beginning, there does not appear to be one specific variable that explains the recent increases over the past several months. For example, most tipping from services like Bitui in China and ChangeTip internationally, is already done off-chain (e.g., the independent site ‘ChangeTip stats’ describes activity on the company database).47 SaruTobi is too new to account for all but the last few weeks of growth and DarkWallet activity will likely be “long chain” related. Perhaps offline P2P transactions from OpenBazaar should be identified, aggregated and brought into future analysis.48

Future analysis should also look to factor in or filter out activity related to “change” addresses.  For instance, the short-term ‘velocity’ seen in the daily and weekly bands of Ratcliff and Badev & Chen’s charts could be overstated due to coins which do not actually swap hands but are rather “spent” to themselves due to how “change” is handled by the protocol.  Furthermore, as has been described in Dave Hudson’s modeling of block sizes, it cannot be said that an increase in on-chain volume is axiomatically “good.”49

All we can say for now is that there is an increase in usage from multiple sources, but not likely from on-chain retail commerce which has remained flat for about a year.

This is still a dynamic space and perhaps it may be months or even years before we will be able to fully identify all the major contributors to volume changes.

Acknowledgements

Special thanks to dexX7, Raffael Danielli, Michael Dann, Dave Hudson, David Lancashire, TM Lee, Jonathan Levin, Atif Nazir, Organ of Corti, Jorge Stolfi, Ernie Teo and Sidney Zhang for their constructive feedback and time.

End notes

________________________________________________________________________

  1. At its peak in the first quarter of 2013, Satoshi Dice (a gambling service) represented roughly 48% of all transactions on the Bitcoin network. This is visualized by dexX7. []
  2. See Peter Todd’s tweet and Questions Linger as Daily Bitcoin Transactions Pass 100,000 Milestone from CoinDesk []
  3. See the original comment from ‘sanswork’ in thread covering “Bitcoin adoption in 2015” from Hacker News []
  4. Personal correspondence, January 19, 2015 []
  5. Number of transactions per day from Blockchain.info []
  6. Number of transactions excluding chains longer than 10 from Blockchain.info []
  7. Personal correspondence, January 18, 2015. See Block.io []
  8. Analysis: Bitstamp Hacker Almost Stole Additional $1.75 Million from CoinDesk []
  9. Personal correspondence, January 18, 2015. See HelloBlock. []
  10. For a brief overview see High-yield investment program []
  11. The relevant “ad” address can be viewed at https://blockchain.info/tx/92aa4e600f15d8e5353b180010a270d4f173a7226cc6dd3f40bd5a7bd20e0082 []
  12. The faucet address is located at: https://blockchain.info/tx/1cca64709d2b1679a1a64253afe01f41e2b684ef7d9cbce67fedb764c5bc78c6 and its ‘parent’ is the following address: https://blockchain.info/address/175o52E64wHQumzfLFnKrPaukJsvo9pgMb []
  13. Hidden surprises in the Bitcoin blockchain and how they are stored: Nelson Mandela, Wikileaks, photos, and Python software by Ken Shirriff []
  14. Personal correspondence, January 20, 2015. See Organ of Corti. []
  15. Apple Approves iOS Game That Tips Players in Bitcoin from CoinDesk []
  16. SaruTobi’s first address conducted 5,255 transactions: https://blockchain.info/address/17ZgzoQUAiCrCgSieYfGhAvToW9kn6uaLt []
  17. SaruTobi’s second address conducted 6,676 transactions: https://blockchain.info/address/1GumHq1f5XVnxBjnz78uRgJad2nyE5TgjS and then its third and as of this writing, most current address, has done 41,677 transactions: https://blockchain.info/address/3MXxfNZoifLYdS8wJTpvfeDNPt9ZWuMAaN []
  18. See Blockscan Counterparty Transaction History []
  19. See Counterparty CEO tweet and The Composition of Metacoins on the Bitcoin Network by Tim Swanson []
  20. GetGems Token Sale Wrap Up – Thanks x38,135,367! by Tom Kysar []
  21. The Composition of Metacoins on the Bitcoin Network by Tim Swanson []
  22. Personal correspondence, January 21, 2015 []
  23. See the conversation Change the default maximum OP_RETURN size to 80 bytes #5286 at github []
  24. An album overview of select metacoins by dexX7 []
  25. See Hidden surprises in the Bitcoin blockchain and how they are stored: Nelson Mandela, Wikileaks, photos, and Python software by Ken Shirriff and this address containing embedded data: https://blockchain.info/tx/6c53cd987119ef797d5adccd76241247988a0a5ef783572a9972e7371c5fb0cc []
  26. For a brief overview see Pay to script hash and developer guide to Transactions []
  27. The Bitstamp and BitGo Partnership Is a Watershed Moment for Bitcoin from BitGo []
  28. State of Bitcoin 2015: Ecosystem Grows Despite Price Decline from CoinDesk []
  29. See Are there changes in the volume of retail transactions through Bitpay this past year? by Tim Swanson and WalletExplorer.com []
  30. A permanent copy of the image is located on Jorge Stolfi’s site. []
  31. Coinbase charts []
  32. The Collective Action Problem of Mining Fees by Tim Swanson []
  33. January 18th 2015 Block Maker Statistics by Organ of Corti []
  34. See The Marginal Cost of Cryptocurrency and Some Crypto Quibbles with Threadneedle Street by Robert Sams; Vitalik Buterin has discussed this several times on the official Ethereum blog. In addition, I discussed this at length in Chapter 3 in The Anatomy of a Money-like Informational Commodity. []
  35. The Future Of Bitcoin Transaction Fees? by Dave Hudson []
  36. The Collective Action Problem of Mining Fees by Tim Swanson []
  37. Singapore Event Puts Bitcoin on Mainstream Finance Agenda from CoinDesk []
  38. The State of the Blockchain Address(es) by John Ratcliff []
  39. Analysis: Around 70% of Bitcoins Unspent for Six Months or More from CoinDesk []
  40. Approximately 70% of all bitcoins have not moved in 6 or more months by Tim Swanson []
  41. For a brief overview see Disposition Effect []
  42. Bitcoin: Technical Background and Data Analysis by Anton Badev and Matthew Chen []
  43. Total Output Volume from Blockchain.info []
  44. My Amsterdam Letdown and Why Bitcoin’s Real Value May Lie Beyond the First World from CoinTelegraph []
  45. BitPay recently announced its whitepaper on “Inter-Channel Payments” also called “Impulse.” []
  46. A Fistful of Bitcoins by Meiklejohn et. al. []
  47. See Changetip real-time usage stats []
  48. A few statistics are available at BazaarBay []
  49. See 7 Transactions Per Second? Really? and The Myth Of The Megabyte Bitcoin Block by Dave Hudson []
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Are there changes in the volume of retail transactions through Bitpay this past year?

