Book Review: Cryptoassets

[Disclaimer: The views expressed below are solely my own and do not necessarily represent the views of my clients.  I currently own no cryptocurrencies.]

As a follow-on to my previous book reviews, an old colleague lent me a copy of Cryptoassets by Chris Burniske and Jack Tatar.

Overall they have several “meta” points that could have legs if they substantially modify the language and structure of multiple sections in the book.  As a whole it’s about on par with the equally inaccurate “Blockchain Revolution” by the Tapscotts.

As I have one in my previous book reviews, I’ll go through and provide specific quotes to backup the view that the authors should have waited for more data and relevant citations as some of their arguments lack definitive supporting evidence.

In short: hold off from buying this edition.

If you’re interested in understanding the basics of cryptocurrencies but without the same level of inaccuracies, check out the new The Basics of Bitcoins and Blockchains by Antony Lewis.  And if you’re interested in the colorful background of some of the first cryptocurrency investors and entrepreneurs, check out Digital Gold by Nathaniel Popper.

Another point worth mentioning at the beginning is that there are no upfront financial disclosures by the authors.  They do casually mention that they have bitcoin once or twice, but that’s about it.

I think this is problematic because it is not being transparent about potential conflicts of interest (e.g., promoting financial products you may own and hope to see financial gain from).

For instance, we learned that Chris Burniske carried around a lot of USD worth of cryptocurrencies on his phone from a NYT article last year:

But a particularly concentrated wave of attacks has hit those with the most obviously valuable online accounts: virtual currency fanatics like Mr. Burniske.

Within minutes of getting control of Mr. Burniske’s phone, his attackers had changed the password on his virtual currency wallet and drained the contents — some $150,000 at today’s values.

Some quick math for those at home.  The NYT article above was published on August 21, 2017 when 1 BTC was worth about $4,050 and 1 ETH was worth about $314.  So Burniske may have had around 37 BTC or 477 ETH or a combination of these two (and other coins).

That is not a trivial amount of money and arguably should have been disclosed in this book and other venues (such as op-eds and analyst reports).1 In the next edition, they should consider adding a disclosure statement.

A final comment is that several reviewers suggested I modify the review below to be (re)structured like a typical book review — comparing broad themes instead of a detailed dissection — after all who is going to read 38,000+ words?

That is a fair point.  Yet because many of the points they attempt to highlight are commonly repeated by promoters of cryptocurrencies, I felt that this review could be a useful resource for readers looking for different perspective to the same topics frequently discussed in media and at events.

Note: all transcription errors are my own.

Authors’ Note

On p. xi, the authors wrote:

When embarking on our literary journey, we recognized the difficulty in documenting arguably the world’s fastest moving markets. These markets can change as much in a day – up or down – as the stock market changes in a year.

It is only mentioned in passing once or twice, but we know that market manipulation is a real on-going phenomenon.  The next edition could include a subsection of cryptocurrencies and ICOs that the CFTC and SEC – among other regulators – have identified and prosecuted for manipulation.  More on that later below.

Foreword

On p. xiv, Brian Kelly wrote in the Foreword

The beauty of this book is that it takes the reader on a journey from bitcoin’s inception in the ashes of the Great Financial Crisis to its role as a diversifier in a traditional investment portfolio.

A small quibble: Satoshi actually began writing the code for Bitcoin sometime in mid-2007, before the GFC took place.  It may be a chronological coincidence that it came out when it did, especially since it was supposed to be a payment system, which is just one small function of a commercial bank.23

On p. xv Kelly writes:

As with any new model, there are questions about legality and sustainability, but the Silicon Valley ethos of “break things first, then ask for forgiveness” has found its way to Wall Street.

There are also two problems with this:

  1. Both the SEC and CFTC – among other federal agencies – were set up in the past because of the behavior that Kelly thinks is good: “break things first, then ask for forgiveness” is arguably a bad ethos to have for any fiduciary and prudential organizations.4
  2. Any organization can do that, that’s not hard.  Some have gotten away with it more than others.  For instance, Coinbase was relatively loose with its KYC / AML requirements in 2012-2014 and has managed to get away with it because it grew fast enough to become an entity that could lobby the government.

On p.xv Kelly writes

“Self-funded, decentralized organizations are a new species in the global economy that are changing everything we know about business.”

In point of fact, virtually all cryptocurrencies are not self-funded.  Even Satoshi had some kind of budget to build Bitcoin with.  And basically all ICOs are capital raises from external parties.  Blockchains don’t run and manage themselves, people do.

On p. xv Kelly writes:

“These so-called fat protocols are self-funding development platforms that create and gain value as applications are built on top.”

The fat protocol thesis has not really born out in reality, more on that in a later chapter below.  While lots of crytpocurrency “thought leaders” love to cite the original USV article, none of the platforms are actually self-funded yet.  They all require external capital to stay afloat because insiders cash out for real money.5 And because there is a coin typically shoehorned at the protocol layer, there is very little incentive for capable developers to actually create apps on top — hence the continual deluge of new protocols each month — few actors want to build apps when they can become rich building protocols that require coins. More on this later.6

Introduction

On p. xxii the authors write:

“… and Marc Andreessen developing the first widely used web browser, which ultimately became Netscape.”

A pedantic point: Marc Andreessen was leader of a team that built Mosaic, not to take away from that accomplishment, but he didn’t single handedly invent the web browser.  Maybe worth rewording in next edition.

On p. xxiii they write:

Interestingly, however, the Internet has become increasingly centralized over time, potentially endangering its original conception as a “highly survivable system.”

This is a valid point however it glosses over the fact that all blockchains use “the internet” and also — in practice — most public blockchains are actually highly centralized as well.  Perhaps that changes in time, but worth looking at “arewedecentralizedyet.”

On p. xxiii they write:

Blockchain technology can now be thought of as a general purpose technology, on par with that of the steam engine, electricity, and machine learning.

This is still debatable.  After all, there is no consensus on what “blockchains” are and furthermore, as we have seen in benchmark comparisons, blockchains (however defined) come in different configurations.  While there are a number of platforms that like to market themselves as “general purpose,” the fact of the matter is that there are trade-offs based on the user requirements: always ask who the end-users and the use-cases a blockchain was built around are.

On p. xxiv they cite Don and Alex Tapscott.  Arguably they aren’t credible people on this specific topic.  For example, their book was riddled with errors and they even inappropriately made-up advisors on their failed bid to launch and fund their NextBlock Global fund.

On p. xxiv the authors write:

Financial incumbents are aware blockchain technology puts on the horizon a world without cash – no need for loose bills, brick-and-mortar banks, or, potentially, centralized monetary policies.  Instead, value is handled virtually through a system that has no central authority figure and is governened in a centralized and democratic manner. Mathematics force order in the operations. Our life savings, and that of our heirs, could be entirely intangible, floating in a soup of secure 1s and 0s, the entire system accessed through computers and smartphones.

This conflates multiple things: digitization with automation.7  Retail banking has and will continue its march towards full digital banking.  You don’t necessarily need a blockchain to accomplish that — we see that with Zelle’s adoption already.8

Also, central banks are well aware that they could have some program adjust interest rates, but discretion is still perceived as superior due to unforeseen incidents and crisis. 9

On p. xxv they write:

The native assets historically have been called cryptocurrencies or altcoins but we prefer the term cryptoassets, which is the term we will use throughout the book.

The term seems to have become a commonly accepted term but to be pedantic: most owners and users do not actually utilize the “cryptography” part — because they house the coins in exchanges and other intermediaries they must trust (e.g., the user doesn’t actually control the coin with a private key).10

And as we continue to see, these coins are easily forkable.  You can’t fork physical assets but you can fork and clone digital / virtual ones.  That’s a separate topic though maybe worth mentioning in the next edition.

On p. xxv they write:

It’s early enough in the life of blockchain technology that no books yet have focused solely on public blockchains and their native cryptoassetss from the investing perspective. We are changing that because investors need to be aware of the opportunity and armed both to take advantage and protect themselves in the fray.

Might be worth rewording because in Amazon there are about 760 books that pop up when “investing in cryptocurrencies” is queried.  And many of those predate the publication of Cryptoassets.  For instance, Brian Kelly, who wrote the Forward, published a fluffy coin promotion book a few years ago.

On p. xv they write:

Inevitably, innovation of such magnitude, fueled by the mania of making money, can lead to overly optimistic investors. Investors who early on saw potential in Internet stock encountered the devastating dot-com bubble. Stock in Books-A-Million saw its price soar by over 1,000 percent in one week simply by announcing it had an updated website. Subsequently, the price crashed and the company has since delisted and gone private. Other Internet-based high flyers that ended up crashing include Pets.com, Worldcom, and WebVan. Today, none of those stocks exist.

So far, so good, right?

Whether specific cryptoassets will survive or go the way of Books-A-Million remains to be seen.  What’s clear, however, is that some will be big winners. Altogether, between the assets native to blockchains and the companies that stand to capitalize on this creative destruction, there needs to be a game plan that investors use to analyze and ultimately profit from this new investment theme of cryptoassets. The goal of this book is not to predict the future – it’s changing too fast for all but the lucky to be right- but rather to prepare investors for a variety of futures.

Even for 2017 when the book was publish, this statement is lagging a bit because there were already several “coin graveyard” sites around.  Late last month Bloomberg ran a story: more than 1,000 coins are dead according to Coinopsy.

It is also unclear, “that some will be big winners.”  Maybe modify this part in the next version.11

On p. xxvi they write:

“One of the keys to Graham’s book was always reminding the investor to focus on the inherent value of an investment without getting caught in the irrational behavior of the markets.”

There is a healthy debate as to whether cryptocurrencies and “cryptoassets” have any inherent value either.12  Arguably most coins traded on a secondary market depend on some level of ‘irrational’ behavior: many coin holders have short time horizons and want someone else to help push up the price so they can eventually cash out.13

Chapter 1

On p. 3 they write:

In 2008, Bitcoin rose like a phoenix from the ashes of near Wall Street collapse.

This a little bit of revisionist history.14

The Bitcoin whitepaper came out on October 31, 2008 and Satoshi later said that he/she had spent the previous 18 months coding it first before writing it up in a paper.  The authors even discuss this later on page 7.  Worth removing in next edition.

On p. 3 they write:

Meanwhile, Bitcoin provided a system of decentralized trust for value transfer, relying not on the ethics of humankind but on the cold calculation of computers and laying the foundation potentially to obviate the need for much of Wall Street.

This is not quite true.  At most, Bitcoin as it was conceived and as it is today — is a relatively expensive payment network that doesn’t provide definitive settlement finality.15 Banks as a whole, do more than just handle payments — they manage many other services and products.  So the comparison isn’t really apples-to-apples.

Note: banks again as a whole spend more on IT-related systems than nearly any other vertical — so there is already lots of “cold calculation” taking place within each of these financial institutions.16

Now, maybe blockchain-related ideas replace or enhance some of these institutions, but it is unlikely that Bitcoin itself as it exists today, will do any of that.

On p. 5 they write:

What people didn’t realize, including Wall Street executives, was how deep and interrelated the risks CMOs posed were. Part of the problem was that CMOs were complex financial instruments supported by outdated financial architecture that blended and analog systems.

That may have been part of a bigger problem.17

There were a dozen plus factors for how and why the GFC arose and evolved, but “outdated financial infrastructure” isn’t typically at the top of the list of culprits.  Would blockchain-like systems have prevented the entire crisis?  There are lots of op-eds that have made the claim, but the authors do not really provide much evidence to support the specific “blended” argument here.  Perhaps worth articulating in its own section next time.

Speaking of which, also on p. 5 they write:

Whether as an individual or an entity, what’s now clear is that Satoshi was designing a technology that if existent would have likely ameliorated the toxic opacity of CMOs. Due of the distributed transparency and immutable audit log of a blockchain, each loan issued and packaged into different CMOs could have been documented on a single blockchain.

This seems to conflate two separate things: Bitcoin as Satoshi originally designed it in 2008 (for payments) and later what many early adopters have since promoted it as: blockchain as FMI.18

Bitcoin was (purposefully) not designed to do anything with regulated financial instruments, it doesn’t meet the PFMI requirements.  He was trying to build e-cash that didn’t require KYC and was difficult to censor… not ways to audit CMOs.  If that was the goal, architecturally Bitcoin would likely look a lot different than it did (for instance, no PoW).

And lastly on p. 5 they write:

This would have allowed any purchaser to view a coherent record of CMO ownership and the status of each mortgage within.  Unfortunately, in 2008 multiple disparate systems – which were expensive and therefore poorly reconciled – held the system together by digital strings.

Interestingly, this is the general pitch for “enterprise” blockchains: that with all of the disparate siloed systems within regulated financial institutions, couldn’t reconciliation be removed if these same systems could share the same record and facts on that ledger?  Hence the creation of more than a dozen enterprise-focused “DLT” platforms now being trialed and piloted by a slew of businesses.

This is briefly discussed later but the next edition could expand on it as the platforms do not need a cryptocurrency involved.19

On p. 7 they write:

By the time he released the paper, he had already coded the entire system.  In his own words, “I had to write all the code before I could convince myself that I could solve every problem, then I wrote the paper.” Based on historical estimates, Satoshi likely started formalizing the Bitcoin concept sometime in late 2006 and started coding around May 2007.

Worth pointing out that Hal Finney and Ray Dillinger — and likely several others – helped audit the code and paper before any of it was publicly released.

On p. 8 they write:

Many years later people would realize that one of the most powerful use cases of blockchain technology was to inscribe immutable and transparent information that could never be wiped from the face of digital history and that was free for all to see.

There appears to be a little hyperbole here.

Immutability has become a nebulous word that basically means many different things to everyone.  In practice, the only thing that is “immutable” on any blockchain is the digital signature — it is a one-way hash.   All something like proof-of-work or proof-of-stake do is decide who gets to vote to append the chain.

Also, as mentioned above, there are well over 1,000 dead coins so it is actually relatively common for ‘digital history’ to effectively be wiped out.

On p. 8 they write:

A dollar invested then would be worth over $1 million by the start of 2017, underscoring the viral growth that the innovation was poised to enjoy.

Hindsight is always 20-20 and the wording above seems to be a little unclear with dates.  As often as the authors say “this is not a book endorsing investments,” other passages seem do just the opposite: by saying how smart you would’ve been if you had bought at a relative low, during certain (cherry picked) dates.

Also, what viral growth?  What are the daily active and monthly active user numbers they think are occurring on these chains?  In later chapters, they do cite some on-chain activity but this version lacks specific DAU / MAU that would strengthen their arguments.20 Worth revisiting in the next edition.

On p. 8 they write:

Diving deeper into Satoshi’s writings around the time, it becomes more apparent that he was fixated on providing an alternative financial system, if not a replacement entirely.

This isn’t quite right.  The very first thing Satoshi tried to build was a marketplace to play poker which was supposed to be integrated with the original wallet itself.

A lot of the talk about “alternative financial system” is arguably revisionist propaganda from folks like Andreas Antonopoulos who have tried to rewrite the history of Bitcoin to conform with their political ideology.

Readers should also check out MojoNation and what that team tried to accomplish.

On p. 9 they write;

While Wall Street as we knew it was experiencing an expensive death, Bitcoin’s birth cost the world nothing.

There are at least two issues that can be modified for the future:

  1.  Wall Street hasn’t died, maybe parts of the financial system are replaced or removed or enhanced, but for better and worse almost 10 years since the collapse of Lehman, the collective financial industry is still around.
  2.  Bitcoin cost somebody something, there were opportunity costs in its creation.  And as we now know: the ongoing environmental impact is enormous.  Yet promoters typically handwave it away as a “cost of doing anarchy.”  Thus worth rewording or removing in the next edition.

On p. 9 they also wrote:

It was born as an open-source technology and quickly abandoned like a motherless babe in the world. Perhaps, if the global financial system had been healthier, there would have been less of a community to support Bitcoin, which ultimately allowed it to grow into the robust and cantankerous toddler that it currently is.

This prose sounds like something from Occupy Wall Street and not something found in literature to describe a computer program.

For example, there are lots of nominally open source blockchains, hundreds or maybe even thousands.21 That’s not very unique (it is kind of expected since there is a financial incentive to clone them).

And again, Satoshi worked on it for at least a couple years.  It’s not like he/she dropped it off at an orphanage after immediate gestation.  This flowery wording acts like a distraction and should be removed in the next edition.

Chapter 2

On p. 12 they write:

Three reputable institutions would not waste their time, nor jeopardize their reputations, on a nefarious currency with no growth potential.

There is a bit of an unnecessary attitude with this statement.  The message also seems to go against the criticism earlier in the book towards banks.  For instance, the first chapter was critical of the risks that banks took leading up to the GFC.  You can’t have it both ways.  In the next edition, should either remove this or explain what level or risk is appropriate.

Also, what is the “growth potential” here?  Do the authors mean the value of a coin as measured in real money?  Or actual usage of the network?

Lastly, the statement above equates the asset value growth (USD value increases) with a bank’s interest. Bank’s do not typically speculate on the price, they usually only care about volumes which make revenues. A cryptocurrency could go to $0.01 for all they care; and if people want to use it then they could consider servicing it provided the bank sees an ability to make money.  For example, UK banks did not abandon the GBP even though it lost 20% of its value in 2016 following the Brexit referendum.

On p. 12 they write:

Certainly, some of the earliest adopters of Bitcoin were criminals. But the same goes for most revolutionary technologies, as new technologies are often useful tools for those looking to outwit the law.

This a “whataboutism” and is actually wrong.  Satoshi specifically says he/she has designed Bitcoin to route around intermediaries (like governments) and their ability to censor.  It doesn’t take too much of a stretch to get who would be initially interested in that specific set of payment “rails” especially if there is no legal recourse.22

On p. 12 they also write:

We’ll get into the specific risks associated with cryptoassets, including BItcoin, in a later chapter, but it’s clear that the story of bitcoin as a currency has evolved beyond being solely a means of payment for illegal goods and services. Over 100 media articles have jumped at the opportunity to declare bitcoin dead, and each time they have been proven wrong.

The last sentence has nothing to do with the preceding sentence, this is a non sequitur.

Later in the book they do talk about other use cases but the one that they don’t talk about much is how — according to analytics — the majority of network traffic in 2017 was users moving cryptocurrencies from one exchange to another exchange.

For example, about a month ago, Jonathan Levin from Chainalysis did an interview and mentioned that:

So we can identify, it is quite hard to know how many people. I would say that 80% of transactions that occur on these cryptocurrency ledgers have a counterparty that is a 3rd party service. More than 80%.

Maybe mention in the second edition: the unintended ironic evolution of Bitcoin has had… where it was originally designed to route around intermediaries and instead has evolved into an expensive permissioned-on-permissionless network.23

On p. 13 they write:

It operates in a peer-to-peer manner, the same movement that has driven Uber, Airbnb, and LendingClub to be multibillion-dollar companies in their own realms. Bitcoin lets anyone be their own bank, putting control in the hands of a grassroots movement and empowering the globally unbanked.

Not quite.  For starters: Uber, Airbnb, and LendingClub all act as intermediaries to every transaction, that’s how they became multibillion-dollar companies.

Next, Bitcoin doesn’t really let anyone be their own bank because banks offer a lot more products and services beyond just payments.  At most, Bitcoin provides a way of moving bitcoins you control to someone else’s bitcoin address (wallet).  That’s it.24

And there is not much evidence that Bitcoin or any cryptocurrency for that matter, has empowered many beyond relatively wealthy people in developed or developing countries.  There have been a few feel-good stories about marginalized folks in developing countries, but those are typically (unfortunately) one-off theatrics displaying people living in squalor in order to promote a financial product (coins).  It would be good to see more evidence in the next edition.

For more on this topic, recommend listening to LTB episode 133 with Richard Boase.

On p. 13 they write:

Decentralizing a currency, without a top-down authority, requires coordinated global acceptance of a shared means of payment and store of value.

Readers should check out “arewedecentralizedyet” which illustrates that nearly all cryptourrencies in practice have some type of centralized, top-down hierarchy as of July 2018.

On p. 13 they write:

Bitcoin’s blockchain is a distributed, cryptographic, and immutal database that uses proof-of-work to keep the ecosystem in sync.

Worth modifying because the network is not inherently immutable — only digital signatures have “immutability.”25 Also, proof-of-work doesn’t keep any “ecosystem” in sync.  All proof-of-work does is determine who can append the chain.  The “ecosystem” thing is completely unrelated.

On p. 15 they write:

There is no subjectivity as to whether a transaction is confirmed in Bitcoin’s blockchain: it’s just math.

This isn’t quite true.26 Empirically, mining pools have censored transactions for various reasons.  For example, Luke-Jr (who used to run Eligius pool) thinks that SatoshiDice misuses the network; he is also not a fan of what OP_RETURN was being used for by Counterparty.

Also, humans control pools and also manage the code repositories… blockchains don’t fix and run themselves.  So it’s not as simple as: “it’s just math.”

On p. 15 they write an entire paragraph on “immutability”:

The combination of globally distributed computers that can cryptographically verify transactions and the building of Bitcoin’s blockchain leads to an immutable database, meaning the computers building Bitcoin’s blockchain can only do so in an append only fashion. Append only means that information can only be added to Bitcoin’s blockchain over time and cannot be deleted – an audit trail etched in digital granite. Once information is confirmed in Bitcoin’s blockchain, it’s permanent and cannot be erased. Immutability is a rare feature in a digital world where things can easily be erased, and it will likely become an increasingly valuable attribute for Bitcoin over time.

This seems to have a few issues:

  1. As mentioned several times before in this review, “immutability” is only a characteristic of digital signatures, which are just one piece of a blockchain.  Recommend Gwern’s article entitled “Bitcoin-is-worse-is-better” for more details.
  2. Empirically lots of blockchains have had unexpected and expected block reorgs and hard forks, there is nothing fundamental to prevent this from happening to Bitcoin.  See this recent article discussing a spate of attacks on various PoW coins: Blockchain’s Once-Feared 51% Attack Is Now Becoming Regular
  3. The paragraph above ignores the reality that well over 1,000 blockchains are basically dead and Bitcoin itself had a centralized intervention on more than one occasion, such as the accidental hardfork in 2013 and the Bitcoin block size debate from 2015-2018.

On p. 15 they introduce us to the concept of proof-of-work but don’t really explain its own origin as a means of combating spam email in the 1990s.

For instance, while several Bitcoin evangelists frequently (mistakenly) point to Hashcash as the original PoW progenitor, that claim actually legitimately goes to a 1993 paper entitled Pricing via Processing or Combatting Junk Mail by Cynthia Dwork and Moni Naor.  There are others as well, perhaps worth adding in the next edition.27

On p. 16 they write:

Competition for a financial rewad is also what keeps Bitcoin’s blockchain secure.  If any ill-motivated actors wanted to change Bitcoin’s blockchain, they would need to compete with all the other miners distributed globally who have in total invested hundreds of millions of dollars into the machinery necessary to perform PoW.

This is only true for a Maginot Line attack (e.g., attack via hashrate).28 There are  cheaper and more effective out of band attacks, like hacking BGP or DNS.  Or hacking into intermediaries such as exchanges and hosted wallets.  Sure the attacker doesn’t directly change the blocks, but they do set in motion a series of actions that inevitably result in thefts that end up in blocks further down the chain, when the transactions otherwise wouldn’t have taken place.

On p. 17 they write:

The hardware runs an operating system (OS); in the case of Bitcoin, the operating system is the open-source software that facilitates everything described earlier.  This software is developed by a volunteer group of developers, just as Linux, the operating system that underlies much of the cloud, is maintained by a volunteer group of developers.

This isn’t quite right in at least two areas:

  1. Linux is not financial market infrastructure software; Bitcoin originally attempted to be at the very least, a payments network.  There are reasons why building and maintaining FMI is regulated whereas building an operating system typically isn’t.  It has to do with risk and accountability when accidents happen.  That’s why PFMI exists.
  2. At least in the case of Bitcoin (and typically in most other cryptocurrencies), only one group of developers calls the shots via gating the BIP / EIP process.  If you don’t submit your proposals and get it approved through this process, it won’t become part of Bitcoin Core.  For more on this, see: Bitcoin Is Now Just A Ticker Symbol and Stopped Being Permissionless Years Ago

On p. 17 they discuss “private versus public blockchains”:

The difference between public and private blockchains is similar to that between the Internet and intranets.  The internet is a public resource.  Anyone can tap into it; there’s not gate keepers.

This is wrong.  All ISPs gate their customers via KYC.  Not just anyone can set up an account with an ISP, in fact, customers can and do get kicked off for violating Terms of Service.

“The Internet” is just an amalgamation of thousands of ISPs, each of whom have their own Terms of Service.  About a year ago I published an in-depth article about why this analogy is bad and should not be use: Intranets and the Internet.

On p. 18 they write:

Public systems are ones like BItcoin, where anyone with the right hardware and software can connect to the network and access the information therein.  There is no bouncer checking IDs at the door.

This is not quite right.  The “permissionless” characteristic has to do with block making: who has the right to vote on creating/adding a new block… not who has the ability to download a copy of the blockchain.  Theoretically there is no gatekeeper for block making in Bitcoin. Although, there are explicit KYC checks on the edges (primarily at exchanges).

In practice, the capital and knowledge requirements to actually create a new mining pool and aggregate hashpower that is sufficiently capable of generating the right hash and “winning” the scratch-off lottery is very high, such that on a given month just 20 or so block makers are actually involved.29

While there is no strict permissioning of these participants (some come and go over the years), it is arguably a de facto oligopoly based on capital expenditures and not some type of feel-good meritocracy described in this book.30

On p. 18 they write:

Private systems, on the other hand, employ a bouncer at the door. Only entities that have the proper permissions can become part of the network. These private systems came about after Bitcoin did, when enterprises and businesses realized they liked the utility of Bitcoin’s blockchain, but weren’t comfortable or legally allowed to be as open with he information propagated among public entities.

This is not nuanced enough.  What precisely is permissioned on a “permissioned” blockchain is: who gets to do the validation.

While there are likely dozens of “permissioned” blockchain vendors — each of which may have different characteristics — the common one is that the validators are KYC’ed participants.  That way they can be held accountable if there is a problem (like a fork).

For example, many enterprises and businesses tried to use Bitcoin, Ethereum, and other cryptocurrencies but because these blockchains were not built with their use cases in mind, unsurprisingly found that they were not a good fit.

This is not an insult: the “comfort” refrain is tiring because there have been a couple hundred proofs-of-concept on Bitcoin – and variants thereof – to look into whether those chains were fit-for-purpose… and they weren’t.  This passage should be reworded in the second edition.

On p. 18 they write:

Within financial services, these private blockchains are largely solutions by incumbents in a fight to remain incumbents.

Maybe that is the motivation of some stakeholders, but I don’t think I’ve ever been in a meeting in which the participants (banks) specifically said that.  It would be good to have a citation added in the next edition.  Otherwise, as Hitchens said: what can be presented without evidence can be dismissed without evidence.

On p. 18 they write:

While there is merit to many of these solutions, some claim the greatest revolution has been getting large and secretive entities to work together, sharing information and best practices, which will ultimately lower the cost of services to the end consumer. We believe that over time the implementation of private blockchains will erode the position held by centralized powerhouses because of the tendency toward open networks. In other words, it’s a foot in the door for further decentralization and the use of public blockchains.

This is a “proletariat” narrative that is frequently used many cryptocurrency books.  While there is a certain truth to an angle – collaboration of regulated entities that normally compete with one another – many of the vendors and platforms that they are piloting are actually “open.”

Which brings up the euphemism that some vocal public blockchain promoters like to stake a claim in… the ill-defined “open.”  For instance, coin lobbyists such as Coin Center and coin promoters such as Andreas Antonopoulos regularly advertise that they are experts and advocates of “open” chains but their language is typically filled with strawmen.

For instance, enterprise-specific platforms such as Fabric, Corda, and Quorum are all open sourced, anyone can download and run the code without the permission of the vendors that contribute code or support to the platforms.

Thus, it could be argued that these platforms are “open” too… which they are.

But it is highly unlikely that ideological advocates would ever defend or promote these platforms, because of their disdain and aversion to platforms built by financial organizations. 31

Lastly, this “foot in the door” comment comes in all shapes and sizes; sometimes coin promoters use “Trojan horse” as well.  Either way it misses the point: enterprises will use technology that solves problems for them and will no use technology that doesn’t solve their problem.

In practice, most cryptocurrencies were not designed – on purpose – to solve problems that regulated institutions have… so it is not a surprise they do not use coin-based platforms as FMI.  It has nothing to do with the way the coin platforms are marketed and everything to do with the problems the coins solve.

On p. 19 they write:

Throughout this book, we will focus on public blockchains and their native assets, or what we will define as cryptoassets, because we believe this is where the greatest opportunity awaits the innovative investor.

The authors use the term “innovative investor” a dozen or more times in the book.  It’s not a particularly useful term.32

Either way, later in the book they don’t really discuss the opportunity cost of capital: what are the tradeoffs of an accredited investor who puts their money long term into a coin versus buys equity in a company.  Though, to be fair, part of the problem is that most of the companies that actually have equity to buy, do not publish usage or valuation numbers because they are still private… so it is hard to accurately gauge that specific trade-off.33

On p. 19 they write about Bitcoin maximalism (without calling it that):

We disagree with that exclusive worldview, as there are many other interesting consensus mechanisms being developed, such as proof-of-stake, proof-of-existence, proof-of-elapsed time, and so on.

Proof-of-existence is not a consensus mechanism.  PoE simply verifies the existence of a file at a specific time based on a hash from a specific blockchain.  It does not provide consensus.  This should be reworded in the next edition.

Furthermore, neither proof-of-stake or proof-of-elapsed-time are actual consensus mechanisms either… they are vote ordering mechanisms — a mechanism to prevent or control sybil attacks. 34  See this excellent thread from Emin Gun Sirer.

Chapter 3

On p. 22 they write:

Launched in February 2011, the Silk Road provided a rules-free decentralized marketplace for any product one could imagine, and it used bitcoin as the means of payment.

This isn’t quite true.  Certain guns and explosives were considered off-limits and as a result “The Armory” was spun off.

On p. 22 they write:

Clearly, this was one way that Bitcoin developed its dark reputation, though it’s important to know that this was not endorsed by Bitcoin and its development team.

Isn’t Bitcoin — like all cryptocurrences — supposed to be decentralized?  So how can there be a singular “it” to not endorse something?35

On p. 22 they write:

The drivers behind this bitcoin demand were more opaque than the Gawker spike, though many point to the bailout of Cyprus and the associated losses that citizens took on their bank account balances as the core driver.

This is mostly hearsay as several independent researchers have tried to identify the actual flows coming into and going out of Cyprus that are directly tied to cryptocurrencies and so far, have been unable to.36

On p. 23 they write about Google Search Trends:

We recommend orienting with this tool even beyond cryptoassets, as it’s a fascinating window into the global mesh of minds.

Incidentally, despite the authors preference to the term “cryptoassets” —  according to Google Search Trends, that term isn’t frequently used in search’s yet.

Source: Google

On p. 24 they write:

This diversity has led to tension among players as some  of these cryptoassets compete, but this is nothing like the tension that exists between Bitcoin and the second movement.

Another frequent name typically used to call “the second movement” was Bitcoin 2.0.

For example, back in 2014 and 2015 I interviewed a number of project organizers and attempted to categorize them into buckets, including things like “commodities” and “assets.”  See for instance my guest presentation in 2014 at Plug and Play: (video) (slides).

This label isn’t frequently used as much anymore, but that’s a different topic entirely.

On p. 25 they write an entire section entitled: Blockchain, Not Bitcoin

The authors stated:

Articles like one from the Bank of England in the third quarter of 2014 argued, “The key innovation of digital currencies is the ‘distributed ledger,’ which allows a payment system to operate in an entirely decentralized way, without intermediaries such as banks. In emphasizing the technology and not the native asset, the Bank of England left an open question whether the native asset was needed

[…]

The term blockchain, independent of Bitcoin, began to be used more widely in North America in the fall of 2015 when two prominent financial magazines catalyzed awareness of the concept.

Let’s pull apart the problems here.

First, the “blockchain not bitcoin” mantra was actually something that VCs such as Adam Draper pushed in the fall of 2015.

For instance, in an interview with Coindesk in October 2015 he said:

“We use the word blockchain now. I say bitcoin, and they think that’s the worst thing ever. It just feels like they put up a guard. Then, I switch to blockchain and they’re very attentive and they’re very interested.”

Draper seems ambivalent to the change, though he said he was initially against using it, mostly because he believes it’s superficial. After all, companies that use the blockchain as a payments rail, the argument goes, still need to interface with its digital currency, which is the mechanism for transactions on the bitcoin blockchain.

“When we talk about blockchain, I mean bitcoin,” Draper clarifies. “Bitcoin and the blockchain are so interspersed together, the incentive structure of blockchain is bitcoin.”

Draper believes it’s mostly a “vernacular change”, noting the ecosystem has been through several such transitions before. He rifles off the list of terms that have come and gone including cryptocurrency, digital currency and altcoin.

“It’s moved from bitcoin to blockchain, which makes sense, it’s the underlying tech of all these things,” he added. “I think in a lot of ways blockchain is FinTech, so it will become FinTech.”

If you’re looking for more specific examples of companies that began using “blockchain” as a euphemism for “bitcoin” be sure to check out my post: “The Great Pivot.”

The authors also fail to identify that there were lots of early stage vendors and entrepreneurs working in the background on educating policy makers and institutions on what the vocabulary was and how the various moving pieces worked throughout 2015.

Want evidence?

Check out my own paper covering this topic and a handful of vendors in April 2015: Consensus-as-a-service.  This paper has been cited dozens of times by a slew of academics, banks, regulators, and so forth.  And contra Draper: you don’t necessarily need a coin or token to incentivize participants to operate a blockchain.37

On p. 26 they write:

A private blockchain is typically used to expedite and make existing processes more efficient, thereby rewarding the entities that have crafted the software and maintain the computers. In other words, the value creation is in the cost savings, and the entities that own the computers enjoy these savings. The entities don’t need to get paid in a native asset as reward for their work, as is the case with public blockchains.

First, not all private blockchains are alike or commoditized.

Two, this statement is mostly true.  At least those were the initially pitches to financial institutions.  Remember the frequently cited Oliver Wyman / Santander paper from 2015?  It was about cost savings.  Since then, the story has evolved to also include revenue generation.

For more up-to-date info on the “enterprise” blockchain world, recommend reading:

On p. 26 they write:

On the other hand, for Bitcoin to incentivize a self-selecting group of global volunteers, known as miners, to deploy capital into the mining machines that validate and secure bitcoin transactions, there needs to be a native asset that can be paid out to the miners for their work. The native asset builds out support for the service from the bottom up in a truly decentralized manner.

This may have been true in January 2009 but is not true in July 2018.  There are no “volunteers” in Bitcoin mining as running farms and pools have become professionalized and scaled in industrial-sized facilities.

Also, that last sentence is also false: virtually every vertical of involvement is dominated by centralized entities (e.g., exchanges, hosted wallets, mining manufacturing, etc.).

On p. 27 they write:

Beyond questioning the need for native cryptoassets – which would naturally infuriate communities that very much value their cryptoassets – tensions also exist because public blockchain advocates believe the private blockchain movement bastardizes the ethos of blockchain technology. For example, instead of aiming to decentralize and democratize aspects of the existing financial services, Masters’s Digital Asset Holdings aims to assist existing financial services companies in adopting this new technology, thereby helping the incumbents fight back the rebels who seek to disrupt the status quo.

Ironically, virtually all major cryptocurrency exchanges now have institutional investors and/or partnerships with regulated financial institutions.38 Like it or not, but the cryptocurrency world is deep in bed with the very establishment that it likes to rail at on social media.

Also, Bitcoin again is at most a payments network and does not actually solve problems for existing financial service providers on their many other lines of business.

On p. 27 they write:

General purpose technologies are pervasive, eventually affecting all consumers and companies. They improve over time in line with the deflationary progression of technology, and most important, they are a platform upon which future innovations are built. Some of the more famous examples include steam, electricity, internal combustion engines, and information technology. We would add blockchain technology to this list. While such a claim may appear grand to some, that is the scale of the innovation before us.

If you’re not familiar with hyperbole and technology, I recommend watching and reading the PR for the Segway when it first came out.  Promoters and enthusiasts repeatedly claimed it would change the way cities are built.  Instead, it is used as a toy vehicle to shuffle tourists around at national parks and patrol suburban malls.

Maybe something related to “blockchains” is integrated into various types of infrastructure (such as trade finance), but the next edition should provide proof of some actual user adoption.

For example, the authors in the following paragraph say that “public blockchains beyond Bitcoin that are growing like gangbusters.”

Which ones?  In the approximately 9 months since this book was published, most “traction” has been issuing ICOs on these public blockchains.  Currently the top 3 Dapps at the time of this writings, run decentralized exchanges… which trade ICO tokens.  Now maybe that changes, that is totally within the realm of possibility.39  But let’s take the hype down a few notches until consistent measurable user growth is observed.

On p. 28 they write:

The realm of public blockchains and their native assets is most relevant to the innovative investor, as private blockchains have not yielded an entirely new asset class that is investable to the public.

The wording and attitude should be changed for the next edition.  This makes it sound as if the only real innovation that exists are network-based coins that a group of issuers continually create and that you, the reader, should buy.

By downplaying opportunities being tackled by enterprise vendors, the statement glosses over the operating environment enterprise clients reside in and how they must conduct unsexy due diligence and mundane requirements gathering because they have to follow laws and regulations otherwise their customers won’t use their specific platforms.

These same vendors could end up “tokenizing” existing financial instruments, it just takes a lot longer because there are real legal consequences if something breaks or forks.40

On p. 28 and 29 they ask “where is blockchain technology in the hype cycle.”

This section could be strengthened by revisiting and reflecting on the huge expectations that these coin projects have raised and were raising at the time the book was first being written.  How were expectations eventually managed?

Specifically, on p. 29 they write:

While it’s hard to predict where blockchain technology currently falls on Gartner’s Hype Cycle (these things are always easier in retrospect), we would posit that Bitcoin is emerging from the Trough of Disillusionment. At the same time, blockchain technology stripped of native assets (private blockchain) is descending from the Peak of Inflated Expectations, which it reached in the summer of 2016 just before The DAO hack occurred (which we will discuss in detail in Chapter 5).

The first part is probably wrong if measured by actual usage and interest (as shown by the Google Search image a few sections above).41

The second part of the paragraph is probably right, though the timing was probably a little later: likely in the last quarter of 2016 when the first set of pilots turned out to require substantially larger budgets.  That is to say, in order to be put platforms into production most small vendors with short runways realized they needed more capital and time to integrate solutions into legacy systems.  In some cases, that was too much work and a few vendors pivoted out of enterprise and created a coin or two instead.42

Chapter 4

On p. 31 they write:

Yes, the numbers have changed a lot since.  Crypto moves fast.

This isn’t a hill I want to die on, but historically “crypto” means cryptography.  Calling cryptocurrencies “crypto” is basically slang, but maybe that’s the way it evolves towards.

On p. 32 they write:

Historically, crypotassets have most commonly been referred to as cryptocurrencies, which we think confuses new users and constrains the conversation on the future of these assets. We would not classify the majority of cryptoassets as currencies, but rather most are either digital commodities (cryptocommodities), provisioning raw digital resources, or digital tokens (cryptotokens), provisioning finished digital goods and services.

They have a point but a literature review could have been helpful at showing this categorization is neither new nor novel.

For instance, the title of my last book was: The Anatomy of a Money-like Informational Commodity.  A bit long-winded?

Where did I come up with that odd title?

In 2014, an academic paper was published that attempted to categorize Bitcoin from an ontological perspective. Based on the thought process presented in that paper, the Dutch authors concluded that Bitcoin is a money-like informational commodity.  It isn’t money and isn’t a currency (e.g., isn’t actually used).434445

On p. 32 they write:

In an increasingly digital world, it only makes sense that we have digital commodities, such as computer power, storage capacity, and network bandwidth.

This book only superficially explains each of these and doesn’t drill down into why these “digital commodities” can’t be priced in good old fashioned money or why an internet coin is needed.  If this is a good use case, is it just a matter of time before Blizzard and Steam get on board?  Maybe worth looking at what entertainment companies do for the next edition.

On p. 33 they write about “why crypto” as shorthand for “cryptoassets” instead of “cryptography.”

For historical purposes, Matt Blaze, the most recent owner of crypto.com, provides a good explanation that could be included or cited next edition: Exhaustive Search Has Moved.

On p. 35 they write:

Except for Karma, the problem with all these attempts at digital money was that they weren’t purely decentralized — one way or another they relied on a centralized entity, and that presented the opportunity for corruption and weak points for attack.

This seems to be conflating two separate things: anonymity with electronic cash.  You can have one without the other and do.46

Also, the BIP process is arguably a weak point for attack.47

On p. 35 they write:

One of the most miraculous aspects of bitcoin is how it bootstrapped support in a decentralized manner.

The fundamental problem with this statement is that it is inaccurate.48 Large amounts of centralization continues to exist: mining, exchanges, BIP vetting, etc.

On p. 35 they write:

Together, the combination of current use cases and investors buying bitcoin based on the expectation for even greater future use cases creates market demand for bitcoin.

Is that a Freudian slip?

Speculators buy bitcoin because they think can sell bitcoins at a higher price because a new buyer will come in at a later date and acquire the coins from them.49

For example, last month Hyun Song Shin, the BIS’s economic adviser and head of research, said:

“If people pay to hold the tokens for financial gain, then arguably they should be treated as a security and come under the same rigorous documentation requirements and regulation as other securities offered to investors for a return.”

In the United States, recall that one condition for what a security is under the Howey framework is an expectation of profit.

Whether Bitcoin is a security or not is a topic for a different post.50

On p. 36 they write:

For the first four years of Bitcoin’s life, a coinbase transaction would issue 50 bitcoin to the lucky miner.

[…]

On November 28, 2012, the first halving of the block reward from 50 bitcoin to 25 bitcoin happened, and the second halving from 25 bitcoin to 12.5 bitcoin occurred on July 9, 2016.  The thrid will happen four years from that date, in July 2020. Thus far, this has made bitcoin’s supply schedule look somewhat linear, as shown in Figure 4.1.

Technically incorrect because of the inhomogeneous Poisson process and the relatively large amounts of hashrate that came online, the first “4 year epoch” was actually less than 4 years.

Whereas the genesis block was released in January 2009, the first halving should have occurred in January 2013, but instead it took place in November 2012.  Similarly, the second halving should have — if rigidly followed — taken place in November 2016, but actually occurred in July 2016 because even more hashrate had effectively accelerated block creation a bit faster than expected.

On p. 36 they write:

Based on our evolutionary past, a key driver for humans to recognize something as valuable is its scarcity. Satoshi knew that he couldn’t issue bitcoin at a rate of 2.6 million per year forever, because it would end up with no scarcity value.

This is a non sequitur.51

Maybe Satoshi did or did not think this way, but irrespective of his or her view, having a finite amount of something means there is some amount of scarcity… even if it is a relatively large amount.  Now this discussion obviously leads down the ideological road of maximalism which we don’t have time to go into today.52  Suffice to say that bitcoin is fundamentally not scarce do to its inability to prevent forks that could increase or decrease the money supply.

On p. 37 they write:

Long term, the thinking is that bitcoin will become so entrenched within the global economy that new bitcoin will not need to be issued to continue to gain support. At that point, miners will be compesnated for processing transaction and securing the network through fees on high transaction volumes.

This might happen but hasn’t yet.

For instance, Kerem Kaskaloglu (see p. 71) created a cartoon model to show what this should look like.

But the actual curves do not exist (yet).

Recommended reading: Analysing Costs & Benefits of Public Blockchains (with Data!) by Colin Platt.

Notice how reality doesn’t stack up to the idealized version (yet)?

On p. 39 they write about BitDNS, Namecoin, and NameID:

Namecoin acts as its own DNS service, and provides users with more control and privacy.

In the next edition they should mention how Namecoin ended up having one mining pool that consistently had over 51% of the network hashrate and as a result, projects like Onename moved over to Bitcoin and then eventually its own separate network altogether (Blockstack).

On p. 41 they write:

This is an important lesson, because all cryptocurrencies differn in their supply schedules, and thus the direct price of each cryptoasset should not be compared if trying to ascertain the appreciation potential of the asset.

One way to strengthen this section is to provide a consistent model or methodology to systemically value a coin that doesn’t necessarily involve future demand from new investors.  Maybe in the second edition they could provide a way to compare or at least say that no valuation model works yet, but here is a possible alternative?

On p. 42 they write:

A word to the wise for the innovative investor: with a new cryptocurrency, it’s always important to understand how it’s being distributed and to whom (we’ll discuss further in Chapter 12). If the core community feels the distribution is unfair, that may forever plague the growth of the cryptocurrency.

