[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.
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):
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
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
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
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:
for X amount of BTC the CM will actively solicit and get your coin listed on various exchanges;
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.
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 .”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.
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.
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!
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
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
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 SaveOnSendarticle 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
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.
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.
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.]
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.
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” [↩]
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?” [↩]
Not unique to cryptocurrencies, but by enabling such bad actors, certain platform operators may even increase their short term profit. [↩]
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. [↩]
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.” [↩]
It has a complex corporate structure and is nominally based in Hong Kong, operations and incorporation of subsidiaries are in other jurisdictions including BVI. [↩]
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. [↩]
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. [↩]
Bitfinex also recently announced that they will be doing an ICO (called NEC) to capitalize on the current token mania. [↩]
Bitfinex does do KYC and AML when a user withdraws USD and when they receive subpoenas. [↩]
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.” [↩]
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?” [↩]
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.” [↩]
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. [↩]
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. [↩]
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. [↩]
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? [↩]
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.” [↩]
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. [↩]
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.” [↩]
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. [↩]
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). [↩]
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.” [↩]
Whalepool and The Coin Farm on Telegram are both examples of this type of coordination. [↩]
Based on translated stories from after the investigations as well as conversations with observers of these training sessions. [↩]
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 [↩]
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. [↩]
He had to refund the ICOs he promote (plus with an added premium). [↩]
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.” [↩]
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. [↩]
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. [↩]
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. [↩]
Another tech company that supposedly struggled raising funding and later issued its own coin (through an ICO) is Kik, through its Kin Foundation. [↩]
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. [↩]
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?” [↩]
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.” [↩]
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. [↩]
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. [↩]
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?” [↩]
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.” [↩]
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). [↩]
To be fair, this is not unique to the cryptocurrency space. [↩]
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 [↩]
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? [↩]
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? [↩]
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. [↩]
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. [↩]
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.”
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!
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!
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.
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. [↩]
The R3CEV.com domain was created on August 13, 2014. [↩]
It may look like an odd spelling, but Treasurys is the correct spelling. [↩]
At the time, I was an advisor to Hyperledger which was acquired by Digital Asset the following month. [↩]
The DistributedLedgerGroup.com domain was created on December 23, 2014 and R3members.com was created on March 15, 2016. [↩]
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.
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)
[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 Motherboardfeature on Yifu Guo, the young Chinese man who led the Avalon team’s effort on building the first commercially available ASIC.
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 DailyTecharticle 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.
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)
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 Timesarticle (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.
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.”
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)
“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.
It’s unclear how many of the salacious stories were left on the cutting board, but there is always Brian Eha’s upcoming book.
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)
“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.
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)
“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 (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.”
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 attemptedto assuage concerns by stating they will make sure their own pool doesn’t go above a self-imposed threshold of 40%.
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.”
“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.
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.
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.
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.
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.]
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 datdescribed 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:
purchase bitcoins from some kind of exchange
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 inc 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.
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.
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.
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.”
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.
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.
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.
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.
The 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.
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.
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 may 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).
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.
Small 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:
how many upvotes your comment has on reddit (or how many retweets it gets on Twitter)
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.
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.
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.”
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.
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.
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.
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 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.
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?
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.
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 suffered waves of financial crises are used to volatility. People who have spent years trusting expensive middlemen and flipping back and forth between dollars and their home currency are probably more likely to understand bitcoin’s advantages and weather its flaws.”
This is probably wishful thinking too. Residents of Argentina and Ukraine may be used to volatility but it does not mean it is something they want to adopt. Why would they want to trade one volatile asset for another? Perhaps they will but the authors do not provide any data for actual usage or adoption in these countries, or explain why the residents prefer bitcoin instead of something more global and stable such as the US dollar.
On page 193 they write that, “In many cases, these countries virtually skip over legacy technology, going straight to high-tech fiber-optic cables.”
While there is indeed a number of legacy systems used on any given day in the US, it is not like Bitcoin itself is shiny new tech. While the libraries and BIPS may be new, the components within the consensus critical tech almost all dates back to the 20th century.
For instance, according to Gwern Branwen, the key moving parts that Bitcoin uses:
That’s not to say that Bitcoin is bad, old or that other systems are not old or bad but rather the term “legacy” is pretty relative and undefined in that passage.
On page 194 they discuss China and bitcoin, “With bitcoin, the theory goes, people could bypass that unjust banking system and get their money out of China at low cost.”
This is bad legal advice, just look at the problems this caused Coinbase with regulators a couple months ago. And while you could probably do it low-scale, it then competes with laundering via art sales and Macau junkets and thus expecting this to be the killer use-case for adoption in China is fairly naive.