A couple days ago I noted that because Bitpay reuses its addresses, it is possible to monitor them and that there hasn’t been much of a growth since May (the last time they announced numbers).

Today a redditor posted some visual analysis and explanation of these same Bitpay addresses.  [Note: I’ve reached out to the user and will update this post if they provide any other information.]  Below is their analysis:

2014-12-04-bitpay-2013-01-01--2014-11-30-num-day

The green line on this graph shows the number of payments per day into the presumed (see below) receiving address of BitPay, from 2013-01-01 to 2014-11-3. Note that the vertical axis uses log scale. The number was about 1000–1500 per day through most of 2014, with a strong weekly pattern. The spike at the right end is Black Friday; there were about 3200 inputs, i.e. about 2x to 3x as many as in a typical day.

2014-12-04-bitpay-2013-01-01--2014-11-30-btc-day

The green line on this graph shows the number of BTC deposited each day into that wallet. This graph is rather strange since the number is practically constant since January 2013, about 500–1000 BTC/day, and shows no weekly pattern. And no Black Friday spike either.

What happens is that there are two kinds of inputs to that wallet, which I will call “retail” and “wholesale” (although I have no idea what the latter are, really). The wholesale inputs are large (often hundreds of BTC) and have been regular in amount since 2013-01. The “retail” ones are much smaller (mostly under 10 BTC, many under 1 BTC), much more numerous, and have increased about 3x from mid-2013 to mid-2014. Hence the first graph above is dominated by the retail inputs, while the second graph basically shows the wholesale ones.

The data for these plots comes from these pages that are claimed to show all transactions into the BitPay receiving wallet since it was created. However, the addresses that make up that “wallet” were inferred from the blockchain by an undisclosed heuristic that is supposed to identify addresses belonging to the same owner.

My guess is that the heuristic simply assumes that two addresses that are inputs to the same transaction must belong to the same owner (since one needs both private keys to sign the transaction) and assigns them to the same “wallet”. If my guess is correct, the heuristic may fail to include in the “Bitpay.com wallet” some addresses that belong to BitPay but were never used together with the identified ones.

However, the volume of BTC that went into that heuristic “wallet” during May/2014 seems to match what BitPay said to process per day in that month (assuming that they picked the best day of May); so it seems that the heuristic wallet is fairly close to the real one.

Updated with more from the same user:

  • BitPay now processes about 1000-1500 “retail” payments per day, averaging less than 1 BTC each;
  • The number of retail transactions processed by BitPay has grown 3x since mid-2013, and has been flat through most of 2014;
  • The amount of BTC processed by BitPay (including “retail” and “wholesale” payments) has been quite constant since Jan/2013, about 500-1000 BTC/day
  • In terms of dollar value, the amount processed by BitPay (including “retail” and “wholesale” payments) has increased a lot from 2013 to 2014, but has fallen 50% or more since February, as the BTC price fell.
  • Black Friday had a modest effect (2x to 3x) on the number of “retail” payments, but had no effect on the total BTC/day (which is dominated by the “wholesale” payments).
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Does spending decrease as purchasing power declines?

ecommerceLast year Peter Coy illustrated what a deflationary economy looks like (such as the Bitcoin economy) and explained how this impacts consumer spending (and lending).  Depending on what peak someone may have bought at, the very reverse happened this year, with prices denominated in bitcoin rising by perhaps as much as 65% (a full analysis should probably also adjust a couple percent to include CPI).  Though, to my knowledge there are no products actually denominated in bitcoin (yet).

So then, did spending habits change over the course of the year?

Not really, users as a whole still preferred to simply hold onto coins either because they had low time preferences with future expectations of large price appreciation and/or they were ‘underwater’ in coin (e.g., they bought at a peak).  Off-chain transactions on Coinbase did not see much of a difference (yet) either.

Economic theory suggests that consumers prefer a medium of exchange with stable purchasing power and in practice that seems to be the case.

For instance, on January 9, 2014 online retailer Overstock.com began accepting bitcoin as payment.  In the first two months it generated $1 million in bitcoin payments and through May the tally had grown to $1.6 million in bitcoin payments.

According to a new story yesterday, Overstock announced it would likely generate $3 million in bitcoin payments this year (though they do not specify how many bitcoins that is altogether).  This is in contrast to the estimates at the beginning of the year:

The figures are notable given that the e-commerce company had issued a wide range of potential estimates for its first-year bitcoin sales over the course of the year. In March, CEO Patrick Byrne suggested Overstock was on pace to achieve $10m–$15m, or even $20m, in bitcoin sales.

Such estimates were also below the $5m Byrne said Overstock originally anticipated, though on par with those suggested by Overstock chairman of the board Jonathan Johnson in interviews.

Altogether approximately 11,100 customers paid with bitcoin this past year at Overstock — these customers spent an average of $273 in bitcoins.  That means that after the initial power law from the first couple months, roughly $200,000 in bitcoin sales occurred from March onwards, or roughly $6,700 per day.

If bitcoin denominated prices had stayed the same, would that have increased the amount purchased?  Perhaps, but as articulated by both Robert Sams and Yanis Varoufakis, bitcoin stability is perpetually ephemeral and perhaps the only solution is to switch the monocoin ledger and adopt a dual currency ledger design instead (a topic for another day).

Besides a decline in purchasing power, is there anything else that may have caused this?

In chapter 11, pages 181-182 I explored another reason (see this image): demographics.  Most (60%) of the customer base of Overstock are female and as we know empirically, there are very few females that inhabit the Bitcoin ecosystem.  Perhaps this will change in time, so what are other datum in this exhibit?

Specifically, what does Overstock do with these coins?  One redditor looked through the most recent 10-Q filing and found:

At present we do not accept bitcoin payments directly, but use a third party vendor to accept bitcoin payments on our behalf. That third party vendor then immediately converts the bitcoin payments into U.S. dollars so that we receive payment for the product sold at the sales price in U.S. dollars.

[…]

We have also begun accumulating bitcoin in an amount of approximately 10% of the amount of our bitcoin-denominated sales as well as other cryptocurrency.

[…]

We hold cryptocurrency denominated assets such as bitcoin. We currently consider these holdings to be investments and include them with other long-term assets in our Consolidated Balance Sheets. Cryptocurrency denominated assets were $346,000 and zero at September 30, 2014 and December 31, 2013, respectively … Losses on cryptocurrency holdings were $50,000 during the three and nine months ended September 30, 2014. There were no losses on cryptocurrency holdings for the three and nine months ended September 30, 2013.

Or in other words, Overstock.com sells all but 90% of the coins it receives and puts the remaining portion onto its books as an investment, which saw a loss of $50,000 through Q3.  Perhaps this reverses next year if there is another run up in prices.