Two things:

  1. If a cryptocurrency or “cryptoasset” is supposed to be decentralized, how can it have a singular “core” community too?
  2. In practice, most retail buyers of coins don’t seem to care about centralization or even coin distribution.  Later in the book they mention Dash and its rapid coin creation done in the first month.  Few investors seem to care. 53

On p. 42 they write:

Ripple has since pivoted away from being a transaction mechanism for the common person and instead now “enables banks to send real-time international payments across network.” This focus plays to Ripple’s strengths, as it aims to be a speedy payment system that rethinks correspondent banking but still requires some trust, for which banks are well suited.

If readers have time, I recommend looking through the marketing material of OpenCoin, Ripple Labs, and Ripple from 2013-2018 because it has changed several times.54 Currently there are a couple of different products including xRapid and xCurrent which are aimed at different types of users and as a result, the passage above should be updated.

On p. 43 they write:

Markus used Litecoin’s code to derive Dogecoin, thereby making it one more degree of spearation removed from Bitcoin.

This is incorrect.  Dogecoin was first based off of Luckycoin and Luckycoin was based on a fork of Litecoin.  The key difference involved the erratic, random block reward sizes.

On p. 45 they write about Auroracoin.

Auroracoin is a cautionary tale for both investors and developers. What began as a seemingly powerful and compelling use case for a cryptoasset suffered from its inability to provide value to the audience it sought to impact. Incelanders were given a cryptocurrency with little education and means to use it. Unsurprisingly, the value of the asset collapsed and most considered it dead. Nevertheless, cryptocurrencies rarely die entirely, and Auroracoin may have interesting times ahead if its developer team can figure out a way forward.

A few problems:

  1. Auroracoin is still basically dead
  2. Over 1,000 other coins have died, so “rarely” should be changed in the next edition
  3. Why does a decentralized cryptocurrency have a singular development team, isn’t that centralization?

On p. 46 they write:

Meanwhile, Zcash uses some of the most bleeding-edge cryptography in the world, but it is one of the youngest cryptoassets in the book and suitable only for the most experienced cryptoasset investors.

In the next edition it would be helpful to specifically detail what makes someone an experienced “cryptoasset” investor.

On p. 46 they write:

Adam Back is considered the inspiration for Satoshi’s proof-of-work algorithm and is president of Blockstream, one of the most important companies in the Bitcoin space.

While Hashcash was cited in the original Satoshi whitepaper, recall above, that the original idea can be directly linked to a 1993 paper entitled Pricing via Processing or Combatting Junk Mail by Cynthia Dwork and Moni Naor.  Also, it is debatable whether or not Blockstream is an important company, but that’s a different discussion altogether.

On p. 46 they write:

Bitcoin and the permissionless blockchain movement was founded on principles of egalitarian transparency, so premines are widely frowned upon.

What are the founding principles?  Where can we find them?   Maybe it exists, but at least provide a footnote.55

On p. 47 they write:

While many are suspicious of such privacy, it should be noted that it has tremendous benefits for fungibility.  Fungibility refers to the fact that any unit of currency is as valuable as another unit of equal denomination.

Cryptocurrencies such as Bitcoin are not fungible.  Be sure to listen to this interview with Jonathan Levin from May.  See also: Bitcoin’s lien problem and also nemo dat.

On p. 48 they write:

Monero’s supply schedule is a hybrid of Litecoin and Dogecoin. For monero, a new block is appended to its blockchain every 2 minutes, similar to Litecoin’s 2.5 minutes.

In the next edition I’d tighten the language a little because a new monero block is added roughly or approximately every 2 minutes, not exactly 2 minutes.

On p. 48 they write:

By the end of 2016, Monero had the fifth largest network value of any cryptocurrency and was the top performing digital currency in 2016, with a price increase over the year of 2,760 percent. This clearly demonstrates the level of interest in privacy protecting cryptocurrency. Some of that interest, no doubt, comes from less than savory sources.

That is a non sequitur.

Where are the surveys of actual Monero purchasers during this time frame and their opinions for why they bought it? 56

For instance, in looking at the two-year chart above, how much on-chain activity in 2016 was due to speculators interest in “privacy” versus coin flipping?  It is impossible to tell.  Even with analytics all you will be able to is link specific users with purchases.  Intent and motivation would require  surveys and subpoenas; worth adding if available in the next edition.

On p. 48 they write:

Another cryptocurrency targeting privacy and fungiblity is Dash.

Is Dash really fungible though?  That isn’t explored in this section.  Plus Dash has a CEO… how is that decentralized?

On p. 49 they write:

In fact, Duffield easily could have relaunched Dash, especially considering the network was only days onld when the instamine began to be widely talked about, but he chose not to.  It would have been unusual to relaunch, given that other cyrptocurrencies have done so via the forking of original code. The creators of Monero, for example, specifically chose not to continue building off Bytecoin because the premine distribution had been perceived as unfair.

How is this not problematic: for a “decentralized” cryptocurrency to be controlled and run by one person who can unilaterally stop and restart a chain?

It actually is common, that’s the confusing part.  Why have regulators such as FinCEN and the SEC not provided specific guidance (or enforcement) on the fact that one or a handful of individuals actually are unlicensed / non-exempted administrators of financial networks?

On p. 49 they write:

The Bitcoin and blockchain community has always been excited by new developments in anonymity and privacy, but Zcash took that excitement to a new level, which upon issuane drove the price through the roof.

Putting aside the irrational exuberance for Zcash itself, why do the authors think so many folks are vocal about privacy and anonymity?

Could it be that a significant portion of the coins are held by thieves of exchanges and hosted wallets who want to launder them?  Here are a few recent examples:

On p. 49 they write:

Through his time at DigiCash and longstanding involvement in cryptography and cryptoassets, Zooko has become one of the most respected members in the community.

Let’s put aside Zooko and Zcash.  The phrase, “the community” frequently appears in this book and similar books.  It is an opaque, ill-defined (and cliquish) term that is frequently used by coin promoters to shun certain people that do not promote specific policies (and coins).57  It’s a term that should be clearly defined in the next edition.

On p. 50 they write:

While it is still early days for Zcash, we are of the belief that the ethics and technology chops of Zooko and his team are top-tier, implying that good things lie in wait for this budding cryptocurrency.

The statement above seems like an endorsement.  Did either of the authors own Zcash just as the book came out?  And what are the specific ethics they speak of?  And why do the authors call it a cryptocurrency instead of a “cryptoasset”?

Chapter 5

On p. 51 they write:

For example, the largest cryptocommodity, Ethereum, is a decentralized world computer upon which globally accessible and uncensored applications can be built.

How is it a commodity?  Maybe it is and while they use a lot of words in this chapter, they never really precisely why it is in a way that makes much sense.  Recommend modifying the first few pages of this chapter.

On p. 52 they write about “smart contracts” and mention Nick Szabo.

For a future edition I recommend diving deeper into the different uses and definitions of smart contracts.  Also could be worth following Tony Arcieri suggestion:

I really like “authorization programs” but people really seem married to the “smart contract” terminology. Never mind Martin Abadi’s work on authorization languages (e.g. Binder) predates Nick Szabo’s “smart contracts” by half a decade…

For instance, there has been a lot of work done via the Accord Project with Clause.io and others such as IBM and R3.  Also worth looking into Barclay’s and UCL’s effort with the Smart Contract Templates.  A second edition that aims to be up-to-date should look at these developments and how they have evolved from what Abadi and Szabo first proposed.

On p. 53 they mentioned that Counterparty “was launched in January 2014.”  Technically that is not true.  The fundraising (“proof-of-burn”) took place in January and it was the following month that it “launched.”

On p. 54 they write:

The reason Bitcoin developers haven’t added extra functionality and flexibility directly into its software is that they have prioritized security over complexity. The more complex transactions become, the more vectors there are to exploit and attack these transactions, which can affect the network as a whole. With a focus on being a decentralized currency, Bitcoin developers have decided bitcoin transactions don’t need all the bells and whistles.

This is kind of true but also misses a little history.

For instance, Zerocoin was first proposed as an enhancement directly built into Bitcoin but key, influential Bitcoin developers who maintained the repository, pushed back on that for various technological and philosophical reasons.  As a result, the main authors of that proposal went on to form and launch Zcash.58

On p. 56 they write:

Buterin understood that building a system from the ground up required a significant amount of work, and his announcement in January 2014 involved the collaboration of a community of more than 15 developers and dozens of community members that had already bought into the idea.

I assume the authors mean, following the Bitcoin Miami announcement in January 2014, but they don’t really say.  I’m not sure how they arrive at the specific headcount numbers they did above, would be good to add a footnote in the future.

On p. 56 they write:

The ensuing development of the Bitcoin software before launch mostly involved just two people, Satoshi and Hal Finney.

This assumes that Satoshi is not Hal Finney, maybe he was.  But it should also include the contributions of Ray Dillinger and others.

On p. 56 they write:

Buterin also knew that while Ethereum could run on ether, the people who designed it couldn’t, and Ethereum was still over a year away from being ready for release. So he found funding through the prestigious Thiel Fellowship.

This is inaccurate.

After reading this, I reached out to Vitalik Buterin and he said:59

That’s totally incorrect. Like the $100k made very little difference.

So that should be corrected in the next version.

On p. 57 they write:

Ethereum democratized that process beyond VCs. For perspective on the price of ether in this crowdsale, consider that at the start of April 2017, ether was worth $50 per unit, implying returns over 160x in under three years. Just over 9,000 people bought ether during the presale, placing the average initial investment at $2,000, which has since grown to over $320,000.

There are a few issues with this:

  1. Ethereum did a small private and a larger public sale.  We do have the Terms and Conditions of the public sale but we do not know how many participated in the private sale and under what terms (perhaps the T&Cs were identical).
  2. Over the past 12 months there has been a trend for the “top shelf” ICOs to eschew a public sale (like Ethereum did) and instead, conduct private placement offerings with a few dozen participants at most… typically VCs and HNWIs.
  3. There are lots of dead ICOs.  One recent study found that, “56% of crypto startups that raise money through token sales die within four months of their initial coin offerings.”  Ethereum is definitely an exception to that and should be highlighted as such.

On p. 57 they write:

The extra allocation of 12 million ether for the early contributors and Ethereum Foundation has proved problematic for Ethereum over time, as some feel it represented double dipping. In our view, with 15 talented developers involved prior to the public sale, 6 million ether translated to just  north of $100,000 per developer at the presale rate, which is reasonable given the market rate of such software developers.

Who are these 15 developers, why is that the number the authors have identified?

Also, how much should FOSS developers be compensated and/or the business model around that is a topic that isn’t really addressed at all in this book, yet it is a glaring omission since virtually all of the projects they talk about are set up around funding and maintaining a FOSS team(s).  Maybe some findings will be available for the next version.

On p. 57 they write:

That said, the allocation of capital into founders’ pockets is an important aspect of crowdsales. Called a “founder’s reward,” the key distinction between understandable and a red flag is that founders should be focused on building and growing the network, not fattening their pockets at the expensse of investors.

Because coins do not typically provide coin holders any type of voting rights, it is legally dubious how you can hold issuers and “founders” accountable.60

That is why, as mentioned above, there has been an evolution of terms and conditions such that early investors in a private placement for coins may have certain rights and that the founders have certain duties that are all legally enforceable (in theory).

Because no one is publishing these T&Cs, it is hard to comment on what are globally accepted practices… aside from allowing early investors liquidity on secondary markets where they can quickly dump coins.61

Without the ability to legally hold “founders” accountable for enriching themselves at the expense of the project(s), the an interim solution has been to get on social media and yell alot… which is really unprofessional and hit or miss.  Another solution is class action lawsuits, but that’s a different topic.

Also, I put the “founders” into quotes because these seem to be administrators of a network, maybe in the next edition they will be described as such?

On p. 58 they write:

Everyone trusts the system because it runs in the open and is automated by code.

There is lots of different types of open source code that runs on systems that are automated.  For instance, the entire Linux, Apache, and Mozilla worlds predate Bitcoin.  That isn’t new here.62

Also, as mentioned in the previous chapter: Researchers: Last Year’s ICOs Had Five Security Vulnerabilities on Average.  As a result, this has led to the loss of nearly $400 million in ICO funds.

Readers and investors shouldn’t just trust code because someone created a GitHub repo and said their blockchain is open and automated.63

On p. 59 they write:

Most cryptotokens are not supported by their own blockchain.

This is actually true and problematic because it creates centralization risks and the ability for one party to unilaterally censor transactions and/or act as administrators.

For instance, a few days ago, Bancor had a bug that was exploited and about $13.5 million in ETH were stolen… and Bancor was able to freeze the BNT.  That’s because BNT is effectively a centrally administered ERC20 token on top of Ethereum.

Ignoring for the moment whether or not BNT is or is not a security, this is not the first time such issuance and centralization has occurred.  See the colored coin mania from 2014-2015.

On p. 60 they write about The DAO:

Over time, investors in these projects would be rewarded through dividends or appreciation of the service provided.

They mention regulators briefly later on – about SEC views – but most of the content surrounding crowdsales was non-critical and borderline promotional.64  Might be worth adding more meat around this in the next edition.

On p. 61 they write about The DAO:

The hack had nothing to do with an exchange, as had been the case with Mt. Gox and other widely publicized Bitcoin-related hacks. Insted, the flaw existed in the software of The DAO.

Is it really possible to call it a “flaw” or “hack” and not a feature?  See also: “Code is not law” as well as “Cracking MtGox.”

On p. 61 they write:

However, a hard fork would run counter to what many in the Bitcoin and Ethereum communities felt was the power of a decentralized ledger.  Forcefully removing funds from an account violated the concept of immutability.

Just a few pages earlier the authors were saying that the lead developer behind Dash should have restarted the network because that was common and now they’re saying that doing a block reorg is no bueno.  Which is it?

Why should the reader care what a nebulously defined “community” says, if it is is not defined?

The reason we have codes of conduct, terms of service, and EULAs is to specifically answer these types of problems when they arise.

Since public blockchains are supposed to be anarchic, the lack of formal governance is supposed to be a feature, right?   That’s a whole other topic but suffice to say that these two sentences should be reworded in the next edition to incorporate the wisdom found in the Lexicon paper.

On p. 62 they write:

Many complained of moral hazard, and that this would set a precdent for the U.S. government or other powerful entities to come in someday and demand the same of Ethereum for their own interests. It was a tough decision for all involved, including Buterin, who while not directly on The DAO developer team, was an admistrator.

This is the first and only time they point out that key participants collectively making governance decisions are administrators… a point I have been highlighting throughout this review.

I don’t think it is fair to label Vitalik Buterin as a singular administrator, because if he was, he wouldn’t have had to ask exchanges to stop trading ether and/or The DAO token.  Perhaps he was collectively involved in that process, but mining pool operators and exchange managers are arguably just as important if not more so.  See also: Sufficiently Decentralized Howeycoins

On p. 62 they write:

While hard fork are often used to upgrade a blockchain architecture, they are typically employed in situations where the community agrees entirely on the beneficial updates to the architecture. Ethereum’s situation was different, as many in the community opposed a hard fork. Contentious hard forks are dangerous, because when new software updates are released for a blockchain in the form of a hard fork, there are then two different operating systems.

A few things:

  1. Notice the continued use of an ill-defined “the community”
  2. How is agreement or disagreement measured?  During the Bitcoin block size debate, folks tried to use various means to express interest, most of which resulted in sybil attacks such as retweets and upvotes on social media by an army of bots.
  3. Is any fork non-contentious.  Surely if we looked hard enough, we could always find more than a handful of coin owners and/or developers that disagreed with the proposal.  Does that mean you should ignore them?  Whose opinion matters?  These types of questions were never really formally answered either in the case of the Bitcoin Segwit / Bitcoin Cash fork… or in the Ethereum / Ethereum Classic / The DAO fork.  Governance is pretty much an off-chain popularity contest, just like voting for politicians.65

On p. 63 they write:

The site for Ethereum Classic defines the cryptoasset as “a continuation of the original Ethereum blockchain–the classic version preserving untampered history; free from external interference and subjecitve tampering of transactions.”

This could be revised since Ethereum Classic itself has now had multiple forks.

As mentioned in a previous post last year:

Ethereum Classic: this small community has held public events to discuss how they plan to change the money supply; they video taped this coordination and their real legal names are used; only one large company (DCG) is active in its leadership; they sponsor events; they run various social media accounts

There has been lots of external interference, that’s been the lifeblood of public blockchains… because they don’t run themselves, people run and administer them.

Continuing on p. 63 they write:

While many merchants understably complain about credit card fees of 2 to 3 percent, the “platform fees” of Airbnb, Uber, and similar platform services are borderline egregious.

Maybe they are, maybe they are not.66 What is the right fee they should be?  Miners take a cut, exchanges take a cut, developers take a cut via “founder’s funds.”

The next edition should give a step-by-step comparison to show why fee structures are egregious (maybe they are, it just is not clear in this book).

On p. 64 they wrote about Augur.  Incidentally, Augur finally launched in early July while writing this review.  I have an origin story but will keep that for later.

On p. 65 they wrote about Filecoin:

For example, a dApp may use a decentralized cloud storage system like Filecoin to store large amounts of data, and another cryptocommodity for anonymized bandwidth, in addition to using Ethereum to process certain operations.

A couple thoughts:

  1. That’s the theory, though Filecoin hasn’t launched yet — why do they get the benefit of the doubt yet other projects don’t?
  2. There is no price or use comparison in this chapter or elsewhere… the book could be strengthened if it provided more evidence of adoption because we have seen that running decentralized services such as Tor or Freenet have been less than spectacular.

On p. 65 they write:

Returning to the fundamentals of investment theory will allow innovative investors to properly position their overarching portfolio to take advantage of the growth of cryptoassets responsibly.

It is still unclear what an “innovative investor” is — at least the way these authors describe it.67

Chapter 6

On p. 69 Tatar writes:

Not only did I decide to inveset in bitcoin, I decided to place the entirety of that year’s allocation for my Simplified Employee Pension (SEP) plan into bitcoin. When I announced what I had done in my article “Do Bitcoin Belong in your Retirement Portfolio?,” it created a stir online and in the financial planning community.

This was one of just a couple places where the authors actually disclose that they own specific coins, next edition they should put it up front.

On p. 70 Tatar writes:

Was I chasing a similar crash-and-burn scenario with bitcoin? Even my technologically and investment savvy son, Eric, initially criticized me about bitcoin. “They have tehse things called dollar bills, Dad. Stick to using those.”

Eric is probably right: that the authors of this book accepted traditional money for their book (Amazon doesn’t currently accept cryptocurrencies).

Based on their views presented in this book, the authors probably don’t spend (many) coins they may have in the portfolio, instead holding on to them with the belief that other investors will bid up the price (measured in actual money).

On p. 77 they write about the GFC prior to 2008:

Becoming a hedge fund manager became all the rage for business-minded students when it was revealed that the top 25 hedge fund managers earned a total of $22.3 billion in 2007 and $11.6 billion in 2008.

Coincidentally a similar “rage” for running cryptocurrency-related funds has occured in the past 18 months, especially for ICOs.

More than two hundred “funds” quickly popped up in order to gobble up coins during coin mania.  At least 9 have closed down through April and many more were down double digits due to a bear market (and not hedging).

Chapter 7

On p. 83 they write:

Bitcoin is the most exciting alternative asset in the twenty-first century, and it has paved the way for its digital siblings to enjoy similar success.

It is their opinion that this is the case, but the authors don’t really provide a lot of data to reinforce it yet, other than the fact that there have been some bull runs due to exuberance.68 Worth rewording in the next edition.

On p. 83 they write:

Because bitcoin can claim the title of being the oldest cryptoasset…

Historically it is not.  It may be the oldest coin listed on a liquid secondary market, but there were cryptocurrencies before bitcoin.

On p. 85 Berniske writes:

Similarly, I (Chris) didn’t even consider investing in bitcoin when I first heard about it in 2012. By the time I began considering bitcoin for my portfolio in late 2014, the price was in the mid $300s, having increased 460,000-fold from the initial exchange rate.

I believe this is the only time in the book that Burniske discloses any coin holdings.

On p. 85 they make some ridiculous comparison with the S&P 500, DJIA, NASDAQ 100… and Bitcoin.

The former three are indices of multiple regulated securities.  The latter is just one coin that is easily influenced and manipulated by external unaccountable parties.  How is that an apples to apples comparison?

On p. 87 they continue by comparing Bitcoin with Facebook, Google, Amazon, and Netflix.

Again, these are regulated securities that reflect cash flows and the financial health of multinational companies… Bitcoin has no cash flows and isn’t (yet) setup to be a company… and isn’t regulated (no KYC/AML at the mining farm or mining pool level).

Bitcoin was originally built to be an e-cash transmission network, a decentralized MSB.69 How is comparing it with non-MSBs a useful comparison?

On p. 88 they write:

Remember that, as of January 2017, bitcoin’s network value was 1/20, 1/22, 1/3, and 1/33 that of the FANG stocks respectively. Therefore, if bitcoin is to grow to a similar size much opportunity remains.

This whole section should be probably be modified because these aren’t apples-to-apples comparisons.  FANG stocks represent companies that have to build and ship multiple products in order to generate continuous revenue.

With Bitcoin, it is bitcoin that is the product, nothing else is being shipped nor is revenue being generated70

Maybe the price of a bitcoin — as measured with actual money — does reach a 1:1 or even surpass the stocks above.  But a new version of this book could be strengthened with an outline on how it could do so sustainably.

Also, the whole “market cap” topic should be removed from next edition as well.  About 20% of all bitcoins have been lost or destroyed and this is never reflected in those exuberant “market cap” stories.  See: Nearly 4 Million Bitcoins Lost Forever, New Study Says

On p. 92 they write about volatility:

Upon launch, cryptoassest tend to be extremely volatile because they are thinly traded markets.

Actually, basically all cryptocurrencies including the ones that the authors endorse throughout the book — are still very volatile.

Below is one illustration:

Source: JP Koning

The authors do have a couple narrow, daily volatility charts in the book, but none that provide a similar wideview comparison with something that is remotely comparable (Bitcoin versus Twitter doesn’t make any sense).

On p. 101 they write:

Cryptoassets have near-zero correlation to other captial market assets.

That’s loosey goosey at best.71

For instance, as pointed out in multiple articles this year: Bitcoin and other cryptocurrencies tend to be locked together – and that’s a big problem

On p. 102 they write:

In contrast, the past few years have been more nuanced: bitcoin’s volatily has calmed, yet it retains a low correlation with other assets.

That first part is untrue, as shown by the chart above from JP Koning.  The second part is relative.72

Chapter 8

On p. 107 they write:

The Securities and Exchange Commission has thus far steered clear of applying a specific label to all cryptoassets, though in late July 2017 it did release a report detailing how some cryptoassets can be classified as securities, with the most notable example being The DAO.

That’s pretty much the extent of the authors analysis of the issue.  Granted they aren’t lawyers but this is a pretty big deal, maybe in the next edition beef this up?

On p. 107 they write:

While it’s a great validation of cryptoassets that regulators are working to provide clarity on how to classify at least some of them, most of the existing laws set forth suffer from the same flaw: agencies are interpereting cryptoassets through the lens of the past.

From this wording it seems that the authors want laws changed or modified to protect their interests and the financial interests of their LPs.  This isn’t the first or last time that someone with a vested interest lobbies to get carve outs, exceptions, or entire moratoriums.

Maybe that it is deserved, but it’s not well-articulated in this chapter other than to basically call regulators “old-fashioned” and out of touch with technology.73 Could be worth rethinking the wording here.

On p. 107 they write:

Just as there is diversity in equities, with analsts segmenting companies depending on their market capitalization, sector, or geography, so too is there diversity in cryptoassets. Bitcoin, litecoin, monero, dash, and zcash fulfill the three definitions of a currency: serving as a means of exchange, store of value and unit of account.

This is empirically incorrect.  None of these coins functions as a unit of account, they all depend on and are priced in… actual money.74

There are lots of reasons for why this is case but that is beyond the scope of this review. 7576

On p. 110 they write about ETFs:

It should be noted that when we talk about asset classes we are not doing so in the context of the investment vehicle that may “house” the underlying asset, whether that vehicle is a mutual fund, ETF, or separately managed account.

They don’t really discuss it in the book, but just so readers are aware, there have been about 10 Bitcoin-only ETFs proposed in the US, all of which have been rejected by the SEC (or applications were voluntarily removed).

Curious to know why?  See the March 10, 2017 explanation from the SEC.

Note: this hasn’t stopped sponsors from re-applying.  In the process of writing this review, the CBOE filed for a Bitcoin ETF.

On p. 111 they write:

Much of the thinking in this chapter grew out of a collaboration between ARK Invest and Coinbase through late 2015 and into 2016 when the two firms first made the claims that bitcoin was ringing the bell for a new asset class.

Just to be clear: the joint paper they published in that time frame was a bit superficial as it lacked actual user data from Coinbase exchanges (both GDAX and the consumer wallet).  I pointed that out back then and this book is basically an expanded form of that paper: where is specific usage data on Coinbase?  The only way we have learned any real user numbers about Coinbase is from an IRS lawsuit.

For instance, a future edition should try to differentiate on-chain activity that is say, gambling winnings or miners payouts from exchange arbitrage or even coin shuffling.  Their analysis should be redone once they remove the noise from the signal (e.g., not all transactional activity is the same).

This is a real challenge and not a new issue.  For instance, see: Slicing data.

On p. 112 they write:

Cryptoasset adhere to a twenty-first century model of governance unique from all other asset classes and largely inspired by the open source software movement. The procurers of the asset and associated use cases are three pronged. First, a group of talented software developer decide to create the blockchain protocol or distributed application that utilizes a native asset. These developers adhere to an open contributor model, which means that over time any new developer can earn his or her way onto the development team through merit.

There is no new governance model.

In practice, changes are done via social media popularity contests.  We saw that with the Bitcoin blocksize debate and Ethereum hard fork.  And in some ways, strong vocal personalities (and cults of personality) is how other FOSS projects (like Python) are managed and administered.

The fluffy meritocracy feel-goodism is often not the order of the day and we see this in many projects such as Bitcoin where the commit access and BIP approval process is limited to a small insular clique.

Source: Jake Smith (section 3)

The 4 point plan above is a much more accurate break down of how most coin projects are setup.

On p. 112 they write:

However, the developers are not the only ones in charge of procuring a cryptoasset; they only provide the code. The people who own and maintain the computers that run the code–the-miners–also have a say in the development of the code because they have to download new software updates. The developers can’t force miners to update software. Instead, they must convince them that it makes sense for the health of the overall blockchain, and the economic health of the miner, to do so.

But in many projects: developers and miners are one in the same.  This is why it is so confusing to not have seen additional clarity or guidance from FinCEN because of how centralized most projects are in practice.

Be sure to look at “arewedecentralizedyet.”77

On p. 113 they write:

These companies often employ some of the core developers, but even if they don’t, they can assert significant influence over the system if they are a large force behind user adoption.

Maybe that is the case for some cryptocurrencies.78  Should “core” developers be licensed like professional engineers are?

Also, isn’t their statement above evidence that most projects are fairly centralized because the division of labor results in specialization?

On p. 113 they write:

These users are constantly providing feedback ot the developers, miners, and companies, in whose interest it is to listen, because if users top using the cryptoasset, then demand will go down and so too will the price.  Therefore, the procurers are constantly held accountable by the users.

Except this isn’t what happens in practice.

Relatively little activity takes place at all on most of these coin platforms and most of what does occur involves arbitrage trading and/or illicit activity.

This activity seems to have little direct connection to the price of the coin because the price of the coin is still largely determined by the whims of speculative demand.

For instance, above is a two-year transactional volume chart for bitcoin.  The price of bitcoin in the summer of 2016 was in the $600-$700 range whereas it is 10x that today.  Yet daily transaction volume is actually lower than it was back then.  Which means: the two are separate phenomenon.

Also, arguably the only direct way coin owners can — in practice —  hold maintainers accountable is via antics on social media.  That is why control of a specific reddit, Telegram, or Twitter account is very important and why hackers target those channels in order to influence prices.

On p. 113 they write about supply schedules:

For example, with oil, there’s the famous Organization of the Petroleum Exporting Countries (OPEC), which has had considerable control over the supply levels of oil.

Inadvertently they actually described how basically all proof-of-work coins operate: via a small clique of known miners and mining pools.  A cartel?

Source: Jameson Lopp

While these miners have not yet increased or decreased the supply of bitcoins, mining is a specialized task that requires certain capital and connections to be successful at.  These participants could easily collude to change the money supply, censor transactions, etc. and there would be no immediate legal recourse.

On p. 115 they write:

Cryptoassets, like gold, are often constructed to be scarce in their supply. Many will be even more scarce than gold and other precious metals. The supply schedule of cryptoassets typically is metered mathematically and set in code at the genesis of the underlying protocol or distributed application.

How to measure scarcity here?

Despite what alchemists tried for centuries to do: aside from particle accelators, on Earth the only way of increasing the supply of gold and silver is via digging it out of the ground.  For cryptocurrencies, it is relatively easy to fork and clone both code and chains.  Digital scarcity for most — if not all — public chains, seems to be is a myth.

In the next edition, maybe remove the “backed by maths” trope?  None of these chains run themselves, they all depend on humans to run the equipment and maintain the code.

On p. 115 they write:

As discussed earlier, Satoshi crafted the system this way because he needed initially to bootstrap support for Bitcoin which he did by issuing large amounts of the coin for the earliest contributors.  As Bitcoin matured, the value of its native asset appreciated, which means less Bitcoin is over eight years old, it provides strong utility to the world beyond as an investment, which drive demand.

Satoshi likely mined around 1 million bitcoins for himself/herself.  Because of how centralized and small the network originally was in 2009, he/she probably could have unilaterally stopped the network and relaunched it and effectively removed that insta-mine. 79

In addition, there was almost no risk to either be a developer or a miner… the entry/exit costs were very low… so why did he issue large amounts of coins for these contributors?80

Also, how does it provide strong demand beyond investment?  How many people do the authors know regularly use Bitcoin itself for retail payments?81

Also, through Bitcoin’s evolution, arguably some of its utility was removed by going down a specific block size path.  The counterargument is that payments will be done via some other networks (such as Lightning) attached to Bitcoin, but as of this writing, that hasn’t panned out.

One last comment about this passage, FOSS is historically charity work and difficult to build a sustainable operation. A couple notable exceptions are Red Hat and SUSE (which was just acquired by EQT).

On p. 115 they write:

The Ethereum team is currently rethinking that issuance strategy due to an intended change in its consensus mechanism.

In the second edition is it possible to be consistent on this one point: how is an “official” or “centralized” development team congruent with the idea of having a “decentralized ecosystem”?

Also, the administrators of Ethereum Classic modified the money supply last year and most folks were blasé.  Where is the relevant FinCEN guidance?

On p. 115 they write:

Steemit’s team pursued a far more complicated monetary policy with its platform, composed of steem (STEEM), steem power (SP), and steem dollars (SMD).

[…]

They have also chosen to modify their monetary policy post-inception.

The authors of this book need to be consistent in their wording because in other places they criticize centralize financial institutions but do not criticize centralized monetary supply decision of coin makers.  Also, again, why or how does a decentralized project have a singular team?

On p. 116 they write:

Crypotassets can be likened to silicon. They have come upon the scene due to the rise of technology, and their use cases will grown and change as technology evolves.  Currently, bitcoin is the most straightforward, with its use case being that of a decentralized global currency. Ether is more flexible, as developer use it for computational gas within a decentralized world computer.

This isn’t a good analogy.  Silicon exists as a naturally occurring element… whereas cryptocurrencies do not naturally arise — humans create them.

In addition, bitcoin is arguably not the most straightforward due to a long divorce and schism process the past three years.  One distinct group of promoters calls it “digital gold” and another distinct group calls it a “payment system” — the two groups are almost violently opposed to one another’s existence.

On p. 116 they write:

Then there are the trading markets, which trade 24/7, 365 days a year. These global and eternally open markets also differentiate cryptoassets from other assets discussed herein.

The FX markets are open globally almost 24/6 for most of the year, so that’s not really a braggable claim.82 There are legal, regulatory, and practical reasons why most capital markets operate in the time windows they do… it is not because of some technological limitation.  Worth rewording in the next edition.

On p. 116 they write:

In short, the use cases for cryptoassets are more dynamic than any preexisting asset class. Furthermore, since they’re brought into the world and then controlled by open-source software, the ability for cryptoassets to evolve is unbounded.

In the next edition, maybe remove the pomp and circumstance unless there is actual data to back up the platitudes.  We can all easily conjure up lots of potential use cases for just about any type of technology, but unless they are built and used, the hype should be turned down a few notches.

Also, there are many other open source software projects that have actually shipped frequently used productivity tools and no one is yelling from the mountain tops about how they have unbounded potential.  How are internet coins any different?

On p. 117 they write:

Cryptoassets have two drivers of their basis of value: utility and speculative.

In theory, perhaps.  But in practice, most coins just have potential utility because with few exceptions, most buyers typically hold with the expectation the coin will appreciate.  Maybe that change in the future.

On p. 117 the write:

For example, Bitcoin’s blockchain is used to transact bitcoin and therefore much of the value is driven by demand to use bitcoin as a means of exchange.

Perhaps, though in the next edition recommend modifying the wording to include: “… as a means of exchange or investment…”  Currently, we know a large portion of activity is likely movement (arbitrage) between exchanges.8384

But even ignoring this data (from analytics companies) this scenario has been diced-up elsewhere:

On p. 117 they write:

Speculative value is driven by people trying to predict how widely used a particular cryptoasset will be in the future.

If there were systematic surveys of actual buyers and sellers perhaps add those in the second edition?85

On p. 118 they write:

With crypotassets, much of the speculative value can be drived from the development team. People will have more faith that a cryptoasset will be widely adopted if it is crafted by a talented and focused development team. Furthermore, if the development team has a grand vision for the widespread use of the cryptoasset, then that can increase the speculative value of the asset.

This is false.

For starters, the value of a new coin is almost entirely a function of the marketing effort from the coin issuers: that’s why nearly all ICOs carve out a portion of their funding pie to market, promote, and advertise… spreading the sexy gospel of the new coin.

This is a big bucks opaque industry, with all sorts of shenanigans that take place just to get listed on secondary markets… with coin issuers paying more than $1 million to get listed.

While $1 million or even $3 million may sound like a lot to get listed, the issuers know it is worth it because the retail speculators on the other end will at least temporarily pump the coin price up often long enough for the original insiders and investors to cash out.

Now the coin issuers may talk a big game and at eloquent length about how their grand vision: that their coin will end world hunger and save the environment, but they often have no ability to execute and build the product(s) they claimed in their whitepaper.

As mentioned above, one recent study found that, “56% of crypto startups that raise money through token sales die within four months of their initial coin offerings.”

Also, how does a decentralized cryptocurrency have an official singular development team?

On p. 118 they write:

As each cryptoasset mature, it will converge on its utility value. Right now, bitcoin is the furthest along the transition from speculative price support to uility price support because it has been around the longest and people are using it regularly for its intended utility use case.

And what is its intended use case?  The maximalist vision (digital gold) or the originalist payments vision?

On p. 118 they write:

For example, in 2016, $100,000 of bitcoin was transacted every minute, which creates real demand for the utility of the asset beyond its trading demand. A great illustration of bitcoin’s price support increasingly being tied to utility came from Pantera Capital, a well-respected investment firm solely focused on cryptoassets and technology. in Figure 8.2 we can see that in November 2013 bitcoin’s speculative value skyrocketed beyond its utility value, which is represented here by transactions per day using Bitcoin’s blockchain (CAGR is the compound annual growth rate).

But this didn’t happen.

Pantera has a habit of cherry picking dates and using different types of graphs (such as log versus linear) in order to talk its book.

For instance, they conjured up and pushed the “bitcoin absorbs the value of gold” narrative back in late 2014.  Then a year later, they became part of the “great pivot” by rebranding everything “blockchain” instead of bitcoin.

Putting those aside, the transactional part of the graph (Figure 8.2) from Pantera was published in early 2017 and has not held up to further scrutiny by mid-2018.

Source: Pantera

Compare that with the actual transactional volume for the past two years, including the most recent bull run:

Perhaps for some unknown reason the up-and-to-the-right hockey stick graph that Pantera tried to create with its dotted lines will germinate.  But for now, as of this writing, their transactional / utility thesis is incorrect.

Why?  Because the assumptions were the same as the authors of this book: they assume retail or institutional users will flock to using bitcoin for non-speculative reasons, but that has not occurred yet.

On p. 119 they write:

Speculative value diminishes as a cryptoasset matures because there is less speculation regarding the future markets the cryptoasset will penetrate. This means people will understand more clearly that demand for the asset will look like going forward. The younger the cryptoasset is, the more its value will be driven by speculative vlaue, as shown in Figure 8.3. While we expect cryptoassets to ossify into their primary use cases over time, especially as they become large system that support significant amounts of value, their open-source nature leaves open the possiblity that they will be tweaked to pursue new tangential use cases, which could once again add speculative value to the asset.

Their wording in this and other passages has definitive certainty without any hedging.

This is unfounded.  Recall, what can be presented without evidence can be dismissed without evidence.  This also makes a circular argument that the next edition needs to provide evidence for (or just remove it).

Chapter 9

On p. 122 the write:

For example, currently the bond markets are undergoing significant changes, as a surprising amount of bond trading is still a “voice and paper market,” where trades are made by institutions calling one another and tangible paper is processed. This makes the bond market much more illiquid and opaque than the stock market, where most transactions are done almost entirely electronically: With the growing wave of digitalization, the bond markets are becoming increasingly liquid and transparent. The same can be said of markets for commodities, art, fine wine, and so on.

In re-reading this I can’t tell if the authors recognize that the bond market, as well as all of the other markets listed, started out in pre-electronic and even pre-industrial times.

That’s not to defend the status quo, only that if modern day trading platforms and automation existed a couple hundreds years ago, it is likely that bonds trading would have migrated much earlier than 2018… maybe even on a blockchain!

On p. 122 they write:

Cryptoassets have an inherent advantage in their liquidity and trading volume profile, because they are digital natives. As digital natives, cryptoassets have no physical form, and can be moved as quickly as the Internet can move the 1s and 0s that convey ownership.

This is conflating digitization/digitalization with blockchains.  You can have one without the other and in fact, do.

For instance, with US equities, beginning in the ’60s through the ’70s, stocks were dematerialized then immobilized in CSDs and ownership is now transferred electronically.86

Perhaps there is something to be said about this market infrastructure further evolving in time with a blockchain of some kind.

For example in the US, the DTCC (a large CSD) has:

Virtually every major CSD, stock exchange, and clearing house has likewise publicly opined or participated in some blockchain-related initiatives.  But that is a separate topic maybe worth looking into for the next edition.

On p. 123 they write:

Even though they are growing at an incredible clip, separation between cryptoasset markets and traditional investor capital pools still largely remains the case.

How much real money has actually entered the cryptocurrency market?

There have been several attempts to quantify it and it is still rather small, maybe up to $10 billion came in during 2017.

On p. 125 they write:

For example, in 2016, Monero experienced a sizeable increase in notoriety–largely because its privacy features began to be utilized by a well-known dark market–which sent its average trading volume skyrocketing. In December 2015, daily volume for the asset was $27,300, but by December 2016 it was $3.25M, well over a hunderfold increase. The price of the asset had appreciated more than 20-fold in the same period, so some of the increase in trading volume was due to price appreciation, but clearly a large amount was due to increased interest and trading activity in the asset.

But how do the authors know this “clearly” was the case?  Did they do some random sample surveys?  The next edition they need to prove their assumption, not just make them.  After all, it is hard — perhaps impossible — to externally ascertain what is going on at an exchange simply by looking at self-published volumes.

Also, the exchanges that these coins trade on are still typically unregulated, with little optics into how often manipulation occurs.  That is why a number of them have been subpoenaed by various governmental bodies; in the US this includes the SEC, CFTC, IRS, FBI, and even separate states acting in coordination.

On p. 129 they write:

From these trends, we can infer that this declining volatility is a result of increased market maturity. Certainly, the trend is not a straight line, and there are significant bumps in the road, depending on particular events. For example, monero had a spike in volatility in late 2016 because it experienced a significant price rise. This shows volatility is not only associated with a tanking price but also a skyrocketing price. The general trend, nonetheless, is of dampening volatility […].

This is not true either.  Maybe there are cherry picked dates in which there is relatively lower volatility than normal, but this year alone prices as measured in real money, declined between 60-100% for basically all crypotocurrencies and this involved a roller coaster to achieve.

In fact, in the process of writing this review, there were multiple days in which prices increased 5-10% for most coins and then a few days later, saw the same size of loses.  Erratic volatility have not disappeared.

On p. 133 they write:

Despite the many PBOC interventions, Chinese citizens used bitcoin to protect themselves against the erosion in value of their national currency.

Who in China did this?

I have spent an enormous amount of time visiting China the past several years on business trips and not once did someone say they had shifted their wealth from RMB into bitcoin because of RMB depreciation.  There are many speculators and miners, but to my knowledge there has not been a formal survey of buyers and their motivations… and the result being because of RMB depreciation.

The next edition should either remove this statement or add a citation.

On p. 134 they write:

As bitcoin rose and fell, so too did these assets. This reinforces the need for the innovative investor to become knowledgeable about these assets’ specific characteristics and recognize where correlations may or may not occur.

Recommend removing “innovative investor” in this location.87

Chapter 10

On p. 137 they write:

On its path to maturity, bitcoin’s price has experienced euphoric rise and harrowing drops, as have many cryptoassets. One of the most common complaints among bitcoin and cryptoasset naysayers is that these fluctuations are driven by the Wild West nature of the markets, implying that cryptoassets are a strange new breed that can’t be trusted. While each cryptoasset and its associated markets are at varying levels of maturity, associating Wild West behavior as unique to cryptoasset markets is misleading at best.

No it isn’t.  The authors do not even define or provide some kind of way to measure “maturity.”  This paragraph creates a strawman.

The burden-of-proof rests on the party making the positive claim.  In this case, the party claiming that a coin is becoming mature must provide objective evidence this is taking place.  Should reword in the next edition.

On p. 138 they write:

Broadly, we categorize five main patterns that lead to markets destabilizing: the speculation of crowds, “This time is different,” Ponzi schemes, Misleading information from asset issuers, Cornering.

Those are valid patterns, in full agreement here.  But this edition does not help in dispelling these problems and arguably even contributes to some of the speculative frenzy.

On p. 138 they write:

Sometimes they do this to capitalize on short-term information they believe will move the market, other times they do it because they expect to ride the momentum of the market, regardless of its fundamentals. In short, they try to profit within the roller-coaster ride.

What are the fundamentals of any coin described in this book?  Next edition, clearly write out 5-10 if possible.

On p. 139 they write:

As America was struggling through the Great Depression, which many pinned on the stock market crash of 1929, there was strong resentment against speculators. Every crisis loves a scapegoat.

And in Bitcoinland there is no difference.  Bitcoiners love to blame: bankers, the Illuminati, naysayers, concern trolls, academics, the government, Jamie Dimon, big blockers, small blockers, weak hands, statists, other coins, China, George Soros, Warren Buffett, Mike Hearn… virtually every month there is a new boogeyman to blame something on.  I’ve even been blamed many times and I’m not involved at all in the market.

On p. 143 they write:

Cheap credit often fuels asset bubbles, as seen with the housing bubble that led to the financial crisis of 2008. Similarly, cryptoasset bubbles can be created using extreme margin on some exchanges, where investors are effectively gambling with money they don’t have.

Fully agree, good point.

On p. 144 they write:

The best way to avoid getting burned in this manner is to do proper due diligence and have an investment plan that is adhered to.

Fully agree, good point.

On p. 145 they write:

The key to understanding bitcoin’s value is recognizing it has utility as “Money-over-Internet-Protocol”( MoIP)–allowing it to move large amounts of value to anyone anywhere in the world in a matter of minutes–which drives demand for it beyond mere speculation.

This might be partially true but is has the same feel-good narrative that folks like Andreas Antonopoulos have been getting paid handsomly to regurgitate.  Bitcoin (the network) does not move anything beyond bitcoins (the coin).  Users still have to convert bitcoins into actual money at end points.

Converting a large amount — greater than $10,000 — will likely require KYC and AML and maybe even sanctions checks.  This adds time and money which is one of the reason why the remittance use-case didn’t really get much traction after the hype in 2014 – 2015 and why companies such as Abra had to pivot a few times.

With that said, their metapoint is valid on the edges: despite the frictions that may exist, some participants are willing to go through this experience in order to gain more anonymity for uses they might not otherwise be able to do using traditional methods.88

Over the past three years there has also been an expansion of country- and region-based payment schemes worldwide to achieve near-real-time transfers, with Europe being one of the most significant accomplishments.89

In parallel, there are on-going experimentation and scaling of private blockchain-based ‘rails’ like Swift gpi or Alipay with GCash which have a potential to surpass volumes of the Bitcoin network.90

On p. 145 they write:

When Mt. Gox was established, bitcoin finally became accessible to the mainstream.