On page 195 they write “Bitcoin in China is purely a speculator’s game, a way to gamble on its price, either through one of a number of mainland exchanges or by mining it. It is popular — Chinese trading volumes outstrip those seen anywhere else in the world.”
Two months ago Goldman Sachs published a widely circulated report which stated that “80% of bitcoin volume is now exchanged into and out of Chinese yuan.”
This is untrue though as it is solely based on self-reporting metrics from all of the exchanges (via Bitcoinity). As mentioned in chapter 1 notes above, the top 3 exchanges in China run market-making bots which dramatically inflate trading volume by 50-70% each day. While they likely still process a number of legitimate trades, it cannot be said that 80% of bitcoin volume is traded into and out of RMB. The authors of both the report and the book should have investigated this in more depth.
On page 196 they write, “This service, as well as e-marketplace Alibaba’s competing Alipay offering, is helping turn China into the world’s most dynamic e-commerce economy. How is bitcoin to compete with that?”
Next on page 196 they write, “But what about the potential to get around the controls the government puts on cross-border fund transfers?”
By-passing capital controls was discussed two pages before and will likely cause problems for any VC or PE-backed firm in China, the US and other jurisdictions. I am not defending the current policies just being practical: if you are reading their book and plan to do this type of business, be sure to talk to a legal professional first.
On page 197 they discuss a scenario for bitcoin adoption in China: bank crisis. The problem with this is that in the history of banking crisis’ thus far, savers typically flock to other assets, such as US dollars or euros. The authors do not explain why this would change. Now obviously it could or in the words of the authors, the Chinese “may warm to bitcoin.” But this is just idle speculation — where are the surveys or research that clarify this position? Why is it that many killer use-cases for bitcoin typically assumes an economy or two crashes first?
On page 198 they write, “The West Indies even band together to form one international cricket team when they play England, Australia, and other members of the Commonwealth. What they don’t have, however, is a common currency that could improve interisland commerce.”
More idle speculation. Bitcoin will probably not be used as a common currency because policy makers typically want to have discretion via elastic money supplies. In addition, one of the problems that a “common currency” could have is what has plagued the eurozone: differing financial conditions in each country motivate policy makers in each country to lobby for specific monetary agendas (e.g., tightening, loosening). Bitcoin in its current form, cannot be rebased to reflect the changes that policy makers could like to make. While many Bitcoin enthusiasts like this, unless the authors of the book have evidence to the contrary, it is unlikely that the policy makers in the West Indies find this desirable.
On page 199 they write, “A Caribbean dollar remains a pipe dream.”
It is unclear why having a unified global or regional currency is a goal for the authors? Furthermore, there is continued regional integration to remove some frictions, for instance, the ECACH (Eastern Caribbean Automated Clearing House) has been launched and is now live in all 8 member countries.
On page 203 they spoke to Patrick Byrne from Overstock.com about ways Bitcoin supposedly saves merchants money. They note that, “A few weeks later, Byrne announced he would not only be paying bitcoin-accepting vendors one week early, but that he’d also pay his employee bonuses in bitcoin.”
Except so far this whole effort has been a flop for Overstock.com. According to Overstock, in 2014 approximately 11,100 customers paid with bitcoin at both its US and international websites. Altogether this represented roughly $3 million in sales which when coupled with low margin products (based on the top 10 list of things sold on Overstock) is an initiative that Stone Street Advisors labeled “distracting” (see slides 21, 32, 33, 37, 58).
This continues onto page 204, “As a group of businesses in one region begins adopting the currency, it will become more appealing to others with whom they do business. Once such a network of intertwined businesses builds up, no one wants to be excluded from it. Or so the theory goes.” Byrne then goes on to describe network effects and fax machines, suggesting that this is what will happen with bitcoin.
In other words, a circular flow of income. The challenge however goes back to the fact that the time preferences of individuals is different and has not lended towards the theory of spending. As a whole, very few people spend and suppliers typically cash out to reduce their exposure to volatility. Perhaps this will change, but there is no evidence that it has so far.
On page 206 they talk to Rulli from Film Annex (who was introduced in the introduction):
With bitcoin, “you can clearly break down the value of every single stroke on the keyboard, he says.
And you cannot with fiat?
Continuing the authors talk about Rulli:
He wanted the exchange to be solely in bitcoin for other digital currencies, with no option to buy rupees or dollars: “The belief I have is that if you lock these people into this new economy, they will make that new economy as efficient as possible.”
What about volatility? Why are marginalized people being expected to hold onto an asset that fluctuates in value by more than 10% each month? Rulli has a desire to turn the Film Annex Web site “into its own self enclosed bitcoin economy.” There is a term for this: autarky or closed economy.