In addition, the coin sales created (a marginal) sell side pressure on the market through the intermediary, Bitpay, the largest payment processor in this space.

What changes did Bitpay see this year?  In a recent profile they noted that:

BitPay, the largest and oldest bitcoin payment processor with a daily volume of $1 million bitcoin transactions supporting more than 44,000 merchants, stated in an email exchange to CCN that more than 4,400 of their merchants keep all of their settlement in bitcoin, almost 18,000 keep some of their settlement in bitcoin while the remaining 22,000 convert it all to fiat.

While the amount of merchants accepting bitcoin more than quadrupled this year, the amount of retail commercial transactions did not.  Because Bitpay re-uses the addresses for purchases, it is possible to monitor them for inflows.  And over the past 6 months, there has not been a significant change: roughly 2,000 bitcoins in aggregate (+/- 200) are received by Bitpay each day.  In fact, they have been receiving approximately the same $1 million in bitcoin transactions since May. [Note: at current market prices, even 2,200 bitcoins does not equal to $1 million thus a contradiction, which can only be cleared if/when Bitpay releases its methodology]

Because of the ecosystem still lacks a ‘circular flow of income,’ in return Bitpay sells these coins to other inventory providers such as financial institutions, family offices and exchanges (detailed here).  This further creates sell side price pressure and if there is not a corresponding increase in speculative or transactional demand in bitcoins, effectively lowers the purchasing power of a coin.

For instance, last Wednesday, December 10th, Microsoft announced that it had added bitcoin as a payment vehicle for games and apps.  The price rallied 10% in the course of an hour yet subsequently declined to pre-rally prices.  Why?

As analyst Raffael Danielli explained to me, on the one hand, Microsoft under the new CEO — Satya Nadella — seems to push deliberately into areas at the forefront of the tech sector.  Accepting bitcoin is an item on their list that can easily be implemented and subsequently crossed off (e.g., a cheap point in terms of risk / reward due to the usage of an intermediary).

On the other hand, if people are less willing to spend Bitcoin while ‘underwater’ this can lead to more ‘bad’ news regarding a lack of consumer adoption.  For example, one could see a correlation between Xbox One’s less-than-stellar sales and losses against the Playstation 4 (PS4 is outselling 2:1), versus the need to get some kind of PR spark before the Christmas shopping spree.  Similarly Time magazine’s announcement today probably will only produce a temporary marginal increase in bitcoin activity and was likely done with similar motivations (positive PR before holidays) because Time been hit hardest (it’s 2012 sales of single-issue copies declined 27%, the most across the entire industry and it laid off 5% of its workforce in early 2013).

Yet most bitcoin holders are probably not the usual demographic of paper magazine subscribers.  Or as one droll redditor explained:

Venn diagram of people who use bitcoin and people who subscribe to print magazines: OO

Perhaps market participants as a whole see this too or perhaps they recognize that even if there was an upsurge in bitcoin usage to Microsoft product lines (which we can monitor as Microsoft is using Bitpay), those coins will ultimately put sell side pressure because there is no circular flow of income.  And again, without a corresponding amount of speculative or transactional demand, the price of a bitcoin could decline as would its purchasing power.

There is never a dull moment in this space, perhaps 2015 will create new patterns to analyze.

 

[Special thanks to Jop Hartog and Jonathan Levin for their feedback and information this past month]

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

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

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

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

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

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

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

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

A taste of quotes

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

On first-movers and fads:

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

On the externalizing the costs of mining:

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

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

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

On his use of imagery:

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

On putting the theft at Mt. Gox into perspective:

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

Regarding the hype of adoption and ATMs in Canada:

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

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

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

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

On the odds that Bitcoin will supplant the state:

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

More on whether or not it will supplant the state:

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

On volatility:

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

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

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

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

Is it similar to how the internet evolved?

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

On hype and irrational exuberance:

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

On the wisdom of trying to short exuberance:

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

On the difficulty of creating other derivative products:

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

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

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

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

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

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

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The “pain point” of payments in the developed world

paymentsVitalik Buterin is one of the smartest writers and developers in the digital currency space. At the ripe age of 20 he has put together a repertoire of code, articles and most importantly challenges that the “cryptocurrency” world faces.

He recently penned an article that argues what Bitcoin needs today is usage by employers, not just more merchants.  That one of the ways to subdue and mitigate the high levels of volatility is for employers to pay employees in the digital currency whereupon employees then can pay for wares from existing merchants whom in turn pay their employees in bitcoin.

This sounds nice in theory — a fully enclosed system — but there are a number of problems with it, namely that in practice bitcoin is treated as a commodity or collectible (not a currency) by market participants and its deflationary allocation + inelastic money supply makes it a poor modern medium of exchange.

This point is argued in a recent paper by Ferdinando Ametrano:

The unfeasibility of a bitcoin loan is similar to that of a bitcoin salary: neither a borrower nor an employer would want to face the risk of seeing their debt or salary liabilities grow hundredfold in few years. A manufacturing firm cannot accept an order in bitcoin with the risk of its value doubling or halving on a single bad day. Even the development of a derivative market could only hedge these risks with an implausibly high price. This is the cryptocurrency paradox: arguably the best ever kind of money by any metrics, marred by the severe inability to serve as reliable unit of account.

Perhaps this will change over time, maybe one solution is through hard forks involving “growthcoin” (as proposed by Robert Sams) and “stablecoin” (as proposed by Ametrano).

However, one of the challenges will always be the “pain point” — what incentive do people have to switch to a competing platform in the first place?  Why should consumers or employers want to adopt bitcoin the currency?  For instance, most users in the developed world do not have to deal with double-spending or rampant inflation.  Credit card fraud rates represent roughly just 7 bps and some cards provide other types of incentive like cash-back rewards or frequent flier miles — something that bitcoin cards (if they existed) would have a uphill task of providing.  Similarly many modern savings accounts provide some form of interest rate plus deposit insurance — trying to on-board these types of users would be difficult because there is no current equivalent with Bitcoin (yet).  [Note: savings is different than speculative hoarding, see discussions here and possibly here.]

Two days ago Ben Edelman explained how in most circumstances, customers pay more just to use bitcoin yet without gaining any additional benefits.  By “use” he means using it for actual commerce and not holding on to it for speculative purposes.  Because of this friction, because bitcoin users typically need to spend more than the alternative forms of payment, despite the large increase in adoption by merchants over the past 6 months there has been very little corresponding transactional volume.  Instead it is being treated as a novelty, a speculative collectible.