One nitpick:

Up until recently it was difficult for even diehard users to get onboarded onto most exchanges.  And specifically in 2010 with the launch of Mt. Gox, Jed McCaleb used Paypal to help facilitate the transfer of money… until Paypal dropped Mt. Gox because of too many chargebacks.  To get money into and out of Mt. Gox often was a frictionfull task, unless you lived in Japan.

On p. 149 they write:

As shown in Figure 10.4, steem’s price in bitcoin terms would fall from its mid-July peak by 94 percent three months later, and by 97 percent at the end of the year. This doesn’t mean the platform is bad. Rather, it shows the speculation and excitement about its prospects fueled a sharp rise and fall in price.

In hindsight, everything is 20-20.  The same truism in their last sentence can be said just about with every coin that sees the meteoric rise that Steemit did in 2016.91

On p. 150 they write:

While zcash has since stabilized and continues to hold great promise as a cryptoasset, its rocky start was caused by mass speculation.

Two comments:

  • Do the authors own any Zcash (or other cryptocurrencies mentioned in this book besides bitcoin)?
  • In late 2016 there were oodles of “thought leaders” talking about how Zcash was — for a moment — valued at a trillion dollars because of the very thin supply that was trading on exchanges.  It was a headscratching meme that illustrates a shortcoming to the common “market cap” valuation mehtod.92

On p. 152 they write:

The idea of valuation, which we will tackle in the next chapters, is a particularly challenging one for cryptoassets. Since they are a new asset class, they cannot be valued as companies are, and while valuing them based on supply and demand characteristics like that of commodiites has some validity, it doesn’t quite suffice.

Then why spend an entire chapter (Chapter 7) comparing coins such as bitcoin, to companies and their stock?

You can’t have it both ways.  Either heavily modify Chapter 7 in the next edition, or remove this comment.

Chapter 11

On p. 155 they write:

Given the emerging nature of the cryptoasset markets, it’s important to recognize that there is less regulation (some would say none) in this arena, and therefore bad behavior can persist for longer than it may in more mature markets.

And there are now full-time lobbyists and trade associations — sponsored by donors whom have benefited from this unregulated / underregulated market — that actively push back against sensible regulations being applied.  But that’s a different conversation beyond this post.

On p. 155 they write:

As activity grows in bitcoin and crypotasset markets, investors must look beyond the madness of the crowd and recognize that there are bad actors who seek easy prey in these young markets.

Even for a book published in late 2017, this is pretty much lip service.  Volumes of books can be written about the shenanigans within nearly every public ICO and high-profile coin project.  The authors should either modify the statement above or ideally expand it to detail specific egregious examples besides just OneCoin.

For instance, a new study found that: More Than Three-Quarters of ICOs Were Scams.  And these were ICOs done in 2017.

On p. 158 they write:

While a truly innovative crypotasset and its associated architecture requires a heroic coding effort from talented developers, because the software is open source, it can be downloaded and duplicated. From there, a new cryptoasset can be issued wrapped in slick marketing. If the innovative investors doesn’t do proper due diligence on the underlying code of read other trusted sources who have, then it’s possible to fall victim to a Ponzi scheme.

Enough with the “heroic” adjectives, let’s not put anyone on a pedestal, especially if the platform is not being used by anyone besides speculators and illicit actors.

Secondly, a minor grammar question: other uses of “open-source” in this book have a dash and the one above does not.

Lastly, recommend readers look into “Nakomoto Schemes” described in this article: The Problem with Calling Bitcoin a “Ponzi Scheme”

On p. 158 they write:

Millions of dollars poured into OneCoin, whose technology ran counter to the values of the cryptoasset community: its software was not open source (perhaps out of fear that developers would see the holes in its design), and it was not based on a public ledger, so no transactions could be tracked.

First, what are the “values” that the “community” has?  Are these explicity written somewhere?  Who decided those?

Second, those actually don’t sound too uncommon.

For instance, one recent study found: “Security researchers have found, on average, five security flaws in each cryptocurrency ICO (Initial Coin Offering) held last year. Only one ICO held in 2017 did not contain any critical flaws.”

And remember, these projects are “open source” yet most buyers and investors didn’t bother looking at the code.  OneCoin is par for the course.

On p. 159 they write:

The swift action revealed the strength of a self-policing, open-source community in pursuit of the truth.

In my most popular post last year, I went through in detail explaining how self-policing is an oxymoron in the cryptocurrency world.

For example, “the community” actively listed OneCoin on secondary markets and profited from its trading.  Did exchange operators return those gains to victims?  In addition, “the community” has thus far, not set up any self-regulating organization (SRO) that has any ability or teeth to enforce a code-of-conduct.

In fact, it was agencies from Sweden, the UK, and other governments that acted and cracked down on OneCoin… not a collective effort from exchanges or VCs or twitter personalities.

On p. 159 they explain googling for code on GitHub:

If nothing pops up with signs of the code on GitHub, then the cryptoasset is likely not open source, which is an immediate red flag that a cryptoasset and investment should be avoided.

Sure, but it doesn’t include the fact(s) that even in 2017 we knew that many coin projects had bugs in it… because there is no incentive to independently audit this code or to publish it in an objective manner.

For example, often when someone tries to help highlight problems, they are demonized as a “concern troll” as the coin tribes brigade their Twitter and reddit threads.  There are a couple of sites like ConcourseQ that now do help highlight problems, but most “crypto thought leaders” on social media spend their time rallying retail investors to buy coins instead of busting or calling out the legitimate coin scams.

On p. 161 they write about John Law:

Fortunately, today it’s quite easy to find information on just about anyone through Google searches.

Yes and no.  And that still doesn’t act as a shield against fraud.  The founders of Centra had shady, criminal pasts but were still able to raise more than $30 million in an ICO.  Their misdeeds only became widely known after a New York Times article explored it… this was not a story that was investigated by any of the “coin media” who collectively have a vested interested not to “self-police” the market they cover.

Furthermore, prior to getting busted and sued, Centra became a dues paying member of: Hyperledger, the Enterprise Ethereum Alliance, and the Chamber of Digital Commerce.  What are the filtering mechanisms in place at these types of organizations?  How do they determine who can join and if a coin is a security?

On p. 165 they write:

As with most panics, the contagion spread from the Gold Exchange.  Because of Goluld’s cornering of the market, stock prices dropped 20 percent, a variety of agricultural exports fell 50 percent in value, and the national economy was disrupted for several months. Gould exited with a cool $11 million profit from the debacle, and scot-free from legal charges. It is all too common that character like Gould escape unscathed by the havoc they create, which then allows them to carry on with their machinations in other markets.

These kinds of panics and manipulation are part and parcel to retail traders on cryptocurrency exchanges.  Scapegoats and the blame game consist of a myriad of boogeymen — but typically the culprits are never found.93

On p. 167 they write:

In addition to miners, in Dash there are entities called masternodes, which are also controlled by people or groups of people. Masternodes play an integral role in performing near instant and anonymous transaction with Dash.

Putting aside whether Dash is or is not anonymous… the fact that the authors state that humans play a direct role in running the infrastructure raises a bunch of questions that I have repeated in this review.

How are these participants held accountable?  How is governance managed?  Have these participants registered with FinCEN?  Why or why not?

On p. 168 they write about the Bitcoin Rich List:

Another 116 addresses hold a total of 2.87 million bitcoin, or 19 percent of the total outstanding, which is sizeable. Unlike dash, however, these holders aren’t necessarily receiving half the newly minted bitcoin, and so their ability to push the price upward is less.

Should there be a thorough investigation of how any one party or set of parties can artificially move prices around based on control of the money supply?  In meat space, there are frequent public hearings and audits done.  When will minters of cryptocurrencies be publicly audited?

Chapter 12

On p. 171 they write:

Each cryptoasset is different, as are the goals, objectives, and risk profiles of each investor. Therefore, while this chapter will provide a starting point, it is by no means comprehensive. It’s also not investment advice.

Throughout the book the authors have repeatedly endorsed or not-endorsed specific coins.  The second edition needs to be a lot more consistent.

On p. 172 they write:

Currently, there is no such thing as sell-side research for cryptoassets, and this will require innovative investors to scour through the details on their own or rely on recognized thought leaders in the space.

This is a sad truth: it is nearly impossible to get neutral, objective research on any coin that has been created.

Why?  Because all coin holders basically have an incentive to promote and advertise the coins they own and talk down other coins they perceive as competition.  Paying “researchers” has happened and will continue to do so.

Also, here’s another appearance of “innovative investor” — can that be removed altogether?

And lastly, how to know who the “recognized thought leaders” are?  Based on the amount of twitter followers they have?  That has been gamed.  Based on how popular their Youtube account is?  That has been gamed.

For example, these two article explain some of this payola world:

Another instance, a couple weeks ago a government department in China (CCID) released its second ranking table of coins: China’s Crypto Ratings Index Puts EOS in Top Slot, Drops Bitcoin

It’s unclear if this is due to lobbying efforts or maybe the researchers owned a bunch of EOS coins.  At this time, the EOS block producing and arbitrator framework are both broken.  Block producers paused the network a few weeks ago and the arbitrators / constitutions will probably be scrapped.

How can this rating system be trusted?

On p. 173 they write about white papers:

Any cryptoasset worth its mustard has an origination white paper. A white paper is a document that’s often used in business to outline a proposal, typically written by a thought leader or someone knowledgeable on a topic. As it relates to cryptoassets, a white paper is the stake in the ground, outlining the problem the asset addresses, where the asset stands in the competitive landscape, and what the technical details are.

During the Consensus event this past May, someone accidentally dropped a napkin on the floor and someone loudly said: watch out, that’s the latest multimillion dollar white paper.

And that’s the situation where we are in now.  Readers: the passage above was not at all critical of the real mess we are in today.  For instance, Tron literally plagiarized in its whitepaper, raised a ton of money in its ICO and recently bought BitTorrent.

There is no direct connection between a “good” or “bad” whitepaper and the performance of the coin.  Retail investors do not typically care and haven’t done much research.  Yet another reason agencies such as the SEC will be overwhelmed in the coming years due to rampant fraud and deceit.  Worth looking into the next edition.

On p. 173 they write:

Some of these white papers can be highly technical, though at the very least perusing the introduction and conclusion is valuable.

This seems like an incongruent statement compared to other advice in the book about doing deep research.  Recommend revising.

On p. 174 they write:

A number of cryptoasset-based projects focus on social networks, such as Steemit and Yours, the latter of which uses litecoin. While we admire these projects, we also ask: Will these networks and their associated assets gain traction with competitors like Reddit and Facebook? Similarly, a cryptoasset service called Swarm City (formerly Arcade City) aims to decentralize Uber, which is already a highly efficient service. What edge will the decentralized Swarm City have over the centralized Uber?

And that in a nutshell is why the second edition of the book arguably needs to be slimmed down by 25%+.  Virtually all of the use cases in this book are simply potential use cases and have shown little or even no traction in reality.  For example, if the authors were as critical to Bitcoin and Zcash as they were to Swarm City then the second edition might be perceived as more balanced.

Specifically, in their promotion of Bitcoin as a payments platform, they have not done a deep dive into other existing payment networks, such as Visa or an RTGS from a central bank.94 They should do that in the next edition otherwise these come across as one-sided arguments.

Also, Yours switched from Litecoin over to Bitcoin Cash last year (around the time the book was published) and Swarm City is still not very active at the time this review was written.

On p. 175 they write about The Lindy Effect

The same applies to cryptoassets. The longest-lived cryptoasset, bitcoin, now has an entire ecosystem of hardware, software developers, companies, and users built around it. Essentially, it has created its own economy, and while a superior cryptocurrency could slowly gain share, it would have an uphill battle given the foothold bitcoin has gained.

This is untrue in theory and practice.

While maximalists would vocally claim that there can only be one-chain-to-rule-them-all, there is no real moat that Bitcoin has to prevent users from exiting or switching to other platforms (see discussion on substitute goods).

In practice, effectively all proof-of-work cryptocurrencies depend on external capital to stay afloat, often in the form of venture capital. ((See Robert Sams on rehypothecation, deflation, inelastic money supply and altcoins)) Part of the reason is that miners need to pay their bills in traditional currency and therefore must liquidate some or all of their coins to do so.  Another issue is that because many participants think or believe that coin prices as measured in real money will increase in the future, they hold.  Yet the expenses of service providers (exchanges, wallets, etc.) typically need to be paid with traditional money.

As a result, this creates sell-side pressure.  And unlike the traditional FX market which has “natural” buyers in the form of international merchants and multinational corporations: there still is no “natural” buyers of cryptocurrencies outside of illicit activity (e.g., darknet market participants).

To compound this situation is that there is still no real circular flow of income, no real economy for any of these cryptocurrencies.95  And with the exception of a few cases each year, miners typically do not directly invest their coin holdings into companies, so crypotcurrency-related startups are dependent on foreign currency.

On p. 175 they write:

The demise of The DAO significantly impacted Ethereum (which The DAO was built on), but through leadership and community involvement, the major issues were addressed, and as of April 2017 Ethereum stands solidly as the second largest cryptoasset in terms of network value.

In the second edition, could the authors explicitly lay out how they define “leadership” in this context as well as what the “community” is?  If it is singular and centralized, how is that fitting for an entity that is supposed to be decentralized?

Also, for readers interested in The DAO, here’s a short fiery thread on that topic.

On p. 176 they discuss “utility value and speculative value”

For bitcoin, its utility is that it can safely, quickly, and efficiently transfer value to anyone, anywhere in the world.

That may have been the original vision expressed in the whitepaper but it is not what the maximalists now claim Bitcoin is.  Who’s promotion around utility is something we should take into consideration?

Also, considering how easy and common it is to hack cryptocurrency intermediaries such as exchanges, I think it is debatable that Bitcoin is “safe” for unsophisticated retail users, but that’s a separate topic.

On p. 176 they write:

The merchants wants to use bitcoin because it will allow her to transfer that money within an hour as opposed to waiting a week or more. Therefore, the Brazilian merchant buys US$100,000 worth of bitcoin and sends it ot the Chinese manufacture.

They explain a little more but the difficulties with this example starts here.  The authors only focus on the bitcoins themselves, they don’t explore the actual full lifecycle that international merchants and manufacturers have to go through in order to exchange bitcoins into real money that they can use to pay bills.

That is to say: the Brazilian merchant and Chinese manufacture do not hold onto coins, so it is not just a matter of how fast they can send or receive the coins.  What ultimately matters to them is how quickly they can receive the real money from a bank.

So the next edition needs to include the full roundtrip costs and frictions including the on-ramps and off-ramps into the traditional financial system.  This is why many Bitcoin remittance companies struggled and ultimately had to pivot out of that cross-border use case (such as Abra).  For the next edition, a side-by-side cost comparison would be helpful.96

On p. 177 they write:

That means on average each of these addresses is holding US$5.5 million worth of bitcoin, and it’s fair to assume that these balances are not those of merchants waiting for their transactions to complete. Instead, these are likely balances of bitcoin that entities are holding for the long term based on what they think bitcoin’s future utility value will be. Future utility value can be thought of as speculative value, and for this speculative value investors are keeping 5.5 million bitcoin out of the supply.

This seems like euphemisms.  We understand that time preferences and discounted utility come into dramatic effect here.  Maybe worth rewording?

For example, a large portion of those coins could be permanently destroyed (e.g., someone deleted the private key or threw away the hard drive).  Though a significant portion could also be maximalists holding onto their coins with the hope that other investors create sufficient demand to move the price — as measured in real money — upward and upward.  So they can then cash out.

If daily and weekly anecdotes on twitter and reddit are any indication, that’s arguably the real utility value of most coins, not just bitcoin.  And there is some analytics to back up that argument too.

On p. 177 they write:

At the start of April 2017, there were just over 16 million bitcoin outstanding. Between international merchants needing 10 million bitcoin, and 5.5 million bitcoin held by the top 1,000 investors, there are only roughly 500,000 bitcoin free for people to use.

Citation needed. If the authors have any specific information that can share with the audience about any of these numbers, that’d be very helpful.  Especially regarding the merchants needing 10 million bitcoin.  If anything, there may be fewer merchants actively accepting bitcoin today than there were a couple years ago.

On p. 177 they write:

If demand continues to go up for bitcoin, then with a disinflationary supply schedule, so too will its price (or velocity).

Couple of things:

  • Bitcoin’s current supply schedule is perfectly inelastic (whereas say gold, is elastic).
  • It would be good to see what the authors think the velocity of bitcoin is.  I’ve tried to track down and write about it in the past.  See all of Chapter 9.

On p. 177 they write:

In other words, those investors no longer feel bitcoin has any speculative value left, and instead its price is only supported by current utility value.

As mentioned above, it would be helpful in the next edition if the authors included specific definitions and characteristics in a chart for what utility versus speculative value are.

Also, I don’t endorse the post in its entirety, but about five years ago Rick Falkvinge wrote an interesting note about the transactional value from illicit activity as it relates to Bitcoin.  That has some actual data in it (though very old now).

On p. 178 they write:

For bitcoin, instead of looking at the “domestically produced goods and services” it will purchase in a period, the innovative investor must look at the internationally produced goods and services it will prucahse. The global remittances market–currently dominated by companies that provide the ability for people to send money to one another internationally–is an easy graspable example of service within which bitcoin could be used.

This whole section should probably be culled because this isn’t really a viable, scalable use case that bitcoin itself can solve.

For example, between 2014-2016, tens of millions of dollars were invested in more than a dozen “rebittance” companies (Bitcoin-focused remittance) and most either failed or pivoted.

Those that still exist had to build additional services and bitcoin were a means to an end.  In all cases, these companies had to build their own cryptocurrency exchange and/or partner with several cryptocurrency exchanges in order to liquidate the coins — they need to hedge and limit their exposure to volatility.  Bitcoin also doesn’t solve for the last-mile problem at all… but that is a separate topic.97

On p. 179 they write:

If each bitcoin needs to be worth $952 to service 20 percent of the remittance market and $11,430 to service the demand for it as digital gold, then in total it needs to be worth $12,382. There is no limit to the number of use cases that can be added in this process, but what is extremely tricky is figuring out the percent share of the market that bitcoin will ultimately fulfill and what the velocity of bitcoin will be in each use case.

This is highly debatable.  And it is exactly what Pantera stated four years ago.  Sources should be cited in the next edition; and also provide a velocity estimate for the potential use cases.

On p. 180 they write:

Taking the concepts of supply and demand, velocity, and discounting, we can figure out what bitcoin’s value should be today, assuming it is to serve certain utility purposes 10 years from now. However, this is much easier said than done, as it involves figuring out the sizes of those markets in the future, the percent share that bitcoin will take, what bitcoin’s velocity will be, and what an appropriate discount rate is.

An actual asset would certainly need these blanks filled, but Bitcoin doesn’t behave like a normal asset.  For instance, it goes through enormous speculative bubbles and busts.  It reached just under $20,000 per coin in mid-December last year not for any utility reason but pure speculation… yet many of the “thought leaders” at the time said it was because new buyers were going to use it for its utility.

On p. 180 they write:

Already there have been reports, such as those from Spence Bogart at Needham & Company, as well as Gil Luria at Webush, that look at the fundamental value of bitcoin.

I’ve read most of their reports, they’re nearly all based on edge-case assumptions or one-off anecdotes that never saw much traction (such as remittances).  In addition, arguably both of their analysis may have been colored by their coin investments at the time they published their work.  That’s not to say their material is discredited but I would discount some of their cryptocurrency-related reports.98

On p. 180 they write:

The valuations these analysts produce can be useful guides for the innovative investor, but they should not be considered absolute dictations of the truth. Remember, “Garbage in, garbage out.” We suspect that as opposed to these reports remaining proprietary, as is currently the case with much of the research of equities and bonds, many of these reports will become open-source and widely accessible to all levels of investors in line with the ethos of cryptoassets.

This has not happened.  If anything, the market has been flooded with junk marketing material that masquerades as “research.”  Unviersities are now getting funded by coin issuers and asked to co-publish papers.  Even if there are no explicit shenanigans going on, there is now a shadow of doubt that hangs over these organizations.

Also, the next edition needs to define what “the ethos of cryptoassets” is somewhere up front.  And dispense with “innovative investor”?99

On p. 182 they write about getting to know “the community and the developers”:

In getting to know the community better, consider a few key points. How committed is the developer team, and what is their background? Have they worked on a previous cryptoasset and in that processrefined their ideas so that they now want to alunch another?

[…]

If information cannot be found on the developers, or the developers are overtly anonymous, then this is a red flag because there is no accountability if things go wrong.

Satoshi clearly wouldn’t have been able to pass this test.  Nor BitDNS originally (which later became Namecoin).

It is a double-standard to want accountability here yet promote an ill-defined “decentralization” throughout this book.  You really can’t have it both ways.

Remember, the reason why administrators and operators of financial market infrastructure are heavily regulated is to hold participants legally responsible and accountable for when mistakes and accidents occur.

Cryptocurrencies were designed to be anarchic and purposefully were designed to not make a single participant accountabile.  Trying to merge those two worlds creates the worst of both: permissioned-on-permissionless.

On p. 183 they write:

If Ethereum gets big enough, there may eventually be those who call themselves Ethereum Maximalists!

Yes, they exist and largely self-selected themselves into the Ethereum Classic world… you can see that by their antics on social media.

On p. 183 they write about issuance models:

Next, consider if the distribution is fair. Remember that a premine (where the assets are mined before the network is made widely available, as was the case with bytecoin) or an instamine (where many of the assets are mined at the start, as was the case with dash) are both bad signs because assets and power will accrue to a few, as opposed to being widely distributed in line with the egalitarian ethos.

Let’s tone down the talk on egalitarianism in a market fueled by greed and a perpetually high Gini coefficient.

In practice as of July 2018, many ICOs are pre-mined or pre-allocated, most as ERC20 tokens that are controlled by a singular entity (usually an off-shore foundation).100

Is this a “bad sign”?  It would be helpful to see what the explicit criteria around token distribution should be in the next edition.101

On p. 183 they write:

For example, Ethereum started with one planned issuance model, but is deciding to go with another a couple years into launch. Such changes in the issuance model may occur for other assets, or impact those assets that are significatnly tied to the Ethereum network.

Those decision are made by individuals.  Perhaps by the next edition we will know what FinCEN and other regulatory positions on individuals creating monetary policy and running financial market infrastructure.

On p. 184 they write:

With Dogecoin we saw that it needed lots of units outstanding for it to function as a tipping service, which justifies it currently having over 100 billion units outstanding, a significantly larger amount than Bitcoin. With many people turning to bitcoin as gold 2.0, an issuance model like Dogecoin’s would be a terrible idea.

What?  Why?  This passage conflates many different things.

  1. As Jackson Palmer has repeatedly said: Dogecoin was set up as a joke, based on a meme.  The authors seem to be taking its existence a little too seriously.
  2. Dogecoin was originally based on Luckycoin which had a random money supply, so its original hashrate charts were all over the map, bipolar.
  3. Its money supply was changed in part because it ran into an exitential crisis that it later (mostly) solved by merge mining with Litecoin in 2014

How does any of this have to do with maximalist narrative of “gold 2.0”?

On p. 186 they write:

The only way attackers can process invald transactions is if they own over half of the computer power of the network, so it’s critical that no single entity ever exceeds 50 percent ownership.

Technically this is not quite right.

The actual figure to sucessfully censor and/or reorg the chain may be as low as 33% and perhaps even 25% (dubbed “selfish mining“).102  More than 50% would mean the participants could do so repeatedly until their hashrate declines and/or a permanent fork occurs.

Aside from pressure on social media, there is nothing to prevent such “ownership” from taking place.  And there is no legal recourse or accountability in the event it happens.  And such “attacks” have occured on many different cryptocurrencies.103

On p. 186 they write:

In other words, miners are purley economically rational individuals–mercentaries of computer power–and their profit is largely driven by the value of the crypotasset as well as by transaction fees.

This should be reworded from the next edition because it is not true.  Miners and mining pools are operated by people and they have various incentives, including to attack networks or abandon them altogether.

On p. 186 they write:

A clearly positively reinforcing cycle sets in that ensures that the larger the asset grows, the more secure it becomes–as it should be.

This is not true for proof-of-work coins.

If anything, mining and development have both trended towards centralization.  For instance, it is estimated that Bitmain-manufactured hashing equipment currently generates 60-80% of the network hashrate and Bitmain-affiliated mining pools comprise about 50%+ of the current Bitcoin network.  Maybe that is just momentary but singular entities on the mining side dominate many other cryptocurrencies as well.  Perhaps that changes later in the year so it is worth revisiting in the next edition.

Recommended reading:

On p. 187 they write:

At the risk of being repetitive, more hash rate signifies more computers are being added to support the network, which signifies greater security.

This is a non sequitur.  A new hashing machine capable of generating 10 times the amount of hashes as the previous machine could — ceteris paribus — result in other machines being turned off.  In practice, you often have the Red Queen Effect take place (see Chapter 3).

Either way, depending on the costs of more efficient ASIC design, there could actually be fewer (or more) hashing machines added to a network depending on the expected price of the coin minus operating costs.

And in some cases, the network may become more centralized and therefore arguably less secure.  Worth revising in next edition.

On p. 188 they write:

While hash rate often follows price, sometimes price can follow hash rate. This happens in situations where miners expect good things of the asset in the future, and therefore proactively connect machines to help secure the network. This instills confidence, and perhaps the expected good news has also traveled to the market, so the price start going up.

This passage has entered Rube Goldberg territory, where a series of specific events turn into a virtuous cycle in which prices go up and up but not down?  How can we ever know what caused certain price increases or decreases with this type of asymmetric information occurring in the background?  Suggest scrapping it in the next edition.

On p. 188 they write:

Ethereum’s mining network, on the other hand, is less built out because it’s a younger ecosystem that stores less value. As of March 2017, a 230 megahash per second (MH/s) mining machine could be purchased for $4,195, and it would take 70,000 of these machines to recreate Ethereum’s hash rate, totaling $294 million in value. Also, because Ethereum is supported by GPUs and not ASICs, the machines can more easily be constructed piecemeal by a hobbyist on a budget.

There are a few issues with this:

  1. How do the authors measure or quantify “less built out”?  Is there a line that is crossed in which Ethereum or other coins are “more built out” or the right size?
  2. About a year ago a coin reporter asked me to detail the hypothetical lower bound costs for recreating the hashrate of the Bitcoin network.  I provided those numbers based on Bitmain’s latest device… but the article instead ignored any of that and instead quoted some random conspiracy theory from a Twitter personality.  Rather than rehashing the full story here, keep in mind that the geographic distribution and control of mining equipment is arguably as important as the aggregate network hashrate.
  3. Their last sentence does not make much sense.  How to define a hobbyist?  If a hobbyist is defined as an individual who can afford to spend $4,195… then they can probably also buy ASIC equipment as well for other cryptocurrencies, including Ethereum today.

On p. 188 they write:

This range is a good baseline for the innovative investor to use for other cryptoassets to ensure they are secured with a similar level of cpaital spend as Bitcoin and Ethereum, which are the two best secured assets in the blockchain ecosystem.

There is another appearance of the “innovative investor,” remove in next edition?

Also, if security is solely measured by hashrate then yes, Bitcoin (BTC) and Ethereum (ETH) might be the “best secured.”  But that assumes a purely Maginot Line attack and not a BGP or wrench attack.

On p. 189 they write:

Overall, hash rate is important, but so too is decentralization. After all, if the hash rate is extremely high but 75 percent of it is controlled by a single entity, then that is not a decentralized system. It is actually a highly centralized system and therefore vulnerable to the whims of that one entity.

This probably should come at the beginning of the chapter, not in this location.  Also recommend adding some citations to the Onename and BGP posts.

On p. 189 they write:

It’s apparent that Litecoin is the most centralized, while Bitcoin is the most decentralized. A way to quanitfy the decentralization is the Herfindahl Hirschman Index (HHI), which is a metric to measure competition and market concentration.

HHI is used with known, legally identifiable parties.  With cryptocurrencies such as Bitcoin, Litecoin, and Ethereum — the mining entities were not originally supposed to be known at all — over time they self-doxxed themselves.104

Should the Department of Justice and similar organizations coordinate and carry out HHI analysis on mining pools to prevent monopolization, oligopolization, and/or coordination?   What happens if participants refuse to comply?

On p. 191 they write:

Blockchain networks should never classify as a highly concentrated marketplace, and ideally, should always fall into the competitive market place category.

Okay, but what if they don’t and no one cares?  Who should enforce this?

Recommend reading a relevant paper published this past winter: Decentralization in Bitcoin and Ethereum Networks

On p. 193 they write:

At times, Bitcoin has been a moderately concentrated marketplace, just as Litecoin mining is currently a moderately concentrated marketplace. Litecoin recognizes the impact that large mining pools can have on the health of its ecosystem and the quality of its coin. To that point, Litecoin developers have instituted an awareness campaign called “Spread the Hashes” for those mining litecoin to consider spreading out their mining activies. The campaign recommends that litecoin computers mine with a variety of mining pools rather than concentraing solely in one.

The anthropomorphism needs to be removed in the second edition.  “Litecoin” does not recognize anything because Litecoin is not a singular autonomous entity.

There are individual people, developers who work on a certain implementation of Litecoin that may promote something — and if they coordinate (which they do) then perhaps they could be classified as administrators.

Either way, this “Spread the Hashes” campaign didn’t seem to work:

Source: Litecoinpool.org visited on July 11, 2018

As the pie chart above illustrates, just 5 entities currently account for about 90% of the network hashrate.  And the largest 3 effectively could coordinate to control the network if they wanted to.

Worth noting that similar marketing campaigns to “spread the hashes” have been done on other networks.  Back in 2014 when GHash.io reached the 50% mark, reddit was filled with discussions imploring miners to switch to P2Pool.

Why don’t miners move to smaller pools?  Two words: reliable revenue.  Recommended reading: The Gambler’s Guide To Bitcoin Mining

On p. 194 they write:

Not all nodes are made equal. A single node could have a large number of mining computers behind it, hence capturing a large percentage of the overall network’s hash rate, while another node could have mining computer supporting it, amounting to a tiny fraction of Bitcoin’s hash rate.

Sort of.  There are two different nodes: nodes that fully validate and attempt to append the blockchain by submitting a proof-of-work that meets the necessary difficulty threshold… and nodes that don’t.  In practice, today we call the former “mining pools” and the latter, just nodes.

For instance, in Bitcoinland there was a vicious war of words from 2015-2017 waged by several parties who did not operate mining pools, or nodes that generated proofs-of-work.105  One subset of these parties used various means and channels to insist that miners did not ultimately matter, that it was “users” who truly controlled the network and they labeled themselves “UASF.”  And some of the most vocal members of this “populism wing” insisted that the nodes run by mining pools were no more important than the nodes run by some hobbyist in an apartment.

The views were irreconcilable and the ultimate result is that one group involved in that battle, forked off and created a new chain called Bitcoin Cash (BCH), whereas many of the other parties coalesced with what is called Bitcoin (BTC).  There is a lot more to the story, a messy emotional divorce that still continues today.

Technically the decision to fork or not fork is made by mining pools and the nodes they each manage, but there are more nuances and politics involved that go beyond the scope of this review.

On p. 194 they write:

William Mougayar, author of The Business Blockchain, has written extensively about how to identify and evaluate new blockchain ventures and sums up the importance of developers succinctly: “Before users can trust the protocol, they need to trust the people who created it.” As we touched upon in the prior chapter, investigate the prior qualifications of lead developers for a protocol as much as possible.

Two problems with this:

  1. I wrote a lengthy book review of Mougayar’s book and found it disappointing and do not recommend because of statements like the one above.
  2. What were Satoshi’s qualifications?  No one knows, but no one really cares either.  Similarly, what were Vitalik Buterin’s qualifications?  He was 19 when he announced Ethereum at Bitcoin Miami and had recently dropped out of college.  Similarly, Gavin Wood was a 34 year-old developer building music-related apps prior to co-founding Ethereum.  Would these two key guys been deemed qualified?  What are the qualifications necessary to be a blockchain wizard?

On p. 194 they write:

Developers have their own network effect: the more smart developers there are working on a project, the more useful and intriguing that project becomes to other developers. These developers are then drawn to the project, and a positively reinforcing flywheel is created. On the other hand, if developers are exiting a project, then it quickly becomes less and less interesting to other developers, ultimately leaving no one to captain the software ship.

A couple of thoughts:

  1. This is a nice sounding theory, but that’s not really what happens with most of these projects.  Generally developers are attracted due to the compensation they can receive… they do a risk-reward analysis.  I’ve met and spoken to dozens, perhaps north of 100 cryptocurrency-related teams in the past 12 months across the globe.  Attracting talented developers is not nearly as easy and clear cut as the authors make it sound above.
  2. Also, having a single “captain of the ship” seems like a single point of failure and a centralization risk.  Is that part of the undefined ethos?

On p. 195 they write:

Recall that this is how Litecoin, Dash, and Zcash were created from Bitcoin: developers forked Bitcoin’s code, modified it, and then re-released the software with different functionality. Subscribers refer to people wanting to stay actively involved with the code. In short, the more code repository points, the more developer activity has occured around the cryptoasset’s code.

That’s not necessarily true, and in fact, has been gamed by coin issuers who want to make it look like there is a lot of independent activity and traction with developers… by creating spam accounts and very small changes to simple documents (like grammar).

It can be a helpful metric but you need someone technically inclined to dive into the code that is being added/removed/modified.  See: Increased Github Scrutiny Means Lazy ICO Developers Have No Place to Hide

Readers may also be interested in CoinGecko to see how this acitivity is weighted.

On p. 198 they write:

A different approach is to monitor the number of companies supporting a cryptoasset, which can be done by tracking venture capital investments. CoinDesk provides some of this information as seen in Figure 13.13. Though as we will address in Chapter 16 on ICOs, the trend in this space is moving away from venture funding and toward crowdfunding.

Actually, as mentioned a couple time earlier, there has been a noticeable divergence the past 12 months: coin sales that are done as private placements versus coin sales that have a public facing sale.

In general, most of the coins that have raised capital through private placement deals typically have less than 100 investors, many of which are the aforementioned “crypto hedge funds” and coin-focused venture funds such as Andreessen Horowitz and Union Square Ventures.

The public facing sales are generally eschewed by venture funds.  If venture funds are involved in a coin that does a public sale, they typically are involved in what is called a “pre-sale” where they receive preferential terms and conditions, such as discounted coins.

Upon the conclusion of the “pre-sale” the actual public sale begins with heavy marketing on social media towards retail investors.  Sometimes these sales have hundreds or even thousands of individual participants.  That could be called a “crowdsale” and these participants typically get worse terms than those who participated in the pre-sale.

On p. 199 they write:

Another good proxy for the increased acceptance of a cryptoasset and its growing offering by highly regulated exchanges is the amount of fiat currency used to purchase it.

Maybe consider revising because we have all been told that cryptocurrencies would not only displace “fiat currency” but also topple and replace the existing financial system… how does measuring these new internet coins with old money help achieve that?

For instance, at the time of this writing none of the US-based retail exchanges with domestic bank accounts have recently listed an ICO (with the exception of ETH and ETC).  This includes: itBit, Bitflyer, Coinbase, and Gemini.106  Kraken’s retail exchange uses payment processors and banking partners outside of the US.107

On p. 199 they write:

in the one-year period from March 2016 to March 2017, ether went from being traded 12 percent of the time with fiat currency to 50 percent of the time. This is a good sign of the maturation of an asset, and shows it is gaining wider recognition and acceptance.

Why is that specific ratio or percentage deemed good?  The next edition should include a table explaining this in further because it is unclear why it is good, neutral, or bad.

On p. 201 they write about wallets from Blockchain.info:

Clearly, having more users that can hold a cryptoasset is good for that asset: more users, more usage, more acceptance. While the chart shows an exponential trend, there are a few drawbacks for this metric. For one, it only shows the growth of Blockchain.info’s wallet users, but many other wallet providers exist. For example, as of March 2017, Coinbase had 14.2 million wallets, on par with Blockchain.info. Second, an individual can have more than one wallet, so some of these numbers could be due to users creating many wallets, a flaw which extends to other wallet providers and their metrics as well.

In the past I have written extensively on how these headline wallet numbers are basically gimmicks and don’t accurately measure users or user activity.

Why?  Because it costs nothing to open one.  And often there is no KYC or AML involved in creating one as well.  As a result, bots can be used to create many each day to inflate the metric.

Coinbase has actually removed usage data in the past and they still don’t define what the difference between a user or wallet is.  Nor do either company provide traditional DAU / MAU metrics.  It’s not hard to do and it is unclear why they don’t.  The only way we have some semblance of an idea of what Coinbase user numbers were between 2013-2015 is because of the IRS lawsuit mentioned above.

On p. 201 they write about a search trend, “BTC USD,” first described by Willy Woo:

If we assume this to be true, then Woo’s analysis indicating a doubling in bitcoin users every year and an order of magnitude growth every 3.375 years. He calls this Woo’s Law in honor of Moore’s Law […] It will be interesting to see how Woo’s Law holds up over time.

How has it done?  “Woo’s Law” has thus far not held up.

For instance, below is a 5 year trend chart of the same search term promoted by Woo and others last year:

As we can see above, this term has some correlation between interest in coins specifically during price bubbles.  But this has not translated into large quantities of new daily users.108

The next edition of this book should remove this faux eponym because it has not withstood the test of time and doesn’t measure actual users.

On p. 202 they write:

Figure 13.17 shows the hyper growth of Ethereum’s unique address count. With Ethereum, an address can either store a balance of either, like Bitcoin, or it can store a smart contract. Either denotes an increase in use.

Below is a screenshot of a recent address count:

Source: Etherscan

The next edition should include a caveat because it is unclear from this chart alone what kind of use is taking place.  Is it coin shuffling, miner payouts, gambling payouts, Crypokitty activity, etc.?  Maybe it is just someone spamming the network?

For instance, according to DappRadar which tracks 650 ethereum Dapps, over the past 24 hours there have only been 9,926 users sending 43,652 transactions.  That may sound intriguing but… nearly about 2/3rd of all these users are using decentralized exchanges (DEX).  If trading and arbitraging are the “killer apps” of cryptocurrencies, then the next edition of this book could be a lot slimmer than it is now.

As described in “Slicing data,” not all transactions are the same and a deep dive needs to be done to fully describe the behavior taking place.

On p. 204 they cite a “Dollar Value of Transactions” chart:

Source: Blockchain.info

But this is just an estimate from Blockchain.info and is likely widely exaggerated because Blockchain.info — like most wallet providers — probably has no idea what the intent behind those transactions are.  We need data from all of the exchanges, payment processors, and merchants that accept coins in order to conclusively know what activity was commercial versus non-commercial in nature.

For instance, a large portion of those transactions could simply be “change address.”

Not to get too technical, but with Bitcoin, in order to manually send X amount of bitcoin on-chain, users typically must enter a “change address” unless the whole amount of UTXO is consumed.  It’s kind of like a bank teller moving money from one till to another between shifts.  No new economic activity is actually taking place in the bank or in the real economy, but in this specific chart above, there is no way to differentiate “change address” activity with real commercial activity and so it all gets mixed and muddied.

On p. 204 they write:

If the network value has outpaced the transactional volume of that asset, then this ratio will grow larger, which could imply the price of the asset has outpaced its utility. We call this the crypto “PE ratio,” taking inspiration from the common ratio used for equities.

Except, without a thorough deep dive from an analytics provider who has mapped out activity into all of the exchanges, payment processors, and merchants — it is very difficult to actually differentiate the noise from the actual transactional utility.109

Here the authors take all on-chain transaction volume at face value.  The next edition should scrap this section unless they get access to a thorough deep dive.

On p. 204 they write:

One would assume that an efficient price for an asset would indicate a steadiness of network value to the transaction volume of the asset. Increasing transactional volume of an asset should be met by a similar increase in the value of that asset. Upside swings in pricing without similar swings in transaction volume could indicate an overheating of the market and thus, overvaluation of an asset.

That is a popular model but could be incorrect.

I recommend readers check-out this excellent recent thread started by Nathaniel Popper as well as Debunking Bitcoin’s Remittance Valuation. Featuring a Lead Pipe by Anshuman Mehta.

On p. 207 they write about technical analysis:

In Figure 13.22 the top line is called the resistance line, indicating a price that bitcoin is having trouble breaking through. Often these lines can be numbers of psychological weight, in this case the $300 mark.

I looked it up and couldn’t find a definition for what “psychological weight” is, so this should either be defined in the book or removed in the next edition.110

On p. 209 they write:

You’ll find many instances of newer cryptoassets experiencing wild price swings after their creation, but over time these younger assets begin to follow the rules of technical analysis. This is a sign that these assets are maturing, and as such, are being followed by a broader group of traders. This indicates they can be more fully analyzed and evaluated using technical analysis, allowing the innovative investor to better time the market and identify buy and sell opportunities.

Technical analysis may have its uses but by itself it is basically cargo cult science.

Recommend rephrasing it and maybe inserting this great reference: The Vomiting Camel has escaped from Bitcoin zoo

Chapter 14

On p. 211 they write:

Since cryptoassets are digital bearer instruments, they are unlike many other investments that are held by a centralized custodian. For example, regardless of which platform an investor uses to buy stocks, there is a centralized custodian who is “housing” the assets and keeping track of the investor’s balance. With cryptoassets, the innovative investor can opt for a similar situation or can have full autonomy and control in storage. The avenue chosen depends on what the innovative investor most values, and as with much of life there are always trade-offs.

This is true: there are many choice.  But in practice, as noted above by Jonathan Levin, a significant majority of transactions typically involves a 3rd party intermediary.

Why?  Because Securing a bearer instrument can be a major hassle, as a result companies like Coinbase and Xapo offer custodial services.  While re-introducing an intermediary helps with coin management that kind of defeats the purpose of having a pseudonymous bearer asset in the first place.111 But that’s a different discussion.112

On p. 212 they write:

Anyone with a computer can connect to Bitcoin’s network, download past blocks, keep track of new transactions, and crunch the necessary data in pursuit of the gold hash. Such open architecture is one of Bitcoin’s strongest points.

It may sound like a irrelevant nitpick but this is not unique to Bitcoin.  Nearly every cryptocurrency listed on Coinmarketcap has the same set of “features.”  Similarly, many enterprise vendors also are open source and anyone could set up their own network with the software.  Future editions should include a more nuanced definition of “open.”

On p. 213 they write:

The first computer – or mining rig – with ASIC chips that were specifically manufactured for the process was connected in January 2013.

The citation the authors included was for Avalon.  This is true insomuch as these systems were available for purchase to the general retail public.  But the first known ASIC-mining system was launched in late 2012: ASICMiner privately run out of Hong Kong (from BitQuan and BitFountain). 113

On p. 214 they write:

For perspective, the combined compute power of Bitcoin’s network is over 100,000 times faster than the top 500 supercomputers in the world combined.

This type of stat is frequently repeated throughout the Bitcoin world but it is not an apples-to-apples comparison and should be removed in the next edition.  The supercomputers are largely comprised of CPUs and GPUs which — as their names suggest — are flexible and capable of handling many different types of general purpose tasks.

ASICs on the other hand, are focused and specialized: capable of doing just one set of tasks over and over.  ASICs found in a Bitcoin mining farm are not even capable of creating blocks to propagate on the network: they simply generate hashes.  That is how limited they are in functionality.

On p. 214 they write:

Conceptually, mining networks are a perfect competition, and thus as margins increase, new participants will flood in until economic equilibrium is once again achieved. Thus the greater the value of the asset, the more money miners make, which draws new miners into the ecosystem, thereby increasing the security of the network. It’s a virtuous cycle that ensures the bigger the network value of a cryptoasset, the more security there is to support it.

I think this could be rewritten in the next edition to be closer with what happens in practice.114

For instance, as coin prices decrease, margins are squeezed and “marginal” operators exit, leaving fewer overall miners.  In the past this has led to bankruptcies, such as KnC and HashFast.

Does this lead to a less secure network?

Maybe, maybe not.  Depends on how we define secure and insecure.  Pure hashrate is just one attribute… geographical location, amount of participants, and diversity of participants could be others as well.  For example, see the discussion earlier on selfish-mining.

On p. 215 they write:

Before investing in a cloud-based mining pool, conduct research on the potential investment. If it sounds too good to be true, it probably is.

This is good advice.

Also worth mentioning that “cloud-based mining” kind of the defeats the purpose of pseudonymous mining.  If you have to trust the infrastructure provider to manage and operate the hashing equipment, why not just buy the coins?  Why take that risk and also have to divulge your identity?

Incidentally, NiceHash is one of the most well-known cloud mining services available today.  It partly cemented its notoriety (this is not an endorsement) as its mining units have been rented and used to attack several different cryptocurrencies.  A site called Crypto51.app categorizes the costs of doing a brute force attack on dozens of coins and even lists the amount of hashrate NiceHash has in order to perform a hypothetical attack.

On p. 216 they write:

However, Ethereum will potentially switch to proof-of-stake early in 2018, as it is more efficient from an energy perspective, and therefore many claim is more scalable.