Continuing Rulli states, ‘If you start giving people opportunities to get out of the economy, they will just cut it down, whereas if the only way for you to enrich yourself is by trading bitcoins for litecoins and dogecoins, you are going to become an expert in that… you will become the best trader in Pakistan.”
This seems to be a questionable strategy: are these users on bitLanders supposed to be artisans or day traders? Why are marginalized people expected to compete with world-class professional traders?
On page 210 the second time the term “virtual currency” is mentioned, this time by the Argentinian central bank.
On page 213 they write, “With bitcoin, it is possible to sen money via a mobile phone, directly between two parties, to bypass that entire cumbersome, expensive system for international transfers.”
What an updated version to the book should include is an actual study for the roundtrip costs of doing international payments and remittances. This is not to defend the incumbents, but rebittance companies and enthusiasts on reddit grossly overstate the savings in many corridors.7 And it still does not do away with the required cash-in / cash-out steps that people in these countries still want and need.
On page 216 they write about the research of Hernando de Soto who discusses the impediments of economic development including the need to document ownership of property. Unfortunately Bitcoin does not currently solve this because ultimately the recognition of a hash of a document on a blockchain comes down to recognition from the same institutions that some of these developing countries lack.
Continuing on page 217 they write that, “Well, the blockchain, if taken to the extent that a new wave of bitcoin innovators believe possible, could replace many of those institutions with a decentralized authority for proving people’s legal obligations and status. In doing so, it could dramatically widen the net of inclusion.”
How? How is this done? Without recognized title transfers, hashing documents onto a chain does not help these people. This is an institutional issue, not one of technology. Human corruption does not disappear because of the existence of Bitcoin.
On page 219 they write, “Like everything else in the cryptocurrency world, the goal is to decentralize, to take power out of the hands of the middleman.”
By recreating the same middleman, depository institutions, yet without robust financial controls.
On page 220 and 221 they mention “basic encryption process” and “standard encryption models” — I believe that it is more accurately stated as cryptographic processes and cryptographic models.
On page 222 they define “Bitcoin 2.0” / “Blockchain 2.0” and put SatoshiDice into that bucket. Ignoring the labels for a moment, I don’t think SatoshiDice or any of the other on-chain casino games are “2.0” — they use the network without coloring any asset.
One quibble with Mike Hearn’s explanation on page 223 is when he says, “But bitcoin has no intermediaries.” This is only true if you control and secure the privkey by yourself. In practice, many “users” do not.
On page 225 they write, “Yet they are run by Wall Street banks and are written and litigated by high-powered lawyers pulling down six- or seven-figure retainers.”
Is it a crime to be able to charge what the market bears for a service? Perhaps some of this technology will eventually reduce the need for certain legal services, but it is unclear what the pay rate of attorneys in NYC has in relation with Bitcoin.
Also on page 225 a small typo: “International Derivatives and Swaps Association (ISDA)” — need to flip Derivatives and Swaps.
On page 226, 227, 229 and 244: nextcoin should be called NXT.
On page 227 they write, “Theses are tradable for bitcoins and other cryptocurrencies on special altcoin exchanges such as Cryptsy, where their value is expected to rise and fall according to the success or failure of the protocol to which they belong.”
There is a disconnect between the utility of a chain and the speculative activity around the token. For instance, most day traders likely do not care about the actual decentralization of a network, for if they did, it would be reflected in prices of each chain. There are technically more miners (block makers) on dozens of alternative proof-of-work chains than there in either bitcoin or litecoin yet market prices are (currently) not higher for more decentralized chains.
On page 228 they write that:
“Under their model, the underlying bitcoin transactions are usually of small value — as low as a “Satoshi” (BTC0.00000001). That’s because the bitcoin value is essentially irrelevant versus the more important purpose of conveying the decentralized application’s critical metadata across the network, even though some value exchange is needed to make the communication of information happen.”
Actually in practice the limit for watermarked coins typically resides around 0.0001 BTC. If it goes beneath 546 satoshi, then it is considered dust and not included into a block. Watermarked coins also make the network top heavy and probably insecure.8
On page 209, the third time “virtual currency” is used and comes from Daniel Larimer, but without quotes.
On page 230 they discuss an idea from Daniel Larimer to do blockchain-based voting. While it sounds neat in theory, in practice it still would require identity which again, Bitcoin doesn’t solve. Also, it is unclear from the example in the book as to why it is any more effective/superior than an E2E system such as Helios.
On page 238 they write, “It gets back to the seigniorage problem we discussed in chapter 5 and which Nakamoto chose to tackle through the competition for bitcoins.”