Or as a friend of mine, Bob, calls it a “My Little Pony” toy.  In a nutshell Bob compares the bitcoin currency system with the My Little Pony collectible.  Bob has a daughter and according to her each Pony has its own story in its own little special universe filled with cartoons, video games, clothes and toys and that’s how bitcoin the currency is treated: many early bitcoin adopters enjoy the ever grander mythos and backstory, that it was created by an anonymous developer, the ledger entry cannot be double-spent, its distribution and promotion involves volunteers organically threaded together via Meet-ups and bulletin boards and is purportedly impervious to political whims.  This brings it to life in a more colorful way that other systems like Square or Stripe have not similarly created (see Seth Godin’s Purple Cow).  And according to Bob, My Little Pony characters can also have plight-filled adventures, though none involving subpoenas (yet).  See also: Bitcoin: a Money-like Informational Commodity

Perhaps Buterin’s solution will gather momentum over the coming years, however unless the average consumer needs to spend less (not more) to gain the same level of advantages and protections that current platforms have, it is unlikely that a snowball effect in payments will take place anytime soon.  Incidentally, one crowdfunded innovation that could likely move beyond “toy” phase soon is the Trezor hardware wallet because it fulfills a real pain point today, horribad security issues with protecting private keys.

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Cryptocurrency in the news: #14

I have been pretty busy this past week on China-related activities, but below are some interesting stories, projects and companies I came across concerning the growing cryptocurrency ecosystem.

Of particular interest is the follow-up piece from Preston Byrne (one of the lawyers who helped me with Chapter 2, hire him, he’s brilliant): Bitcoin and the English legal system, part II

Probably the weirdest article was this one calling for Dogecoin to become the “national” currency of Venice (due to a historical spelling similarity).  If this doesn’t illustrate “jumping the shark,” I don’t know what else can.  But then again, I’m just one market participant.

Thanks to Petri Kajander and Andrew White for several of the links:

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Proof-of-Gox and Recoverycoins

Yesterday I had the pleasure to moderate a panel discussing Goxcoin on LTB episode #89.  Participants included Adam B. Levine who is the editor-in-chief of Let’s Talk Bitcoin! as well the chief visionary officer to the Humint project (and who wrote the foreword to GCON).  David Johnston is the managing director of BitAngels, the first angel investment network focused on digital-currency startups, and a board member at the Mastercoin Foundation (I also interviewed him for GCON and included his insights in Chapter 3).  And the final panelist was Pete Earle, who is a multi-decade veteran of the financial trading sector as well as an economics writer (the article that sticks out most to me was incidentally his piece on mudflation).

It’s a very thought provoking conversation as it raises real-world use-cases for using cryptoprotocols (such as Bitcoin and Mastercoin) in a more effective, efficient, secure and transparent manner than existing models and frameworks.

Developers can find out more information about the Master protocol white paper.

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Presentation covering Smart Contracts, Smart Property and Trustless Asset Management

Earlier tonight I gave a presentation at Hacker Dojo with the Ethereum project.  I would like to thank Chris Peel and Joel Dietz for organizing it.  Below is a video and accompanying slide deck.  In addition to the footnotes in the PPT, I recommend looking at the wiki on smart contracts and Nick Szabo’s writings (1 2 3).

Also, some quotes regarding synthetic assets in Szabos’ work:

Citation 1:  “Another area that might be considered in smart contract terms is synthetic assets[5]. These new securities are formed by combining securities (such as bonds) and derivatives (options and futures) in a wide variety of ways.”

Citation 2: “Creating synthetic assets or combinations that mimic the financial functionality of some other contract while avoiding its legal limitations”

Citation 3: “Reference to Perry H. Beaumont, Fixed Income Synthetic Assets”

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Casual conversation with Mastercoin, Ethereum and Invictus (Bitshares/Protoshares)

A week ago, Let’s Talk Bitcoin sat down with three developers Charles Hoskinson (Ethereum), David Johnston (Mastercoin) and Daniel Larimer (Invictus/Bitshares).  Well worth your time as it covers all the hot topics in this space today: smart contract, smart property, DAX (decentralized autonomous corporation/organization/application/etc.).  Lot’s of great quotes, insights and vision.

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Outside funding of cryptocurrency and Bitcoin startups

According to CB Insights, VCs spent $74 million across 40 BTC-related deals in 2013,  the two largest rounds were Coinbase ($25m) and Circle ($9m).

Despite the increased media attention, even if these numbers are repeated again this year this may not help boost the poor performance for VC funds as a whole.1 Even with the optimistic outlook many of the VC firms apparently now have, their actual results at ~6% per annum over the past decade have underperformed the Russel 2000.2

Why?  Some VCs not as nimble at feeling out business models with actual revenue generating capabilities as many angel investors are.

Changes over four decades

Consistent with secular theme of ubiquitous adoption of open source software as well as cloud computing that has lowered the cost of developing software and more importantly the costs associated with launching new companies, so too has this trend lowered the threshold for tech investments.  Where previously the funding of start-ups was limited to deep-pocketed professional investors, namely VCs, the deflationary landscape has increasingly enabled greater numbers of individual investors, angels to compete in funding environment.

The new class of angel investors is more astute than the passive and non-tech-savvy high net worth investor of yesteryear.  Increasingly, angel investors today have deep domain experience.  Many have worked in the sector that they are funding, are entrepreneurs and experienced operators themselves and visionary at feeling out new business and innovative trends.  The historical barrier to entry for angel investing is one of risk given the magnitude of investment commitment.  With lower costs of starting businesses, this hurdle is largely gone.  Smart angels with deep operational domain expertise is disruptive to the traditional VC universe.  They may be better attuned and friendlier with terms that are less predatory than the historical VC norm.

This is not to say that VCs will not flourish once again, however as it stands most angels began as entrepreneurs and learned how to generate sales and revenue first hand.  Furthermore, as noted above, over the past decade technological costs that have driven down expenses.  For example, relatively cheap cloud services like github and Compute Engine provide services (CaaS, SaaS and IaaS) that allow many tech start-ups to be leaner than before in terms of what funding they require to cover operating costs.  On top of this are better organized angels who now have an entire ecosystem of choices to fund through such as AngelList, 500 Startups and Y Combinator.  In fact, over the past six months, BitAngels.co have invested $7 million in 12 crypto projects globally.

Another way that cryptocurrency-related startups are being funded through are crowdfunded IPOs.  This includes Mastercoin, which raised $5 million in part by 4,700 bitcoins from “investors.”3  NextCoin (Nxt) and the upcoming Ethereum IPO have also included raising funds through bitcoin transfers.  While I am not necessarily endorsing any of these particular fundraising models, this illustrates how small (and perhaps large) development teams can financially cover costs without seed funding by VCs.

See also: MoneyTree Report from PricewaterhouseCoopers and the every-growing list of funded Bitcoin companies listed on CrunchBase

[Special thanks to DA for his comments and feedback.]