Quick note: this transition has been delayed again until at least the end of 2018 and more likely sometime in 2019 (although it has been moved many times before as well).

On p. 217 they write:

To this end, today numerous quality exchange are available to investors looking to gain and transact the more than 800 cryptoassets that currently exist.

In the next edition it is worth clarifying and defining what “quality” means because just about every retail / consumer-facing exchange has had its share of problems, including hacks and thefts.115 This is one of the reasons the SEC has denied ETF proposals.

With that said, there are a number of OTC trading desks run by reputable financial organizations that enable investors to trade, however, typically the minimum order size (buy/sell) is $100,000.116

On p. 218 they write:

Cryptoasset transactions are irreversible; therefore chargebacks are impossible. While an irreversible transaction may sound scary, it actually benefits the efficiency of the overall system. With credit card chargebacks, everyone has to bear the cost, whereas with cryptoassets only those who are careless bear the cost.

Two comments worth considering for the next edition:

  1. Transactions in cryptocurrencies are possible through block reversals, which can and do happen.  Often times they are relatively expensive to do, but during a “51% attack” it can occur, thus it is not impossible.  In fact, as part of the Nano class action lawsuit, one of the suggested remedies is a roll-back.
  2. As far as credit card chargebacks: this is largely borne by the merchant (not everybody).  In fact, charge backs are largely a consumer-friendly feature, a type of insurance.117

On p. 221 they discuss insurance at exchanges.

At this time, no retail cryptocurrency exchange actually insures a users coin deposit.  As a result, most custodians and intermediaries have had to self-insure (e.g., create their own insurance entity).  There are institutional products (vaults) which are attempting to get 3rd party insurance.

For example, see: Insurers gingerly test bitcoin business with heist policies

On p. 224 they write:

Prior to the hack, Bitfinex had settled with the CFTC for $75,000 primarily because its cold storage of bitcoin ran afoul of CFTC regulations. The move to place all clients’ assets into hot wallets is cited by many as due to the fine and CFTC regulations. Either way, this hack proved that no matter the security protocols put in place, hot wallets are always more insecure than properly executed cold storage because the hot wallet can be accesssed from afar by anyone with an Internet connection.

This passage should be revised in the next edition for a few reasons:

First, as mentioned earlier, Bitcoiners like to find a good boogeyman and in this hacking incident, they blamed the CFTC.

For example, Andreas Antonopoulos tweeted:

Source: Twitter

Several people told him he got the facts wrong.

For instance, I reached out to Zane Tackett who — at the time — was head of communications for Bitfinex.

According to Tackett: “We migrated to the bitgo setup before any discussions or anything with the CFTC happened”

I then publicly pointed out, to Antonopoulos and others, that the CFTC blame game was false.  But instead of deleting that tweet and focusing on who actually hacked Bitfinex, the ideological wing of the Bitcoin tribe continues to push this false narrative.

Tackett even explicitly answered this question in detail on reddit that same day.

So either Tackett is lying or Antonopoulos is wrong.  In this case, it is likely the latter.

The second point worth adding to the passage above in the book is that after nearly two years we still haven’t been told exactly what happened with the hack and theft.  This, despite the fact that Bitfinex has said on more than one occasion that it would provide an audit and public explanation.

Incidentally, this hack and the response, set in motion a series of events that included socialized loses, a lost correspondent banking relationship, and even a heightened reliance on Tether.118 For more, see: How newer regtech could be used to help audit cryptocurrency organizations

Chapter 15

On p. 231 they write:

Founded by Barry Silbert, a serial entrepreneur and influential figure in the Bitcoin community, some would say that DCG is in the early stages of becoming the Berkshire Hathaway of Bitcoin.

Perhaps DCG achieves that, however it hasn’t been done in a classy manner.  For example, see: Ex-banker cheerleads his way to cryptocurrency riches and Barry Silbert and the Cost of Bitcoin’s Malfeasance Culture

On p. 235 they write

An ETF is arguably the best investment vehicle to house bitcoin.

This is debatable.  Last year Jack Bogle – founder of Vanguard, a firm that popularized broad market index ETFs – implored the public to avoid bitcoin like the plague for several reasons.  Critics say he is out of touch, but even if that were true that doesn’t mean his expert views on structuring ETFs should be dismissed.

On p. 238 they write:

Regardless of what people expected going into the SEC decision most everyone was taken aback by the rigidity of the SEC’s rejection. Notably the SEC didn’t spend much time on the specifics of the Winklevoss ETF but focused more on the overarching nature of the bitcoin markets. Saying that these markets were unregulated was an extra slap to the Winklevosses, who had spent significant time and money on setting up the stringently regulated Gemini exchange. In focusing on the bitcoin markets at large, the rejection implied that an ETF will not happen in the United States for some time.

For the next edition, this paragraph should probably be removed.

The facts of the Bitcoin markets today are as follows:

  1. Mining is the process of minting new coins as well as processing transactions and… is largely unregulated in any jurisdiction.
  2. Many exchanges, in particular those outside the US, comply with a hodge podge of regulations, often without the same strict KYC / AML / sanctions checks required for US exchanges.

Gemini and the Winklevoss have no ability to police these unregulated trading venues and unregulated coin minters.  That probably won’t change in the near future.

Perhaps the SEC will eventually approve an ETF, but they arguably were not being rigid — they were being practical.  In their view: why allow an unregulated asset whose underlying genesis and trading market is still very opaque and frequently is used for illicit activity?

Lastly the next edition should include a citation for who “most everyone” includes, because in my own anecdotal experience, the majority of traders at US exchanges I interact with did not think it would be allowed at that time.  Note: my deep dive on the COIN ETF and its ever changing history, can be found here.

On p. 238 they write:

On Monday, naysarers were faced with the reality that bitcoin was once again back over $1,200, and the network for all cryptoassets had increased $4 billion since the SEC decision. Yes, $4 billion in three days.

A couple of thoughts:

  1. Typo: naysarers should be naysayers
  2. Recommend removing this sentence in the next edition because the attitude comes off as a little smug and has an ad hominem.  People are allowed to have different views on the adoption of technology which is separate from what the price of a coin will be.  And justifying a trading position based on price movements which are based on the mood of retail investors should probably not be the takeaway message for a mainstream book.

On p. 240 they write:

By purchasing XBT Provider, GABI strengthened the reliability of the counterparty to the bitcoin ETNs and added a nice asset to its growing bitcoin investing platform for institutions.

For the next edition, recommend removing “nice” because that is a subjective word.  There are other ways to describe this acquisition.

On p. 242 they write:

It also created an independent advisory committee, including bitcoin evangelist Andreas Antonopoulos to oversee its pricing model, which utilized prices from various exchanges throughout the world.

Why is this specific person considered an expert on futures?  There are a lot of articulate developers involved in promoting cryptocurrencies, but their expertise is typically not in finance.  If anything, this specific person has a vocal disdain for regulators, financial institutions, and regulated instruments… just see his tweet above in Chapter 14.119

Maybe in the next edition discuss the controversy of having a futures contract that is not physically deliverable.  Could also include how the CFTC has subpoenaed the four partner exchanges working with the CME: Coinbase, Kraken, itBit, and Bitstamp.  These four exchanges create the price used in bitcoin futures by the CME.

Chapter 16

On p. 249 they write:

For first-time founders who want to approach venture capitalists for an investment, often they must know someone-who-knows-someone. Having such a connection allows for a warm introduction as opposed to being among the hundreds of cold calls that venture capitalists inevitably receive. To know someone-who-knows-someone requires already being in the know, which creates a catch-22.

This is a very good point.  However, it would be worth adding in the next version how most ICOs and coin sales now require knowing someone because most private sales involve roughly the same insular, exclusive set of funds and investors as the “old method” did.

On p. 252 they write:

Before we dive into the specifics of how a cryptoasset offering is carried out, the innovative investor needs to understand that the model of crowdfunding cryptoassets is doubly disruptive. By leveraging crowdfunding, cryptoasset offering are creating room for the average investor to stand alongside venture capitalists, and the crowdfunding structure is potentially obviating the need for venture capitalists and the capital markets entirely.

In the next edition, worth mentioning that this was the general pitch for ICOs starting with Mastercoin (2013) all the way up through 2016.  But over the past two years and certainly in the past 12 months it has dramatically shifted back towards the traditional venture route.

One of the reasons why is because of the filtering and diligence process.  Those that don’t get selected and/or those ICOs that don’t meet the requirements of this small group of funds often decide to do a public sale.  And many of these ideas were half-baked and sometimes fraudulent, according to one recent report: More Than Three-Quarters of ICOs Were Scams

On p. 253 they write:

Monegro’s thesis is as follows: The Web is supported by protocols like the transmission control protocol/Internet protocol (TCP/IP), the hypertext transfer protocol (HTTP), and simple mail transfer protocol (SMTP), all of which have become standards for routing information around the internet. However, these protocols are commotidized, in that while they form the backbone of our internet, they are poorly monetized.

It could be argued that Monegro’s thesis has failed to live up to its hype thus far.  And counterfactually, if “tcpipcoin” existed, it may have actually stunted the growth of the internet as Vinton Cerf and Bob Kahn would have allocated more time promoting the coin rather than the technology.    We can disagree about this alternative scenario, but I have mentioned it before in Section 8.

For example, we frequently see that dozens of nonsensical conferences and meetups conducted on a weekly basis globally try to promote a shiny new protocol coin of some kind.  Trying to monetize a public good with a coin thus far has not removed the traditional incentive and sustainability issues around a public good.  That would also be worth discussing in the next edition.120

On p. 253 they write:

All the applications like Coinbase, OpenBazaar, and Purse.io rely on Bitcoin, which drives up the value of bitcoin.

Worth updating this because Purse.io added support to Bitcoin Cash.  And OpenBazaar switched over to Bitcoin Cash altogether.

Also, Coinbase has become less maximalist over time and now provides trading support for four different coins.121  Though it probably wouldn’t be technically correct to call Coinbase or Purse a Bitcoin application.  In the case of Coinbase, users use an off-chain database to interact and Coinbase controls the private key as a custodian / deposit-taking institution.

On p. 254 they write:

Interestingly, once these blockchain protocols are released, they take on lives of their own. While some are supported by foundations, like the Ethereum Foundation or Zcash Foundation, the protocols themselves are not companies. They don’t have income statements, cash flows, or shareholders they report to. The creation of these foundations is intended to help the protocol by providing some level structure and organization, but the protocol’s value does not depend on the foundation.

This is another reason to heavily modify chapter 7 in future versions because it is not an apples-to-apples comparison: coins and coin foundations are not the same thing as for-profit companies that issue regulated instruments (stocks, bonds, etc.).

Also, the very last sentence is highly debatable because of how often foundation and foundation staff are integral to the longevity of a coin.

Recall that blockchains do not maintain or market themselves, people do.  And is often the case: staff and contractors of these foundations frequently use social media to promote potential upgrades as well as publicize the coins attributes to a wider audience.  In many cases it could be the case that the protocol’s value does depend on the work and efforts of others including specifically those at a coin foundation.122

On p. 254 they write:

Furthermore, as open-source software projects, anyone with the proper merits can join the protocol development team. These protocols have not need for the capital markets because they create self-reinforcing economic ecosystems. The more people use the protocol, the more valuable the native assets within it become, drawing more people to use the protocol, creating a self-reinforcing positive feedback loop. Often, core protocol developers will also work for a company that provides application(s) that use the protocol, and that is a way for the protocol developers to get paid over the long term. They can also benefit from holding the native asset since inception.

There are several points here that should be modified or removed in the next edition:

For instance, with Bitcoin, due to a variety of political fights and personality conflicts, multiple “core” developers have had their access rights removed including: Jeff Garzik, Mike Hearn, Gavin Andresen, and Alex Waters.  Thus it is not true that anyone can join a team.  It is also unclear what those merits may be as most of the projects don’t explicitly provide those in written format yet.

In addition, internet coins are often traded on secondary markets in order to provide liquidity to coin holders such as developers.  They all need access to capital markets to stay afloat.  No project is self-sustainable at this time because no coin is being used as a unit of account — miners and developers must liquidate coins in order to pay their bills which are denominated in foreign currency.

Lastly, in practice, there are many coins that have died or lost any developer support yet initially they may have had a small army of programmers and media attention.  According to Coinopsy, more than 1,000 coins are dead.  Thus in the next edition the “self-reinforcing” loop should probably be removed too.

On p. 256 they write:

ICOs have a fixed start and end date, and often there is a bonus structure involved with investing earlier. For instance, investing at an early stage may get an investor 10 to 20 percent more of a cryptoasset. The bonus structure is meant to incentivize people to buy in early, which helps to assure that the ICO will hit its target offering. There’s nothing like bonuses followed by scarcity to drive people to buy.

This should definitely be removed.  In May, the SEC released a parody website called “HoweyCoins” which explicitly points to this precise FOMO behavior as a big no-no for both issuers and investors alike.

Also recommend the inclusion of the Munchee Order in this chapter as it would help illustrate what regulators such as the SEC perceive as improper fundraising techniques.  Specifically, include this in the “announcing the ICO” section.

On p. 258 and 259 they discuss the Howey Test.  It is strongly recommended that these two pages be reworded and modified based on the enforcement actions and guidance from the SEC and other securities regulators.

For instance, they write:

A joint effort by Coinbase, Coin Center, ConsenSys, and Union Square Ventures with the legal assistance of Debevoise & Plimpton LLP, produced a document called, “A Securities Law Framework for Blockchain Tokens.” It is especially important for the team behind an ICO to utilize this document in conjunction with a lawyer to determine if a cryptoasset sale falls under SEC jurisdiction. The SEC made it clear in July 2017 that some cryptoassets can be considered securities.

The first sentence should probably be moved into a footnote and the second sentence removed altogether because this document did not age well.

In fact, the current version of the document – as it exists on Coinbase – informs readers in bright red that:

Please note that since this document was originally published on December 7, 2016, the regulatory landscape has changed. The information contained in this document, including the Framework may no longer be accurate. You should not rely on this document as legal advice and you should seek advice from your own counsel, who is familiar with the particular facts and circumstances of what you intend and can give you tailored advice. This Framework is provided “as is” with no representations, warranties or obligations to update, although we reserve the right to modify or change this Framework from time to time. No attorney-client relationship or privilege is created, nor is this intended to be attorney advertising in any jurisdiction.

On p. 259 they write:

Does the token sale tout itself as an investment? It should instead be promoted for its functionality and use case and include appropriate disclaimers that identify it as a product, not an investment.

This is arguably not good advice and should be removed.  Why?  Courts in the US will likely see through this euphemism.  For other things not to do, recommend reading the ICO Whitepaper Whitepaper from Stephen Palley.

On p. 260 they write:

One of the oldest groups of angel investors in the blockchain and bitcoin space is called BitAngels. Michael Terpin of BitAngels has been active in angel investing in blockchain companies for as long as the opportunities have existed. Terpin’s annual conference, CoinAgenda, is one of the best opportunities for investors to see and hear management from blockchain startups present their ideas and business models.

For the next edition, I’d reconsider including this type of endorsement.123 There are some interesting stories that involving these specific entities worthy of a different post.

Chapter 17

On p. 263 they write:

For instance, if Bitcoin influences how remittances are handled, what impact may that have on stocks like Western Union, a remittances kingpin? If Ethereum takes off as a decentralized world computer, will that have any effect on companies with cloud computing offerings, such as Amazon, Microsoft, and Google? If companies can get paid more quickly with lower transaction fees using the latest cryptocurrency, will that have an impact on credit card providers like Visa and American Express.

For the next edition, this paragraph — or at least argument — should come earlier, perhaps even in Chapter 7 (since there is a discussion of specific publicly traded companies).

Another thing that should have been added to this section is actual stock prices for say, the past five years of the companies mentioned: Western Union, Visa, and American Express.

I have included those three below:

If the narrative is that Bitcoin or the “latest cryptocurrency” will erode the margins and even business models of existing payment providers, then at some point that should be reflected in their share prices.

As shown above, that does not seem to be the case (yet).

Perhaps that will change in the future, but consider this: all three of the companies above have either directly invested in and/or are collaborating in blockchain-related platforms — most of which do not involve any coin.  Perhaps these firms never use a blockchain.  In fact, maybe they find blockchains to be unhelpful as infrastructure altogether.

That is possible, hence the need to update this chapter to reflect the actual realities.

In addition, the other three companies listed by the authors have publicly discussed various blockchain-related efforts beyond just pilot offerings.

For instance, both Amazon and Microsoft have supported blockchain-as-a-service (BaaS) offerings in production for over a year.  Google has been a laggard but has internal projects attempting to leverage some of these ideas as well.

On p. 266 they write:

In 2016, the father-son team of Don and Alex Tapscott published the book Blockchain Revolution: How the Technology behind Bitcoin Is Changing Money, Business, and the World, and William Mougayar published the book, The Business Blockchain: Promise, Practice, and Application of the Next Internet Technology.

I wrote lengthy reviews of both.  The short summary is that both were fairly superficial in their dive into use cases and vendors.  The Mougayar book felt like it could use a lot more detailed meat.  The Tapscott book was riddled with errors and unproven assertions.  Would reconsider citing them in the next edition (unless they each dramatically update their content).

On p. 266 they write:

For companies pursuing a DLT strategy, they will utilize many of the innovations put forth by the developers of public blockchains, but they don’t have to associate themselves with those groups or share their networks. They pick and choose the parts of the software they want to use and run it on their own hardware in their own networks, similar to intranets (earlier referred to as private, permissioned blockchains).

These are pretty broad sweeping comments that should be modified in the next edition.  Not every vendor or platform provider uses the same type of chain or ledger.  These are not commoditized (yet).

There are many nuances and trade-offs for each platform.  For the next edition, it would be helpful worth doing a comparison of: Fabric, Pantheon, Quorum, Corda, and other enterprise-focused platforms.  In some cases, they may have an on-premise requirement and in others, nodes can run in a public cloud.

But the language of “intranets and the internet” should not be used in the next edition as it is a misleading analogy.

On p. 267 they write:

We see many DLT solutions as band-aids to the coming disruption. While DLT will help streamline existing processes–which will help profit margins in the short term–for the most part these solutions operate within what will become increasingly outdated business models.

Perhaps that it is true, but again, this language is very broad sweeping and definitive.  It needs citations and references in the next edition.

On p. 267 they write:

The incumbents protect themselves by dismissing cryptoassets, a popular example being JPMorgan’s Jamie Dimon, who famously claimed bitcoin was “going to be stopped.” Mr. Dimon and other financial incumbents who dismiss cryptoassets are playing exactly to the precarious mold that Christensen outlines:

[…]

Disruptive technologies like cryptoassets initially gain traction because they’re “cheaper, simpler, smaller.” This early traction occurs on the fringe, not in the mainstream, which allows incumbents like Mr. Dimon to dismiss them. But cheaper, simpler, smaller things rarely stay on the fringe, and the shift to mainstream can be swift, catching the incumbents off guard.

For the next edition it would be good to remove the misconceptions repeated in the statement above.  Jamie Dimon was specifically dismissing the exuberance of coin mania, not the idea of enhancing IT operations with something like a blockchain.

Worth adding to future versions: JPMorgan has financial sponsored Quorum, an open-source fork of Ethereum modified for enterprise-related uses.  The bank has also invested in Digital Asset.  It is also a member of three industry organizations: EEA, Hyperledger, and IC3.  In addition, JP Morgan has filed blockchain-related patents, has launched a blockchain-based payment network with several banking partners, and also partnered with the parent company of Zcash to integrate ZSL into Quorum.

While Jamie Dimon may not share the same bullish views about coins as the authors do, the firm he is the CEO seems to be taking “blockchains” seriously.

On p. 267 they write:

One area long discussed as ripe for disruption is the personal remittances market, where individuals who work outside of their home countries send money back home to provide for their families.

This specific use case is a bit repetitive as it has been mentioned 5-6 times before in other chapters.  Should probably remove this in future editions unless there is something different to add that wasn’t already explained before.

On p. 268 they write:

It’s no stretch then to recognize that bitcoin, with its low cost, high speed, and a network that operates 24/7, could be the preferred currency for these types of international transactions. Of course, there are requirements to make this happen. The recipient needs to have a bitcoin wallet, or a business needs to serve as an intermediary, to ultimately get the funds to the recipient. While the latter option creates a new-age middleman–which potentially has its own set of problems–thus far these middlemen have provided to be much less costly than Western Union. The middleman can be a pawnshop owner with a cell phone, who receives the bitcoin and pays out local currency to the intended recipient.

This should be modified in the next versions because it is a stretch to make those claims.  That is the reason why multiple Bitcoin-focused remittance companies have pivoted or branched out because “moving” bitcoins across borders is the only easy part of the entire process.  For instance, the KYC / AML checks during the on- and off-ramps are costly and are required in most countries.  This should be included in any analysis.

Also, there are no citations in this paragraph.  And the last sentence is describing the pawnshop owner as a money transmitter / money service business which is a regulated operation.  Maybe the laws change, which is possible.  But for the next version, the authors should include specific corridors and the costs and margins for MSBs operating in those corridors.

Lastly, any future analysis on this topic should also include the online and app-based product offerings from traditional remittance players such as Western Union.  In nearly all cases, these products and services are faster and cheaper in the same corridors relative to traditional in-person visits.

Recommended reading:

On p. 268 they write:

The impact of this major disruption in teh remittance market should be recognized by the innovative investor not only because of the threat it creates to a publicly traded company like Western Union (WU) but for the opportunities it provides as well.

It is strange to hear this repeated multiple times without providing quantifiable specifics on how to measure this threat.

As mentioned a few pages earlier, if competitors (including, hypothetically cryptocurrencies) were to erode the margins of publicly traded companies, we should be able to see that eventually reflected in the share price.  But Western Union has been doing more or less the same as it has the past couple of years.

What about others?

Above is the five year performance of Moneygram, another remittance service provider.

What happened the past two years?  Did Bitcoin or another cryptocurrency pound its share value into the ground?  Nope.

What happened is that one of Alibaba’s affiliates – Ant Financial – attempted to acquire Moneygram.  First announced in early January 2017, Ant Financial wanted to acquire it for $880 million.  Despite approval from the Moneygram board, the deal faced scrutiny from US regulators.  Then in January 2018, the deal was axed as the US government blocked the transaction on national security grounds.

This hasn’t stopped Alibaba and its affiliates with finding other areas to grow.  For instance, last month Alipay (part of Ant Financial) announced it had partnered with G Cash to in the Hong Kong – Philippines corridor, using a blockchain platform for remittances.  No coin was needed in this process so far.

There may be some success stories of new and old MSBs that utilize cryptocurrencies in ways that make them more competitive, those should be included in the next edition along with more metrics readers can compare.124

On p. 270 they write:

For the long term investor, careful analysis should be undertaken to understand if insurance companies are pursing DLT use cases that will provide a lasting and meaningful solution. Lastly, some of the major consulting firms may be so entrenched in incumbent ideology that they too may be blind to the coming distruption.

A few comments that should be finnesed in the next version:

  1. What is the definition of “incumbent ideology”?
  2. Virtually every major insurance and reinsurance company is hands-on involved with some kind of blockchain-related consortium and/or enterprise-focused platform.  This includes both B3i and RiskBlock as well as Asia-based reinsurers.  Recommended reading: RiskBlock’s blockchain targets entire insurance industry
  3. Similarly, every major consulting company and systems integrator has a team or two dedicated to helping clients build and integrate applications with specific enterprise-related “blockchain” platforms.  Many of them have joined related consortia too.  There are too many to even list here so it is unlikely they will get collectively blind-sighted as alluded to in the passage above.

On pgs. 272 and 273 they write about consortia:

Another consortium, The Hyperledger Project, offers more open membership than R3. Remember, one of the strengths and defining aspects of an effective blockchain project is its open source ethos.

[…]

While the [EEA] consoritum will work on software outside of Ethereum’s public blockchain, the intent is for all software to remain interoperable in case companies want to utilize Ethereum’s open network in the future.

Based on the passages above the next edition should incorporate a few changes.

The Hyperledger Project (HLP) is a non-profit group that does not itself aim to commercialize or deploy or operate any technology.125 The membership dues are largely used to maintain code repositories and sponsor events which educate attendees on projects incubated within HLP.  It currently has around 200 members, including R3 which was a founding member.  There are more than 5 codebases that are officially incubated, the most well-known is Fabric.  However, HLP seeks to maintain a neutral position on which platform its members should use.  Other notable platforms incubated within HLP include Iroha and Sawtooth (Lake).

In contrast, R3 is a for-profit company that set up a consortium in order to commercialize and deploy technology within the regulated financial industry.126 Its membership model has changed over time and it is the main sponsor for Corda, an open source platform.  The consortium composition initially started with 42 banks and now includes about 200 entities including insurance companies, central banks, financial market infrastructure operators, and others.

The third most known consortium is the Enterprise Ethereum Alliance (EEA).  It is kind of like the combination of the two above.  It is a non-profit organization and itself does not aim to commercialize or deploy or operate any technology.  It seeks to be a neutral entity within the greater Ethereum ecosystem and has many different working groups that span topics similar as the other two consortia above.  It has hundreds of members and the main efforts have been around formalizing an enterprise-focused specification (EEA 1.0) that other vendors can create implementations of (such as Pantheon).

Like the members of the other two consortia above, nothing prevents an EEA member from using any other platform.  Thus the authors usage of “open network” is superfluous because all of the codebases in each of these three consortia is open, anyone can download and use.  The key differences are: what are the trade-offs with using each platform versus what are the benefits of membership for joining the consortia.  These are two separate points that could be discussed further in the next edition.

On p. 276 they write:

The CFTC Director of Enforcement, Aitan Goelman, tried to clarify his opinion with this satement, “While there is a lot of excitement surrounding bitcoin and other virtual currencies, innovation does not excuse those acting in this space from following the same rules applicable to all participants in the commodity derivatives markets.” It is clearly confusing that the Direct of Enforcement of the agency that ruled bitcoin a commodity also called it a “virtual currency.”

For the next edition the authors should remove the unnecessary attitude in the last sentence.

Up through 2017, most US and even foreign regulators used the term “virtual currency” — not as a slight against Bitcoin or cryptocurrencies, but because that was the catchall term of art used for many years.

For instance, in March 2013, FinCEN released its guidance and it was entitled: “Application of FinCEN’s Regulations to Persons Administering, Exchanging, or Using Virtual Currencies”

Throughout the guidance, the term “virtual currency” is used more than 30 times.

And one relevant passage – especially for this book review – involves the definition of an administrator.  According to FinCEN’s guidance:

“An administrator is a person engaged as a business in issuing (putting into circulation) a virtual currency, and who has the authority to redeem (to withdraw from circulation) such virtual currency.”

As it relates to the CFTC, earlier this year a federal judge in New York ruled that: “virtual currencies can be regulated by CFTC as a commodity.”

The ruling (pdf) specifically uses the phrase “virtual currency” not as a slight, but as a term of art.  Perhaps other terms are used over time.  For instance, in its new customer advisory issued this week, the CFTC mentioned potential scams that describe themselves as “utility coins” or “consumption coins.”  Worth revisiting in the next edition.

Chapter 18

On p. 280 they write:

Here’s another Burniske-Tatar Rule: Don’t invest in bitcoin, ether, or any other cryptoasset just because it’s doubled or tripled in the last week. Before investing, be able to explain the basics of the asset to a friend and ascertain if it fits well given the risk profile and goals of your investment portfolio.

This is good advice.  And while the eponymous rule was coined several chapters ago,  future editions should probably drop the name of that rule… because similar advice with slightly different wording has existed for decades (e.g., don’t invest more than you can afford to lose, do your own research, etc.).

On p. 282 they write:

Are millenials turning to bitcoin and cryptoassets for their investment? Is a Vanguard fund or a small investment in Apple any better?  Whereas the Vanguard fund has a minimum investment amount and buying an equity will require commission, millennials see cryptoasset markets as a way to begin investing with a modest amount of money and in small increments, which is is often not possible with stocks or funds.

They also include a footnote that reads:

Each bitcoin can be divided into 100 million units, making it easy to buy 1/2, 1/10, 1/100 or 1/1000 of a bitcoin

Would recommend removing this passage altogether because there really aren’t many good surveys that indicate who actually bought coins versus who was just interested in them.

For instance, a flawed Finder.com survey that is still being cited, says that 8% of Americans have invested in cryptocurrencies.127  While it says the majority of investors are “millenials,” the survey doesn’t ask the most important question: does the investor control the private key.  If you do not control the private key then you do not control the coin, someone else does.

In addition, there are online brokerages that do allow investors to invest with modest amounts, the most notable being Robinhood (which coincidentally also allows users to purchase several different cryptocurrencies).  There are also a variety of spare change investment apps and robo-advisor products that allow users to have some exposure to regulated capital market too.

Lastly, regarding the footnote they provide: due to the fees required by Bitcoin miners, in practice over the past several months 1/1000 of a bitcoin is typically the minimum transaction fee.  This is one reason why many investors simply leave coins on cryptocurrency exchanges: so they don’t have to pay fees to move them to other wallets.128

On p. 282 they write:

The important point is that at least they’re doing something to invest their funds and build the groundwork for a healthy financial future. We have seen firsthand millenials who have learned about investing from buying cryptoassets and have implemented investing approaches, such as taking profits at certain price points, seeking diversification into multiple assets, and so on.

This should probably be removed too because the same thing can be said to a new cohort of investors twenty years ago, such as the ones that invested in dotcom-related companies.  Who remembers Beenz?

Conclusion

I fully expect some reaction towards this review along the lines that it was too picky or too pedantic.  Perhaps this a little true but consider: what is the right size for a thorough book review in the age of so-so fact-checking?129 Also, most of my previous reviews were about the same length, or at least used the same page-by-page model.

There is obvious room for disagreement in areas involving opinions, but there are many technical and non-technical mistakes that the authors made, not just a small handful.  By highlighting these, not only could the next edition be significantly improved but it helps readers new to this space get a better understanding of what the prevalent themes versus realities are.

The goal of this review was not to be overbearing but to be dispassionate about supposed common wisdom promoted in the cryptocurrency world.

For example, just the other day I noticed in a chatroom the following statement from a maximalist:

HODLer = DAU.  Bitcoin has the most DAUs on any protocol.

HODLing is bitcoinspeak for “hoarding.”

Several people in the room agreed with those this statement and they are not alone.  If the reader is interested in learning about the sociology and subculture of many Bitcoin enthusiasts, its worth skimming reddit and twitter occasionally to see how passionate coin investors think.130

But for businesspeople who are not part of the inner sanctum of Bitcoinland, the statement above from the chatroom may make you shrug.

After all, HODLing a dollar doesn’t make you a dollar user.  HODLing a barrel of oil doesn’t make you a oil user.  HODLing a brick of gold doesn’t make you a gold user.  HODLing a digitized Pokemon card doesn’t make you a Pokemon user.  HODLing a Stradivarius violin doesn’t make you a violin player.  HODLing an Olympic medal doesn’t make you an Olympic athlete.  And so forth.  The valuation of an auction house isn’t measured by the amount of rare collectibles it sells in a day, why should internet coins and their platforms be an exception to that rule?131

Inactivity isn’t how activity is measured.  Or to look at this argument from another angle: HODLing is not ‘active’ anything.  If all an investor did was buy bitcoin and then lose their keys, they would accomplish the same thing described in the chatroom.132

Sure it is possible to redefine what Bitcoin or cryptocurrencies are supposed to do, but that’s after the fact.  For example, if Satoshi had wanted to explicitly build “digital gold” he/she would likely have mentioned it in the original paper at least once and even architected Bitcoin to be something different than what it looked like in 2009.133  As mentioned above, the first app he looked at building was for poker.

This is definitely a topic worth including in the next edition, but I digress.134

Other general areas for improvement:

  • Add a glossary.
  • Add financial disclosures of coins owned by each author.
  • Provide specific definitions for vague terms like “the community,” “administrator,” and the attributes of a target investor; ditch the “innovative” investor nomenclature.
  • Chapter 7 probably should be removed until more accurate comparisons can be found and Chapter 17 seemed a bit unfocused and covered a wide array of topics instead of just one or two… even dropping in thoughts about regulators. Future versions likely need an entire set of chapters focused on regulations, not just mentioned in passing.
  • Based on the incorrect view of financing mentioned in Chapter 5, interview Vitalik Buterin and other co-founders regarding how Ethereum was bootstrapped.
  • In one of the future regulatory chapters, would be good to have a discussion around PFMI, CBDCs, and settlement finality.
  • Provide a lot more references and citations regarding cryptocurrency-focused use cases, especially remittance providers.  This seemed to be the most repeated use case but nary a mention of a specific Bitcoin remittance company, its valuation, or volume corresponding to the use case.

Have a book or paper you’d like me to look at?  Feel free to send it across.  Also, it just came out but this one sounds like a doozy already.  See my other book reviews.

End notes

  1. To be fair, Burniske is not the only analyst-turned-VC who has not publicly disclosed his trading positions of coins, but that’s a separate topic. []
  2. One reviewer mentioned: “Likely it was partially intentional to release in late 2008 / early 2009, but did in fact coincide mainly with internal constraints. We could also argue that the GFC commenced in mid-2007 when BNP Paribas froze two mortgage-backed security funds which became the catalyst of the summer 2007 credit crunch, but that is neither here nor there. I also debate the argument that it was ‘intended’ as anything other than a solution to the double-spend problem, be it a payments system or an investment.” []
  3. As an aside, Brian Kelly, frequently promotes various coins on CNBC.  Unclear what his trading positions are on each coin at the time of recording.  While that may not be illegal, it’s arguably not classy. []
  4. One reviewer mentioned: “This was literally the ethos that led to the GFC. Securitization and Mark-to-model were heralded as “innovation” and championed for their ability to move faster than the academic foundation and until 2007 seen as a way to ‘completely engineer risk out of from the system.'” []
  5. See: Robert Sams on rehypothecation, deflation, inelastic money supply and altcoins []
  6. See tcpipcoin in Section 8 []
  7. See: Digitalization or Automation – Is There a Difference? from Gartner []
  8. One reviewer mentioned: “The authors also miss that “value” is still a function of ‘the market’, i.e. supply and demand. Simply by fixing supply does not equalize demand. I also take massive issue with the governance in “a [de]centralized and democratic manner.” Are the authors able to write C++ or GOLang protocol code for Bitcoin Core or GETH? Likely not. So if anything this walks us towards a new form of governance, except where we elect leaders in the US who ultimately appoint Fed governors in cryptocurrencies there are generally no elections. Long story short, in all cases, it ain’t democratic and it probably remained at least partially centralised at a given point in time.” []
  9. See Central bank digital currencies from the BIS.  I know, I’ll get spammed by all the “sound money” promoters out there who insist that Bitcoin will replace central banks — it’s a religious zeal to many. []
  10. For example, about a month ago, Jonathan Levin from Chainalysis did an interview and mentioned that: “So we can identify, it is quite hard to know how many people. I would say that 80% of transactions that occur on these cryptocurrency ledgers have a counterparty that is a 3rd party service. More than 80%.” []
  11. For instance, on p. xxvi they list “the top 50” coins at the end of 2016 and don’t disclose if they own any specific ones at all, but talk about many of them in positive ways.  Adding a disclosure would be helpful. []
  12. Bitcoin has ‘no intrinsic value,’ Brookfield CEO says: ‘It’s not for us’ from Financial Post []
  13. The Economist wrote a nice short article on this behavior — the greater fool – last year. []
  14. For example, on p. 9 they write: “Shortly thereafter, Satoshi vanished.  Some speculate it was for the good of Bitcoin. After all, being the creator of a technology that has the potential to replace much of the current financial system is bound to eventually invoke the wrath of powerful government and private sector forces.”  This seems like a strawman.  Bitcoin was designed for just one simple thing: payments.  The financial system is an interwoven network of hundreds of regulated and unregulated goods and services, not just payments.  Also, this paragraph, like a few others later, has elements of conspiratorial boogeymanism.  Just around the corner, the government is preparing to shut down Bitcoin!  Nothing like that has happened in the past 9+ years.  In fact, the opposite has been true as most jurisdictions have been pretty accommodating, arguably even too lenient on the issuance and usage of cryptocurrencies, but that is a topic for a different post. []
  15. See Layer 2 and settlement []
  16. See Breakthrough IT Banking from McKinsey and Bank IT spending to hit $241bn across four major global regions from ComputerWeekly []
  17. One reviewer mentioned: “Are the authors aware that CMOs first appeared in 1983, and that in many countries where they were heavily utilised including in the late 2000s they worked as advertised? In fact many CMOs in the US performed as modelled. The issue was, and is, always liquidity, over-leverage and most of all deteriorating lending standards. Cryptocurrencies will most likely be looked at as catalysts of these risks should their notional rise substantially, not their saviour.” []
  18. One reviewer commented: “Are they arguing that people would have been more able to pay their mortgages or that home values wouldn’t have fallen if CMOs were on a blockchain?” []
  19. One reviewer explained: “When someone claims that blockchain would have prevented the mortgage crisis, they are revealing their ignorance of their ignorance.  I worked with some of that CMO data. One former colleague works for one of the large consulting firms ‘blockchain’ practices. He posted something about how blockchain would address the problems with mortgage servicing . When I privately asked him how it would do so,and that the problems with mortgage servicing that I was aware of were either failure to do certain required activities or their failure to record that they did them, as opposed to someone changing the record after it was entered, he did not respond.” []
  20. See also: The Problem with Calling Bitcoin a “Ponzi Scheme” by Preston Byrne []
  21. For example, at the time of this writing, Coinmarketcap tracks 1641 different types of coins and tokens.  Many of these are likely ERC20 tokens and thus rely on Ethereum itself and are not independent blockchains. []
  22. Worth re-reading the recent DOJ indictment of GRU officers as the DOG provides a reason for why Bitcoin was used versus other transmission methods. []
  23. Someone should create a website that tracks all of the gigantic bullish claims from Bitcoin promoters on how it will topple banks and destroy governments.  There are at least more than 100 such public predictions each month. []
  24. But “be your own payment processor” isn’t a catchy phrase. []
  25. Readers should check out: “The Path of the Blockchain Lexicon (and the Law)” by Angela Walch. []
  26. It ignores how mining pools can unilaterally determine what transactions to include and how much a fee a transaction should include in order to be included in a block. []
  27. For example, KARMA : A Secure Economic Framework for Peer-to-Peer Resource Sharing by Vivek Vishnumurthy, Sangeeth Chandrakumar and Emin Gun Sirer []
  28. Recommended reading: The Economic Limits of Bitcoin and the Blockchain by Eric Budish []
  29. Some literature describes the proof-of-work process used in Bitcoin as a “scratch-off puzzle.” []
  30. One reviewer mentioned: “A model that I like to describe this with is how the main professional soccer leagues are selected in Europe and other regions. For example, France specifically has an annual selection of the “League 1” after the Coupe de French. Basically any team can enter, but practically there is minimal turnover because a team from a town of 5,000 people is unlikely to reasonably beat a team like Paris or Lyon which has multi-million euro budgets. There are few upsets, but these can generally be modeled by statistical chance.” []
  31. For example, Coin Center circulated a borderline defamatory note to ESMA with regards to Corda – even before the Corda introductory whitepaper was released – likely because its author was unfamiliar with how the platform actually worked. []
  32. It seems to be a euphemism and code word for “someone with money who should buy coins.” []
  33. Based on public information, over the past four years pretty much the only cryptocurrency-related companies that probably were profitable equity investments were: exchanges and handful of mining companies operating outside of the US (e.g., some service providers have also generated steady income including several law firms and conference organizers). []
  34. In both cases, consensus is achieved by the longest chain rule. []
  35. May not be a Freudian slip here, but keep in mind all blockchains have operators and maintainers.  See “arewedecentralizedyet” for more. []
  36. It arguably could have been a self-fulfilling prophecy: investors outside of Cyprus hear news about the Cyprus bailout and bitcoin… thereby marketing bitcoin to new retail investors who then go out and buy bitcoins to try it out. []
  37. See also the background of R3 / DLG as well. []
  38. It is common to see Bitcoin promoters regularly demonize these companies who are trying to improve and automate infrastructure, vilified as a bourgeoisie activity that must be shunned.  Worth revisiting to see if this changes over time. []
  39. One of the few exceptions is the Brave browser. []
  40. Creating and marketing coins to retail investors is relatively easy… building infrastructure that customers actually regularly use for commerce is another level altogether. []
  41. If measured by price, there was a large bubble that popped in December 2017, but that was something that happened after publication. []
  42. I have given several public presentations in the past year explaining the “trough of disillusionment” phenomenon in this context, including in Seoul and Tokyo during July 2017. []
  43. See also: Tokens: Investment Vehicle or Medium of Exchange (Not Both) by Cathy Barrera and MV=P…Que? Love and Circularity in the Time of Crypto by Anshuman Mehta and Brian Koralewski []
  44. Furthermore, in September 2014 I gave a presentation (video) (slides) that similarly tried to bucket different types of proposed coins as “commodities” and the like.  And I know I wasn’t the first to try and do so.  Recommend readers do a bit more digging on this topic if they’d like to see a more thorough origin story. []
  45. One reviewer mentioned: “The native tokens / coins / assets inside a ledger are “cryptocurrencies”, they are currency in the single sense that they the only form of compensation accepted by the miner / staker in a network. This cryptoasset business really only makes sense in the context of units which are not used to pay for the security of a blockchain.” []
  46. But that doesn’t necessarily excite speculators and coin holders. []
  47. See: Bitcoin Is Now Just A Ticker Symbol and Stopped Being Permissionless Years Ago []
  48. There are few religious undertones here that could be removed in the next edition. []
  49. As mentioned above, The Economist wrote a nice short article on this behavior — the greater fool – last year. []
  50. The authors of this book are likely unintentionally promoting coin buying with a security-like mentality, the wording could be modified in the next edition. []
  51. One reviewer mentioned: “Unless the authors explain how ETH is worth precisely zero based on the same logic then their statement seems disingenuous. Not that I believe that is the case, but I am not the one stating that scarcity in the future is the reason for the value.” []
  52. See Saifedean Ammous: The Bitcoin Standard — making the Austrian School case for Bitcoin by David Gerard, The Bitcoin Standard – a critical review by Frances Coppola, and The Politics of Bitcoin by David Golumbia []
  53. Why?  Most probably are unaware and the typical retail investors seems to just want the USD number to go up so they can sell the coin to someone else. []
  54. Also worth reviewing Consensus-as-a-service and The Blockchain Threat Has Drastically Sped Up Cross-Border Payments []
  55. Since the authors are making this claim, would they be willing to disclose or be transparent about their own coin holdings for the date when they published this book? []
  56. The most likely answer is: speculators bought these coins because they knew others would buy it too thus driving the price higher. []
  57. Or conversely, you are considered “one of us” if you promote the policies and antics of said coin promoters. []
  58. Note: it should be apparent at this stage that “Bitcoin developers” should be in quotes because it is certain key individuals — and centralized organizations such as “Core” — who have the power to sway decisions such as BIP approval.  These are arguably administrators of financial market infrastructure.  See also: In Code(rs) We Trust: Software Developers as Fiduciaries in Public Blockchains []
  59. Personal correspondence on June 5, 2018 []
  60. This is mentioned in the new CFTC warning: CFTC Issues Customer Advisory on Digital Tokens []
  61. It is these types of passages that make a reader scratch their head as to whether or not the lessons for why equity ownership — and the rights afforded to equity holders — evolved to where they have in developed countries. []
  62. This narrative needs to be buried but probably won’t. []
  63. This is a common refrain that needs to stop being repeated. []
  64. A few months before Cryptoassets was published, the SEC published a report that said they found The DAO to have all the hallmarks of a security but they never enforced any specific legal action on its creators. []
  65. See Appendix A: Internal governance []
  66. On p. 63 they write: “For example, a fully functional decentralized insurance company, Airbnb, or Uber all hold great promise, and developer teams are working on similar use cases.”  Why do these hold great promise?  Because everyone else says that on stage? []
  67. One takeaway is that other speculators may buy your coins at a later date when the prices go up, so you should get in before they do. []
  68. One of the biggest flaws in Chapter 7 is that all of the pricing information for the coins are based on markets that are opaque and unregulated… some of whom may be considered bucket shops of yesteryear.  Lack of transparency is one of the reasons why all of the Bitcoin-related ETFs have been (so far) axed by the SEC.  See: Comments on the COIN ETF. []
  69. Are Public Blockchain Systems Unlicensed Money Services Businesses in Disguise? by Ciaran Murray []
  70. With the exception from maybe transaction fees to miners, but those could arguably also be classified as donations.  See p. 65 in The Anatomy []
  71. See: Spurious correlations []
  72. For example, later on p. 104 they write: “More surprisingly, the portfolio with bitcoin would have had lower volatility.” Because of the time period?  We could probably find other things with the same or lower volatility.  That seems like cherry picking. []
  73. Maybe they are both, but that still doesn’t mean that the coins, say that Placeholder Capital invested in, shouldn’t be classified as securities. []
  74. See also: Tokens: Investment Vehicle or Medium of Exchange (Not Both) by Cathy Barrera and MV=P…Que? Love and Circularity in the Time of Crypto by Anshuman Mehta and Brian Koralewski []
  75. Also, these are all arguably poor stores of value because of their relatively high volatility.  For instance, “number goes up” or rapid price increases is not the definition for a store of value.  Claiming bitcoin is a good store of value because it sees swift increases in price appreciation as measured by actual money is a contortionist view which ignores the empirical reality of how money is used. []
  76. For example, later on p. 110 they write: “While many cryptoassets are priced by the dynamics of supply and demand in markets, similar to more traditional C/T assets, for some holder of bitcoin — like holder of gold bars — it is solely a store of value. Other investors use cryptoassets beyond bitcoin in a similar way, holding the asset in the hope that it appreciated over time.” Spoiler alert: everyone that owns internet coins hope they appreciate over time. []
  77. And there are specific projects — such as Bitcoin — in which one clique of developers waged an effective propaganda campaign against miners.  For more on this, look into the actors and organizations behind the Segwit / Segwit2x / UASF online debates. []
  78. Not to rekindle the flames of the Bitcoin blocksize debate but in retrospect, several Blockstream employees and contractors were arguably more effective at swaying public opinion than Coinbase was, even though the latter generates significantly more revenue and has actual customers whereas the former is largely just a R&D dev shop. This discussion deserves its own post but neither company is very forthcoming about client or partnerbase… although Coinbase has published a bit more information over the years relative to Blockstream. []
  79. See also: The Problem with Calling Bitcoin a “Ponzi Scheme” by Preston Byrne []
  80. A large portion of blocks between 2009-2010 also included relatively few transactions, yet miners were being rewarded the same revenue irrespective of the volume or labor involved. []
  81. This is a topic I’ve written extensively about in the past, see (1) A pre-post-mortem on BitPay and (2) Looking at public information for quarterly usage []
  82. There is a small window between when FX markets in San Francisco close on a Friday afternoon and when FX markets open in New Zealand on Monday morning. []
  83. See Bitcoin’s $30 billion sell-off from Chainalysis []
  84. Does trading between exchanges represent 90+% of the total volume on- and off-exchanges?  Without full optics into all major intermediaries, that would be a tough claim to definitively prove. []
  85. In informal surveys most speculators of coins have the same mentality of speculators of other things that are traded on secondary markets: they think the number will go up. []
  86. See When Paper Paralyzed Wall Street: Remembering the 1960s Paperwork Crisis from Finra and The Remaking of Wall Street, 1967 to 1971 from HBS and Dole Food Had Too Many Shares from Matt Levine []
  87. Also recommend Spurious correlations []
  88. The book downplays illicit activity as if it is not a valid, reliable use case when it is.  For instance, the GRU allegedly used bitcoin to finance some of its operations focused on the 2016 US elections and they did so to obfuscate their tracks. []
  89. See The new TARGET instant payment settlement (TIPS) service from the ECB []
  90. For more on this, see: (1) Debunking Bitcoin’s Remittance Valuation. Featuring a Lead Pipe by Anshuman Mehta and (2) Does Bitcoin/Blockchain make sense for international money transfers? from SaveOnSend []
  91. A fundamental problem with this book is that it wants to have it both ways, with no clear goal posts for what a good or bad platform is and how to measure it.  How can an investor know if a coin is any good?  A table of attributes is recommended for the next edition. []
  92. Simply multiplying the amount of mined / pre-mined / pre-allocated coins by the market price to arrive at a “market cap” is a disservice to how market capitalization is actually determined.  See Section 6. []
  93. As an aside, even though there is no law preventing consumers and merchants from using or accepting gold (or silver) as a means of payment in the US, basically no one does because they’d rather hold it with the expectation of future price appreciation. I am sure lots of angry trolls will point out that legal tender laws in the US do not currently include precious metals and neither are cryptocurrencies.  Yet there are other economic reasons why people would rather hold onto an internet coin or a gold bar versus use it as money, and simply blaming legal tender laws is missing those. []
  94. Recommended reading: Distributed ledger technology in payments, clearing, and settlement by the Federal Reserve and Central bank digital currencies from the BIS []
  95. See several articles: The myth of a cheaper Bitcoin network: a note about transaction processing, currency conversion and BitcoinlandWhat is the “real” price of bitcoin?, and What impact have various investment pools had on Bitcoinland? []
  96. Also, as a pre-emption: one of the main reasons why these merchants and manufacturers do not hold on to these coins is because of… volatility.  As shown earlier in this review, that still hasn’t disappeared despite years of promotion that it has.  See also: (1) Debunking Bitcoin’s Remittance Valuation. Featuring a Lead Pipe by Anshuman Mehta and (2) Does Bitcoin/Blockchain make sense for international money transfers? from SaveOnSend []
  97. And as mentioned in the section above, both Zelle and Swift (gpi) will likely make a lot of inroads in the same national and international areas that cryptocurrency advocates were touting… but without needing a coin.  The struggle is real. []
  98. Note: both have since left those jobs.  Bogart became a partner at Blockchain Capital (a venture fund focused on coins) and Luria joined D.A. Davidson []
  99. In the next edition if possible, try to include Placeholder’s research so we can have an idea of the firm’s internal thinking on these issues. []
  100. Recommended: Digital Tulips? Returns to Investors in Initial Coin Offerings by Hugo Benedetti and Leonard Kostovetsky []
  101. Does Placeholder Capital invest in such ICOs? []
  102. Note that selfish mining has some odd game theoretic properties which may not hold up in the real world. But if the selfish mining pool manages to stay a block ahead on average, they can reveal a longer chain whenever they see transactions they want to censor.  It comes with the caveats that it’s not completely reliable in that they aren’t guaranteed to be a block ahead of the rest of the network 100% of the time (due to the inhomogenous Poisson process mentioned earlier). However, if they manage to effect a cohort of self-interested selfish miniers, they could… and that’s the equivalent of a “51% attack.” []
  103. Recommended reading: The Economic Limits of Bitcoin and the Blockchain by Eric Budish []
  104. Recommended: Analysing Costs & Benefits of Public Blockchains (with Data!) by Colin Platt. []
  105. Based on hash rate, the vast majority of mining pools supported Segwit2x and did not support UASF. []
  106. Coincidentally, these have all obtained a Bitlicense from NYS DFS. []
  107. Kraken uses Silvergate for its OTC trading. []
  108. A user can be defined as a person who controls their private keys without relying on a 3rd party intermediary. []
  109. Several analytics providers include: Chainalysis, Blockseer, Elliptic, Scorechain, and CipherTrace. []
  110. This is reminiscent of the BearWhale nonsense a few years ago. []
  111. Recall that historically, humanity went from only having to bearer assets up through the 19th century.  And that for a variety of reasons these became registered and immobilized and then later dematerialized altogether.  Cryptocurrencies recreates a financial order that had already existed. []
  112. See Learning from the past to build an improved future of fintech and Distributed Oversight: Custodians and Intermediaries []
  113. Butterfly Labs began accepting pre-orders in the summer of 2012 but delivered them late in 2013… and got sued by the FTC. []
  114. Regarding ‘perfect competition,’ four years ago Jonathan Levin opined that: “Another simple thing about this is that it is unsurprising that the bitcoin network got into this mess as it is economically rational to join the biggest pool. Minimises variance and ceteris paribus reduce orphans increasing expected return per hash. The other point is that there is still hardware bottlenecks so designing the theoretically most robust system may fail due to market imperfections. Implicitly in many arguments I hear about mining people assume perfect competition. Do we need to remind people what are the necessary conditions for perfect competition? Perfect information, equal access to markets, zero transportation costs, many players ……. this is clearly not going to be a perfectly competitive decentralised market but it certainly should not favour inherently the big players.”  See p. 114 of The Anatomy []
  115. Some of these are detailed in: Comments on the COIN ETF []
  116. For illustrative purposes, this includes: Circle, JUMP Trading, and Cumberland (DRW). []
  117. See also: New Visa chargeback system aims to speed dispute resolution by John Egan []
  118. See U.S. Regulators Subpoena Crypto Exchange Bitfinex, Tether from Bloomberg []
  119. In his public speaking events and social media accounts, Andreas Antonopoulos is quite candid about his dislike of the establishment. []
  120. See Chapter 2 in The Anatomy []
  121. See Brian Armstrong’s tweet in Section 5 []
  122. This raises questions that related to FinCEN and SEC purview but neither has opined at this time on this specific point. []
  123. CoinAgenda Singapore, which took place in June 2018, only had 168 attendees — with ticket prices up to $3,000 apiece. []
  124. Coins.ph and Luno come to mind as examples. []
  125. See What is the difference between Hyperledger and Hyperledger? []
  126. See A brief history of R3 – the Distributed Ledger Group []
  127. Needs a larger sample size conducted in a public venue, and/or with the help of an experienced sampling organization. []
  128. This then leads to incentives to attack and hack exchanges, because they end up acting as deposit-taking institutions, aka banks. []
  129. There were probably 50% more hand-written notes or comments that I could have added that I skipped over. []
  130. The HODLing “digital gold” meme which was only passingly mentioned in this book ultimately degenerates into goldbugism but that’s a topic for a different post. HODLing arguably became a thing once the ideologues realized Bitcoin itself wasn’t a competitive payment system.  An enormous amount of revisionism has taken place since 2014 regarding what Bitcoin was and is and should be. []
  131. Debunking Bitcoin’s Remittance Valuation. Featuring a Lead Pipe by Anshuman Mehta []
  132. One reviewer mentioned: “By hoarding then actively purchasing more coins to hoard, they might temporarily create an effect whereby each marginal contribution to Bitcoin through mining rewards in expanding the effective monetary base is partially neutralized.  In addition to marketing campaigns, this can lead to higher USD values and may incentivize additional mining power, which in turn creates higher hashrate.  However, you cannot make the same argument for gold because simply driving the price of gold up doesn’t make gold harder to find or more secure, and in fact we see the opposite.” []
  133. For instance, the supply of gold is actually elastic whereas many cryptocurrencies including Bitcoin have an inelastic money supply.  Where in the whitepaper does it talk about a store of value?  If that was the goal, surely it would’ve been mentioned in the whitepaper or the first few emails upon Bitcoin’s initial release. []
  134. Recommended reading: The Economic Limits of Bitcoin and the Blockchain by Eric Budish []
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Six bedtime stories from 2017