  1. Kauffman Foundation Bashes VCs For Poor Performance, Urges LPs To Take Charge from The Wall Street Journal and Most venture capital funds lose money from CNN|Fortune []
  2. Venture capital kingpin Kleiner Perkins acknowledges weak results from Reuters []
  3. Backed by $5 Million in Funding (4,700 BTC), Mastercoin Is Building a Flexible, New Layer of Money on Bitcoin from MarketWired []
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Interview with Amos Meiri and Alex Mizrahi of the Colored Coins project

[Note: below are several questions and answers from core developers with the Colored Coins team.  I previously posted answers from Meni Rosefeld several days ago and last week CoinDesk published an article of mine that quotes both Amos and Alex as well.]

Q: What advantages does CC provide to the current global asset management industry?

Amos Meiri: It is going to be very easy for the asset management industry as a whole to use Colored Coins. For example, some of the first places we are going to have adoption will likely be real-estate and portfolio management. In fact, for any type of asset management it’s going to be simple to issue his own color that represents his goods.  In the real estate industry, someone can issue their apartments using colored coins and have them float on the block chain, or manage time-sharing based on color such as Bitcoin Resort.

Alex Mizrahi: I think just like in case with Bitcoin, it will first be used in some niches, perhaps something obscure. And we’ll see what can grow from it.

Q: What businesses do you think can readily adopt CC once it is released?

Amos Meiri: I’ll say it’s endless but will give you few examples of the first and most simple.  One of the biggest demand today for CC would be the second markets of stocks. Company’s who want to issue their own stocks and use the decentralized exchange, many approach us and waiting for the first release.  Examples are: The tickets and coupon market; FX and derivatives market.

Alex Mizrahi: I see a lot of interest in capital market applications, i.e. companies which were previously listed on so-called “Bitcoin stock exchanges” (btct.co, bitfunder.com) have problems finding a reputable exchange and have distrust towards centralized ones.  Particularly, ActiveMining announced that they will issue their shares in form of colored coins when tech is ready (as one of options), and a lot of users support this.

Q: Would it not be easier to simply do all trade privately at the centralized exchange where it will be more scalable and private?

Amos Meiri: Centralized exchanges definitely have their advantages, but colored coins can be useful for following reasons.  First, users do not need to trust their bitcoins to a centralized exchange.  Companies cannot manipulate ownership records (to commit fraud, for example).  So basically, if somebody gives you an IOU, it isn’t a good idea to leave it with the person who issued it or to affiliated parties.  Another reason is that companies cannot control how its shares are being traded, thus it cannot block trade.   And lastly, there is no need to maintain servers or manage security due to its integration with the blockchain.

Q: What are the legal ramifications for creating this approach to asset exchange, in particular securities (e.g., stocks, bonds)?

Amos Meiri: I believe that at first stage we are going to see small and online companies using CC might be on the unregulated zone working as second market.  Same as Bitcoins, when the volumes will grow and we will have mass adoption we might have some regulation.  We are trying to understand all of the legal aspects using CODA.

Q: How does CC able to differentiate itself from other endeavors such as Ripple and Open-Transactions?

Alex Mizrahi:  1) Trade of colored coins for bitcoins can be fast as safe: bitcoins are represented with bitcoins, there are no counter-party risk, they don’t need to leave user’s wallets. 2) Colored coin security is very similar to Bitcoin security, and people trust it. 3) Open-Transactions is a centralized solution, and Ripple is often perceived as centralized solution too.

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Ethereum and vunerabilities of Turing-complete progamming languages

There have been several Reddit threads and bitcointalk forum posts the past couple days regarding integrating a Turing-complete programming language with a cryptoledger.  Bitcoin currently uses a limited, non-TC language called Script.  The comments, feedback and insights revolve largely around the security risks and vulnerabilities that such a language could do.

If you are interested, I highly recommend reading through these threads right now, the first two include comments from Adam Back, creator of Hashcash which is the proof-of-work used in Bitcoin.

Turing complete language vs non-Turing complete (Ethereum vs Bitcoin)
letstalkbitcoin on committed tx, homomorphic value, fungibility, privacy
Will turing compleastness allow contracts to contain viruses and malware that could affect the network in unforeseen ways?
Adam Back about Ethereum and security risks

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Mike Hearn discusses autonomous agents at Turing Festival 2013

Decentralized autonomous organizations (DAO), sometimes called decentralized autonomous corporations or autonomous agents have become a hot new topic both in social media and in software engineering, especially as they are interrelated with advances in cryptoledgers/cryptocurrencies.

Vitalik Buterin has written a three-part series (1 2 3) about software-based DAOs over at the Ethereum blog that gives a pretty good overview and capability of what a DAO is able to do.  While many more volumes will be written on this topic, last Mike Hearn gave a brief overview of what hardware applications may look like:

See also: Mike Hearn’s 2012 presentation in London (video) as well as his interview last fall with Newfination (video).

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Can Robert Wenzel Defeat the Encryption Used by Cryptocurrencies?

 photo NizeLinkedin.png Short answer, no.1 Back to that in a moment.

I am not sure who is doing the vetting process for investor relations at Ripple or Silicon Valley Bank (SVB), but if you are running a crypto-related business be aware that not only is Robert Wenzel (aka Raymond Nize) — the proprietor behind EconomicPolicyJournal — dogmatically anti-cryptocurrency but also not who he says he is.

Why make a blog post about this in the first place?  You may consider this water cooler minutiae and frivolous scuttlebutt, however you are known for whom you associate with.  If you hang out with known con-artists — even if you agree with some of what they say, this reflects poorly on you.  Especially when their entire motivation is not to genuinely learn about your product (crypto), but to merely hype their own investment schemes (e.g., commodities specifically gold).

Sock puppet extraordinaire

Last week I received some trollish comments from “Paul Trombley” (paul.XXXXXX@yahoo.com) regarding a lengthy post on this site (an expose of Nize’s sockpuppets), “Paul” states:

Wow. Utterly fascinating. Wish we could find out where Raymond Nize, et al., grew up and went to school, where he has worked, whom he dated, etc.

In the meantime, I will have to be content with another viewing of Pacific Heights.

A quick google search find four sites that zero in on the possible identity of “Paul”:

Obviously even if I had IP addresses this would not be a smoking gun.  But what are the chances, that a sock puppet posting on the only Nize/Wenzel thread on my site also links to EPJ and discusses many of the same topics in the same tone as Nize/Wenzel does?

Why is this important again?

Because Nize/Wenzel has managed to convince some important cryptocurrency personalities and institutions that he is someone who he is not.  He managed to convince Joseph Salerno that he has 20 years of experience on Wall Street. Where did he work?  His current LinkedIn profile (screenshot 1 2) is completely empty in all but the previous 6 years.  Surely someone with the pedigree he says he has would dutifully link to it and his past associates.

Is this an ad hominem?

No, he is making claims about his past life that are untrue which have in turn built up his credibility as a financial guru.  He has then taken these ill-gotten reputational gains and is now providing investment advice to readers and listeners of his website (which is just one of many websites he has created over the past decade under about 10 different pseudonyms, see Part IV for more).

To top it off, he has a clear anti-cryptocurrency agenda that involves spreading misinformation and/or propaganda.  In nearly every post about Bitcoin or some other aspect of cryptocurrencies he drags it through mud while simultaneously showing his inability to full comprehend how cryptography works.  Hint: if cryptography worked the way he describes it, the entire global financial industry, the diplomatic corps, cloud services and all e-commerce (to name a few) would effectively be unable to securely transmit data.  Trace Mayer did an excellent job pointing this out in the EPJ comments yesterday (SS).  Thereupon Nize notes how in his visits to both Ripple and Silicon Valley Bank he left unconvinced of cryptocurrencies potential (SS).

Strawman made of hand-waving

It is certainly understandable to not be convinced of the merits of a particular asset class, that is not the issue.  Not understanding public-key cryptography and then building bi-weekly cryptostrawman to thwack at, is a problem.  While the math may indeed be confusing to beginners and experts alike, the crypto algorithms used by cryptoledgers like Bitcoin and Litecoin are solid.

In fact, there is an monetary incentive to try and break them and no hacker has thus far been able to.2 If Nize truly believed that this crypto did not work, he could take the alleged holes he claims exist and tap into and forge 12.2 million BTC namespaces/addresses (and 25.1 million LTC).  He needs to show us a broken blockchain to prove his claim, yet has not.  If the pseudonomyous features did not work, then he could name the Top 500 BTC holders, but has not.  Disagree?  Who owns the 268th largest BTC address, the one with 4,719?  If the crypto is bad, did you break into it already?

Perhaps he will come around at some point, but this still does not justify the fraudulent personality that visitors are unaware of (and whom have given goodwill towards).  The lesson for investors doing road shows and presentations: do you due diligence and vetting upfront.3

  1. There are theoretical ways to forge entries in the blockchain, such as a 51% attack, but the crypto in the actual generic wallet most people use is currently not known to be brute-force crackable. []
  2. Nize also has epistimological problems regarding apriori utility and value but that is besides the point. See: The value of cryptocurrencies as well as Economics of Bitcoin by Peter Surda []
  3. As an aside, his Google AdSense has generated, ironically, Bitcoin-related services like Gyft that are displayed on his site — here is a screenshot. []
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Ethereum’s potential: a cursory look

If you haven’t done so yet, I highly recommend reading Vitalik Buterin’s overview of Ethereum published earlier today.  It is very lofty, seemingly feasible and I don’t detect much hyperbole.  He is clearly aware of the short-comings of all the different 1.0/2.0 projects and is pretty much trying to make this stand out by otherwise fulfilling Newton’s, “standing on the shoulders of giants.”  I’d be interested to see what other project leaders from 2.0 initiatives have to say.

A few technical concerns I haven’t really seen addressed but I’m sure are being discussed somewhere:

1) Botnets.  While ASICs do create potential long term centralization problems, Botnets will jump all over the ability to use CPUs again to mine.  How can this be prevented/mitigated?  Can it?  Is there a way for Ethereum the org to prevent miners from participating (if so, can it be abused?)?  [Note: I have discussed mining previously in the Litecoin category.]
2) Even though the money supply is mathematically known, I’m not entirely sure the linear money supply will necessarily have the zeroing effect apriori.  It could, and probably will but obviously this is aposteriori.  For perspective, the token supply in LTC and BTC are significantly higher the first decade than Ether is.
3) While Script is not Turing-complete this also prevents viruses from being created and wreaking havoc on the blockchain.  CLL sounds great on paper in terms of robustness and utility, but how do you fight HNWI hackers who want to cause mischief?

Two other points of interest regarding the business side of this project:

1) I do think that eventually someone, somewhere will create a distributed, encrypted dropbox for global use.  How that is incentivized, or rather, how individuals pay for the resources (bandwidth & space) obviously will be another matter altogether.  Bitcloud is one project that is trying to tackle that (through proof-of-bandwidth).  Perhaps, as part of what Mike Hearn described 2 years ago, users will eventually be able to use microtransactions (e.g., 0.01 BTC) to pay random WiFi hotspots to create adhoc mesh networks — distributed encrypted dropboxes could just as easily follow similar paths in terms of payment/compensation.  Shades of Snow Crash and The Diamond Age

2) Even though I am pretty pro-alt coin/chain/ledger/etc. I do think parts of the Humint project are probably not going to work as initially planned in their press releases this week.  Assuming that Cocacolacoin is not part of the Ethereum blockchain but rather uses its own independent blockchain, it’s hard to imagine how to incentivize network hashrate (which creates network security which prevents a 51% attack).  I’m not saying it won’t work apriori, but from a business model it is difficult to believe that Bob the Miner will want to exchange hashrate for Coca-cola swag.  Obviously stranger things have happened, like the recent “success” of meme-related Dogecoin (wow! so cool! much awesome!); I do think not using the term “coin” will be a better marketing strategy as it is too loaded at this point (I prefer token or ducat).  Other obvious uses within the Ethereum blockchain are Frequentfliercoins from Alice Airlines, could probably help prevent and mitigate the risks involved in travel hacking (FYI: United Airlines frequent flier miles were downgraded effective February 1, 2014 due to rampant inflation).

For example, I think Alice Airlines could utilize the “contract” system by using some amount of Ether (0.01), creating a “contract” which defines a set amount of Mileage (which itself will likely have some predefined expatriation dates).  Assuming this is in the future and flyers are using Ether wallets (oh the 19th century irony) and provide the airline with their wallet address, the user will be able to receive the Mileage amount in their wallet (more than likely it will be an embedded URL that sends you to a screen on Airline Alice with the actual amounts + Terms of Service).  This is what colored coins are, but Ethereum seems to be both more elegant as this is native built-in functionality and in terms of transfer speed (3-30 seconds is the stated goal versus 10 minutes for 1 BTC confirmation).  This is subject to change, but just one potential use of the platform.

It will also be interesting to see how Dark Wallet and Zero Coin projects will react to this announcement (Ethereum is currently stating it is not an anonymous solution though through the “contracts” system this can be obfuscated).

Other resources to peruse:

– Ursium has a live update of publicly known tidbits.
– The Ethereum blog has some interesting info, especially about DAOs

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Smart Property in the news: Counterparty.co

A new project that utilizes a cryptoledger to create decentralized, distributed trustless asset management has been making the rounds: Counterparty.co

It’s legitimate in terms of the codebase and functionality.  Thus it will be very cool to see how other similar projects (Colored Coins, Mastercoin, etc.) germinate as well.  The disruptive potential of these innovations are enormous.

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Cryptocurrency Cat-and-Mouse games in China

btcc voucherSeveral updates to this ongoing cryptocurrency story in China and elsewhere (each subheading below is a slightly different topic).