[Note: I neither own nor have any trading position on any cryptocurrency.  I was not compensated by any party to write this.  The views expressed below are solely my own and do not necessarily represent the views of my employer or any organization I advise.  See Post Oak Labs for more information.]

2017 taught us many things, including the fact that no one reads (or writes) or pays for long-form content any more.  Even with lovable memes and animated gifs, keeping an audience’s attention is hard.

Already too distracted to read further?  How about a quick video from JP Sears on how to appropriately Bitcoin Shame your friends and family:

The other takeaway for 2017 is that, if in doubt, open up hundreds of social media accounts and shill your way to riches.  The worst thing that could happen is no one buys your coin.  The best thing that happens is that someone buys your coin and you can then convert the coin into real money, retire, and act like you are super-wise thought leader with oodles of entrepreneurial and investing experience.

Some other stories with revisiting from the past year:

(1) “Legitimization”

If we were being intellectually honest we would say that the only goal post anyone cared about this year was that the price of cryptocurrencies, as measured in real money, and how high they soared.1 And that the main reason this occurred is because Bob knew Alice and Carol were both going to buy a lot of say, bitcoin, thereby pushing up the price, so he did too.  The Economist called it “the greater fool theory.”  But The Economist are great fools for not buying in at $1, so let’s ignore them.

Basically none of the feel-good goals about lowering remittance fees or increasing financial inclusion promoted in previous years by enthusiasts have really materialized.  In fact, at-risk users and buyers in developing economies probably got screwed on the ICO bandwagon as insiders and sophisticated investors who were given privileged early access to pre-sales, dumped the coins on secondary markets and hoi polloi ended up holding the bag on dozens of quarter-baked ICOs.2

Oh, but transaction fees for Bitcoin are at all-time highs, that’s a real milestone right?

There are many reasons for this, including the fact that Bitcoin Core’s scaling roadmap has thus far failed to achieve its advertised deadlines (see section 5 below).3 Maybe that will change at some point.

Shouldn’t higher fees be a cause for celebration with “champaign” (sic)? 4

Some Bitcoin Core representatives and surrogates have created an ever expanding bingo card of scapegoats and bogeymen for why fees have gone up, ranging from:

  • blaming Roger Ver and Jihan Wu as demonic-fueled enemies of Bitcoin
  • to labeling large chunks of transactions as ‘spam attacks’ from nefarious Lizard-led governments5
  • to flat out bitcoinsplaining: higher fees is what to expect when mass adoption takes place!

I’m sure you’ll be on their bingo card at some point too.

Just like Visa and other widely used payment network operators charge higher and higher rates as more and more users join on… oh they don’t.6 But that’s because they censor your freedom loving transactions!  Right?

So what’s the interim solution during this era of higher fees?  Need to send a bitcoin payment to someone?

You know how supermarkets used to hold items on layaway?  They still do, but it’s not as common to use, hence why you googled the term.  Well, in light of high fees, some Bitcoin Core developers are publicly advising people to open up a “tab” with the merchant.  You know, just like you do with your favorite local bartender.

Fun fact: the original title of the Satoshi whitepaper was, Bitcoin: a peer-to-peer electronic layaway system.

This faux comparison didn’t age well.  In 2014 this was supposed to be a parody. (Source)

For example, the ad above was promoted far and wide by Bitcoin enthusiasts, including Andreas Antonopoulos who still tries to throw sand in Western Union’s eye.  Seriously, watch the linked video in which Antonopoulos claims that Bitcoin will somehow help the poor masses save money such that they can now invest in and acquire clean water.  It’s cringe worthy.  Did Bitcoin, or Bitcoin-related businesses, actually do any of the things he predicted?  Beyond a few one-time efforts, not really.7 Never mind tangible outcomes, full steam ahead on the “save the world” narrative!

Many enthusiasts fail to incorporate in their cartoonish models: that the remittance and cross border payment markets have a set of inflexible costs that have led the price structure to look the way it does today, and a portion of those costs, like compliance, have nothing to do with the costs of transacting.8  There may be a way of reducing those costs, but it is disingenuous (and arguably unethical) to pull on the heart strings of those living on subsistence in order to promote your wares.9

Rather than repeat myself, check out the break down I provided on the same Western Union example back in 2014.  Or better yet, look at the frequently updated post from Save on Send, who has the best analysis bar none on the topic.

Back to loathing about ‘adoption’ numbers: few people were interested in actual usage beyond arbitrage opportunities and we know this because no one writes or publishes usage numbers anymore.10 I’ll likely have a new post on this topic next quarter but for a quick teaser: BitPay, like usual, still puts out headline numbers of “328% growth” but doesn’t say what the original 2016 baseline volume was in order to get the new number today.

I don’t strive to pick on BitPay (to be fair they’re like the only guys to actually publish something) but unfortunately for them, the market still has not moved their way: Steam recently dropped support for Bitcoin payments and a Morgan Stanley research note (below) showed that acceptance from top 500 eCommerce merchants dropped from 5 in 2016 to 3 in 2017.11

“This is possibly the saddest bitcoin chart ever” – BI. Source: Morgan Stanley

Due to a lack of relevant animated gifs, a full break down on the topic wouldn’t fit in this article.  But just a quick note, there were a number of startups that moved decisively away from their original stated business case of remittances and instead in to B2B plays (BitPesa, Bitspark) or to wallets (Abra). 12  These would be worth revisiting in a future article.13

So what does this all have to do with “legitimization”?

If you haven’t seen the Godfather trilogy, it’s worth doing so during or after the holiday break.14

This year we have collectively witnessed the techbro re-enactment of Godfather: Part 3 with the seeming legitimization of online bucket shops and dodgy casinos, aka cryptocurrency intermediaries, you wouldn’t talk about in polite company.

All of the worst elements of society, like darknet market operators, hate groups, and malware developers, effectively got eff you money and a cleansing mainstream “exit” courtesy of financial institutions coming in and regulators overwhelmed by all of the noise.15  Just like in No Country for Old Men, the bad guy(s) sometimes win.  This isn’t the end of that story but the takeaway for entrepreneurs and retail investors: don’t work or build anything. Just shill for coins on social media morning, noon, and night.

(2) Red Scares

I am old enough to remember back in 2013 when Bitcoin “thought leaders” welcomed Chinese Bitcoin users.  In late 2013, during the second bull run of that year, there were frequent reddit threads about how mainland Chinese could use Bitcoin to route around censorship and all the other common civil libertarian tropes.

Guess what happened?  On December 5th, 2013, the People’s Bank of China and four other ministries issued guidance which restricted activities that domestic banks could do with cryptocurrencies, thereby putting spot exchanges in a bit of a bind, causing panic and subsequently a market crash.  Within days there were multiple “blame China” threads and memes that still persist to this day.  Case in point: this thread titled, “Dear China” which had Mr. Bean flipping off people in cars, was voted to the top of /r/bitcoin within a couple months of the government guidance.  Classy.

As I detailed in a previous post, earlier in the autumn, several state organs in China finally closed down the spot exchanges, which in retrospect, was probably a good decision because of the enormous amounts of scams and deception going on while no one in the community was policing itself.16 In fact, some of the culprits that led Chinese exchanges into the dishonesty abyss are still around, only now they’re working for other high-profile Bitcoin companies. 17  Big surprise!

For example, Reuters did an investigation into some of the mainland exchanges this past September, prior to the closure of the spot exchanges.  They singled out BTCC (formerly BTC China) as having a checkered past:

Internal customer records reviewed by Reuters from the BTCChina exchange, which has an office in Shanghai but is stopping trading at the end of this month, show that in the fall of 2015, 63 customers said they were from Iran and another nine said they were from North Korea – countries under U.S. sanctions.

It’s unclear how much volume BTCC processed on behalf of North Koreans, one former employee says the volumes were definitely not zero.18 These were primarily North Koreans working in China, some in Dandong (right across the border).

For perspective: North Korea has been accused of masterminding the WannaCry ransomware attack and also attacking several South Korea exchanges to the tune of around $7 million this year.  Sanctions are serious business, check out the US Department of Treasury resource center to learn more.19

Isn’t China the root of all problems in Bitcoinland?

Source: Twitter

The sensationalism (above) is factually untrue yet look how many people retweeted and liked the quickly debunked conspiracy theory.  It’s almost as if, in the current mania, no one cares about facts.

As Hitchens might say: that which can be asserted without evidence, can be dismissed without evidence.  So to are the conspiracies around Bitcoin in China:

  • Is the Chinese government nationalizing Bitcoin?  No.
  • Is the Chinese government responsible for Bitcoin Cash.  No.
  • Is the Chinese government behind the rise in CryptoKitties. No.

In this bull market it is unclear why Paul has to resort to PR stunts, like making fearmongering tweets or opening a strike/call option at LedgerX with the bet that bitcoin will be worth $50,000 next year.20 There are many other ways to better utilize this capital: rethink investing in funds run by managers who are not only factually wrong but who spread fake rumors around serious issues like nationalization.

For instance, I don’t normally publicly write about who I meet, but this past July, while visiting Beijing I sat down with about a dozen members of their ‘Digital Money‘ team (part of the People’s Bank of China group involved in exploring and researching blockchain-related topics). 21 They had already spoken with my then-current employer as well as many other teams and companies (apparently the Zcash team saw them the very next day). While I don’t want to be perceived as endorsing their views, based on my in-depth discussion that day, this Digital Money team had clearly done their homework and heard from all corners of the entire blockchain ecosystem, both cryptocurrency advocates and enterprise vendors. They were interested in the underlying tech: how could the big umbrella of blockchain-related technology improve their financial market infrastructure?

Look at it another way: the Chinese government (or any government for that matter) has no need to nationalize Bitcoin, what value would it bring to them?  It would just be a cost center for them as miners don’t run for free.22  In contrast, their e-RMB team, based out of Shenzhen, has been experimenting with forks/clones of Ethereum.  This is public information.

But what about Jihan and Bitmain?  Aren’t they out to kill Bitcoin?

I can’t speak on his intentions but consider this: as a miner who manufacturers and sells SHA256 hardware that can be used by both Bitcoin and Bitcoin Cash (as well as any SHA256 proof-of-work coin), Bitmain benefits from repeat business and satisfied customers.  It is now clear that the earlier Antbleed campaign effort to demonize Bitmain was a massive PR effort to create a loss of confidence in Bitmain as it was promoted by several well known Bitcoin Core supporters and surrogates to punish Bitmain for its support for an alternative Bitcoin scaling roadmap and client.  In fact, as of this day, no one has brought forth actual evidence beyond hearsay, that covert ASICBoost is/was taking place.  Maybe they did, but you’d need to prove this with evidence.

Speaking of PR campaigns and mining…

(3a) Energy usage / mining

Over the past two months there have probably been more than a dozen articles whitewashing proof-of-work mining energy consumption numbers.  Coin Center, a lobbying group straight out of Thank You for Smoking, has its meme team out on continuous social media patrols trying to conduct damage control: no one must learn that Bitcoin mining isn’t free or that it actually consumes resources!

Source: Twitter

The title of the article above is complete clickbait BS.  Empirically proof-of-work mining is driving miners to find regions of the world that have a good combination of factors including: low taxes, low wages, low energy costs, quick time-to-market access (e.g., being able to buy and install new hashing equipment), reliable energy, reliable internet access, and low political turmoil (aka stability).23  Environmental impact and “clean energy” are talking points that Van Valkenburgh allege, but don’t really prove beyond one token “we moved to renewables!” story.  The next time Coin Center pushes this agenda item, be sure to just ask for evidence from miners directly.24.

Another example is in a recent Bloomberg View column from Elaine Ou (note: the previous company that she co-founded was shut down by the SEC).  She wrote:

Digital currency is wasteful by design. Bitcoin “miners,” who process transactions in return for new currency, must race to solve extremely difficult cryptographic puzzles. This computational burden helps keep the transaction record secure — by raising the bar for anyone who would want to tamper with it –- but also requires miners to build giant farms of servers that consume vast amounts of energy. The more valuable bitcoin becomes, the more miners are willing to spend on equipment and electricity.

Mining a proof-of-work coin (such as Bitcoin) can only be as ‘cheap‘ or ‘efficient’ as the block reward is worth. As the market price of a coin increases so too does the capital expended by miners chasing seigniorage.  This, we both agree on.

In the long run, proof-of-work miners will invest and consume capital up to the threshold in which the marginal costs of mining (e.g., land, labor, electricity, taxes, etc.) roughly equals the marginal revenue they receive from converting the bitcoins into foreign currency (aka real money) to pay those same costs.  This, we also both agree on.

What Ou makes a mistake on is in her first sentence: digital currencies are not all wasteful, only the proof-of-work variety are.  Digital currency != cryptocurrency.25

I know, I know, all other digital currencies that are not proof-of-work are crap coins and those who make them are pearl-clutching morons.  Contra Ou and Coin Center, it is possible for central banks, and even commercial banks, to issue their own digital currency — and they could do so without using resource intensive proof-of-work.26  The Bank of International Settlements recently published a good paper on the various CBDC models out there, well worth a read.  And good news: no mountains of coal are probably used in the CBDC issuance and redemption process.27

Back to proof-of-work coins: a hypothetically stable $1 million bitcoin will result in a world in which miners as a whole expend up to $1 million in capital to mine.  If the network ever became cheaper to operate it would also mean it is cheaper to permanently fork the network.  You can’t have both a relatively high value proof-of-work coin and a simultaneously non-resource intensive network.

While it is debatable as to whether or not Bitcoin mining is wasteful or not, it empirically does consume real resources beyond the costs of energy and the externalization of pollution onto the environment.  The unseen costs of hash generation for a $20,000 bitcoin is at least $13 billion in capital over a year that miners will eventually consume in their rent-seeking race albeit from a combination of resources.

Data source: BitInfoCharts

I quickly made the chart (above) to illustrate this revenue (or costs depending on the point of view).28 These are the eight largest proof-of-work-based cryptocurrencies as measured by real money market prices.

There are a few caveats: (1) some of the block rewards adjust more frequently than others (like XMR); (2) some of the coins have relatively low transaction fees which equates to negligible revenue so they were not included; (3) the month of December has seen some very high transaction fees that may or may not continue into 2018; (4) because block generation for some of these is based on an inhomogeneous Poisson process, blocks may come quicker than what was supposed to be “average.”

How to interpret the table?

The all-time high price for Bitcoin was nearly $20,000 per coin this year.  If in the future, that price held stable and persisted over an entire year, miners would receive about $13 billion in block rewards alone (not including transaction fees).  Empirically we know that miners will deploy and consume capital up to the point where the marginal costs equals the marginal value of the coin.29  So while there are miners with large operating margins right now, those margins will be eaten up such that about $13 billion will eventually be deployed to chase and capture those rewards.  Consequently, if all 8 of these proof-of-work coins saw their ATH extended through 2018, ceteris paribus, miners would collectively earn about $32.6 billion in revenue (including some fees).

There are a variety of sites that attempt to gauge what the energy consumption is to support the network hashrate.  Perhaps the most frequently cited is Digiconomist.  But Bitcoin maximalists don’t like that site, so let’s put together an estimate they cannot deny (yes, there are climate change denialists in the cryptocurrency world).

For the month of December, the network hashrate for Bitcoin hovered around 13.5 exahash/second or 13.5 million terahash/second (TH/s).

To get a lowerbound on how many hash-generating machines are being used, let’s look at a product called the S9 from Bitmain.  It is considered to be the most “efficient” off-the-shelf product that public consumers can order in volume.30 This mining unit generates around 13.5 TH/s.

So, if we were to magically wave our hands and replace all of the current crop of Bitcoin mining machines into the most efficient off-the-shelf product, we’d need about 1 million of these to be manufactured, shipped, installed, and maintained in order to generate the equivalent hashrate that the Bitcoin network has today.  Multiply 1 million S9’s times the amount of energy individually used by a S9 and you’d get a realistic lowerbound energy usage for the network today.31

Note: this doesn’t factor in land prices, energy costs, wages for employees, building the electrical infrastructure (e.g., installing transformers), and many other line items that are unseen in the chart above.  It also doesn’t include the most important factor: as more mining hashrate is added and the difficulty rating adjust upward, it dilutes the existing labor force (e.g., your mining unit does not improve or become more productive over time).

(3b) Energy usage upperbound

So what are the upperbound costs?

Source: Twitter

The tweet above is not a rare occurrence.  If you are reading this, you probably know someone who tried to mine a cryptocurrency from an office computer or maybe their computer was the victim of ransomware.

You may not think of much of the externalization and socialization of equipment degradation that is taking place, but because mining is a resource intensive process, the machines used for that purpose depreciate far faster than those with normal office usage.32  To date, no one has done a thorough analysis of just how many work-related computers have been on the receiving end of the mining process but we know that employees sometimes get caught, like the computer systems manager for the New York City Department of Education or the two IT staffers in Crimea.33

Even if miners eventually fully utilize renewable energy resources, most hash-generating machines currently deployed do not and will not next year.  These figures also do not factor in the fully validating nodes that each network has that run out of charity (people run them without any compensation) yet consume resources.  According to Bitnodes, Bitcoin has around 11,745 nodes online. According to EtherNodes, Ethereum has around 26,429 nodes online.

So is there an actual upperbound number?

There is, by dividing hashpower by cost and comparing to costs of various known processor types.  For instance, see this footnote for the math on how two trillion low-end laptop CPUs could be used.3435

Just looking at the hash-generating machines, according to Chen Min (a chip designer at Avalon Mining), as of early November, 5% of all transistors in the entire semiconductor industry is now used for cryptocurrency mining and that Ethereum mining alone is driving up DRAM prices.

This is not to say you should march in the streets demanding that miners should forgo the use of coal power plants and only use solar panels (which of course, require consumption of resources including semiconductors), there are after all, many other activities that are relatively wasteful.

But some Bitcoin and cryptocurrency enthusiasts are actively whitewashing the environmental impact of their anarchic systems and cannot empirically claim that their proof-of-work-based networks are any less wasteful or resource intensive than the traditional foreign capital markets they loathe.

In point of fact, while the traditional financial markets will continue to exist and grow without having to rely on cryptocurrencies for rationally pricing domestic economic activity, in 2018, as in years prior, Bitcoinland is still fully dependent on the stability of foreign economies providing liquidity and pricing data to the endogenous labor force of Bitcoin.  Specifically, I argue in a new article, that miners cannot calculate without using a foreign unit of account; that economic calculations on whether or not to deploy and consume capital for expanding mining operations can only be done with stable foreign currency.36

Keep in mind that cryptocurrencies such as Bitcoin only clear (not settle) just one coin (or token) whereas traditional financial markets manage, transact, clear and settle hundreds of different financial instruments each day. 37  For comparison, the Federal Reserve estimates that on any given day about 600 million payment, clearing, and settlement transactions take place in the US representing over $11 trillion in value.38  But this brings up a topic that is beyond the scope of this article.  Next section please.

(4) MIT’s Digital Currency Initiative

On the face of it, MIT’s DCI effort makes a lot of sense: one of the world’s most recognized institutions collaborating with cryptocurrency developers and projects worldwide.

But beneath the slick facade is a potential conflict of interest that has not been looked at by any media outlet.  Specifically, around its formal foray into building tools for central bank digital currency (CBDC).  Rob Ali, a well-respected lawyer turned research scientist (formerly with the Bank of England), was hired earlier this year by DCI to build and lead a team at MIT for the purpose of continuing the research he had started at the BoE.  This is no secret.

Less known is how this research has now morphed into a two-fold business:

  1. DCI charges central banks about $1 million a year to be a partner.39  What this allows the central bank to do is send staff to MIT and tap into its research capabilities.  This includes MIT representatives co-authoring a couple of papers each year focused on topics that the central bank is keen to explore.  Multiple central banks have written checks and are working together with DCI at this time.
  2. Building and licensing tools and modules to central banks and commercial banks.  DCI has hired several Bitcoin developers whom in turn have cloned/forked Bitcoin Core and Lightning.  Using this code as a foundation, DCI is building IP it aims to license to central banks who want to build and issue central bank digital currency.

Where is the conflict of interest?

DCI is housed within MIT’s Media Lab, whose current director is Joi Ito.  Ito is also the co-founder and director of Digital Garage.  Digital Garage is an investor in Blockstream and vocal advocate of Lightning; coincidentally Blockstream is building its own Lightning implementation. Having made several public comments in favor of Bitcoin Core’s hegemony, Ito also appears to be a critic of alternative blockchain implementations.

In looking at his publicly recorded events on this topic Ito does not appear to disclose that the organizations he co-runs and invests in, directly benefit from the marketing efforts that Bitcoin Core and Lightning receive.  Perhaps this is just miscommunication.

I’m all for competition in the platform and infrastructure space and think central bank digital currencies are legit (again check out this BIS paper) but this specific DCI for-profit business should probably be spun off into an independent company.  Why?  Because it would help reduce the perception that Ito – and others developers involved in it – benefits from these overlapping relationships.  After all, Bitcoin Core arguably has a disproportional political clout that his investment (Blockstream) potentially benefits from if/when Lightning goes into production.40 And again, this is not to say there shouldn’t be any private-public partnerships or corporate sponsorships of academic research or that researchers should be prohibited in investing in companies, rather just a recommendation for disclosure and clarity.

(5) Lightning Network

If you haven’t seen The Money Pit (with Tom Hanks), it is well worth it for one specific reason: the contractors and their staff who are renovating Hanks’ home keep telling Hanks that it will be ready in two weeks.

And after those two weeks are over, Hanks is informed yet again that it will be ready in another two weeks.

The Lightning Network, as a concept, was first announced via a draft paper in February 2015. Its authors, Tadge Dryja and Joseph Poon, had initially sketched out some of the original ideas at their previous employer Vaurum (now called Mirror).

Lightning, as it is typically called, is commonly used in the same breath as “the scaling solution,” a silver bullet answer to the current transactional limitations on the Bitcoin network.41 Nearly three years later, after enormous hype and some progress, a decentralized routing version still has not gone into production.  Maybe it will eventually but not one of its multiple implementations is quite ready today unless you want to use a centralized hub.42  Strangely, some of the terminology that its advocates frequently use, “Layer 2 for settlement,” is borderline hokum and probably has not been actually vetted to see if it fulfills the requirements for real “settlement finality.”43

And like multiple other fintech infrastructure projects, some of its advocates repeatedly said it would be ready in less than 6 months, several times.  For instance:

  • On October 7, 2015, Pete Rizzo interviewed multiple developers including Tadge Dryja and Joseph Poon regarding Lightning.  Rizzo wrote that: “In interview, Dryja and Poon suggested that, despite assertions project development could take years, Lightning could take as little as six months to be ready for launch.”
  • On April 5, 2016, Kyle Torpey interviewed Joseph Poon regarding expected time lines, stating that: “Lightning Network co-creator Joseph Poon recently supplied some comments to CoinJournal in regards to the current status of the project and when it will be available for general use. Poon claimed a functional version of the Lightning Network should be ready this summer.”
  • A month later, on May 5, 2016, Kyle Torpey interviewed Adam Back regarding his roadmap.  Torpey wrote that: “While all of these improvements are being implemented on Bitcoin’s base layer, various layer-2 solutions, such as the Lightning Network, can also happen in parallel. The Lightning Network only needs CHECKSEQUENCYVERIFY (along with two other related BIPs) and Segregated Witness to be accepted by the network before it can become a reality on top of the main Bitcoin blockchain.”
  • On November 12, 2016, Alyssa Hertig interviewed several developers including Pierre-Marie Padiou, CEO of ACINQ, one of the startups trying to building a Ligthning implementation.  According to Padiou: “The only blocker for a live Lightning implementation is SegWit. It’s not sure how or when it will activate, but if SegWit does activate, there is no technical thing that would prevent Lightning from working.”

Segregated Witness (SegWit) was activated on August 24, 2017.  More than four months later, Lightning is still not in production without the use of hubs.

Source: Twitter

Not to belabor the point, just this past week, one of the executives at Lightning Labs (which is building one of the implementations) was interviewed on Bloomberg but wasn’t asked about their prior rosy predictions for release dates.  To be fair, there is only so much they could cover in a six minutes allocation.

“Building rock solid infrastructure is hard,” is a common retort.

Who could have guessed it would take longer than 6 months?  Yes, for regular readers of my blog, I have routinely pointed out for several years that architecting and deploying financial market infrastructure (FMI) is a time consuming, laborious undertaking which has now washed out more than a handful of startups attempting to build “enterprise” blockchains.

For example, Lightning as a concept predates nearly every single enterprise-focused DLT vendor’s existence.  While not an equal comparison (they are trying to achieve different goals), there are probably ~5 enterprise-focused, ‘permissioned’ platforms that are now being used in mature pilots with real institutional customers and a couple could flip the “production” button on in the next quarter or so.4445

For what it is worth, enterprise DLT vendors as a whole did a very poor job managing expectations the past couple of years (which I mentioned in a recent interview).  And they certainly had their own PR campaigns during the past couple of years too, there is no denying that.  Someone should measure and quantify the amount of mentions on social media and news stories covering enterprise vendors and proposals like Lightning.46

Better late than never, right?  So what about missed time frames?

In a recent (unscientific) poll I did via Twitter (the most scientific voting platform ever!) found that of the more than 1,600 voters, 81% of respondents thought that relatively inexpensive anonymous Lightning usage won’t really be good to go for at least 6+ months.

Just as Adam Back proposed a moratorium on nebulous “contention” for six months (beginning in August), I propose a moratorium on using the term “Lightning” as a trump card until it is actually live and works without relying on hubs.  But don’t expect to see the crescendo of noise (and some signal) to die down in the meantime, especially once exchanges and wallets begin to demonstrate centralized, MSB-licensed implementations.47

With that suggestion, I can see it now: all of the Lightning supporters flaming me in unison on Twitter for not being a vocal advocate.  Sure beats shipping code!  To be even handed, Lightning’s collective PR effort was just one of many others (hello sofachains!) that could be scrutinized.  A future post could look at all funded infrastructure-related efforts to improve cryptocurrency networks.  Which ones, if any, showed much progress in 2017. 48

Interested in reading more contrarian views on the Lightning Network?  See Gerard and Stolfi (and Stolfi2x) (and Stolfi3x).  Let’s revisit in 6 months to see what has been launched and is in production.

(6) Objective reporting and analysis

Without sugar coating it: with the exception of a few stories, coin media not only dropped the ball on critically, objectively covering ICO mania this past year, but was largely complicit in its mostly corrupt rise.  This includes The Information, which is usually stellar, but seems to have fallen in the tank with the ICO pumpers.  That is, unless you’re a fake advisor and then they’ve got your number.

It took some time, but eventually mainstream and a few not-so-mainstream coverage has brought a much needed spotlight on some of the shady actions that took place this year. There were also a number of good papers from lawyers and academics published throughout 2017.

Your holiday reading list in no particular order:

One of my favorite articles this year should be yours too:

Just a few short months after Stephen Palley published the article above, a lawsuit occurred in which, surprise surprise, the plaintiffs highlighted specific claims in the white paper:

Source: Twitter

Note: that the SEC’s order against the Munchee ICO also relied on highlighting specific claims in the white paper.

Concluding remarks

Unfortunately 2017 will probably go down as the year in which several generations of nerds turned into day-trading schmucks, with colorful technical charts and all.50 This included even adopting religious slogans like:  Buy the dip!  Weakhands!  HODL!  We are the new 1%!  The dollar is crashing!  It’s not a bubble, it’s an adoption curve!

A few parting bits of advice: unfollow anyone that says this time things are different or the laws of economics have changed or calls themselves a “cryptolawyer” or who previously got shutdown by the SEC or who doesn’t have a LinkedIn page.  Rethink donating or investing funds to anyone who makes up rumors about mining nationalization or who was fired for gambling problems or has a communications team solely dedicated to designing memes for Twitter.51

Cryptocurrencies aren’t inherently bad and ideas like ERC721 are even cool.52 But as neat as some of the tech ideas may be, magic internet coins sure as heck continue to attract a lot of Scumbag Steves who are enabled by participants that have turned a blind eye.  It’s all good though, because everyone will somehow get a Moonlambo after the final boss is beaten, right?

Coda

I will have a separate post discussing predictions for 2018 but since we are reflecting on 2017, below are a few other areas worth looking into now that you’re a paper zillionare:

  • We have real empirical observation of hyperdeflation occurring: in which it is more rational to hoard the coin instead of spend it.  As a result, Bitcoin-focused companies that have accumulated bitcoin are still raising capital from external financial markets denominated in foreign currency instead of deploying (consuming) their own bitcoin. And these same startups are receiving valuations measured, not in terms of bitcoin, but in terms of a foreign unit of account.  What would change this trend?
  • Bitcoinland, with its heavy concentration of wealth, looks a lot like a feudal agrarian economy completely dependent on other countries and external financial markets in order to rationally deploy capital and do any economic calculation. Is there a way to build a dynamically adjustable cryptocurrency that does not rely on foreign capital or foreign reference rates?
  • How much proof-of-work related pollution has been externalized and socialized on the public at large due to subsidies in various regions like Venezuela?  What are the effects, if any, on global energy markets?
  • As traditional financial markets add products and solutions with direct ties to cryptocurrencies (futures, options, payments, custody), by the end of 2018 how much of the transactional activity on Bitcoin’s edges will be based on non-traditional financial markets (e.g., LocalBitcoins)?
  • There were a lot of publicity stunts this year.  Working backwards chronologically, the Andreas Antonopoulos donation could have been a publicity stunt, it also could be real.  The argument goes: how is someone with a best selling book, who charges $20,000+ for speaking engagements, and who has been receiving bitcoins for years (here is the public address), still in debt.  Maybe he is, maybe his family fell on hard times.  But few asked any questions when an anonymous person sent what amounted to $1 million in bitcoin enabling him to reset his tax basis.  (Hate me for writing this?  As an experiment, earlier this month I put up a Bitcoin and Ethereum address on the sidebar of the home page, feel free to shower me with your magic coins and prove me wrong.  I promise to convert it all into dirty filthy statist bucks.)  A few months prior to that, Jamie Dimon was accused of everything but eating babies after he said “Bitcoin is a fraud.”  Dozens of “Dear Jamie” letters were written begging him to see Bitcoin with their pure rose-tinted eyes.  At what point will Bitcoin enthusiasts grow some thick skin and ignore the critics they claim don’t matter?  And while we can continue to add PR stunts forever, the “fundraiser” for Luke-Jr’s home after Hurricane Irma had zero proof that it was his house, just a picture that Luke-Jr. says it was and the rest of the Bitcoin Core fan club promoting it.  Trust but verify?

[Note: if you found this research note helpful, be sure to visit Post Oak Labs for more in the future.]

Acknowledgements

Many thanks to the following for their constructive feedback: VB, YK, RD, CM, WG, MW, PN, JH

End notes

  1. Bitcoin fans basically walked onto the field before the football game, toppled the goal posts, and carried it outside the stadium declaring themselves victorious without having actually played the match. []
  2. How many of these unsophisticated buyers have subsequently lost the corresponding private keys?  See “Nearly 4 Million Bitcoins Lost Forever, New Study Says” from Fortune []
  3. I am sure I will be accused of being a “Bitcoin Cash shill” (which obviously I must be, there is no other explanation!) for pointing this out, but last week, one vocal Bitcoin Core supporter even proposed a commit to change the wording on Bitcoin.org surrounding low fees: “These descriptions of transaction features are somewhat open to interpretation; it would probably be best not to oversell Bitcoin given the current state of the network.” []
  4. As an actor on a classic Saturday Night Live sketch said: “You may ask how we at the Change Bank, make money? It’s simple, volume.” []
  5. I take issue with anyone claiming to be able to label transactions specifically as spam without doing an actual graph analysis.  See Slicing Data for more. Proof-of-lizard is not to be conflated with lizardcoin. []
  6. Note: this is not an endorsement of Visa, I do not have any equity or financial stake in Visa. []
  7. One reviewer commented: “One problem that affects all cryptocurrencies whether proof of work or of stake: What reason do most people have for using them that won’t run afoul of social policy objectives? As long as people need to convert them to regular fiat currencies, they have a distinct disadvantage. The only exception would be in failed economies where stable fiat currencies are restricted, until those governments see a cryptocurrency as a potential substitute and ban it. It is not even clear why a government would need to issue a cryptocurrency (not a CBDC). If it wants to serve unbanked people it could open or subsidize a bank for them which is what is being attempted in a few developing countries.” []
  8. One reviewer commented: “Fully peer-to-peer without banks ultimately leads to creating a new currency. A new currency means that for international payments you have the additional costs of converting into the currency and converting out of the currency. A currency not linked to a real world economy is always going to have a more volatile price (assuming it has any price at all). Volatility in FX always, always leads to higher transaction costs for exchange because the bid offer spread has to be wider. This is before you even get into the mining proof or work model and all its inherent flaws, which again ultimately result from trying to build a financial system without banks.” []
  9. One reviewer noted that: “Transferwise, Currency Fair, Revolut, Mondo and other startups are already doing it. And they’re doing it without having to break the rules and laws banks and Western Union have to play by. They’re building actual real, potentially sustainable businesses that are useful to society. They’re just not grabbing the headlines like the greater fool / Nakamoto Scheme is. When you build a real business, your scope for false promise making behind incoherent computer science jargon is pretty small.” []
  10. I even stopped aggregating numbers 18 months ago because fewer companies were making usage numbers public: it’s hard to write about specific trends when that info disappears.  Note: if you think you have some interesting info, feel free to send it my way. []
  11. BitPay has diversified its portfolio of services now, expanding far beyond the original merchant acceptance and recently closed a $30 million funding round.  However, the problem with their growth claims is they are typically measured in $USD volume. So, as the value of bitcoin has grown 10-20x (as measured in USD) in the past year, it is unclear how much BitPay has really grown in terms of new customers and additional transactions.  Note: the same can be said for most Bitcoin-specific companies making big growth-related claims, BitPay is just one example. []
  12. Movements occurred in other areas too, on the enterprise side, Chain was perhaps the most well known company to pivot away from that vertical. []
  13. One reviewer commented: “2017 was a good year for B2B players with some prominent funding rounds (e.g., Bitspark, Veem, BitPesa) and some claimed growth on blockchain “rails” (but also on non-blockchain) namely Veem and BitPesa. A big surprise of 2017 was a much broader awareness of cryptocurrencies, i.e., free massive PR. The Coinbase app became more popular than Venmo (and far ahead of any bank). As a result, one of the most intriguing questions right now for 2018 is if/how Coinbase could capitalize on this opportunity to become a full-fledged bank leveraging the best of banking-like services from players like Xapo, Uphold, and Luno?” []
  14. I suppose it is safe to assume that if you’re reading this, you are coin millionaire so you don’t worry about fiat-mandated holiday breaks like the rest of us. []
  15. Not all medium-to-large coin holders are the adopters you now see wearing suits on television talk shows.  Most coin holders, including the abusive trolls and misogynists on social media, have seen a large pay raise, enabling the worst elements to continue their bullying attacks and illicit activities.  See Alt-right utilizes bitcoin after crackdown on hate speech from The Hill []
  16. Worth pointing out that Ryan Selkis is attempting to push forward with a the self-regulatory effort called Messari.  See also: The Brooklyn Project. []
  17. Earlier this year, right after the law enforcement raids in China, one of the senior executives left BTCC but still remains on the board of the parent company that operates BTCC.  He quickly found a new senior role at another high-profile Bitcoin-focused company and uses his social media accounts to vigorously promote Bitcoin Core and maximalism. []
  18. As explored in a previous post, fake volumes among the Chinese exchanges was not uncommon and several of the large exchanges attempted to gain funding from venture capitalists while simultaneously faking the usage numbers. As one former employee put it: “That was an extraordinary attempt at fraud — faking the numbers through wash trading and simply printing trades, while using that data to attract investment and establish their valuation.” []
  19. Coinbase got into some problems in early 2015 when one of its investor decks highlighted the fact that cryptocurrencies, such as Bitcoin, could be used to bypass sanctions. []
  20. Ari Paul runs a small “crypto” hedge fund called BlockTower Capital (estimated to have between around $50-$80 million AUM) that like many companies in this space, faces an ongoing lawsuit.  Unclear why LPs didn’t just buy and hold cryptocurrencies themselves and cut out the hysteria and management fees. []
  21. Yea, I know, “money” is already digital… I didn’t give them that name, they did. []
  22. One reviewer noted: “The fact remains that if you replace the mining process with a a centralized system for validation of transactions and up-to-date of balances you could run the whole thing on an ordinary sized server for a few thousand dollars per year. Centralisation and a more logical data model are vastly better technically speaking. And it would be far easier to add in compliance and links to banks for more robust and honest methods for exchanging between a centralized bitcoin and fiat. What would the Chinese government gain from mining?” []
  23. One of the often overlooked benefits of setting up a mining farm in China is that many of the parts and components of mining equipment are either manufactured in China and/or final assembly takes place in China.  So logistically it is much quicker to transport and install the hardware on-site within China versus transport and use overseas. []
  24. I know a bunch and could maybe introduce them though some of them make public appearances at conferences so they can usually be approached or emailed. []
  25. In fact, many regulators, such as the ECB, categorize cryptocurrency as a type of “virtual currency,” separate from a “digital currency.” []
  26. There is often confusion conflating “transaction processing” and “hash generation,” the two are independent activities.  Today mining pools handle the transaction processing and have sole discretion to select any transactions from the memory pool to process (historically there have been thousands of ’empty’ blocks) — yet mining pools are still paid the full block reward irrespective of how many transactions they do or not process.  Hash generation via mining farms has been a discrete service for more than 5 years — think of mining pools as the block makers who outsource or subcontract the hash generation out to a separate labor force (mining farms) and then a mining pool packages the transactions into a block once they receive the correct proof-of-work.  Note: “fees” to miners is a slightly different but related topic. []
  27. CBDCs have their own issues, like the risk of crowding out ordinary banks in market for deposits in a low interest rate environment but they have little in common with anarchic crytocurrencies. []
  28. Many thanks to Vitalik Buterin for his feedback and suggestions here. []
  29. See also: Some Crypto Quibbles with Threadneedle Street from Robert Sams []
  30. There are other mining manufacturers, including some who only build for themselves, such as Bitfury. []
  31. Interestingly enough, the market price for one of these machines is around $2,000.  And if you do the math, you’ll see exactly what all professional miners do: it’d only cost $2 billion to buy enough machines to generate 100% of the network hashrate and claim all the $13 billion in rewards to yourself!  In other words, the seigniorage is big, fat, and juicy… and will attract other miners to come and bid up the price of mining to the equilibrium point. []
  32. There are many walk-throughs of bitcoin mining facilities, including this video from Quartz. []
  33. In the process of writing this article, a new story explained how more than 105,000 users of a Chrome extension were unknowingly mining Monero.  Heroic theft of CPU cycles, right? []
  34. In theory, and practice, the upperbound is not infinite.  We know from the hashrate being generated that there are a finite amount of cycles being spent repeatedly multiplying SHA256 over and over.  Perhaps a possible, but improbable way to gauge the upperbound is to take the processing speed of a low-end laptop CPU (which is not as efficient at hashing as its ASIC cousins are).  At 6 MH/s, how many seventh generation i3 chips would it take to generate the equivalent of 13.5 million TH/s?  On paper, over 2 trillion CPUs.  Note: 1 terahash is 1 million megahashes.  So 1 million laptop CPUs each generating 6 MH/s on paper, would collectively generate around 6 TH/s.  The current network hashrate is 13.5 exahash/s.  So you’d need to flip on north of 2 trillion laptop CPUs to reach the current hashrate.  In reality, you’d probably need more because to replace malfunctioning machines: a low-end laptop isn’t usually designed to vent heat from its CPU throttled to the max all day long. []
  35. One China-based miner reviewed this scenario and mentioned another method to arrive at an upperbound: “Look at the previous generation of ASICs which run at 2-3x watt per hash higher.  The previous generation machines normally get priced out within 18 months.  But with differing electricity costs and a high enough price, these machines get turned on.  Or they go to cheap non-petrodollar countries like Russia or Venezuela. So your base load of 1 million machines will have an upperbound of 2x to 3x depending on prevailing circumstances.” []
  36. It may be also worth pointing out that the “evil Chinese miners blocking virtuous Core” narrative is hard to justify because Bitcoin’s current relatively high fees are a direct result of congestion and has consequently increased miner revenue by 33% (based on December’s fees).  So in theory, it’s actually in the miners interest to now promote the small block position.  Instead, in reality, most miners were and are the ones advocating for bigger block sizes, and certain Bitcoin Core representatives were blocking those proposals as described elsewhere but we’re not going down that rabbit hole today. []
  37. One reviewer commented: “Financial instruments that either directly perform a service to our economy and even indirectly via speculation, enable price discovery for things that are important to people’s lives. Who’s lives is Bitcoin really important to right now? To this day the only markets it can claim to have any significant market share in, let alone be leader in, is illicit trade and ransomware. The rest appears to be just people looking to pump and shill.” []
  38. It’s also probably not worth trying to start a discussion about what the benefits, if any, there is for society regarding cryptocurrency mining relative to the resources it collectively consumes, as the comments below or on social media would simply result in a continuous flame war.  Note: colored coins and metacoins create distortions in the security assumptions (and rewards) for the underlying networks.  Watermarked tokens are neither secure nor proper for financial market infrastructure. []
  39. It is not $1 million straight, there are multiple levels and tiers. []
  40. There is an ongoing controversy around key decision makers within Bitcoin Core (specifically those who approve of BIPs) and their affiliation with Blockstream.  One of Blockstream’s largest investors, Reid Hoffman, said Blockstream would “function similarly to the Mozilla Corporation” (the Mozilla Corporation is owned by a nonprofit entity, the Mozilla Foundation). He likened this investment into “Bitcoin Core” (a term he used six times) as a way of “prioritiz[ing] public good over returns to investors.” []
  41. Because it is its own separate network, it actually has cross-platform capabilities.  However, historically it has been promoted and funded for initial uses on the Bitcoin network moreso than others. []
  42. Yes, I am aware of the demo from Alex Bosworth, it is a big step forward that deserves a pat on the back.  Now to decentralize routing and provide anonymity to users and improve the UI/UX for normal users. []
  43. To start with, see the Principles for Financial Market Infrastructures. []
  44. This is not an endorsement of a specific platform or vendor or level of readiness, but examples would include: Fabric, Quorum, Corda, Axcore, Cuneiform, and Ripple Connect/RCL. []
  45. While Lightning implementations should not be seen as a rival to enterprise chains (it is an apples to oranges comparison), the requirements gathering and technical hurdles needed to be overcome, are arguably equally burdensome and maybe moreso for enterprise-focused companies.  Why?  Because enterprise-focused vendors each need approval from multiple different stakeholders and committees first before they deploy anything in production especially if it touches a legacy system; most Lightning implementations haven’t actually formally defined who their end-customer is yet, let alone their needs and requirements, so in theory they should be able to “launch” it faster without the check-off. []
  46. For instance, CoinDesk currently has 229 entries for “lightning,” 279 entries for “DLT,” and 257 entries for “permissioned.” []
  47. It bears mentioning that Teechain, can achieve similar KPIs that Lightning can, via the use of hardware, and does so today.  BitGo’s “Instant” and payment channels from Yours also attempt to achieve one similar outcome: securely transmitting value quickly between participants (albeit in different ways). []
  48. We’d need to separate that from the enterprise DLT world because again, enterprise vendors are trying to solve for different use cases and have different customers altogether.  Speaking of which, on the corporate side, there is a growing impatience with “pilots” and some large corporates and institutions are even pulling back.  By and large, “blockchain stuff” (people don’t even agree on a definition still or if it is an uncountable noun) remains a multi-year play and aside from the DA / ASX deal, there were not many 2017 events that signaled a shorter term horizon. []
  49. Note: both the Fedcoin and CAD-coin papers were actually completed and sent to consortium members in November 2016 then three months later, published online. []
  50. One reviewer commented: “There seems to be a whole new wave of both suckers and crooks to exploit the geeks. I have read some the Chartist analysis on forums for more traditional forms of day-trading such as FX day-trading and it is exactly the same rubbish of trying to inject the appearance of intelligence and analysis into markets that the day-traders (and those encouraging them) simply do not understand.” []
  51. A former Coinbase employee, now running a “crypto” hedge fund, was allegedly fired for gambling issues.  Maybe he wasn’t but there are a lot of addicts of many strains actively involved in trading and promoting cryptocurrencies; remember what one of the lessons of Scarface was? []
  52. ERC20 and ERC721 tokens may end up causing a top-heavy problem for Ethereum. See Watermarked tokens and also Integrating, Mining and Attacking: Analyzing the Colored Coin “Game” []
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Eight Things Cryptocurrency Enthusiasts Probably Won’t Tell You

[Note: I neither own nor have any trading position on any cryptocurrency.  I was not compensated by any party to write this.  The views expressed below are solely my own and do not necessarily represent the views of my employer or any organization I advise.  See Post Oak Labs for more information.]

Alternative title: who will be the Harry Markopolos of cryptocurrencies?

If you don’t know who Harry Markopolos is, quickly google his name and come back to this article.  If you do, and you aren’t completely familiar with the relevance he has to the cryptocurrency world, let’s start with a little history.

Background

Don’t drink the Koolaid

With its passion and perma-excitement, the cryptocurrency community sometimes deludes itself into thinking that it is a self-regulating market that doesn’t need (or isn’t subject to) government intervention to weed out bad actors.1 “Self-regulation,” usually refers to an abstract notion that bad actors will eventually be removed by the action of market forces, invisible hand, etc.

Yet by most measures, many bad actors have not left because there are no real consequences or repercussions for being a bad dude (or dudette).

Simultaneously, despite the hundreds of millions of dollars raised by VCs and over a couple billion dollars raised through ICOs in the past year or so, not one entity has been created by the community with the power or moral authority to rid the space of bad apples and criminals.  Where is the regulatory equivalent of FINRA for cryptocurrencies?2

Part of this is because some elements in the community tacitly enable bad actors. This is done, in some cases, by providing the getaway cars (coin mixers) but also, in other cases, with a wink and a nod as much of the original Bitcoin infrastructure was set-up and co-opted by Bitcoiners themselves, some of whom were bad actors from day one.3

There are many examples, including The DAO.4 But the SEC already did a good dressing down of The DAO, so let’s look at BTC-e.

BTC-e is a major Europe-based exchange that has allegedly laundered billions of USD over the span of the past 6 years.  Its alleged operator, Alexander Vinnik, stands accused of receiving and laundering some of the ill-gotten gains from one of the Mt. Gox hacks (it was hacked many many times) through BTC-e and even Mt. Gox itself.5 BTC-e would later go on to be a favorite place for ransomware authors to liquidate the ransoms of data kidnapping victims.

Who shut down BTC-e?

It wasn’t the enterprising efforts of the cryptocurrency community or its verbose opinion-makers on social media or the “new 1%.”  It was several government law enforcement agencies that coordinated across multiple jurisdictions on limited budgets.6 Yet, like Silk Road, some people in the cryptocurrency community likely knew the operators of the BTC-e and willingly turned a blind eye to serious misconduct which, for so long as it continues, represents a black mark to the entire industry.

In other cases, some entrepreneurs and investors in this space make extraordinary claims without providing extraordinary evidence.  Such as, using cryptocurrency networks are cheaper to send money overseas than Western Union.  No, it probably is not, for reasons outlined by SaveOnSend.7

But those who make these unfounded, feel-good claims are not held accountable or fact-checked by the market because many market participants are solely interested in the value of coins appreciating.  Anything is fair game so as long as prices go up-and-to-the-right, even if it means hiring a troll army or two to influence market sentiment.

And yet in other cases, the focus of several industry trade associations and lobbying groups is to squarely push back against additional regulations and/or enforcement of existing regulations or PR that contradicts their narrative.8

Below are eight suggested areas for further investigation within this active space (there could be more, but let’s start with this small handful):

(1) Bitfinex

Bitfinex is a Hong Kong-based cryptocurrency exchange that has been hacked multiple times.9  Most recently, about 400 days ago, $65 million dollars’ worth of bitcoins were stolen.

Bitfinex eventually painted over these large losses by stealing from its own users, by socializing the deficits that took place in some accounts across nearly all user accounts.10  Bitfinex has – despite promising public audits and explanations of what happened – provided no details about how it was hacked, who hacked it, or to where those funds were drained to.11 It has also self-issued at least two tokens (BFX and RRT) representing their debt and equity to users, listed these tokens on their own exchange and allowed their users to trade them.12

There have been suggestions of impropriety, with its CFO (or CSO?) Phil Potter publicly explaining how they handle being de-banked and re-banked:

“We’ve had banking hiccups in the past, we’ve just always been able to route around it or deal with it, open up new accounts, or what have you… shift to a new corporate entity, lots of cat and mouse tricks that everyone in Bitcoin industry has to avail themselves of.”

Yet there is little action by the cryptocurrency community to seek answers to the open questions surrounding Bitfinex.  I wrote a detailed post several months ago on it and the only reporters who contacted me for follow-ups were from mainstream press.

There are a lot of reasons why, but one major reason could be that some customers have financially benefited from this lack of market surveillance because relatively little KYC (Know Your Customer) is collected or AML (Anti-Money Laundering) enforced, so some trades and/or taxes are probably unreported.13 This wouldn’t be an isolated incident as the IRS has said less than 1,000 United States persons have been filing taxes related to “virtual currencies” each year between 2013 – 2015.

But that’s not all.

The latest series of drama began earlier this spring: Bitfinex sued Wells Fargo who had been providing correspondent banking access to Bitfinex’s Taiwanese banking partners.  Wells Fargo ended this relationship which consequently tied up tens of millions of USD that was being wired internationally on behalf of Bitfinex’s users.  About a week later Bitfinex dropped the suit and at least one person involved on the compliance side of a large Taiwanese bank was terminated due to the misrepresentation of the Bitfinex account relationship.

This also impacted the price of Tether.

Tether, as its name suggests, is a proprietary cryptocurrency (USDT) that is “always backed by traditional currency held in our reserves.”  It initially used a cryptocurrency platform called Mastercoin (rebranded to Omni) and recently announced an ERC20 token on top of Ethereum.1415

As a corporate entity, Tether’s governance, management, and business are fairly opaque.  No faces or names of employees or personnel can be found on its site.16  Bitfinex was not only one of its first partners but is also a shareholder.  Bitfinex has also created a new ICO trading platform called Ethfinex and just announced that Tether will be partnering with it in some manner.17

Tether as an organization creates coins.  These coins are known as Tethers that trade under the ticker $USDT each of which, as is claimed on their webpage, is directly linked, 1-for-1, with USD and yen equivalents deposited in commercial banks.  But after the Wells Fargo suit was announced, USDT “broke the buck” and traded at $0.92 on the dollar.18   It has fluctuated a great deal during the summer currently trades at $1.00 flat.

Which leads to the question: are the seven banks listed by the recent CPA disclosure aware of what Tether publicly advertises its USDT product as?19

Source: Tether LTD

Who is responsible for issuance, and how if at all can they be redeemed?  Are they truly backed 1:1 or is there some accounting sleight-of-hand taking place behind the scenes?20  Where are those reserves going to be exactly?  Who will have access to them?  Will either Tether (the company) or Bitfinex going to use them to trade?21 These are the types of questions that should be asked and publicly answered.

The only reason anyone is learning anything about the project is because of an anonymous Tweeter, going by the handle @Bitfinexed, who seemingly has nothing better to do than listen to hundreds of hours of audio archives of Bitcoiners openly bragging about their day trading schemes and financial markets acumen (in that order).

Despite myself and others having urged coin media to do so, to my knowledge there have been no serious investigations or transparency as to who owns or runs this organization.  Privately, some reporters have blamed a lack of resources for why they don’t pursue these leads; this is odd given the deluge of articles posted every month on the perpetual block size debate that will likely resolve itself in the passage of time.

The only (superficial) things we know about Tether (formerly Realcoin) is from the few bits of press releases over time.22  Perhaps this is all just a misunderstanding due to miscommunication.23  Who wants to fly to Hong Kong and/or Taiwan to find out more?

(2) Ransomware, Ponzi’s, Zero-fee and AML-less exchanges

Last month a report from Xinhua found that:

China’s two biggest bitcoin exchanges, Huobi and OKCoin, collectively invested around 1 billion yuan ($150 million) of idle client funds into “wealth-management products.”

In other words, the reason these exchanges were able to operate and survive while charging zero-fees is partially offset by these exchanges using customer deposits to invest in other financial products, without disclosing this to customers.24

Based on conversations with investigative reporters and former insiders, it appears that many, if not most, mid-to-large exchanges in China used customer deposits (without disclosing this fact) to purchase other financial products.  It was not just OKCoin and Huobi but also BTCC (formerly BTC China) and others.  This is not a new story (Arthur Hayes first wrote about it in November 2015), but the absence of transparency in how these exchanges and intermediaries are run ties in with what we have seen at BTC-e.  While there were likely a number of legitimate, non-illicit users of BTC-e (like this one Australian guy), the old running joke within the community is that hackers do not attack BTC-e because it was the best place to launder their proceeds.

Many exchanges, especially those in developing countries lacking KYC and AML processes, directly benefited from thefts and scams.  Yet we’ve seen very little condemnation from the main cheerleaders in the community.25

For example, two years ago in South Africa, MMM’s local chapter routed around the regulated exchange, patronizing a new exchange that wouldn’t block their transactions.26  MMM is a Ponzi scheme that has operated off-and-on for more than twenty years in dozens of countries.  In its most current incarnation it has raised and liquidated its earnings via bitcoin.  As a result, the volume on the new exchange in South Africa outpaced the others that remained compliant with AML procedures.  Through coordination with law enforcement it was driven out for some time, but in January of this year, MMM rebooted and it is now reportedly back in South Africa and Nigeria.  The same phenomenon has occurred in multiple other countries including China, wherein, according to inside sources, at least one of the Big 3 exchanges gave MMM representatives the VIP treatment because it boosted their volume.

It was a lack of this market surveillance and customer protections and outright fraud that eventually led to many of the Chinese exchanges being investigated and others raided by local and national regulators in a coordinated effort during early January and February 2017.27

Initially several executives at the non-compliant exchanges told coin media that nothing was happening, that all the rumors of investigation was “FUD” (fear, uncertainty, doubt).  But they were lying.28

Regulators had really sent on-site staff to “spot check” and clean up the domestic KYC issues at exchanges.  They combed through the accounting books, bank accounts, and trading databases, logging the areas of non-compliance and fraud.  This included problems such as allowing wash-trading to occur and unclear margin trading terms and practices.29 Law enforcement showed these problems (in writing) to exchange operators who had to sign and acknowledge guilt: that these issues were their responsibility and that there could be future penalties.

Following the recent government ban on ICO fundraising (described in the next section), all exchanges in China involved in fiat-to-cryptocurrency trades have announced they will close in the coming weeks, including Yunbi, an exchange that was popular with ICO issuers.30  On September 14th, the largest exchange in Shanghai, BTCC (formerly BTC China), announced it would be closing its domestic exchange by the end of the month.31 It is widely believed it was required to do so for a number of compliance violations and for having issued and listed an ICO called ICOCoin.32

Source: Tweet from Linke Yang, co-founder of BTCC

The two other large exchanges, OKCoin and Huobi, both announced on September 15th that they will be winding down their domestic exchange by October 31st.33  Although according to sources, some exchange operators hope this enforcement decision (to close down) made by regulators will quietly be forgotten after the Party Congress ends next month.34

One Plan B is a type of Shanzhai (山寨) hawala which has already sprung up on Alibaba whereby users purchase discrete units of funds as a voucher from foreign exchanges (e.g., $1,000 worth of BTC at a US-based exchange).35  Many exchanges are trying to setup offices and bank accounts nearby in Hong Kong, South Korea, and Japan, however this will not solve their ability to fund RMB-denominated trades.36

It is still unclear at this time what the exact breakdown in areas of non-compliance were largest (or smallest).37  For instance, how common was it to use a Chinese exchange for liquidating ransomware payments?

As mentioned in an earlier post, cryptocurrencies are the preferred payment method for ransomware today because of their inherent characteristics and difficulty to reclaim or extract recourse.  One recent estimate from Cybersecurity Ventures is that “[r]ansomware damage costs will exceed $5 billion in 2017, up more than 15X from 2015.”  The victims span all walks of life, including the most at-risk and those providing essential services to the public (like hospitals).

But if you bring up this direct risk to the community, be prepared to be shunned or given the “whataboutism” excuse: sure bitcoin-denominated payments are popular with ransomware, but whatabout dirty filthy statist fiat and the nuclear wars it funds!

Through the use of data matching and analytics, there are potential solutions to these chain of custody problems outlined later in section 8.

(3) Initial coin offerings (ICOs)

Obligatory South Park reference (Credit: Jake Smith)

Irrespective of where your company is based, the fundraising system in developed – let alone developing countries – is often is a time consuming pain in the rear.  The opportunity costs foregone by the executive team that has to road show is often called a necessary evil.

There has to be a more accessible way, right?  Wouldn’t it just be easier to crowdfund from (retail) investors around the world by selling or exchanging cryptocurrencies directly to them and use this pool of capital to fund future development?

Enter the ICO.

In order to participate in a typical ICO, a user (and/or investor) typically needs to acquire some bitcoin (BTC) or ether (ETH) from a cryptocurrency exchange.  These coins are then sent to a wallet address controlled by the ICO organizer who sometimes converts them into fiat currencies (often without any AML controls in place), and sends the user/investor the ICO coin.38

Often times, ICO organizers will have a private sale prior to the public ICO, this is called a pre-sale or pre-ICO sale.  And investors in these pre-sales often get to acquire tokens at substantial discounts (10 – 60%) than the rate public investors are offered.39.  ICO organizers typically do not disclose what these discounts are and often have no vesting cliffs attached to them either.

The surge in popularity of ICOs as a way to quickly exploit and raise funds (coins) and liquidate them on secondary markets has transitively led to a rise in demand of bitcoin, ether, and several other cryptocurrencies.  Because the supply of most of the cryptocurrencies is perfectly inelastic, any significant increase (or decrease) in demand can only be reflected via volatility in prices.

Hence, ICOs are one of the major contributing factors as to why we have seen record high prices of many different cryptocurrencies that are used as gateway coins into ICOs themselves.

According to one estimate from Coin Schedule, about $2.1 billion has been raised around the world for 140 different ICOs this year.40  My personal view is that based on the research I have done, most ICO projects have intentionally or unintentionally created a security and are trying to sell it to the public without complying with securities laws.41 Depending on the jurisdiction, there may be a small handful of others that possibly-kinda-sorta have created a new coin that complies with existing regs.42  Maybe.

Ignoring the legal implications and where each fits on that spectrum for the moment, many ICOs to-date have pandered to and exploited terms like “financial inclusion” when it best suits them.43  Others pursue the well-worn path of virtue signaling: Bitcoiners condemning the Ethereum community (which itself was crowdfunded as an ICO), because of the popularity in using the Ethereum network for many ICOs… yet not equally condemning illicit fundraising that involves bitcoin or the Bitcoin network or setting up bucket shops such as Sand Hill Exchange (strangely one of its founders who was sued by the SEC now writes at Bloomberg).

The cryptocurrency community as a whole condemned the “Chinese government” for its recent blanket ban on fundraising and secondary market listing of ICOs.44 The People’s Bank of China (PBOC) is one of seven regulators to enforce these regulations yet most of the public antagonism has been channeled at just the PBOC.45

Irrespective of whether you think it was the right or wrong thing to do because you heart blockchains, the PBOC and other regulators had quite valid reasons to do so: some ICO creators and trading platforms were taking funds they received from their ICO and then re-investing those into other ICOs, who in turn invested in other ICOs, and so forth; creating a fund of fund of funds all without disclosing it to the public or original investors.46 ICO Inception (don’t tell Christopher Nolan).

In China and in South Korea, and several other countries including the US, there is a new cottage industry made of up entities called “community managers” (CM) wherein an ICO project hires an external company (a CM) who provides a number of services:

  1. for X amount of BTC the CM will actively solicit and get your coin listed on various exchanges;
  2. the CM takes a sales commission while marketing the coin to the public such that after the ICO occurred, they would take a juicy cut of the proceeds; and several other promotional services.47

The ICO issuers and fundraising/marketing teams usually organize a bunch of ICOs weekly and typically employ a market maker (known as an “MM” in the groups) whose role is to literally pump and dump the coin.  They engage in ‘test pumps’ and ‘shakeouts’ to get rid of the larger ICO investors so they can push the price up on a thin order book by 10x, 20x, or 30x before distributing and pulling support. You can hire the services of one of these traders in many of the cryptocurrency trading chat groups.48

There were even ICO boot camps (训练营) in China (and elsewhere) usually setup with shady figures with prior experience in pyramid schemes.49  Here they coached the average person to launch an ICO on the fly based on the ideas of this leader to people of all demographics including the vulnerable and at-risk.50  Based on investigations which are still ongoing, the fraud and deceit involved was not just one or two isolated incidents, it was rampant.51 Obtaining the training literature that was given to them (e.g., the script with the promises made) would make for a good documentary and/or movie.

Scene from Boiler Room

In other words, the ICO rackets have recreated many aspects of the financial services industry (underwriters, broker/dealers) but without any public disclosures, organizational transparency, investor protections, or financial controls.  Much like boiler rooms of days past.  It is no wonder that with all of this tomfoolery, according to Chainalysis, that at least $225 million worth of ETH has been stolen from ICO-related fundraising activity this past year.52

At its dizzying heights, in China, there were about sixty ICO crowdfunding platforms each launching (or trying to launch) new ICOs on a monthly basis.53  And many of these platforms also ran and operated their own exchanges where insiders were pumping (and dumping) and seeing returns of up to 100x on coins that represented “social experiments to test human stupidity” such as the performance art pictured below.

One recent estimate from Reuters was that in China, “[m]ore than 100,000 investors acquired new cryptocurrencies through 65 ICOs in January-June [2017].”54  It’s still unclear what the final straw was, but the universal rule of don’t-pitch-high-risk-investment-schemes-to-grandmothers-on-fixed-incomes was definitely breached.

As a result, the PBOC and other government entities in China are now disgorging any funds (about $400 million) that ICOs had raised in China.55  This number could be higher or lower depending on how much rehypothecation has taken place (e.g., ICOs investing in ICOs).  All crowdfunding platforms such as ICOAGE and ICO.info have suspended operations and many have shut down their websites.  In addition, several executives from these exchanges have been given a travel ban.56

Cryptocurrency exchanges (the ones that predated the ICO platforms) have to delist ICOs and freeze plans from adding any more at this time.  Multiple ICO promotional events, including those by the Fintech Blockchain Group (a domestic fund that organized, promoted, and invested in ICOs) have been canceled due to the new ban.57  Several well-known promoters have “gone fishing” overseas.  This past week, Li Xiaolai, an early Bitcoin investor and active ICO promoter, has publicly admitted to having taken the ICO mania too far (using a car acceleration example), an admission many link to the timing of this crackdown and ban.58

A real ICO in China: “Performance Art Based on Block Chain Technology” (Source)

For journalists, keep in mind this is (mostly) just one country described above.  It would be a mistake to pin all of the blame on just the ICO operators based in China as similar craziness is happening throughout the rest of the world (observe the self-serving celebrity endorsements).  Be sure to look at not just the executives involved in an ICO but also the advisors, investors, figureheads, and anyone who is considered “serious” lending credibility to dodgy outfits and dragging the average Joe (and Zhou) and his fixed income or meager savings into the game.

There may be a legitimate, legal way of structuring an ICO without running afoul of helpful regulations, but so far those are few and far between.  Similarly, not everyone involved in an ICO is a scammer but it’s more than a few bad apples, more like a bad orchard.  And as shown above with the initial enforcement actions of just one country, short sighted hustling by unsavory get-rich-quick partisans unfortunately might deep-six the opportunities for non-scammy organizations and entrepreneurs to utilize a compliant ICO model in the future.59

(4) VC-backed entities

Theranos, Juicero, and Hampton Creek, meet Coinbase, 21.co, Blockstream, and several others.

Okay, so that may be a little exaggerated.  But still the same, few high-profile Bitcoin companies are publishing daily active or monthly active user numbers for a variety of reasons.

Founded in May 2012, the only known unicorn to-date is Coinbase.  Historically it has kept traction stats close to the chest but we got a small glimpse at what Coinbase’s user base was from an on-going lawsuit with the IRS.  According to one filing, between 2013-2015 (the most recent publicly available data) Coinbase had around 500,000 users, of which approximately 14,355 accounts conducted at least $20,000 in business.60 This is a far cry from the millions of wallets we saw as a vanity statistic prominently displayed on its homepage during that same time period.61

What did most users typically do?  They created an account, bought a little bitcoin, and then hoarded it – very few spent it as if it were actual money which is one of the reasons why they removed a publicly viewable transaction chart over a year ago.62

To be fair, the recent surge in market prices for cryptocurrencies has likely resulted in huge user growth.  In fact, Coinbase’s CEO noted that 40,000 new users signed up on one day this past May.  But some of this is probably attributed to new users using Coinbase as an on-and-off ramp: United States residents acquiring bitcoin and ether on Coinbase and then participating in ICOs elsewhere.63

After more than $120 million in funding, 21.co (formerly 21e6) has not only seen an entire executive team churn, but a huge pivot from building hardware (Bitcoin mining equipment) into software and now into a pay-as-you-go-LinkedIn-but-with-Bitcoin messaging service.  Launched with much fanfare in November 2015, the $400 Amazon-exclusive 21.co Bitcoin Computer was supposed to “return economic power to the individual.”

In reality it was just a USB mining device (a Raspberry Pi cobbled together with an obsolete mining chip) and was about as costly and useful as the Juicero juicing machine.  It was nicknamed the “PiTato” and unit sales were never publicly disclosed.  Its story is not over: in the process of writing this article, 21.co announced it will be launching a “social token” (SOC) by the end of the year.64

Blockstream is the youngest of the trio.  Yet, after three years of existence and having raised at least $76 million, as far as the public can tell, the company has yet to ship a commercial product beyond an off-the-shelf hardware product (Liquid) that generates a little over $1 million in revenue a year.65  It also recently launched a satellite Bitcoin node initiative it borrowed from Jeff Garzik, who conceived it on a budget of almost nothing about three years ago.66

To be fair though, perhaps it does not have KPIs like other tech companies.  For instance, about two and half years ago, one of their largest investors, Reid Hoffman, said Blockstream would “function similarly to the Mozilla Corporation” (the Mozilla Corporation is owned by a nonprofit entity, the Mozilla Foundation).  He likened this investment into “Bitcoin Core” (a term he used six times) as a way of “prioritiz[ing] public good over returns to investors.”  So perhaps expectations of product roadmaps is not applicable.

On the flipside, some entrepreneurs have explained that their preference for total secrecy is not necessary because they are afraid of competition (that is a typical rationale of regular startups), but because they are afraid of regulators via banks.67  For example, a regulator sees a large revenue number, finds out which bank provides a correspondent service and if the startup is fully compliant with AML, CFT, and KYC processes, starts auditing that bank, and banks re-evaluates NPV of working with a startup and potentially drops it.  Until that changes, we will not know volumes for Abra, Rebit, Luno, and others and that is why a year-old claim about 20% market share in the South Korea -> Philippines remittance corridor remains evidence-free.6869

While we would all love to see more data, this is a somewhat believable argument.  A more insightful question might be if/when we get to a point where supporting Bitcoin players becomes enough of real revenue that banks would agree to higher investments and support.  In the meantime, business journalists should drill down into the specifics about how raised money has been spent, is compliance being skirted, customer acquisition costs, customer retention rate, etc.70

(5) The decline of Maximalism

If you were to draw a Venn diagram, where one circle represented neo Luddism and another circle represented Goldbugism, the areas they overlap would be cryptocurrency Maximalism (geocentrism and all).71  This increasingly smaller sect, within the broader cryptocurrency community, believes in a couple of common tenets but most importantly: that only one chain or ledger or coin will rule them all.  This includes the Ethereum Classic (ETC) and Bitcoin Core sects, among others.

They’re a bit like the fundamentalists in that classic Monty Python “splitters” sketch but not nearly as funny.

If you’re looking to dig into defining modern irony, these are definitely the groups to interview.  For instance, on the one hand they want and believe their Chosen One (typically BTC or ETC) should and will consume the purchasing power of all fiat currencies, yet they dislike any competing cryptocurrency: it is us versus them, co-existence is not an option!  The rules of free entry do not apply to their coin as somehow a government-free monopoly will form around their coin and only their coin.  Also, you should buy a lot of their coin, like liquidate your life savings asap and buy it now.

Artist rendering of proto-Bitcoin Maximalism, circa 14th century

This rigidity has diminished over time.

Whereas, three years ago, most active venture capitalists and entrepreneurs involved in this space were antagonistic towards anything but bitcoin, more and more have become less hostile with respect to new and different platforms.

Source: Twitter

For instance, Brian Armstrong (above), the CEO of Coinbase, two and a half years ago, was publicly opposed to supporting development activities towards anything unrelated to Bitcoin.

But as the adoption winds shifted and Ethereum and other platforms began to see growth in their development communities (and coin values), Coinbase and other early bastions of maximalism began to support them as well.

Source: Twitter (1 2)

There will likely be permanent ideological holdouts, but as of this writing I would guesstimate that less than 20% of the bitcoin holders I have interacted with over the past 6-9 months would label themselves maximalists (the remaining would likely self-identify with the “UASF” and “no2x” tags on Twitter).

So interview them and get their oral history before they go extinct!

(6) Market caps

There is very little publicly available analysis of what is happening with Bitcoin transactions (or nearly all cryptocurrencies for that matter): dormant vs. active, customers vs. accounts, transaction types (self-transfers vs. remittances vs. B2B, etc.).

On-chain transaction growth seems to be slowing down on the Bitcoin network and we don’t have good public insights on what is going on: are there are pockets of growth in real adoption or just more wallet shuffling?

In other words, someone should be independently updating “Slicing data” but instead all we pretty much see is memes of Jamie Dimon or animated gifs involving roller coaster prices.72

In the real world, “market cap” is based on a claim on a company’s assets and future cash flows.  Bitcoin (and other cryptocurrencies) has neither — it doesn’t have a “market cap” any more than does the pile of old discarded toys in your garage.

“Market Cap” is a really dumb phrase when applied to the cryptocurrency world; it seems like one of those seemingly straightforward concepts ported to the cryptocurrency world directly from mainstream finance, yet in our context it turns into something misleading and overly simplistic, but many day traders in this space who religiously tweet about price action love to quote.

The cryptocurrency “market cap” metric is naively simplistic: take the total coin supply, and multiply it by the current market price, and voila!  Suddenly Bitcoin is now approaching the market cap of Goldman Sachs!73

Yeah, no.

To begin with, probably around 25% or more of all private keys corresponding to bitcoins (and other cryptocurrencies too) have been permanently lost or destroyed.74  Most of these were from early on, when there was no market price and people deleted their hard drives with batches of 50 coins from early block rewards without backing them up or a second thought.

Extending this analogy, 25% of the shares in Goldman Sachs cannot suddenly become permanently ownerless.  These shares are registered assets, not bearer assets.  Someone identifiable owns them today and even if there is a system crash at the DTCC or some other CSD, shareholders have a system of recourse (i.e., the courts) to have these returned or reissued to them with our without a blockchain.  Thus, anytime you hear about “the market price of Bitcoin has approached $XXX billion!” you should automatically discount it by at least 25%.

Also, while liquidity providers and market makers in Bitcoin have grown and matured (Circle’s OTC desk apparently trades $2 billion per month), this is still a relatively thinly traded market in aggregate.  It is, therefore, unlikely that large trading positions could simultaneously move into and out of billion USD positions each day without significantly moving the market.  A better metric to look at is one that involves real legwork to find: the average daily volume on fee-based, regulated spot exchanges combined with regulated OTC desks.  That number probably exists, but no one quotes it.  Barring this, an interim calculation could be based on “coins that are not lost or destroyed.”

(7) Buy-side analysts and coin media

We finally have some big-name media beginning to dig into the shenanigans in the space.  But organizations like CoinDesk, Coin Telegraph, and others regularly practice a brand of biased reporting which primarily focus on the upside potential of coins and do not provide equal focus on the potential risks.75  In some cases, it could be argued that these organizations act as slightly more respectable conduits for misinformation churned out by interested companies.76

Common misconceptions include continually pushing out stories like the example above, on “market caps” or covering vanity metrics such as growth in wallet numbers (as opposed to daily active users).  It is often the case that writers for these publications are heavily invested in and/or own cryptocurrencies or projects mentioned in their stories without public disclosure.

This is not to say that writers, journalists, and staff at these organizations should not own a cryptocurrency, but they should publicly disclose any trading positions (including ‘hodling’ long) as the sentiment and information within their articles can have a material influence on the market prices of these coins.

For instance, CoinDesk is owned by Digital Currency Group (DCG) who in turn has funded 80-odd companies over the last few years, including about 10 mentioned in this article (such as Coinbase and BTC China).  DCG also is an owner of a broker/dealer called Genesis Trading, an OTC desk which trades multiple cryptocurrencies that DCG and its staff, have publicly acknowledged at having positions in such as ETC, BTC and LTC.77

What are the normal rules around a media company (and its staff) retweeting and promoting cryptocurrencies or ICOs the parent company or its principals has a stake in?

If coin media wants to be taken seriously it will have to take on the best practices and not appear to be a portfolio newsletter: divorce itself of conflicts of interest by removing cross ownership ties and prominently disclose all of the remaining potential conflicts of interest with respect to ownership stakes and coin holdings.  Markets that transmit timely, accurate, and transparent information are better markets and are more likely to grow, see, and support longer-term capital inflows.78

Source: Twitter

Source: Twitter

For example, if Filecoin is a security in the US (which its creators have said it is), and DCG is an equity holder in Filecoin/Protocol Labs (which it is)… and DCG is an owner in CoinDesk, what are the rules for retweeting this ICO above?  There are currently 16 stories in the CoinDesk archive which mention Filecoin, including three that specifically discuss its ICO.  Is this soliciting to the public?79

Similarly, many of the buy-side analysts that were actively publishing analysis this past year didn’t disclose that they had active positions on the cryptocurrencies they covered.  We recently found out that one lost $150,000 in bitcoins because someone hacked his phone.

At cryptocurrency events (and fintech events in general), we frequently hear buzz word bingo including: smart assets, tokens, resilience, pilots, immutability, even in-production developments, but there is often no clear articulation of what are the specific opportunities to save or make money for institutions if they acquire a cryptocurrency or uses its network to handle a large portion of their business.80

This was the core point of a popular SaveOnSend article on remittances from several years ago.  I recommend revisiting that piece as a model for similar in-depth assessments done by people who understand B2B payments, correspondent banking and other part of global transfers.  Obviously this trickles into the other half of this space, the enterprise world which is being designed around specific functional and non-functional requirements, the SLAs, compliance with data privacy laws, etc., but that is a topic for another day.

What about Coin Telegraph?  It is only good for its cartoon images.81

Source: LinkedIn

There are some notable outliers that serve as good role models and exceptions to the existing pattern and who often write good copy.  Examples of which can be found in long end note.82

Obviously the end note below is non-exhaustive nor an endorsement, but someone should try to invite some or all these people above to an event, emceed by Taariq Lewis.  That could be a good one.

(8) Analytics

What about solutions to the problems and opaqueness described throughout this article?

There are just a handful of startups that have been funded to create and use analytics to identify usage and user activity on cryptocurrency networks including: Chainalysis, Blockseer, Elliptic, WizSec, ScoreChain, Skry (acquired by Bloq) – but they are few and far between.83  Part of the reason is because the total addressable market is relatively small; the budgets from compliance departments and law enforcement is now growing but revenue opportunities were initially limited (same struggle that coin media has).  Another is that the analytic entrepreneurs are routinely demonized by the same community that directly benefits from the optics they provide to exchanges in order to maintain their banking partnerships and account access.

Such startups are shunned today, unpopular and viewed as counter to the roots of (pseudo) anonymous cryptocurrencies, however, as regulation seeps into the industry an area that will gain greater attention is identification of usage and user activities.

For instance, four years ago, one article effectively killed a startup called Coin Validation because the community rallied (and still rallies) behind the white flag of anarchy, surrendering to a Luddite ideology instead of supporting commercial businesses that could help Bitcoin and related ideas and technologies comply with legal requirements and earn adoption by mainstream commercial businesses.  For this reason, cryptocurrency fans should be very thankful these analytics companies exist.

Source: Twitter. Explanation: Wanna Cry ransomware money laundering with Bitcoins in action. Graph shows Bitcoin being converted to Monero (XMR) via ShapeShift.io

More of these analytics providers could provide even better optics into the flow of funds giving regulated institutions better handling of the risks such as the money laundering taking place throughout the entire chain of custody.

Without them, several large cryptocurrency exchanges would likely lose their banking partners entirely; this would reduce liquidity of many trading pairs around the world, leading to prices dropping substantially, and the community relying once again on fewer sources of liquidity run out of the brown bags on shady street corners.84

One key slide from Kim Nilsson’s eye-opening presentation: Cracking MtGox

And perhaps there is no better illustration of how these analytic tools can help us understand the fusion of improper (or non-existent) financial controls plus cryptocurrencies: Mt. Gox.  Grab some warm buttery popcorn and be sure to watch Kim Nilsson’s new presentation covering all of the hacks that this infamous Tokyo-based exchange had over its existence.

Journalists, it can be hard to find but the full order book information for many exchanges can be found with enough leg work.   If anyone had the inclination to really want to understand what was going on at the exchange, there are 3rd parties which have a complete record of the order book and trades executed.

Remember, as Kim Nilsson and others have independently discovered, WillyBot turned out to be true.

Final Remarks

The empirical data and stories above do not mean that investors should stop trading all cryptocurrencies or pass on investing in blockchain-related products and services.

To the contrary, the goal of this article is to elevate awareness that this industry lacks even the most basic safeguards and independent voices that would typically act as a counterbalance against bad actors.  In this FOMO atmosphere investors need to be on full alert of the inherent risks of a less than transparent market with less than accurate information from companies and even news specialists.

Cryptocurrencies aren’t inherently good or bad.  In a single block, they can be used as a means to reward an entity for securing transactions and also a payment for holding data hostage.

One former insider at an exchange who reviewed this article summarized it as the following:

The cryptocurrency world is basically rediscovering a vast framework of securities and consumer protection laws that already exist; and now they know why they exist. The cryptocurrency community has created an environment where there are a lot of small users suffering diffuse negative outcomes (e.g., thefts, market losses, the eventual loss on ICO projects). And the enormous gains are extremely concentrated in the hands of a small group of often unaccountable insiders and “founders.” That type of environment, of fraudulent and deceptive outcomes, is exactly what consumer and investor protection laws were created for.

Generally speaking, most participants such as traders with an active heartbeat are making money as the cryptocurrency market goes through its current bull run, so no one has much motive to complain or dig deeper into usage and adoption statistics.  Even those people who were hacked for over $100,000, or even $1 million USD aren’t too upset because they’re making even more than that on quick ICO returns.

We are still at the eff-you-money stage, in which everyone thinks they are Warren Buffett.85  The Madoffs will only be revealed during the next protracted downturn.  So if you’re currently getting your cryptocurrency investment advice from permabull personalities on Youtube, LinkedIn, and Twitter with undisclosed positions and abnormally high like-to-comment ratios, you might eventually be a bag holder.86

Like any industry, there are good and bad people at all of these companies.  I’ve met tons of them at the roughly 100+ events and meetups I have attended over the past 3-4 years and I’d say that many of the people at the organizations above are genuinely good people who tolerate way too much drivel.  I’m not the first person to highlight these issues or potential solutions.  But I’m not a reporter, so I leave you with these leads.