Yesterday Bill Bishop linked to a story posted at Sina, “虚拟货币本质上不是货币” written by Sheng Songcheng.  Mr. Sheng is the head official of investigation and statistics at the PBOC (the central bank).

Bishop’s quick comment of the article was that, “No reason the belie[f] there will be any positive news from PRC regulators about bitcoin, or that somehow the recent crackdown was good, as some of the bitcoin bulls have been trying to spin.”

Too long; didn’t read

In addition to Bishop’s nutshell, another tl;dr comment that I would add is this, because Mr. Sheng works for the PBOC, his essay pretty much encapsulates what that important organ of the government thinks. Based on his essay, they do not recognize Bitcoin’s legality (although there is no clear indicator that they see a difference between protocol and token) and according to his own words, without government oversight or backing by any country, the token itself has no value.  Mr. Sheng uses the example of the recent 60% price drop of the bitcoin token on BTCChina last month as proof that without government approval, it has little value (a correlation-causation fallacy).  Furthermore, he thinks that if there is a developing country (such as China) that does begin using it, the deflationary aspect (the fixed ‘money’ / token supply) would actually present an obstacle and hinder the country’s economy to grow.  In fact, he says that Bitcoin and other cryptocurrencies will never become a country’s major currency and as a consequence, will not be a “real” currency.  And that it could only become so in the “utopian view of technocrats and libertarians” (技术至上主义和绝对自由主义者的乌托邦).  Yes, he uses the Chinese word for idyllic libertarian  (绝对自由主义者).

From a technical viewpoint, he states all cryptocurrencies do not have a unique origin, nor are its token generation, exchange and storage methods particularly special.  Any currency that has Bitcoin’s features could replace it such as Litecoin, which the public has become familiar with.  And continuing, he states that Bitcoin does not have any physical attributes found in gold and silver nor exclusivity enforced by the law so it will be really easy to replace.  Therefore it cannot replace the role of general currency which is the medium of trading. Thus his overall attitude (and that of the PBOC) is that the central government does not recognize any specific values of the token; that it is illegal to use (though he does not specifically say who or what timeframe) and it doesn’t justify its own existence.

Again, while we can argue over the epistemological, economic and technical problems with this essay (e.g., why do economies grow, deflation versus inflation [pdf], the economics of Bitcoin [pdf], what utility cryptocurrencies have, how the protocol works, etc.) all of which have been discussed elsewhere, as Bishop noted above, this essay is hardly a positive sign for the crytpocurrency segment in China.  Thus, while speculative, after reading the article the impression readers are left with is that the PBOC will crack down on cryptocurrencies on the mainland for the foreseeable future.

Cat-and-mouse

There have been discussions over the past weeks as to how mainland exchanges could bypass the current hurdles.  One idea was to create yet another type of virtual token that could then be exchanged on exchanges.

Over the past couple of hours on reddit, users have posted a new method that BTCChina is using to get around the current depository predicament the mainland industry is currently in (e.g., all payment processors are barred from providing fiat liquidity to crypto exchanges).  However, the small stop-gap solution is for BTCChina customers internally (this is not the same thing as the online vouchers like BTCe has).  BTCC code is to allow one customer with CNY on the site to sell the CNY to another customer.  The medium is the BTCC code which is in two parts: one is for the customer the other is for the site.

Imaginary Capital Markets has a few more details and screenshots, but let me just emphasize once more that this is not a complete workaround (yet) but just a way for BTCC users to exchange CNY with one another.  My speculation: if the CEO role as sole depositor is still active, perhaps this could be a way for him/her to distribute funds to friends & family who can then exchange the fund to the wider customer base.  If this is the case, perhaps other exchanges will follow suit (assuming that the CEO can still deposit funds into the exchange through their personal account, see the explanation here for more).

[Update: Taobao has a new rule (Chinese) that will ban the buying and selling of crypto coins.  Thus it will purportedly impact vouchers such as those being offered by BTCChina]

Also regarding the CEO bank accounts I discussed the past two weeks, Eric Meng, an American attorney friend of mine currently in China explained to me that the use of personal bank accounts to do business is a huge red flag in general.   It does not mean that anything is being done illegally, but it’s something that investigators watch out for.1

Bots again

Regarding the purported fudged numbers on Chinese exchanges (discussed here), another friend (in Europe) recently wrote to me explaining that someone could easily write a bot and test the liquidity to see whether it is real or not.  It could be that some exchanges on the global stage act as a market maker (similar to the NYSE which employs “specialists” [pdf explanation] who always make sure that there is a reasonable bid and ask available and who take short term positions in order to provide liquidity).

This same friend who has both mined and then built proprietary HFT arb software on BTCe is reasonably sure that BTCe runs their own arbitrage bots with zero fees but sometimes turns them off (or they have certain limits, he is not sure).  Again, arbitrage is not bad per se and basically makes sure that you can execute your orders at a ‘fair price’ all time.  Of course it would be better if the exchanges are more forthcoming about what they do behind the scenes but as long as there are no regulations they can do whatever they want and earn some extra money.  Yet again, no one is forced to use a particular exchange so people can easily vote with their feet or open their own (transparent) exchange.

Notes in the margin

One last comment I received is from Mark DeWeaver (author of Animal Spirits with Chinese Characteristics and GWON’s Foreword) is that,

It occurred to me that the argument about bitcoin having a big “carbon footprint” is really poorly thought out.  Is the footprint really bigger than that of paper currency, which has to be transported from countless businesses to bank’s safe deposit boxes at the end of each day.  And think of all the gas people must burn on trips to ATM’s!

This is in response to my explanation of Charles Stross’ contention that cryptocurrencies are more of a burden on the environment than fiat currencies are (they are not).  Mark’s comments are empirically valid because these up-armored vehicles (typically Ford 550 chassis or similar classes from competitors) are frequently used to move fiat currencies to and from distribution centers to branch banks and ATMs.  For example, The Armored Group currently lists many used armor transportation cars for sale.  And a quick search on Fuelly gives you an idea of how much fuel the average F550 consumes in the city (~9 mpg).  This also ignores the supply chain needed to build the vehicles in the first place which is an entire logistical segment that cryptocurrencies do not need.  Nor does it include the carbon consumption of the driver and guards ferried around in the vehicles (e.g., eating, sleeping, shelter, etc.).  One can only imagine the sheer number of vehicles in developing countries where digital fiat are not nearly as common and thus paper/metal is transported more frequently.

Again, this is not to say that cryptocurrencies are mana from heaven, that they won’t be replaced or will somehow axiomatically usher in a world of milk and honey.  But these specific claims by detractors need to be backed up with real numbers as they are positive claims (e.g., burden of proof).  If you do think that the Bitcoin transaction network (the most computationally powerful, public distributed system currently)2 consumes more carbon than all ~200 fiat currencies right now, you need to prove that.  And from my quick research I detailed in my article, that does not seem to be the case (today).