While everyone waits for Harry Markopolos to come in and uncover more details of the messes in the sections above, other ripe areas worth digging into are the dime-a-dozen cryptocurrency-focused funds.

Future posts may look at the uncritical hype in other segments, including the enterprise blockchain world.  What happened after the Great Pivot?

[Note: if you found this research note helpful, be sure to visit Post Oak Labs for more in the future.]

Acknowledgements

To protect the privacy of those who provided feedback, I have only included initials: JL, DH, AL, LL, GW, CP, PD, JR, RB, ES, MW, JK, RS, ZK, DM, SP, YK, RD, CM, BC, DY, JF, CK, VK, CH, HZ, and PB.

End notes

  1. One reviewer commented: “Another meta-topic is the notion of “community,” which is a myth if you ask me.  Why hasn’t the “community” done “X”? Because the word is mostly a marketing fiction.” See also the discussion of the idea that “Code is not law” []
  2. One former regulator mentioned: “The cryptocurrency community needs to police itself better or it risks being policed more severely by unfriendly and unsympathetic regulators.  Self-regulation is what certain hands-off banking supervisors attempted with US banks and other financial institutions 15 years ago and that ended poorly for many parties including those who were not directly responsible for making the poor decisions in the first place.  Even in sports it is understood, with the exception of golf, it doesn’t work. In this Wild West atmosphere where are the sheriffs?” []
  3. Not unique to cryptocurrencies, but by enabling such bad actors, certain platform operators may even increase their short term profit. []
  4. Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO []
  5. For an in-depth look at how the various moving pieces of the ecosystem interact, see: The flow of funds on the Bitcoin network in 2015, Cryptocurrency KYSF: Know Your Source of Funds, and Cryptocurrency KYSF: Know Your Source of Funds part 2 []
  6. Bitcoin Exchange Was a Nexus of Crime, Indictment Says from The New York Times []
  7. For an in-depth look at these different costs, it is highly recommended to read this post from Save on Send.  Some are convinced that this is the case because, on a small scale, the illiquidity of the end points serves to finance the operation, i.e. buying BTC with USD then selling BTC for MXN, may allow an apparent savings when compared with traditional remittance service providers.  Also oft-forgotten is the cost of cash-out and distribution of cash at the end point; also KYC / AML / CFT functions are frequently left-off the calculation. []
  8. One reviewer stated that, “Any working groups advising the government on policy are certainly worthy of investigation. Who are these people and what are their potential conflicts of interest?  For starters, in the US look at The Bitcoin Foundation and the Blockchain Alliance.” []
  9. It has a complex corporate structure and is nominally based in Hong Kong, operations and incorporation of subsidiaries are in other jurisdictions including BVI. []
  10. There were exceptions. Some users reported smaller haircuts as they were customers of SynapsePay.  Another user claims to have retained a lawyer and he did not have any haircut.  I independently verified this with an executive at SynapsePay. []
  11. Phil Potter, an executive at Bitfinex, has spoken about the hack on multiple different podcasts including once in detail, but this has since been deleted. []
  12. Bitfinex also recently announced that they will be doing an ICO (called NEC) to capitalize on the current token mania. []
  13. Bitfinex does do KYC and AML when a user withdraws USD and when they receive subpoenas. []
  14. ERC20 tokens are arguably not the same thing as a cryptocurrency, they are more like colored coins. See “Watermarked tokens and pseudonymity on public blockchains” by Tim Swanson. []
  15. Tether brings tokenised USD to Ethereum network from Finextra []
  16. We only know who is involved through various reddit threads wherein users dox and identify themselves as employees and founders. []
  17. Tether brings tokenised USD to Ethereum network from Finextra []
  18. This wouldn’t be the first time that a peg “broke the buck;” money market funds have been propped up by a parent organization in the past. []
  19. Tether Update []
  20. One reviewer noted that: “Theoretically they could maintain a fractional reserve to service redemptions although this isn’t a problem per se, provided that it is disclosed.  By saying you have “cash” backing, you could have some really bizarre stuff, like USD loans to unsavory entities.  But maybe they do not do this either.”  []
  21. Source for some of these questions. []
  22. One reviewer commented: “Tether offers users a way to move USD from one country to another, much like Western Union. So Tether should be obligated to run KYC/AML checks on not only those who are depositing US$ funds to get new Tethers (as it currently does), but also everyone who uses second-hand Tethers (it doesn’t). Now if Tether was like bitcoin, and had no physical address, it would be complicated for the authorities to enforce this requirement. But Tether is anchored to the brick & mortar banking system, so law enforcement should be easier, will it?” []
  23. One reviewer commented: “Let’s assume the worst for Tether, what does that mean?  If it were to collapse would it harm the small investors or the whales? A few exchanges that allow Tether also allow you to hold your deposits in USD, aside from the ability to send USDT between exchanges, which arguably could actually be a net positive because it allows clients to net positions between exchanges potentially reducing the overall credit in the system. But this goes back to one of their continual issues: lack of communicating and transparency for how the whole money issuance and transmission process works.” []
  24. Note: they did have withdrawal fees which likely generated revenue from arbitrageurs.  Several of the larger exchanges also raised venture capital and setup (and still run) order books outside of China with other business lines which may help offset some costs. []
  25. Described in further detail, “Comments on the COIN ETF (SR-BatsBZX-2016-30)” by Tim Swanson []
  26. See the section “Stopping Predators” within A Kimberley Process for Cryptocurrencies []
  27. China Central Bank Said to Call Bitcoin Exchanges for Talks from Bloomberg []
  28. In addition to lying about being investigated, they were lying about the true volume on their exchanges.  When the zero-fee domestic exchanges were required to add a minimum fee (to discourage wash trading), volume plummeted. []
  29. Central bank warns Bitcoin exchanges over margin trading, money laundering from Xinhua and Chinese bitcoin exchanges resume withdrawals after freeze from Reuters []
  30. Li Xiaolai: Yunbi Is Winding Down In 3 Months from 8BTC []
  31. BTCC to Cease China Trading as Media Warns Closures Could Continue from CoinDesk []
  32. Sources: CNLedger and ICOcoinOfficial []
  33. Huobi, OKCoin to Stop Yuan-to-Bitcoin Trading By October’s End from CoinDesk []
  34. The 19th National Congress of the Communist Party of China starts on October 18th.  All exchanges involving fiat-to-cryptocurrency trades will be closed. Both OKCoin and Huobi have overseas platforms (with independent order books and bank accounts independent of the domestic Chinese exchanges).  These have cryptocurrency-to-cryptocurrency trading and will remain operating.  Currently, users of the domestic fiat-to-currency platform can move their coins to the overseas platforms. []
  35. Something similar was done with voucher codes sold on Taobao in 2014 as well.  See After Crackdown, A New Bitcoin King Emerges in China from Wired []
  36. At one time or another, the spot price for each of the three large Chinese exchanges was a constituent part of several different pricing indices including the Winkdex, TradeBlock XBX index, and others such as OKEX (OKEX is an international subsidiary of OKCoin who replaced these exchanges on its own index).  This is potentially problematic because, as I detailed in my COIN ETF report, these exchanges were prone to mismanagement, crashes, and ultimately quick closure.  Going forward, what other sources of reliable pricing data can ETFs use that also accurately reflect market prices? []
  37. One insider in China noted that: “These exchanges had multiple chances to clean up their act and even self-regulate but because of the competitive pressures in China towards zero-fees, no one wanted to be left behind.  It was a type of collective action failure, so the government finally had to come in and clean up the mess because no one else would.” []
  38. These are mostly ERC20 tokens, not coins. []
  39. One reviewer mentioned: “Depending on the jurisdiction, these pre-arranged discounts might be deemed as structured products.” []
  40. Is There a Cryptocurrency Bubble? Just Ask Doge. from The New York Times []
  41. “How the ICO, OCO, and ECO ecosystem works at a high level” by Tim Swanson and “Comments on the COIN ETF (SR-BatsBZX-2016-30)” by Tim Swanson []
  42. Note: volumes can and will be written on this section alone.  If not on the legalities but on the ‘pump and dumps’ that have taken place. []
  43. One former regulator suggested: “Ignoring for the moment the overarching legal implications of what they did, because these activities took place on blockchains, future researchers should be able to eventually provide very accurate estimates the costs and losses to investors who put their trust and money into deceptive ICO organizers who were unscrupulous.” []
  44. Some argue this ban may just be temporary and cite a CCTV 13 interview with Hu Bing with the Institute of Finance and Banking who says the government will issue licenses in the future. []
  45. As of this writing there are many rumors circulating regarding how these new guidelines could impact cryptocurrency mining operators based in China.  One recent story from the Wall Street Journal articulates a rumor that miners will need to also shut down operations because they are trading cryptocurrencies without a license.  More existentially, if all fiat-to-cryptocurrency exchanges shut down domestically, miners would need a new method to liquidate their coins because they need to pay utilities in RMB (e.g., it doesn’t help to have a JPY or KRW-denominated bank account because Chinese utilities require being paid in RMB). []
  46. This same phenomenon occurred several years ago with “wealth management products” doing the same re-investment into other WMPs; revisiting the P2P Lending scams that came to light in the past two years as well is helpful.  See China’s ICO ban makes more sense in light of its history with fintech by Nik Milanovic []
  47. One insider noted that: “A New Zealand based person (and company) is one of the main men in all of this. I’ve encountered him on a number of occasions. He’s a complete fraudster. For example he told a group I am in that MGO would be listed on Poloniex within weeks of launch. Months later he hasn’t even got it on Bittrex. He’s now buying up lots of it wholesale from disenchanted investors who’ve taken a massive hit recently and will inevitably be sitting on a pile when the intentionally delayed launch and pump happens.” []
  48. Whalepool and The Coin Farm on Telegram are both examples of this type of coordination. []
  49. ICO被定性为涉嫌非法集资,想一夜暴富的“韭菜”们醒醒吧 from Huxiu []
  50. Based on translated stories from after the investigations as well as conversations with observers of these training sessions. []
  51. According to a source close to the investigations, law enforcement are using WeChat correspondence to chronicle the intentional cases of fraud and deceit.  In some cases, ICO organizers would run a public WeChat group, providing investors with false information and then use a private WeChat group with a smaller circle of insiders to “laugh at the stupidity” of these investors and coordinate dumps.  As a result, ICO organizers are leaving WeChat to use platforms like Telegram.  See China’s WeChat crackdown drives bitcoin enthusiasts to Telegram from South China Morning Post []
  52. That is the best case scenario because it assumes that there were not additional losses to fraud and mismanagement, which we know there has been. []
  53. China bans companies from raising money through ICOs, asks local regulators to inspect 60 major platforms from CNBC []
  54. Cryptocurrency chaos as China cracks down on ICOs from Reuters []
  55. Ibid []
  56. China shuts down Bitcoin industry; bans executives from leaving the country from Australian Financial Review []
  57. Another ICO Conference Cancels in Wake of China Ban from CoinDesk []
  58. He had to refund the ICOs he promote (plus with an added premium). []
  59. One reviewer commented: “The inevitability of regulations coming down the pipeline is a certainty (not just “blanket bans”).  Whether it’s 1 month or 1 year, regulations or enforcement of existing regulations will be coming in. A lot of these participants in the market seem to want to get in before regulations come into effect but in many jurisdictions they can still be liable for past actions (depending on the statute of limitations). That’s part of what I think is driving this tremendous amount of ICOs right now.” []
  60. 14,000 Coinbase Customers Could Be Affected by IRS Tax Summons from CoinDesk and Legitimate? IRS Defends Coinbase Customer Investigation in Court Filing from CoinDesk []
  61. At the time of this writing Coinbase has raised more than $225 million.  By January 2015, Coinbase had in aggregate raised just north of $106 million.  The ongoing lawsuit with the IRS states that there were 500,000 users by the end of the 2013 – 2015 period, of which 14,355 had done $20,000 or more of trading.   Future research can look into Coinbase’s customer acquisition costs over time (e.g., switching costs) versus the same costs traditional banks have.  Note: this also does not include the user numbers at GDAX, their platform marketed to professional traders. []
  62. According to an alleged insider (which may be untrue), some Coinbase users allegedly didn’t even know they may have been entitled to things like CLAM coins.  Maybe they weren’t. Tangentially, the continual high percentage of hoarding done by cryptocurrency enthusiasts suggests that this still remains a virtual commodity and continues to fail the medium of exchange test needed to be defined as a transactional currency. []
  63. At this time, it is unclear what the breakdown of these new (or old) users are acquiring cryptocurrencies on Coinbase and then participating in ICOs.  As a company, Coinbase has been publicly supportive of the ICO zeitgeist and hosted multiple meetups where ICO creators presented.  Earlier this year it co-sponsored a publication discussing the securities law framework of tokens.  Based on several interviews for this article, users of both the Coinbase wallet and its subsidiary, GDAX, currently can send bitcoins and ether from their user accounts to participate in ICOs.  It is unclear how often this is screened and/or prevented.  For perspective, a former employee was allegedly fired for sending bitcoins from his Coinbase account to gamble on Chinese web casinos.  Assuming this is true (and it may not be) then Coinbase could have the knowledge and/or ability to prevent users from participating in ICOs or other off-platform activity that violates its terms of service. []
  64. Another tech company that supposedly struggled raising funding and later issued its own coin (through an ICO) is Kik, through its Kin Foundation. []
  65. If this post is true (and it may not be), a dozen or so exchanges paying between $7,000 – $10,000 a month is roughly $1.4 million a year.  The SaaS monthly estimate has been independently validated from conversations with a couple participating exchanges. []
  66. One reviewer recommended: “If I were a journalist, I would more closely scrutinize the social media habits of the executives (and their surrogates) on these teams so the ecosystem can ascertain the relationship between the amount of time senior employees spend opining on Twitter, Reddit, mailing lists, IRC, WhatsApp, Slack, WeChat, Telegram, BitcoinTalk, GitHub, Discord, etc., and the number of hours in a working day, or number of products shipped.  Other social media analytics ideas for journalists: look at the Twitter tribes of Bitcoin (and other cryptocurrencies). Who is aligned with whom and pushing what agendas? Who are the trolls associated with those different tribes?  How many suspect accounts are associated with each group? For example, how many accounts that were just created, or never tweeted before, or only have followers from within their own tribes?” []
  67. One reviewer argued that, “It could also because they want to protect their valuations and because they are privately held companies that may be legally forbidden to divulge this information.” []
  68. This article in Quartz did not provide actual data or evidence that these remittance numbers were real, no one fact-checked it and instead, reproduced similar headlines for several months. []
  69. According to a recent interview with Forbes, after nearly two years of operations Abra only has 73 users per day. They are currently raising another round at this time; it is believed that this will help fund their compliance team and for licenses which they currently lack. []
  70. One reviewer said, “A counterpoint could be: VC returns are even sharper than standard Pareto; 1:9 or even 1:99 as opposed to 2:8. Startups are hard – most fail – why should cryptocurrency world be any different?” []
  71. One reviewer suggested that: “In the future, you should explain why Maximalism is a type of Authoritarianism and is not to be conflated with cypherpunks.” []
  72.  In mid-September, vocal promoters and owners of cryptocurrencies such as Bitcoin collectively spent thousands of hours yelling on social media and conducting letter writing campaigns all to channel their anger towards comments made by Jamie Dimon.  A couple worthwhile followups include: JPMorgan handles bitcoin-related trades for clients despite CEO warning from Reuters and  MUFG CEO on Dimon Remarks: Bank Cryptocurrencies Have ‘Nothing to Do With Bitcoin’ from CoinDesk []
  73. Bitcoin was only used as an example, nearly all cryptocurrencies listed on CoinMarketCap have the same issue in terms of calculating a real “market cap.” []
  74. Learning from Bitcoin’s past to improve its future from Tim Swanson []
  75. The theatrics around “BearWhale”-like events still persists.  For example, one current conspiracy theory is that: “the Chinese government is shutting down Bitcoin miners to mine bitcoins themselves.”  This is most likely false and the proposed solution is to “use satellites.”  But in talking with professional miners in China, many of them have contracts directly with State Grid, so they could lose access to energy in a worst-case scenario and satellites would not be of any use (assuming any of those rumors are true). []
  76. To be fair, this is not unique to the cryptocurrency space. []
  77. Genesis Trading is also the marketing and distribution agent for Bitcoin Investment Trust and Ethereum Classic Investment Trust, two regulated financial products.  DCG also is an owner in Grayscale Investments which is the legal sponsor both of these Trusts []
  78. Research: How Investors’ Reading Habits Influence Stock Prices by Anastassia Fedyk and Effects of Misinformation on the Stock Return: A Case Study by Ahsan et al. []
  79. Some employees in coin media have used social media channels to discuss various cryptocurrencies including ICOs over the past year.  How many of these were sponsored or received a cut of the coins to do so? []
  80. A great paper on this topic is The Path of the Blockchain Lexicon (and the Law) by Angela Walch []
  81. Nearly all of the coin media site allow ICO advertisements as well.  What are the terms and benefits that these media sites receive in exchange for displaying these advertisements and advertorials? []
  82. Note: this is not an exhaustive list and I’ll likely be flamed for not including X but including Y.  Journalists who write good original stories include: Nathaniel Popper, Matt Levine, and Matt Leising.  There have been several good op-eds written by lawyers which have appeared on CoinDesk, including Joshua Stark, Jared Marx, Brian Klein, Benjamin Sauter and David McGill.  Some other original, constructive views that should be highlighted include Stephen Palley, Ryan Straus, George Fogg, Miles Cowan, Patrick Murck, Amor Sexton, Houman Shadab, Angela Walch, Scott Farrell, Claire Warren, Simon Gilchrist, and two perpetual curmudgeons: Izabella Kaminska and Preston Byrne (very prickly at times!).  Non-lawyer thought-leaders, technical, and subject matter experts with bonafides worth interviewing include: Adam Krellenstein, Alex Batlin, Alex Waters, Andrew Miller, Andy Geyl, Antony Lewis, Ari Juels, Arvind Narayanan, Christian Decker, Christopher Allen, Ciaran Murray, Colin Platt, Danny Yang, Dave Hudson, David Andolfatto, David Schwartz, Dominic Williams, Duncan Wong, Elaine Shi, Emily Rutland, Emin Gun Sirer, Ernie Teo, Fabio Federici, Flavien Charlon, Gideon Greenspan, Ian Grigg, Ittay Eyal, Jackson Palmer, Jae Kwon, James Hazard, James Smith, Jana Moser, Jeff Garzik, JP Koning, John Whelan, Jonathan Levin, Jonathan Rouach, Jorge Stolfi, Juan Benet, Juan Llanos, Kieren James-Lubin, Lee Braine, Leemon Baird, Makoto Takemiya, Mark Williams, Matthew Green, Martin Walker, Massimo Morini, Michael Gronager, Mike Hearn, Muneeb Ali, Piotr Piasecki, Richard Brown, Robert Sams, Ron Hose, Sarah Meiklejohn, Stefan Thomas, Stephen Lane-Smith, Vitalik Buterin, Vlad Zamfir, Yakov Kofner, Zaki Manian, Zennon Kapron, and Zooko Wilcox-O’Hearn, as well as dozens of others from several different financial institutions and enterprises too long to list.  I also think that Michael del Castillo, Ian Allison, Simon Taylor, Jon Southurst, and Arthur Falls try to do an honest job reporting too.  Epicenter TV is arguably the best podcast in this space. []
  83. For an example, see Cracking Mt. Gox by WizSec []
  84. Chainalysis has a partnership with Circle which in turn enabled Circle to open up an account with Barclays.  Two years ago, an alleged business plan for Chainalysis was leaked online and unsurprisingly, some in the community were up in arms that this small company provided these forensic services. []
  85. Partially inspired by this tweet. []
  86. Click farms are being used by various ICO and Bitcoin-related online personalities to boost their perceived importance. []
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A brief history of R3 – the Distributed Ledger Group

What’s in a name?

I was at an event last week and someone pulled me aside asked: why do you guys at R3 typically stress the phrase “distributed ledger” instead of “blockchain”?

The short answer is that they are not the same thing.

In simplest terms: a blockchain involves stringing together a chain of containers called blocks, which bundle transactions together like batch processing, whereas a distributed ledger, like Corda, does not and instead validates each transaction (or agreement) individually.1

The longer answer involves telling the backstory of what the R3 consortium is in order to highlight the emphasis behind the term “distributed ledger.”

Inspired by IMF report, page 8

Genesis

R3 (formerly R3 CEV) started out as a family office in 2014.2 The “3” stood for the number of co-founders: David Rutter (CEO), Todd McDonald (COO), and Jesse Edwards (CFO). The “R” is the first initial of the CEO’s last name.  Very creative!

During the first year of its existence, R3 primarily looked at early stage startups in the fintech space.  The “CEV” was an acronym: “crypto” and “consulting,” “exchanges,” and “ventures.”

Throughout 2014, the family office kept hearing about how cryptocurrency companies were going to obliterate financial institutions and enterprises.  So to better understand the ecosystem and drill into the enthusiasm around cryptocurrencies, R3 organized and held a series of round tables.

The first was held on September 23, 2014 in NYC and included talks from representatives of: DRW, Align Commerce, Perkins Coie, Boost VC, and Fintech Collective.  Also in attendance were representatives from eight different banks.

The second round table was held on December 11, 2014 in Palo Alto and included talks from representatives of: Stanford, Andreessen Horowitz, Xapo, BitGo, Chain, Ripple, Mirror, and myself.  Also in attendance were representatives from 11 different banks.

By the close of 2014, several people (including myself) had joined R3 as advisors and the family office had invested in several fintech startups including Align Commerce.

During the first quarter of 2015, David and his co-founders launched two new initiatives.  The first was LiquidityEdge, a broker-dealer based in NYC that built a new electronic trading platform for US Treasurys.3  It is doing well and is wholly unrelated to R3’s current DLT efforts.

The second initiative was the incorporation of the Distributed Ledger Group (DLG) in Delaware in February 2015.  By February, the family office had also stopped actively investing in companies in order to focus on both LiquidityEdge and DLG.

In April 2015 I published Consensus-as-a-Service (CaaS) which, at the time, was the first paper articulating the differences between what became known as “permissioned” and “permissionless” blockchains and distributed ledgers.  This paper was then circulated to various banks that the small R3 team regularly interacted with.

The following month, on May 13, 2015, a third and final round table was held in NYC and included talks from representatives of Hyperledger (the company), Blockstack, Align Commerce and the Bank of England.  Also in attendance were representatives from 15 banks as well as a market infrastructure operator and a fintech VC firm.  In addition to the CaaS paper, the specific use-case that was discussed involved FX settlement.4

The transition from a working group to a commercial entity was formalized in August and the Distributed Ledger Group officially launched on September 1, 2015 although the first press release was not until September 15.  In fact, you can still find announcements in which the DLG name was used in place of R3.

By the end of November, phase one of the DLG consortium – now known as the R3 consortium – had come to a conclusion with the admission of 42 members.  Because of how the organization was originally structured, no further admissions were made until the following spring (SBI was the first new member in Phase 2).

So what does this all have to do with “distributed ledgers” versus “blockchains”?

Well, for starters, we could have easily (re)named or (re)branded ourselves the “Blockchain Group” or “Blockchain Banking Group” as there are any number of ways to plug that seemingly undefinable noun into articles of incorporation.  In fact, DistributedLedgerGroup.com still exists and points to R3members.com.5 So why was R3 chosen?  Because it is a bit of a mouthful to say DistributedLedgerGroup!

Corda’s genesis

Upon launch, the architecture workstream lead by our team in London (which by headcount is now our largest office), formally recognized that the current hype that was trending around “blockchains” had distinct limitations.  Blockchains as a whole were designed around a specific use-case – originally enabling censorship-resistant cryptocurrencies. This particular use-case is not something that regulated financial institutions, such as our members, had a need for.

While I could spend pages retracing all of the thought processes and discussions surrounding the genesis of what became Corda, Richard Brown’s view (as early as September 2015) was that there were certain elements of blockchains that could be repurposed in other environments, and that simply forking or cloning an existing blockchain – designed around the needs of cryptocurrencies – was a non-starter.  At the end of that same month, I briefly wrote about this view in a post laying out the Global Fabric for Finance (G3F), an acronym that unfortunately never took off. In the post I specifically stated that, “[i]t also bears mentioning that the root layer may or may not even be a chain of hashed blocks.”

In October 2015, both James Carlyle and Mike Hearn formally joined the development team as Chief Engineer and lead platform engineer respectively.  During the fall and winter, in collaboration with our members, the architecture team was consumed in the arduous process of funneling and filtering the functional and non-functional requirements that regulated financial institutions had in relation to back office, post-trade processes.

By the end of Q1 2016, the architecture team gestated a brand new system called Corda.  On April 5, 2016, Richard published the first public explanation of what Corda was, what the design goals were and specifically pointed out that Corda was not a blockchain or a cryptocurrency.  Instead, Corda was a distributed ledger.

Prior to that date, I had personally spent dozens of hours clarifying what the difference between a blockchain and a distributed ledger was to reporters and at events, though that is a different story.  Unfortunately even after all these explanations, and even after Richard’s post, the Corda platform was still inappropriately lumped into the “blockchain” universe.

Following the open sourcing of Corda in November 2016, we formally cut the “CEV” initials entirely from the company name and are now known simply as R3.  Next year we plan to make things even shorter by removing either the R or 3, so watch out domain squatters!

Today

As of February 2017, the R3 consortium is formally split into two groups that share knowledge and resources: one group is focused on building out the Corda platform and the other, the Lab and Research Center, is focused on providing a suite of services to our consortium members.  I work on the services side, and as described in a previous post, my small team spends part of its time filtering vendors and projects for the Lab team which manages several dozen projects at any given time for our consortium members.

The Lab team has completed more than 20 projects in addition to 40 or so ongoing projects.  Altogether these involved (and in some cases still involve) working with a diverse set of platforms including Ethereum, Ripple, Fabric, Axoni, Symbiont and several others including Corda.  Since we are member driven and our members are interested in working and collaborating on a variety of different use-cases, it is likely that the services side will continue to experiment with a range of different technologies in the future.

Thus, while it is accurate to call R3 a technology company focused on building a distributed ledger platform and collaborating with enterprises to solve problems with technology, it is not accurate to pigeonhole it as a “blockchain company.”  Though that probably won’t stop the conflation from continuing to take place.

If you are interested in understanding the nuances between what a blockchain, a database, and a distributed ledger are, I highly recommend reading the multitude of posts penned by my colleagues Antony Lewis and Richard Brown.

  1. Blockchains inspired by cryptocurrencies such as Bitcoin used blocks because Satoshi wanted identity-free consensus (e.g., pseudonymity).  That implies miners can come and go at will, without any kind of registration, which eliminated the choice of using any existing consensus algorithm.

    As a result, Satoshi’s solution was proof-of-work (PoW).  However, PoW is susceptible to collisions (e.g., orphan blocks).  When a collision occurs you have to wait longer to obtain the same level of work done on a transaction. Thus you want to minimize them, which resulted in finding a PoW on average every ten minutes.  This means that in a network with one minute propagation delays, not unlikely in a very large network (BGP sees such propagation times) then you waste ~10% of total work done, which was considered an acceptable loss rate in 2008 when Satoshi was designing and tweaking the parameters of the system.

    Distributed ledgers such as Corda, use a different design because it is an identified network, where members cannot just come and go at will, and do have to register. With Corda, the team also assumes relatively low propagation times between members of a notary cluster.  One of the key differences between mere PoW (i.e. hashcash) and a blockchain is that in the latter, each block references the prior – thus PoWs aggregate.  It can be tough to do that unless all transactions are visible to everyone and there is a single agreed upon blockchain but if you do not, you will not get enough PoW to yield any meaningful security. []

  2. The R3CEV.com domain was created on August 13, 2014. []
  3. It may look like an odd spelling, but Treasurys is the correct spelling. []
  4. At the time, I was an advisor to Hyperledger which was acquired by Digital Asset the following month. []
  5. The DistributedLedgerGroup.com domain was created on December 23, 2014 and R3members.com was created on March 15, 2016. []
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Book review: Digital Gold

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

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

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

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

Note: all transcription errors are my own. See my other book reviews.

digital goldTerminology

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

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

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

In the beginning

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

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

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

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

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

That translates to roughly 20% of the network hashrate.

Having noted this, the author writes:

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

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

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

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

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

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

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

What does this increase look like?

hash-predict

Source: Dave Hudson

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

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

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

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

Moving on, on page 192, Popper writes:

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

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

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

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

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

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

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

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

On page 67 he writes:

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

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

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

On page 77 he writes about Roger Ver:

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

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

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

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

[…]

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

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

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

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

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

Whales

bearwhale

Source: Billy Mabrey

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

Popper identified a few of them in the book.

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

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

Another instance, on page 113:

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

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

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

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

In January 2013, Popper looked at the Winklevoss twins:

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

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

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

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

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

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

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

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

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

Why were they talking about it?

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

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

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

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

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

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

[…]

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

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

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

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

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

Bigwigs

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

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

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

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

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

Some politics:

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

In Wences’ view:

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

[…]

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

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

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

Meet and greet:

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

Who isn’t meddling?

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

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

Public goods problem:

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

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

About Argentina:

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

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

Practicality

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

In the meantime, avoiding the Product Trap:

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

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

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

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

A little irony on page 162:

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

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

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

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

Trusted trustlessness?

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

Origins of Xapo:

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

[…]

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

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

Alex Waters

An unnamed Alex Waters appears twice:

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

And again:

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

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

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

alex waters

Alex Waters (CEO Coin.co), Sarah Tyre (COO Coin.co), Isaac Bergman, myself

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

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

Coinbase compliance

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

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

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

[…]

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

Not quite accurate

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

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

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

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

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

Probably overhyped:

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

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

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

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

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

For example, on page 352 the author notes that:

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

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

Payments again:

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

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

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

Probably not true:

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

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

For instance,

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

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

The more you know:

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

On Roger Ver potentially selling his stake in Blockchain.info:

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

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

Germane citation:

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

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

Federated blockchain:

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

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

Concluding remarks:

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

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

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

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

See my other book reviews.

End notes:

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

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

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

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

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

age of cryptocurrencyIntroduction

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

Unfortunately the experience that individuals like Ahmadi, are not fully reflective of what takes place in practice (and this is not the fault of bitLanders).

For instance, the authors state on p. 2 that:

“Bitcoins are stored in digital bank accounts or “wallets” that can be set up at home by anyone with Internet access.  There is no trip to the bank to set up an account, no need for documentation or proof that you’re a man.”

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

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

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

Cryptocurrencies such as bitcoin are not digital currencies.  Digital currencies are legal tender, as of this writing, bitcoins are not.  This may seem like splitting hairs but the reason regulators use the term “virtual currency” still in 2015 is because no jurisdiction recognizes bitcoins as legal tender.

In contrast, there are already dozens of digital currencies — nearly every dollar that is spent on any given day in the US is electronic and digital and has been for over a decade.  This issue also runs into the discussion on nemo dat described a couple weeks ago.

On page 4 the authors very briefly describe the origination of currency exchange which dates back to the Medici family during the Florentine Renaissance.  Yet not once in the book is the term “bearer asset” mentioned.  Cryptocurrencies such as bitcoin are virtual bearer instruments and as shown in practice, a mega pain to safely secure.

500 years ago bearer assets were also just as difficult to secure and consequently individuals outsourced the security of it to what we now call banks.  And this same behavior has once again occurred as large quantities — perhaps the majority — of bitcoins now are stored in trusted third party depositories such as Coinbase and Xapo.

Why is this important?

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

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

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

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

In practice mining is out of the hands of “the people” due to economies of scale which have trended towards warehouse mining – it is unlikely that embedded ASICs such as from 21 inc, will change that dynamic much, if any.  Why?  Because for every device added to the network a corresponding amount of difficulty is also added, diluting the revenue to below dust levels.

Remember how Tom Sawyer convinced kids to whitewash a fence and they did so eagerly without question?  What if he asked you to mine bitcoins for him for free?  A trojan botnet?  While none of the products have been announced and changes could occur, from the press release that seems to be the underlying assumption of the 21.co business model.

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

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

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

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

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

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

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

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

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

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

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

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

On page 13 they state:

“Public anxiety over such risks could prompt an excessive response from regulators, strangling the project in its infancy.”

Similarly on page 118 regarding the proposed New York BitLicense:

“It seemed farm more draconian than expected and prompted an immediate backlash from a suddenly well-organized bitcoin community.”

This is a fairly alarmist statement.  It could be argued that due to its anarchic code-as-law coupled with its intended decentralized topology, that it could not be strangled.  If a certain amount of block creating processors (miners) was co-opted by organizations like a government, then a fork would likely occur and participants with differing politics would likely diverge.

A KYC chain versus an anarchic chain (which is what we see in practice with altchains such as Monero and Dash).  Similarly, since there are no real self-regulating organizations (SRO) or efforts to expunge the numerous bad actors in the ecosystem, what did the enthusiasts and authors expect would occur when regulators are faced with complaints?

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

On page 13 the authors state that:

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

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

Chapter 1

On page 21 the authors state that:

“Bitcoin seeks to address this challenge by offering users a system of trust based not on human being but on the inviolable laws of mathematics.”

While the first part is true, it is a bit cliche to throw in the “maths” reason.  There are numerous projects in the financial world alone that are run by programs that use math.  In fact, all computer programs and networks use some type of math at their foundation, yet no one claims that the NYSE, pace-makers, traffic intersections or airplanes are run by “math-based logic” (or on page 66, “”inviolable-algorithm-based system”).

A more accurate description is that Bitcoin’s monetary system is rule-based, using a static perfectly inelastic supply in contrast to either the dynamic or discretionary world humans live in.  Whether this is desirable or not is a different topic.

On page 26 they describe the Chartalist school of thought, the view that money is political, that:

“looks past the thing of currency and focuses instead on the credit and trust relationships between the individual and society at large that currency embodies” […] “currency is merely the token or symbol around which this complex system is arranged.”

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

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

On page 27 the authors write:

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

Perhaps this is true.  Yet from the original Nakamoto whitepaper, perhaps he too was a chartalist?

Stating in section 1:

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

A payments rail, a currency, perhaps both?

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

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

On page 31 they write:

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

That is a bit of a stretch.  While Chinese policy makers do likely sweat over the creative ways residents breach and maneuver around capital controls, it is highly unlikely that bitcoin is even on the radar as a high level “threat.”  There is no bitcoin merchant economy in China.

The vast majority of activity continues to be related to mining and trading on exchanges, most of which is inflated by internal market making bots (e.g., the top three exchanges each run bots that dramatically inflate the volume via tape painting).  And due to how WeChat and other social media apps in China frictionlessly connect residents with their mainland bank accounts, it is unlikely that bitcoin will make inroads in the near future.

On page 36 they write:

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

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

On page 39 they write:

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

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

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

The problem for Vigna’s view, (starting around 59m) is that if the value of a bitcoin fell to $30, not only would the network collectively “be cheaper” to maintain, but also to attack.

On paper, the cost to successfully attack the network today by obtaining more than 50% of the hashrate at this $30 price point would be $2,250 per hour (roughly 0.5 x MC) or roughly an order of magnitude less than it does at today’s market price (although in practice it is a lot less due to centralization).

Recall that the security of bitcoin was purposefully designed around proportionalism, that in the long run it costs a bitcoin to secure a bitcoin.  We will talk about fees later at the end of next chapter.

Chapter 2

On page 43, in the note at the bottom related to Ray Dillinger’s characterization that bitcoin is “highly inflationary” — Dillinger is correct in the short run.  The money supply will increase by 11% alone this year.  And while in the long run the network is deflationary (via block reward halving), the fact that the credentials to the bearer assets (bitcoins) are lost and destroyed each year results in a non-negligible amount of deflation.

For instance, in chapter 12 I noted some research: in terms of losing bitcoins, the chart below illustrates what the money supply looks like with an annual loss of 5% (blue), 1% (red) and 0.1% (green) of all mined bitcoins.

lost coins

Source: Kay Hamacher and Stefan Katzenbeisser

In December 2011, German researchers Kay Hamacher and Stefan Katzenbeisser presented research about the impact of losing the private key to a bitcoin. The chart above shows the asymptote of the money supply (Y-axis) over time (X-axis).

According to Hamacher:

So to get rid of inflation, they designed the protocol that over time, there is this creation of new bitcoins – that this goes up and saturates at some level which is 21 million bitcoins in the end.

But that is rather a naïve picture. Probably you have as bad luck I have, I have had several hard drive crashes in my lifetime, and what happens when your wallet where your bitcoins are stored and your private key vanish? Then your bitcoins are probably still in the system so to speak, so they are somewhat identifiable in all the transactions but they are not accessible so they are of no economic value anymore. You cannot exchange them because you cannot access them. Or think more in the future, someone dies but his family doesn’t know the password – no economic value in those bitcoins anymore. They cannot be used for any exchange anymore. And that is the amount of bitcoins when just a fraction per year vanish for different fractions. So the blue curve is 5% of all the bitcoins per year vanish by whatever means there could be other mechanisms.

It is unclear exactly how many bitcoins can be categorized in such a manner today or what the decay rate is.

On page 45 the authors write:

Some immediately homed in on a criticism of bitcoin that would become common: the energy it would take to harvest “bitbux” would cost more than they were worth, not to mention be environmentally disastrous.

While I am unaware of anyone who states that it would cost more than what they’re worth, as stated in Appendix B and in Chapter 3 (among many other places), the network was intentionally designed to be expensive, otherwise it would be “cheap to attack.”  And those costs scale in proportion to the token value.

As noted a few weeks ago:

For instance, last year O’Dwyer and Malone found that Bitcoin mining consumes roughly the same amount of energy as Ireland does annually.  It is likely that their estimate was too high and based on Dave Hudson’s calculations closer to 10% of Ireland’s energy consumption.23 Furthermore, it has likely declined since their study because, as previously explored in Appendix B, this scales in proportion with the value of the token which has declined over the past year.

The previous post looked at bitcoin payments processed by BitPay and found that as an aggregate the above-board activity on the Bitcoin network was likely around $350 million a year.  Ireland’s nominal GDP is expected to reach around $252 billion this year.  Thus, once Hudson’s estimates are integrated into it, above-board commercial bitcoin activity appears to be about two orders of magnitude less than what Ireland produces for the same amount of energy.

Or in other words, the original responses to Nakamoto six and a half years ago empirically was correct.  It is expensive and resource intensive to maintain and it was designed to be so, otherwise it would be easy to attack, censor and modify the history of votes.

Starting on page 56 they describe Mondex, Secure Electronic Transaction (SET), Electronic Monetary System, Citi’s e-cash model and a variety of other digital dollar systems that were developed during the 1990s.  Very interesting from a historical perspective and it would be curious to know what more of these developers now think of cryptocurrency systems.  My own view, is that the middle half of Chapter 2 is the best part of the book: very well researched and well distilled.

On page 64 they write:

[T]hat Nakamoto launched his project with a reminder that his new currency would require no government, no banks and no financial intermediaries, “no trusted third party.”

In theory this may be true, but in practice, the Bitcoin network does not natively provide any of the services banks do beyond a lock box.  There is a difference between money and the cornucopia of financial instruments that now exist and are natively unavailable to Bitcoin users without the use of intermediaries (such as lending).

On page 66 they write:

He knew that the ever-thinning supply of bitcoins would eventually require an alternative carrot to keep miners engaged, so he incorporated a system of modest transaction fees to compensate them for the resources they contributed.  These fees would kick in as time went on and as the payoff for miners decreased.

That’s the theory and the popular narrative.

However, what does it look like in practice?

Above is a chart visualizing fees to miners denominated in USD from January 2009 to May 17, 2015.  Perhaps the fees will indeed increase to replace block rewards, or conversely, maybe as VC funding declines in the coming years, the companies that are willing and able to pay fees for each transaction declines.

On page 67, the authors introduce us to Laszlo Hanyecz, a computer programmer in Florida who according to the brief history of Bitcoin lore, purchased two Papa John’s pizzas for 10,000 bitcoins on May 22, 2010 (almost five years ago to the day).

He is said to have sold 40,000 bitcoins in this manner and generated all of the bitcoins through mining.  He claims to be the first person to do GPU mining, ramping up to “over 800 times” of a CPU; and during this time “he was getting about half of all the bitcoins mined.”  According to him, he originally used a Nvidia 9800 GTX+ and later switched to 2 AMD Radeon 5970s.  It is unclear how long he mined or when he stopped.

In looking at the index of his server, there are indeed relevant OpenCL software files.  If this is true, then he beat ArtForz to GPU mining by at least two months.

solar pizza

Source: Laszlo Hanyecz personal server

On page 77 they write:

Anybody can go on the Web, download the code for no cost, and start running it as a miner.

While technically this is true, that you can indeed download the Satoshi Bitcoin core client for free, restated in 2015 it is not viable for hoi polloi.  In practice you will not generate any bitcoins solo-mining on a desktop machine unless you do pooled mining circa 2011.

Today, even pooled mining with the best Xeon processors will be unprofitable.  Instead, the only way to generate enough funds to cover both the capital expenditures and operating expenditures is through the purchase of single-use hardware known as an ASIC miner, which is a depreciating capital good.

Mining has been beyond the breakeven reach of most non-savvy home users for two years now, not to mention those who live in developing countries with poor electrical infrastructure or uncompetitive energy rates.  It is unlikely that embedded mining devices will change that equation due to the fact that every additional device increases the difficultly level whilst the device hashrate remains static.

This ties in with what the authors also wrote on page 77:

You don’t buy bitcoin’s software as you would other products, which means you’re not just a customer.  What’s more, there’s no owner of the software — unlike, say, PayPal, which is part of eBay.

This is a bit misleading.  In order to use the Bitcoin network, users must obtain bitcoins somehow.  And in practice that usually occurs through trusted third parties such as Coinbase or Xapo which need to identify you via KYC/AML processes.

So while in 2009 their quote could have been true, in practice today that is largely untrue for most new participants — someone probably owns the software and your personal data.  In fact, a germane quote on reddit last week stated, “Why don’t you try using Bitcoin instead of Coinbase.”

Furthermore, the lack of “ownership” of Bitcoin is dual-edged as there are a number of public goods problems with maintaining development that will be discussed later.

On page 87 they describe Blockchain.info as a “high-profile wallet and analytics firm.”

I will come back to “wallets” later.  Note: most of these “wallets” are likely throwaway, temp wallets used to move funds to obfuscate provenance through the use of Shared Coin (one of the ways Blockchain.info generates revenue is by operating a mixer).

Overall Chapter 3 was also fairly informative.  The one additional quibble I have is that Austin and Beccy Craig (the story at the end) were really only able to travel the globe and live off bitcoins for 101 days because they had a big cushion: they had held a fundraiser that raised $72,995 of additional capital.  That is enough money to feed and house a family in a big city for a whole year, let alone go globe trotting for a few months.

Chapter 4

On page 99 they describe seven different entities that have access to credit card information when you pay for a coffee at Starbucks manually.  Yet they do not describe the various entities that end up with the personal information when signing up for services such as Coinbase, ChangeTip, Circle and Xapo or what these depository institutions ultimately do with the data (see also Richard Brown’s description of the payment card system).

When describing cash back rewards that card issuers provide to customers, on page 100 they write:

Still it’s an illusion to think you are not paying for any of this.  The costs are folded into various bank charges: card issuance fees, ATM fees, checking fees, and, of course, the interest charged on the millions of customers who don’t pay their balances in full each month.

Again, to be even handed they should also point out all the fees that Coinbase charges, Bitcoin ATMs charge and so forth.  Do any of these companies provide interest-bearing accounts or cash-back rewards?

On page 100 they also stated that:

Add in the cost of fraud, and you can see how this “sand in the cogs” of the global payment system represents a hindrance to growth, efficiency, and progress.

That seems a bit biased here.  And my statement is not defending incumbents: global payment systems are decentralized yet many provide fraud protection and insurance — the very same services that Bitcoin companies are now trying to provide (such as FDIC insurance on fiat deposits) which are also not free.

On page 100 they also write:

We need these middlemen because the world economy still depends on a system in which it is impossible to digitally send money from one person to another without turning to an independent third party to verify the identity of the customer and confirm his or her right to call on the funds in the account.

Again, in practice, this is now true for Bitcoin too because of how most adoption continues to take place on the edges in trusted third parties such as Coinbase and Circle.

On page 101 they write:

In letting the existing system develop, we’ve allowed Visa and MasterCard to form a de facto duopoly, which gives them and their banking partners power to manipulate the market, says Gil Luria, an analyst covering payment systems at Wedbush Securities.  Those card-network firms “not only get to extract very significant fees for themselves but have also created a marketplace in which banks can charge their own excessive fees,” he says.

Why is it wrong to charge fees for a service?  What is excessive?  I am certainly not defending incumbents or regulatory favoritism but it is unclear how Bitcoin institutions in practice — not theory — actually are any different.