Also, for other occasional commentary on crypto in China I recommend visiting my friend’s site, Aha Moments (specifically this recent post).  Drop him a note and tell him to update more.

  1. Eric also suggested I link to the following guide that potential investors conducting due diligence pay attention to in the aftermath of Madoff: Six Red Flags and Tips for Investment Risks from CAMICO. []
  2. See Global Bitcoin Computing Power Now 256 Times Faster Than Top 500 Supercomputers, Combined! from Forbes []
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How to use Bitcoin

Had lunch with a couple of friends today and the topic turned to Bitcoins (BTC).  If you’re unfamiliar with this digital currency in addition to the obligatory wiki entry, I recommend reading Are Bitcoins The Future? from Priceonomics.

If you are interested in actually mining for new BTC I would suggest holding off, unless you own a supercomputer connected to a solar powered grid.  The reason why is that until recently it actually cost more in terms of electricity than you actually made in mining new coins.  See Bitcoin Mining Update: Power Usage Costs Across the United States (this analysis was done in July 2011 so rates are different now.)

If you are looking to buy/sell BTC I recommend creating an account at Mt. Gox which is the biggest BTC exchange globally as well as Dwolla which makes it very easy to move money from you bank account into it and get BTC from exchanges like Mt. Gox.  Once you have some BTC you need to move them into a wallet, one of the most popular is BlockChain.

And if you plan on drinking in NYC there is now a bar that accepts BTC.

Update: Meet the $2 Million Bitcoin Pizza from Hit & Run

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Where should you buy or sell online in China?

CO, an old friend from grad school sent me this (slightly modified) email this morning:

I work a side job for an endurance coaching service.  We are sponsoring a few races and were looking to include the laces as freebies in race packets.  I may be in the market for about 5,000 pair of bungee shoe laces and found some interesting prices on Alibaba… I’ve never used Alibaba or even heard of it prior to a Google search.  Do you have any recommendations I should look into if I got serious about purchasing?

Unless they have lived in China before, most foreigners are unfamiliar with the Alibaba Group, even though its subsidiaries (Tmall, Taobao, Alibaba) collectively sell more merchandise (by value) than eBay and Amazon combined.  To quickly understand the differences: Alibaba is B2B, Taobao is C2C and Tmall is B2C.

In Chapter 12 I mention that:

Altogether in 2012, e-commerce revenue totaled $196 billion.1During the 2012 Single’s Day (November 11th or 11-11) on the mainland, Alibaba Group e-commerce properties (Tmall and Taobao) purportedly broke the single day sales record with over 100 million visitors and $3.03 billion.2

This is not to say that there have not been significant hurdles that Alibaba had to overcome to reach these new heights.  Two years ago the company was rocked with the revelation that 2,236 sellers had defrauded buyers.  As noted then by The Economist, Alibaba’s reputation was on the line so a slew of personnel responsible were axed and new quality control mechanism were put in place.   And because of its recent concerted efforts to crack down on fraud, Alibaba was removed from the “Notorious Markets” list maintained by the USTR regarding the sale of counterfeit goods.

So to answer CO’s question, while I cannot vouch for all of the material sold by sellers on Alibaba sites, I can say that I usually trust the built-in rating system more today than I did  four years ago.  I am not saying it is perfect or that there is no longer  fraud, but many of my friends (both local and expat) regularly buy products from the e-tailers, including shoe accessories.

Selling to the mainland

In Chapter 7 I spend a bit of time discussing one way foreign firms can sell into China with ExportNow, a turn-key solution that gets your product onto Tmall, to be sold on the mainland.

While I won’t rehash that chapter, I wanted to point readers to a new report published this week by McKinsey & Company regarding e-commerce growth on the mainland.  According to the write-up from the WSJ:

China’s e-commerce market, largest in the world behind the U.S., is booming, with sales expected to reach $420 billion to $650 billion by 2020, up from $190 billion to $210 billion in 2012, according to McKinsey. Around 40% of China’s consumers wouldn’t have made purchases if not for the option of e-commerce, added the report, which used data provided by a major online company to analyze online spending from consumers in 266 cities.

The persuasive power of e-commerce is really playing out with shoppers in China’s smaller cities, where retailers like Swedish apparel giant H&M haven’t expanded. Consumers in so-called fourth-tier cities, like Wuzhou in China’s eastern Guangxi province, are spending as much as 27% of their disposable income online. That compares to 18% of disposable income for big-city dwellers, the report said.

That last statistic is the one that I will highlight to friends, family members and clients.  Consumers in fourth-tier cities are spending more than a quarter of their disposable income online for the same reasons that their peers do so in other countries, lack of local consumer options.  Yet before thinking you may strike a goldmine, consider that the average salary in these smaller cities obviously varies on age but is substantially less than Tier 1 cities which are roughly $9,000 a year.3 And Wuzhou — far from being an Alpha city, has roughly the same size of population as Bengbu, a city I lived in for more than 2 years.  In fact, the average annual salary in Bengbu is less than $5,000.

So keep that in mind before trying to sell boat loads of diamond and platinum coated cutlery nationwide.

Also, if you want to try selling through Taobao (which is C2C) here is a simple, English translation of a step-by-step guide to do so.

Be mindful that if you are looking to sell bulk items into China, you may eventually be able to partner directly with Alibaba.  As I mention in Chapter 3, Jack Ma (the founder of the Alibaba Group) announced that “Tmall will work with [a new customized] center to build a database of international suppliers that Chinese consumers are most interested in.  It would then collect orders to make group purchases.”4 The new system is expected to be rolled out within the next two years and part of the domestic plans is to deliver anywhere on the mainland within 24 hours.5.

Thus, in addition to using ExportNow or hiring someone to list it on Taobao, perhaps you should look into finding an Alibaba account executive to connect your inventory and supply chain into their new streamlined system.

Update: David Schatz sends me this relevant new story from the latest print edition of The Economist: E-commerce in China – The Alibaba phenomenon

[Note: this is not an endorsement of any particular service, I hold no financial or equity stake in any of the aforementioned services or companies.  These were used as examples and illustrations.]

  1. Bezos’ Kindle-Less Amazon Mashed in China by Ma’s Alibaba from Bloomberg []
  2. See Black Friday in Red China by Evan Osnos and Singles Day: China’s online shopping holiday from the Associated Press []
  3. Guangzhou has highest average salaries for cities in mainland China from South China Morning Post []
  4. Tmall Plans to Link China’s Consumers with Foreign Goods from Caixin []
  5. The plans are being rolled out together however the domestic 24-hour delivery service is expected to be completed within 1 year.  See 马云1000亿建电商物流 目标全国任何地区24小时内送达from ifeng []
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