And, the cost per transaction for Bitcoin is actually quite high (see chart below) relative to these other systems due to the fact that Bitcoin also tries to be a seigniorage system, something that neither Visa or MasterCard do.

cost per transaction

Source: Markos05

On page 102 when talking about MasterCard they state:

But as we’ve seen, that cumbersome system, as it is currently designed, is tightly interwoven into the traditional banking system, which always demands a cut.

The whole page actually is a series of apples-and-oranges comparisons.  Aside from settlement, the Bitcoin network does not provide any of the services that they are comparing it to.  There is nothing in the current network that provides credit/lending services whereas the existing “cumbersome” system was not intentionally designed to be cumbersome, but rather is intertwined and evolved over decades so that customers can have access to a variety of otherwise siloed services.

Again, this is not to say the situation cannot be improved but as it currently exists, Bitcoin does not provide a solution to this “cumbersome” system because it doesn’t provide similar services.

On page 102 and 103 they write about payment processors such as BitPay and Coinbase:

These firms touted a new model to break the paradigm of merchants’ dependence on the bank-centric payment system described above.  These services charged monthly fees that amounted to significantly lower transaction costs for merchants than those charged in credit-card transactions and delivered swift, efficient payments online or on-site.

Except this is not really true.  The only reason that both BitPay and Coinbase are charging less than other payment processors is that VC funding is subsidizing it.  These companies still have to pay for customer service support and fraud protection because customer behavior in aggregate is the same.  And as we have seen with BitPay numbers, it is likely that BitPay’s business model is a losing proposition and unsustainable.

On page 103 they mention some adoption metrics:

The good news is found in the steady expansion in the adoption of digital wallets, the software needed to send and receive bitcoins, with Blockchain and Coinbase, the two biggest providers of those, on track to top 2 million unique users each at the time of the writing.

This is at least the third time they talk about wallets this way and is important because it is misleading, I will discuss in-depth later.

Continuing they write that:

Blockchain cofounder Peter Smith says that a surprisingly large majority of its accounts — “many more than you would think,” he says cryptically — are characterized as “active.”

This is just untrue and should have been pressed by the authors.  Spokesman from Blockchain.info continue to publish highly inflated numbers.  For instance in late February 2015, Blockchain.info claimed that “over $270 million in bitcoin transactions occurred via its wallets over the past seven days.”

This is factually untrue.  As I mentioned three months ago:

Organ of Corti pointed out that the 7 day average was indeed ~720,000 bitcoins in total output volume (thus making) the weekly volume would be about “5e06 btc for the network.”

Is it valid to multiply the total output volume by USD (or euros or yen)?  No.

Why not?  Because most of this activity is probably a combination of wallet shuffling, laundering and mixing of coins (e.g., use of SharedSend and burner wallets) or any number of superfluous activity.  It was not $270 million of economic trade.

Blockchain.info’s press release seems to be implying that economic trade is taking place, in which all transactions are (probably) transactions to new individuals when in reality it could simply be a lot of “change” address movement.  And more to the point, the actual internal volume looks roughly the same as has been the past few months (why issue a press release now?).

Continuing on page 103 they write:

“For the first eight months months of 2014, around $50 million per day was passing thought the bitcoin network (some of which was just “change” that bitcoin transactions create as an accounting measure)…”

There is a small typo above (in bold) but the important part is the estimate of volume.  There is no public research showing a detailed break down of average volume of economic activity.  Based on a working paper I published four months ago, it is fairly clear that this figure is probably in the low millions USD at most.  Perhaps this will change in the future.

On page 106 they write about Circle and Xapo:

For now, these firms make no charge to cover costs of insurance and security, betting that enough customers will be drawn to them and pay fees elsewhere — for buying and selling bitcoins, for example — or that their growing popularity will allow them to develop profitable merchant-payment services as well.  But over all, these undertaking must add costs back into the bitcoin economy, not to mention a certain dependence on “trusted third parties.”  It’s one of many areas of bitcoin development — another is regulation — where some businessmen are advocating a pragmatic approach to bolstering public confidence, one that would necessitate compromises on some of the philosophical principles behind a model of decentralization.  Naturally, this doesn’t sit well with bitcoin purists.

While Paul Vigna may not have written this, he did say something very similar at the Google Author Talk event (above in the video).

The problem with this view is that it is a red herring: this has nothing to do with purism or non-purism.

The problem is that Bitcoin’s designer attempted to create a ‘permissionless’ system to accommodate pseudonymous actors.  The entire cost structure and threat model are tied to this.  If actors are no longer pseudonymous, then there is no need to have this cost structure, or to use proof-of-work at all.  In fact, I would argue that if KYC/KYM (Know Your Miner) are required then a user might just as well use a database or permissioned system.  And that is okay, there are businesses that will be built around that.

This again has nothing to do with purism and everything to do with the costs of creating a reliable record of truth on a public network involving unknown, untrusted actors.  If any of those variables changes — such as adding real-world identity, then from a cost perspective it makes little sense to continue using the modified network due to the intentionally expensive proof-of-work.

On page 107 they talk about bitcoin price volatility discussing the movements of gasoline.  The problem with this analogy is that no one is trying to use gasoline as money.  In practice consumers prefer purchasing power stability and there is no mechanism within the Bitcoin network that can provide this.

For instance:

volatility 1volatility 2volatility 3The three slides above are from a recent presentation from Robert Sams.  Sams previously wrote a short paper on “Seigniorage Shares” — an endogenous way to rebase for purchasing power stability within a cryptocurrency.

Bitcoin’s money supply is perfectly inelastic therefore the only way to reflect changes in demand is through changes in price.  And anytime there are future expectations of increased or decreased utility, this is reflected in prices via volatility.

Oddly however, on page 110, they write:

A case can be made that bitcoin’s volatility is unavoidable for the time being.

Yet they do not provide any evidence — aside from feel good “Honey Badger” statements — for how bitcoin will somehow stabilize.  This is something the journalists should have drilled down on, talking to commodity traders or some experts on fuel hedging strategies (which is something airline companies spend a great deal of time and resources with).

Instead they cite Bobby Lee, CEO of BTC China and Gil Luria once again.  Lee states that “Once its prices has risen far enough and bitcoin has proven itself as a store of value, then people will start to use it as a currency.”

This is a collective action problem.  Because all participants each have different time preferences and horizons — and are decentralized — this type of activity is actually impossible to coordinate, just ask Josh Garza and the $20 Paycoin floor.  This also reminds me of one of my favorite comments on reddit: “Bitcoin will stabilize in price then go to the moon.”

The writers then note that, “Gil Luria, the Wedbush analyst, even argues that volatility is a good thing, on the grounds that it draws profit-seeking traders into the marketplace.”

But just because you have profit-seeking traders in the market place does not mean volatility disappears.

trading view

Credit: George Samman

For instance, in the chart above we can see how bitcoin trades relative to commodities over the past year:

  • Yellow is DBC
  • Red is OIL
  • Bars are DXY which is a dollar index
  • And candlesticks are BTCUSD
DBC is a commodities index and the top 10 Holdings (85.39% of Total Assets):
  • Brent Crude Futr May12 N/A 13.83
  • Gasoline Rbob Fut Dec12 N/A 13.71
  • Wti Crude Future Jul12 N/A 13.56
  • Heating Oil Futr Jun12 N/A 13.20
  • Gold 100 Oz Futr Dec 12 N/A 7.49
  • Sugar #11(World) Jul12 N/A 5.50
  • Corn Future Dec12 N/A 5.01
  • Lme Copper Future Mar13 N/A 4.55
  • Soybean Future Nov12 N/A 4.38
  • Lme Zinc Future Jul12

It bears mentioning that Ferdinando Ametrano has also described this issue in depth most recently in a presentation starting on slide 15.

Continuing on page 111, the writers note that:

Over time, the expansion of these desks, and the development of more and more sophisticated trading tools, delivered so much liquidity that exchange rates became relatively stable.  Luria is imagining a similar trajectory for bitcoin.  He says bitcoiners should be “embracing volatility,” since it will help “create the payment network infrastructure and monetary base” that bitcoin will need in the future.

There are two problems with Luria’s argument:

1) As noted above, this does not happen with any other commodity and historically nothing with a perfectly inelastic supply

2) Empirically, as described by Wences Casares above, nearly all the bitcoins held at Xapo (and likely other “hosted wallets”) are being held as investments.  This reduces liquidity which translates into volatility due to once again the inability to slowly adjust the supply relative to the shifts in demand.  This ties into a number of issues discussed in, What is the “real price” of bitcoin? that are worth revisiting.

Also on page 111, they write that “the exchange rate itself doesn’t matter.”

Actually it does.  It directly impacts two things:

1) outside perception on the health of Bitcoin and therefore investor interest (just talk to Buttercoin);

2) on a ten-minute basis it impacts the bottom line of miners.  If prices decline, so to is the incentive to generate proof-of-work.  Bankruptcy, as CoinTerra faces, is a real phenomenon and if prices decline very quickly then the security of the network can also be reduced due to less proof-of-work being generated

Continuing on page 111:

It’s expected that the mirror version of this will in time be set up for consumers to convert their dollars into bitcoins, which will then immediately be sent to the merchant.  Eventually, we could all be blind to these bitcoin conversions happening in the middle of all our transactions.

It’s unfortunate that they do not explain how this will be done without a trusted third party, or why this process is needed.  What is the advantage of going from USD-> paying a conversion fee -> BTC -> conversion fee -> back into USD?  Why not just spend USD and cut out the Bitcoin middleman?

Lastly on page 111:

Still, someone will have to absorb the exchange-rate risk, if not the payment processors, then the investors with which they trade.

The problem with this is that its generally not in the mandate or scope of most VC firms to purchase commodities or currencies directly.  In fact, they may even need some kind of license to do so depending on the jurisdiction (because it is a foreign exchange play).  Yet expecting the payment processors to shoulder the volatility is probably a losing proposition: in the event of a protracted bear market how many bitcoins at BitPay — underwater or not — will need to be liquidated to pay for operating costs?4

On page 112 they write:

‘Bitcoin has features from all of them, but none in entirety.  So, while it might seem unsatisfying, our best answer to the question of whether cryptocurrency can challenge the Visa and MasterCard duopoly is, “maybe, maybe not.”

On the face of it, it is a safe answer.  But upon deeper inspection we can probably say, maybe not.  Why?  Because for Bitcoin, once again, there is no native method for issuing credit (which is what Visa/MasterCard do with what are essentially micro-loans).

For example, in order to natively add some kind of lending facility within the Bitcoin network a new “identity” system would need to be built and integrated (to enable credit checks) — yet by including real-world “identity” it would remove the pseudonymity of Bitcoin while simultaneously maintaining the same costly proof-of-work Sybil protection.  This is again, an unnecessary cost structure entirely and positions Bitcoin as a jack-of-all-trades-but-master-of-none.  Why?  Again recall that the cost structure is built around Dynamic Membership Multi-Party Signature (DMMS); if the signing validators are static and known you might as well use a database or permissioned ledgers.

Or as Robert Sams recently explained, if censorship resistance is co-opted then the reason for proof-of-work falls to the wayside:

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

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

On page 113, they write:

“the government might be able to take money out of your local bank account, but it couldn’t touch your bitcoin.  The Cyprus crisis sparked a stampede of money into bitcoin, which was now seen as a safe haven from the generalized threat of government confiscation everywhere.”

In theory this may be true, but in practice, it is likely that a significant minority — if not majority — of bitcoins are now held in custody at depository institutions such as Xapo, Coinbase and Circle.  And these are not off-limits to social engineering.  For instance, last week an international joint-task force confiscated $80,000 in bitcoins from dark web operators.  The largest known seizure in history were 144,000 bitcoins from Ross Ulbricht (Dread Pirate Roberts) laptop.

Similarly, while it probably is beyond the scope of their book, it would have been interesting to see a survey from Casey and Vigna covering the speculators during this early 2013 time frame.  Were the majority of people buying bitcoins during the “Cyprus event” actually worried about confiscation or is this just something that is assumed?  Fun fact: the largest transaction to BitPay of all time was on March 25, 2013 during the Cyprus event, amounting to 28,790 bitcoins.

On page 114, the writers for the first time (unless I missed it elsewhere), use the term “virtual currency.”  Actually, they quote FinCEN director Jennifer Calvery who says that FincCEN, “recognizes the innovation virtual currencies provide , and the benefits they might offer society.”

Again recall that most fiat currencies today are already digitized in some format — and they are legal tender.  In contrast, cryptocurrencies such as bitcoin are not legal tender and are thus more accurately classified as virtual currencies.  Perhaps that will change in the future.

On page 118 they note that, “More and more people opened wallets (more than 5 million as of this writing).”

I will get to this later.  Note that on p. 123 they say Coupa Cafe has a “digital wallet” a term used throughout the entire book.

Chapter 5

On page 124:

“Bitcoins exist only insofar as they assign value to a bitcoin address, a mini, one-off account with which people and firms send and receive the currency to and from other people’s firms’ addresses.”

This is actually a pretty concise description of best-practices.  In reality however, many individuals and organizations (such as exchanges and payment processors) reuse addresses.

Continuing on page 124:

“This is an important distinction because it means there’s no actual currency file or document that can be copied or lost.”

This is untrue.  In terms of security, the hardest and most expensive part in practice is securing the credentials — the private key that controls the UTXOs.  As Stefan Thomas, Jason Whelan (p. 139) and countless other people on /r/sorryforyourloss have discovered, this can be permanently lost.  Bearer assets are a pain to secure, hence the re-sprouting of trusted third parties in Bitcoinland.

One small nitpick in the note at the bottom of page 125, “Sometimes the structure of the bitcoin address network is such that the wallet often can’t send the right amount in one go…” — note that this ‘change‘ is intentional (and very inconvenient to the average user).

Another nitpick on page 128:

Each mining node or computer gathers this information and reduces it into an encrypted alphanumeric string of characters known as a hash.

There is actually no encryption used in Bitcoin, rather there are some cryptographic primitives that are used such as key signing but this is not technically called encryption (the two are different).

On page 130, I thought it was good that they explained where the term nonce was first used — from Lewis Carroll who created the word “frabjous” and described it as a nonce word.

On page 132, in describing proof-of-work:

While that seems like a mammoth task, these are high-powered computers; it’s not nearly as taxing as the nonce-creating game and can be done relatively quickly and easily.

They are correct in that something as simple as a Pi computer can and is used as the actual transaction validating machine.  Yet, at one point in 2009, this bifurcation did not exist: a full-node was both a miner and a hasher.  Today that is not the case and we technically have about a dozen or so actual miners on the network, the rest of the machines in “farms” just hash midstates.

On page 132, regarding payment processors accepting zero-confirmation transactions:

They do this because non-confirmations — or the double-spending actions that lead to them — are very rare.

True they are very rare today in part because there are very few incentives to actually try and double-spend.  Perhaps that will change in the future with new incentives to say, double-spend watermarked coins from NASDAQ.

And if payment processors are accepting zero confirmations, why bother using proof-of-work and confirmations at all?  Just because a UTXO is broadcast does not mean it will not be double-spent let alone confirmed and packaged into a block.  See also replace-by-fee proposal.

Small note on page 132:

“the bitcoin protocol won’t let it use those bitcoins in a payment until a total of ninety-nine additional blocks have been built on top its block.”

Sometimes it depends on the client and may be up to 120 blocks altogether, not just 100.

On page 133 they write:

“Anyone can become a miner and is free to use whatever computing equipment he or she can come up with to participate.”

This may have been the case in 2009 but not true today.  In order to reduce payout variance, the means of production as it were, have gravitated towards large pools of capital in the form of hashing farms.  See also: The Gambler’s Guide to Bitcoin Mining.

On page 135 they write:

“Some cryptocurrency designers have created nonprofit foundations and charged them with distributing the coins based on certain criteria — to eligible charities, for example. But that requires the involvement of an identifiable and trusted founder to create the foundation.”

The FinCEN enforcement action and fine on Ripple Labs could put a kibosh on this in the future.  Why?  If organizations that hand out or sell coins are deemed under the purview of the Bank Secrecy Act (BSA) it is clear that most, if not all, crowdfunding or initial coin offerings (ICO) are violating this by not implementing KYC/AML requirements on participants or filing SARs.

On page 136 they write:

“Both seigniorage and transaction fees represent a transfer of value to those running the network. Still, in the grand scheme of things, these costs are far lower than anything found in the old system.”

This is untrue and an inaccurate comparison.  We know that at the current bitcoin price of $240 it costs roughly $315 million to operate the network for the entire year.  If bitcoin-based consumer spending patterns hold up and reflect last years trends seen by BitPay, then roughly $350 million will be spent through payment processors, nearly half of which includes mining payouts.

Or in other words, for roughly every dollar spent on commerce another dollar is spent securing it.  This is massive oversecurity relative to the commerce involve.  Neither Saudi Arabia or even North Korea spend half of, let alone 100% of their GDP on military expenditures (yet).

Chapter 6

Small nitpick on page 140, Butterfly Labs is based in Leawood, Kansas not Missouri (Leawood is on the west side of the dividing line).

I think the story of Jason Whelan is illuminating and could help serve as a warning guide to anyone wanting to splurge on mining hardware.

For instance on page 141:

“And right from the start Whelan face the mathematical reality that his static hashrate was shrinking as a proportion of the ever-expanding network, whose computing power was by then almost doubling every month.”

Not only was this well-written but it does summarize the problem most new miners have when they plan out their capital expenditures.  It is impossible to know what the network difficulty will be in 3 months yet what is known is that even if you are willing to tweak the hardware and risk burning out some part of your board, your hashrate could be diluted by faster more efficient machines.  And Whelan found out the hard way that he might as well bought and held onto bitcoins than mine.  In fact, Whelan did just about everything the wrong way, including buying hashing contracts with cloud miners from “PBCMining.com” (a non-functioning url).

On page 144 the authors discussed the mining farms managed by now-defunct CoinTerra:

With three in-built high-powered fans running at top speed to cool the rig while its internal chi races through calculations, each unit consumes two kilowatts per hour, enough power to run an ordinary laptop for a month. That makes for 20 kWh per tower, about ten times the electricity used for the same space by the neighboring server of more orthodox e-commerce firms.

As noted in Chapter 2 above, this electricity has to be “wasted.”  Bitcoin was designed to be “inefficient” otherwise it would be easy to attack and censor.  And in the future, it cannot become more “efficient” — there is no free lunch when it comes to protecting it.  It also bears mentioning that CoinTerra was sued by its utility company in part for the $12,000 a day in electrical costs that were not being paid for.

On page 145 they wrote that as of June 2014:

“By that time, the network, which was then producing 88,000 trillion hashes every second, had a computing power six thousand times the combined power of the world’s top five hundred supercomputers.”

This is not a fair comparison.  ASIC miners can do one sole function, they are unable to do anything aside from reorganize a few fields (such as date and nonce) with the aim of generating a new number below a target number.  They cannot run MS Office, Mozilla Firefox and more sobering: they cannot even run a Bitcoin client (the Pi computer run by the pool runs the client).

In contrast, in order to be recognized as a Top 500 computer, only general purpose machines capable of running LINXPACK are considered eligible.  The entire comparison is apples-to-oranges.

On page 147 the authors described a study from Guy Lane who used inaccurate energy consumption data from Blockchain.info.

And then they noted that:

“So although the total consumption is significantly higher than the seven-thousand-home estimate, we’re a long way from bitcoin’s adding an entire country’s worth of power consumption to the world.”

This is not quite true.  As noted above in the notes of Chapter 2 above, based on Dave Hudson’s calculations the current Bitcoin network consumes the equivalent of about 10% of Ireland’s annual energy usage yet produces two orders of magnitude less economic activity.  If the price of bitcoin increases so to does the amount of energy miners are willing to expend to chase after the seigniorage.  See also Appendix B.

On page 148 they write that:

For one, power consumption must be measured against the value of validating transactions in a payment system, a social service that gold mining has never provided.  Second, the costs must be weighed against the high energy costs of the alternative, traditional payment system, with its bank branches, armored cars, and security systems. And finally, there’s the overriding incentive for efficiency that the profit motive delivers to innovators, which is why we’ve seen such giant reductions in power consumption for the new mining machines. If power costs make mining unprofitable, it will stop.

First of all, validation is cheap and easy, as noted above it is typically done with something like a Pi computer.  Second, they could have looked into how much real commerce is taking place on the chain relative to the costs of securing it so the “social service” argument probably falls flat at this time.

Thirdly, the above “armored cars and security systems” is not an apples-to-apples comparison.  Bitcoin does not provide any banking service beyond a lock box, it does not provide for home mortgages, small business loans or mezzanine financing.  The costs for maintaining those services in the traditional world do not equate to MC=MV as described at the end of Chapter 1 notes.

Fourthly, they ignore the Red Queen effect.  If a new hashing machine is invented and consumes half as much energy as before then the farm owner will just double the amount of machines and the net effect is the same as before.  This happens in practice, not just in theory, hence the reason why electrical consumption has gone up in aggregate and not down.

On page 149 they write:

“But the genius of the consensus-building in the bitcoin system means such forks shouldn’t be allowed to go on for long. That’s because the mining community works on the assumption that the longest chain is the one that constitutes consensus.”

That’s not quite accurate.  Each miner has different incentives.  And, as shown empirically with other altcoins, forks can reoccur frequently without incentives that align.  For now, some incentives apparently do.  But that does not mean that in the future, if say watermarked coins become more common place, that there will not be more frequent forks as certain miners attempt to double-spend or censor such metacoins.

Ironically on page 151 the authors describe the fork situation of March 2013 and describe the fix in which a few core developers convince Mark Karpeles (who ran Mt. Gox) to unilaterally adopt one specific fork.  This is not trustless.

On page 151 they write:

“That’s come to be known as a 51 percent attack.  Nakamoto’s original paper stated that the bitcoin mining network could be guaranteed to treat everyone’s transactions fairly and honestly so long as no single miner or mining group owned more than 50 percent of the hashing power.”

And continuing on page 153:

“So, the open-source development community is now looking for added protections against selfish mining and 51 percent attacks.”

While they do a good job explaining the issue, they don’t really discuss how it is resolved.  And it cannot be without gatekeepers or trusted hardware.

For instance, three weeks ago there was a good reddit thread discussing one of the problems of Andreas Antonopolous’  slippery slope view that you could just kick the attackers off the network.  First, there is no quick method for doing so; second, by blacklisting them you introduce a new problem of having the ability to censor miners which would be self-defeating for such a network as it introduces a form of trust into an expensive cost structure of trust minimization.

On page 152 they cite a Coinometrics number:

“in the summer of 2014 the cost of the mining equipment and electricity required for a 51 percent attack stood at $913 million.”

This is a measurement of maximum costs based on hashrate brute force — a Maginot Line attack.  In practice it is cheaper to do via out of band attacks (e.g., rubber hose cryptanalysis).  There are many other, cheaper ways, to attack the P2P network itself (such as Eclipse attacks).

On page 154 when discussing wealth disparity in Bitcoin they write:

“First, some perspective.  As a wealth-gap measure, this is a lousy one.  For one, addresses are not wallets.  The total number of wallets cannot be known, but they are by definition considerably fewer than the address tally, even though many people hold more than one.”

Finally.  So the past several chapters I have mentioned I will discuss wallets at some length.  Again, the authors for some reason uncritically cite the “wallet numbers” from Blockchain.info, Coinbase and others as actual digital wallets.

Yet here they explain that these metrics are bupkis.  And they are.  It costs nothing to generate a wallet and there are scripts you can run to auto generate them.  In fact, Zipzap and many others used to give every new user a Blockchain.info wallet por gratis.

And this is problematic because press releases from Xapo and Blockchain.info continually cite a number that is wholly inaccurate and distorting.

For instance Wences Casares said in a presentation a couple months ago that there were 7 million users.  Where did that number come from?  Are these on-chain privkey holders?  Why are journalists not questioning these claims?  See also: A brief history of Bitcoin “wallet” growth.

On page 154 they write:

“These elites have an outsize impact on the bitcoin economy. They have a great interest in seeing the currency succeed and are both willing and able to make payments that others might not, simply to encourage adoption.”

Perhaps this is true, but until there is a systematic study of the conspicuous consumption that takes place, it could also be the case that some of these same individuals just have an interest in seeing the price of bitcoin rise and not necessarily be widely adopted.  The two are not mutually exclusive.

On page 155 and 156 they describe the bitsat project, to launch a full node into space which is aimed “at making the mining network less concentrated.”

Unfortunately these types of full nodes are not block makers.  Thus they do not actually make the network less concentrated, but only add more propagating nodes.  The two are not the same.

On page 156 they describe some of the altcoin projects:

“They claim to take the good aspects of bitcoin’s decentralized structure but to get ride of its negative elements, such as the hashing-power arms race, the excessive use of electricity, and the concentration of industrialized mining power.”

I am well aware of the dozens various coin projects out there due to work with a digital asset exchange over the past year.  Yet fundamentally all of the proof-of-work based coins end up along the same trend line, if they become popular and reach a certain level of “market cap” (an inaccurate term) specialized chips are designed to hash it.

And the term “excessive” energy related to proof-of-work is a bit of a non-starter.  Ignoring proof-of-stake systems, if it becomes less energy intensive to hash via POW, then it also becomes cheaper to attack.  Either miners will add more equipment or the price has dropped for the asset and it is therefore cheaper to attack.

On page 157 regarding Litecoin they write that:

“Miners still have an incentive to chase coin rewards, but the arms race and the electricity usage aren’t as intense.”

That’s untrue.  Scrypt (which is used instead of Hashcash) is just as energy intensive.  Miners will deploy and utilize energy in the same patterns, directly in proportion to the token price.  The difference is memory usage (Litecoin was designed to be more memory intensive) but that is unrelated to electrical consumption.

Continuing:

“Litecoin’s main weakness is the corollary of its strength: because it’s cheaper to mine litecoins and because scrypt-based rigs can be used to mine other scrypt-based altcoins such as dogecoin, miners are less heavily invested in permanently working its blockchain.”

This is untrue.  Again, Litecoin miners will in general only mine up to the point where it costs a litecoin to make a litecoin.  Obviously there are exceptions to it, but in percentage terms the energy usage is the same.

Continuing:

“Some also worry that scrypt-based mining is more insecure, with a less rigorous proof of work, in theory allowing false transactions to get through with incorrect confirmations.”

This is not true.  The two difference in security are the difficulty rating and block intervals.  The higher the difficulty rating, the more energy is being used to bury blocks and in theory, the more secure the blocks are from reversal.

The question is then, is 2.5 minutes of proof-of-work as secure as burying blocks every 10 minutes?  Jonathan Levin, among others, has written about this before.

cthuluSmall nitpick on page 157, fairly certain that nextcoin should be referred to as NXT.

On page 158 they write:

If bitcoin is to scale up, it must be upgraded sot hat nodes, currently limited to one megabyte of data per ten-minute block, are free to process a much larger set of information.  That’s not technically difficult; but it would require miners to hash much larger blocks of transactions without big improvements in their compensation.  Developers are currently exploring a transaction-fee model that would provide fairer compensation for miners if the amount of data becomes excessive.

This is not quite right.  There is a difference between block makers (pools) and hashers (mining farms).  The costs for larger blocks would impact block makers not hashers, as they would need to upgrade their network facilities and local hard drive.  This may seem trivial and unimportant, but Jonathan Levin’s research, as well as others suggest that block sizes does in fact impact orphan rates.5

It also impacts the amount of decentralization within the network as larger blocks become more expensive to propagate you will likely have fewer nodes.  This has been the topic of immense debate over the past several weeks on social media.

Also on page 158 they write:

The laboratory used by cryptocurrency developers, by contrast, is potentially as big as the world itself, the breadth of humanity that their projects seek to encompass. No company rulebook or top-down set of managerial instructions keeps people’s choice in line with a common corporate objective. Guiding people to optimal behavior in cryptocurrencies is entirely up to how the software is designed to affect human thinking, how effectively its incentive systems encourage that desired behavior

This is wishful thinking and probably unrealistic considering that Bitcoin development permanently suffers from the tragedy of the commons.  There is no CEO which is both good and bad.

For example, directions for where development goes is largely based on two things:

  1. how many upvotes your comment has on reddit (or how many retweets it gets on Twitter)
  2. your status is largely a function of how many times Satoshi Nakamoto responded to you in email or on the Bitcointalk forum creating a permanent clique of “early adopters” whose opinions are the only valid ones (see False narratives)

This is no way to build a financial product.  Yet this type of lobbying is effectively how the community believes it will usurp well-capitalized private entities in the payments space.

Several months ago a user, BitttBurger, made a similar observation:

I’ve said it before and I will say it again. There is a reason why Developers should not be in control of product development priorities, naming, feature lists, or planning for a product. That is the job of the sales, marketing, and product development teams who actually interface with the customer. They are the ones who do the research and know what’s needed for a product. They are the ones who are supposed to decide what things are called, what features come next, and how quickly shit gets out the door.

Bitcoin has none of that. You’ve got a Financial product, being created for a financial market, by a bunch of developers with no experience in finance, and (more importantly) absolutely no way for the market to have any input or control over what gets done, or what it’s called. That is crazy to me.

Luke is a perfect example of why you don’t give developers control over anything other than the structure of the code.

They are not supposed to be making product development decisions. They are not supposed to be naming anything. And they definitely are not supposed to be deciding “what comes next” or how quickly things get done. In any other company, this process would be considered suicide.

Yet for some reason this is considered to be a feature rather than a bug (e.g., “what is your Web of Trust (WoT) number?”).

On page 159 they write:

“The vital thing to remember is that the collective brainpower applied to all the challenges facing bitcoin and other cryptocurrencies is enormous.  Under the open-source, decentralized model, these technologies are not hindered by the same constraints that bureaucracies and stodgy corporations face.”

So, what is the Terms of Service for Bitcoin?  What is the customer support line?  There isn’t one.  Caveat emptor is pretty much the marketing slogan and that is perfectly fine for some participants yet expecting global adoption without a “stodgy” “bureaucracy” that helps coordinate customer service seems a bit of a stretch.

And just because there is some avid interest from a number of skilled programmers around the world does not mean public goods problems surrounding development will be resolved.

For reference: there were over 5000 co-authors on a recent physics paper but that doesn’t mean their collective brain power will quickly resolve all the open questions and unsolved problems in physics.

Chapter 7:

Small nitpick on page 160:

“Bitcoin was born out of a crypto-anarchist vision of a decentralized government-free society, a sort of encrypted, networked utopia.”

As noted above, there is actually no encryption used in Bitcoin.

On page 162 they write:

“Before we get too carried away, understand this is still early days.”

That may be the case.  Perhaps decentralized cryptocurrencies like Bitcoin are not actually the internet in the early 1990s like many investors claim but rather the internet in the 1980s when there were almost no real use-cases and it is difficult to use.  Or 1970s.  The problem is no one can actually know the answer ahead of time.

And when you try to get put some milestone down on the ground, the most ardent of enthusiasts move the goal posts — no comparisons with existing tech companies are allowed unless it is to the benefit of Bitcoin somehow.  I saw this a lot last summer when I discussed the traction that M-Pesa and Venmo had.

A more recent example is “rebittance” (a portmanteau of “bitcoin” and “remittance”).  A couple weeks ago Yakov Kofner, founder of Save On Send, published a really good piece comparing money transmitter operators with bitcoin-related companies noting that there currently is not much meat to the hype.  The reaction on reddit was unsurprisingly fist-shaking Bitcoin rules, everyone else drools.

yakov breakfast

With Yakov Kofner (CEO Save On Send)

When I was in NYC last week I had a chance to meet with him twice.  It turns out that he is actually quite interested in Bitcoin and even scoped out a project with a VC-funded Bitcoin company last year for a consumer remittances product.

But they decided not to build and release it for a few reasons:

  1.  in practice, many consumers are not sensitive enough to a few percentage savings because of brand trust/loyalty/habit;
  2.  lacking smartphones and reliable internet infrastructure, the cash-in, cash-out aspect is still the main friction facing most remittance corridors in developing countries, bitcoin does not solve that;
  3.  it boils down to an execution race and it will be hard to compete against incumbents let alone well-funded MTO startups (like TransferWise).

That’s not to say these rebittance products are not good and will not find success in niches.

For instance, I also spoke with Marwan Forzley (below), CEO of Align Commerce last week.  Based on our conversation, in terms of volume his B2B product appears to have more traction than BitPay and it’s less than a year old.

What is one of the reasons why?  Because the cryptocurrency aspect is fully abstracted away from customers.

marwan p2p

Raja Ramachandran (R3CEV), Dan O’Prey (Hyperledger), Daniel Feichtinger (Hyperledger), Marwan Forzley (Align Commerce)

In addition, both BitX and Coins.ph — based on my conversations in Singapore two weeks ago with their teams — seem to be gaining traction in a couple corridors in part because they are focusing on solving actual problems (automating the cash-in/cash-out process) and abstracting away the tech so that the average user is oblivious of what is going on behind the scenes.

singapore ron

Markus Gnirck (StartupBootCamp), Antony Lewis (itBit) and Ron Hose (Coins.ph) at the DBS Hackathon event

On page 162 and 163 the authors write about the Bay Area including 20Mission and Digital Tangible.

There is a joke in this space that every year in cryptoland is accelerated like dog years.  While 20Mission, the communal housing venue, still exists, the co-working space shut down late last year.  Similarly, Digital Tangible has rebranded as Serica and broadened from just precious metals and into securities.  In addition, Dan Held (page 164) left Blockchain.info and is now at ChangeTip.

On page 164 they write:

“But people attending would go on to become big names in the bitcoin world: Among them were Brian Armstrong and Fred Ehrsam, the founders of Coinbase, which is second only to Blockchain as a leader in digital-wallet services and one of the biggest processors of bitcoin payments for businesses.”

10 pages before this they said how useless digital wallet metrics are.  It would have been nice to press both Armstrong and Ehrsam to find out what their actual KYC’ed active users to see if the numbers are any different than the dated presentation.

On page 165 they write:

“It’s a very specific type of brain that’s obsessed with bitcoin,” says Adam Draper, the fourth-generation venture capitalist…”

I hear this often but what does that mean?  Is investing genetic?  If so, surely there are more studies on it?

For instance, later on page 176 they write:

“The youngest Draper, who tells visitors to his personal web site that his life’s ambition is to assist int he creation of an iron-man suit, has clearly inherited his family’s entrepreneurial drive.”

Perhaps Adam Draper is indeed both a bonafide investor and entrepreneur, but it does not seem to be the case that either can be or is necessarily inheritable.

On page 167:

“The only option was to “turn into a fractional-reserve bank,” he said jokingly, referring tot he bank model that allows banks to lend out deposits while holding a fraction of those funds in reserve.  “They call it a Ponzi scheme unless you have a banking license.”

Why is this statement not challenged?  I am not defending rehypothecation or the current banking model, but fractional reserve banking as it is employed in the US is not a Ponzi scheme.

Also on page 167 they write:

“First, he had trouble with his payments processor, Dwolla which he later sued for $2 million over what Tradehill claimed were undue chargebacks.”

A snarky thing would be to say he should have used bitcoin, no chargebacks.  But the issue here, one that the authors should have pressed is that Tradehill, like Coinbase and Xapo, are effectively behaving like banks.  It’s unclear why this irony is not discussed once in the book.

For instance, several pages later on page 170 they once again talk about wallets:

The word wallet is thrown around a lot in bitcoin circles, and it’s an evocative description, but it’s just a user application that allows you to send and receive bitcoins over the bitcoin network. You can download software to create your own wallet — if you really want to be your own bank — but most people go through a wallet provider such as Coinbase or Blockchain, which melded them into user-friendly Web sites and smart phone apps.

I am not sure if it is intentional but the authors clearly understand that holding a private key is the equivalent of being a bank.  But rather than say Coinbase is a bank (because they too control private keys), they call them a wallet provider.  I have no inside track into how regulators view this but the euphemism of “wallet provider” is thin gruel.

On the other hand Blockchain.info does not hold custody of keys but instead provide a user interface — at no point do they touch a privkey (though that does not mean they could not via a man-in-the-middle-attack or scripting errors like the one last December).

On page 171 they talk about Nathan Lands:

The thirty-year-old high school dropout is the cofounder of QuickCoin, the maker of a wallet that’s aimed directly at finding the fastest easiest route to mass adoption.  The idea, which he dreamed up with fellow bitcoiner Marshall Hayner one night over a dinner at Ramen Underground, is to give nontechnical bitcoin newcomers access to an easy-to-use mobile wallet viat familiar tools of social media.

Unfortunately this is not how it happened.  More in a moment.

Continuing the authors write:

“His successes allowed Lands to raise $10 million for one company, Gamestreamer.”

Actually it was Gamify he raised money for (part of the confusion may be due to how it is phrased on his LinkedIn profile).

Next the authors state:

“He started buying coins online, where her ran into his eventual business partner, Hayner (with whom he later had a falling-out, and whose stake he bought).”

One of the biggest problems I had with this book is that the authors take claims at face value.  To be fair, I probably did a bit too much myself with GCON.

On this point, I checked with Marshall Hayner who noted that this narrative was untrue:  “Nathan never bought my stake, nor was I notified of any such exchange.”

While the co-founder dispute deserves its own article or two, the rough timeline is that in late 2013 Hayner created QuickCoin and then several months later on brought Lands on to be the CEO.  After a soft launch in May 2014 (which my wife and I attended, see below) Lands maneuvered and got the other employees to first reduce the equity that Hayner had and then fired him so they could open up the cap table to other investors.

quickcoin

QuickCoin launch party with Marshall Hayner, Jackson Palmer (Dogecoin), and my wife

With Hayner out, QuickCoin quickly faded due to the fact that the team had no ties to the local cryptocurrency community.  Hayner went on to join Stellar and is now the co-founder of Trees.  QuickCoin folded by the end of the year and Lands started Blockai.

On page 174 they discuss VCs involved in funding Bitcoin-related startups:

Jerry Yang, who created the first successful search engine, Yahoo, put money from his AME Ventures into a $30 million funding round for processor BitPay and into one of two $20 million rounds raised by depository and wallet provider Xapo, which offers insurance to depositors and call itself a “bitcoin vault.”

While they likely couldn’t have put it in this section, I think it would have been good for the authors to discuss the debate surrounding what hosted wallets actually are because regulators and courts may not agree with the marketing-speak of these startups.6

On page 177 they write about Boost VC which is run by Adam Draper:

“He’d moved first and emerged as the leader in the filed, which meant his start-ups could draw in money from the bigger guys when it came time for larger funding rounds.”

It would be interesting to see the clusters of what VCs do and do not co-invest with others.  Perhaps in a few years we can look back and see that indeed, Boost VC did lead the pack.

However while there are numerous incubated startups that went on to close seed rounds (Blockcypher, Align Commerce, Hedgy, Bitpagos) as of this writing there is only one incubated company in Boost that has closed a Series A round and that is Mirror (Coinbase, which did receive funding from Adam Draper, was not in Boost).  Maybe this is not a good measure for success, perhaps this will change in the future and maybe more have done so privately.

On page 179-180 the discussion as to what Plug and Play Tech Center does and its history was well written.

On page 184 they write:

With every facet of our economy now dependent on the kinds of software developed and funded in the Bay Area, and with the Valley’s well-heeled communities becoming a vital fishing ground for political donations and patronage, we’re witnessing a migration of the political and economic power base away from Wall Street to this region.

I have heard variations of this for the past couple of years.  Most recently I heard a VC claim that Andreessen Horrowitz (a16z) was the White House of the West Coast and that bankers in New York do not understand this tech.  Perhaps it is and perhaps bankers do not understand what a blockchain is.

Either way we should be able to see the consequences to this empirically at some point.  Where is the evidence presented by the authors?

incumbents

Source: finviz

Fast forwarding several chapters, on page 287 they write:

“Visa, MasterCard, and Western Union combined – to name just three players whose businesses could be significantly reformed — had twenty-seven thousand employees in 2013.”

Perhaps these figures will dramatically change soon, however, the above image are the market caps over the past 5 years of four incumbents: JP Morgan (the largest bank in the US), MasterCard and Visa (the largest card payment providers) and Western Union, the world’s largest money transfer operator.

Will their labor force dramatically change because of cryptocurrencies?  That is an open question.  Although it is unclear why the labor force at these companies would necessarily shrink because of the existence of Bitcoin rather than expand in the event that these companies integrated parts of the tech (e.g., a distributed ledger) thereby reducing costs and increasing new types of services.

On page 185 they write:

“Those unimaginable possibilities exist with bitcoin, Dixon says, because “extensible software platforms that allow anyone to build on top of them are incredibly powerful and have all these unexpected uses. The stuff about fixing the existing payment system is interesting, but what’s superexciting is that you have this new platform on which you can move money and property and potentially build new areas of businesses.”

Maybe this is true.  It is unclear from these statements as to what Chris Dixon views as broken about the current payment system.  Perhaps it is “broken” in that not everyone on the planet has access to secure, near-instant methods of global value transer.  However it is worth noting that cryptocurrencies are not the only competitors in the payments space.

According to AngelList as of this writing:

Chapter 8

This chapter discussed “The Unbanked” and how Bitcoin supposedly can be a solution to banking these individuals.

On page 188 they discuss a startup called 37coins:

“It uses people in the region lucky enough to afford Android smartphones as “gateways” to transmit the messages.  In return, these gateways receive a small fee, which provides the corollary benefit of giving locals the opportunity to create a little business for themselves moving traffic.”

This is a pretty neat idea, both HelloBit and Abra are doing something a little similar.  The question however is, why bitcoin?  Why do users need to go out of fiat, into bitcoin and back out to fiat?  If the end goal is to provide users in developing countries a method to transmit value, why is this extra friction part of the game plan?

Last month I heard of another supposed cryptocurrency “killer app”: smart metering prepaid via bitcoin and how it is supposed to be amazing for the unbanked.  The unbanked, they are going to pay for smart metering with money they don’t have for cars they don’t own.

There seems to be a disconnect when it comes to financial inclusion as it is sometimes superficially treated in the cryptocurrency world.  Many Bitleaders and enthusiasts seem to want to pat themselves on the back for a job that has not been accomplished.  How can the cryptocurrency community bring the potential back down to real world situations without overinflating, overhyping or over promising?

If Mercedes or Yamaha held a press conference to talk about the “under-cared” or “under-motorcycled” they would likely face a backlash on social media.  Bitcoin the bearer instrument, is treated like a luxury good and expecting under-electrified, under-plumbed, under-interneted people living in subsistence to buy and use it today without the ability to secure the privkey without a trusted third party, seems far fetched (“the under bitcoined!”).  Is there a blue print to help all individuals globally move up Maslow’s Hierarchy of Financial Wants & Needs?

On page 189 they write:

“But in the developing world, where the costs of an ineffectual financial system and the burdens of transferring funds are all too clear, cryptocurrencies have a much more compelling pitch to make.”

The problem is actually at the institutional level, institutions which do not disappear because of the Bitcoin blockchain.  Nor does Bitcoin solve the identity issue: users still need real-world identity for credit ratings so they can take out loans and obtain investment to build companies.

For instance on page 190 the authors mention the costs of transferring funds to and from Argentina, the Philippines, India and Pakistan.  One of the reasons for the high costs is due to institutional problems which is not solved by Bitcoin.

In fact, the authors write:

“Banks won’t service these people for various reasons. It’s partly because the poor don’t offer as fat profits as the rich, and it’s partly because they live in places where there isn’t the infrastructure and security needed for banks to build physical branches. But mostly it’s because of weak legal institutions and underdeveloped titling laws.”

This is true, but Bitcoin does not solve this.  If local courts or governments do not recognize the land titles that are hashed on the blockchain it does the local residents no good to use Proof of Existence or BlockSign.

They do not clarify this problem through the rest of the chapter.  In fact the opposite takes place, as they double down on the reddit narrative:

“Bitcoin, as we know, doesn’t care who you are. It doesn’t care how much money you are willing to save, send, or spend. You, your identity and your credit history are irrelevant. […] If you are living on $50 a week, the $5 you will save will matter a great deal.”

This helps nobody. The people labeled as “unbanked” want to have access to capital markets and need a credit history so they can borrow money to create a companies and build homes.  Bitcoin as it currently exists, does not solve those problems.

Furthermore, how do these people get bitcoins in the first place?  That challenge is not discussed in the chapter.  Nor is the volatility issue, one swift movement that can wipe out the savings of someone living in subsistence, broached.  Again, what part of the network does lending on-chain?

On page 192 they write:

“They lack access to banks not because they are uneducated, but because of the persistent structural and systemic obstacles confronting people of limited means there: undeveloped systems of documentation and property titling, excessive bureaucracy, cultural snobbery, and corruption. The banking system makes demands that poor people simply can’t meet.”

This is very true.  The Singapore conference I attended two weeks ago is just one of many conferences held throughout this year that talked about financial inclusion.  Yet Bitcoin does not solve any of these problems.  You do not need a proof-of-work blockchain to solve these issues.  Perhaps new database or permissioned ledgers can help, but these are social engineering challenges — wet code — that technology qua technology does not necessarily resolve.

Also on page 192 they write:

“People who have