I am not sure I would classify it as a problem per se, it is by design one method for rewarding security and distributing tokens. There may be other ways to do it in a decentralized manner but that is beyond the scope of this review.
On page 239 they discuss MaidSafe and describe the “ecological disaster” that awaits data-center-based storage. This seems a bit alarmist because just in terms of physics, centralized warehouses of storage space and compute will be more efficient than a decentralized topology (and faster too). This is discussed in Chapter 3 (under “Another facsimile”).
Continuing they quote the following statement from David Irvine, founder of MaidSafe: “Data centers, he says, are an enormous waste of electricity because they store vast amounts of underutilized computing power in huge warehouse that need air-condition and expensive maintenance.”
Or in other words: #bitcoin
On page 242 they mention Realcoin whose name has since been changed to Tether. It is worth pointing out that Tether does not reduce counterparty risk, users are still reliant on the exchange (in this case Bitfinex) from not being hacked or shut down via social engineering.
On page 244, again to illustrate how fast this space moves, Swarm has now pivoted from offering cryptocurrency-denominated investment vehicles into voting applications and Open-Transactions has hit a bit of a rough patch, its CTO, Chris Odom stepped down in March and the project has not had any public announcements since then.
If you missed it, the last few weeks on social media have involved a large debate around blockchain stability with respect to increasing block sizes. During one specific exchange, several developers debated as to “who was in charge,” with Mike Hearn insisting that Satoshi left Gavin in charge and Greg Maxwell stating that this is incorrect.
This ties in with the beginning of page 247, the authors write about Gavin Andresen, “A week earlier he had cleared out his office at the home he shares with his wife, Michele – a geology professor at the University of Massachusetts — and two kids. He’d decided that a man essentially if not titularly in charge of running an $8 billion economy needed something more than a home office.”
Who is in charge of Bitcoin? Enthusiasts on reddit and at conferences claim no one is. The Bitcoin Foundation claims five people are (those with commit access). Occasionally mainstream media sites claim the Bitcoin CEO or CFO is fired/jailed/dead/bankrupt.
The truth of the matter is that it is the miners who decide what code to update and use and for some reason they are pretty quiet during all of this hub bub. Beyond that, there is a public goods problem and as shown in the image above, it devolves into various parties lobbying for one particular view over another.
The authors wrote about this on page 247, “The foundation pays him to coordinate the input of the hundreds of far-flung techies who tinker away at the open-licensed software. Right now, the bitcoin community needed answers and in the absence of a CEO, a CTO, or any central authority to turn to, Andresen was their best hope.”
It is unclear how this will evolve but is a ripe topic of study. Perhaps the second edition will include other thoughts on how this role has changed over time.
On page 251 they write, “Probably ten thousand of the best developers in the world are working on this project,” says Chris Dixon, a partner at venture capital firm Andreessen Horowitz.
How does he know this? There are not 10,000 users making changes to Bitcoin core libraries on github or 10,000 subscribers to the bitcoin development mailing list or IRC rooms. I doubt that if you added up all of the employees of every venture-backed company in the overall Bitcoin world, that the amount would equate to 2,000 let alone 10,000 developers. Perhaps it will by the end of this year but this number seems to be a bit of an exaggeration.
Continuing Dixon states, “You read these criticisms that ‘bitcoin has this flaw and bitcoin has that flaw,’ and we’re like ‘Well, great. Bitcoin has ten thousand people working hard on that.”
This is not true. There is a public goods problem and coordination problem. Each developer and clique of developers has their own priorities and potential agenda for what to build and deploy. It cannot be said that they’re all working towards one specific area. How many are working on the Lightning Network? Or on transaction malleability (which is still not “fixed”)? How many are working on these CVE?
On page 254 they discuss Paul Baran’s paper “On Distributed Communications Networks,” the image of which has been used over the years and I actually used for my paper last month.
On page 255 the fourth usage of “virtual currency” appears regarding once more, FinCEN director Jennifer Shasky. Followed by page 256 with another use of “virtual currency.” On page 257 Benjamin Lawsky was quoted using “virtual currency.” Page 259 the term “virtual currency” appears when the European Banking Authority is quoted. Page 260 and 261 sees “virtual currency” being used in relation with NYDFS and Lawsky once more. On page 264 another use of “virtual currency” is used and this time in relation with Canadian regulations from June 2014.
On page 265 they mention “After the People’s Bank of China’s antibitcoin directives…”
I am not sure the directives were necessarily anti-bitcoin per se. Rather they prohibited financial institutions like banks and payment processors from directly handling cryptocurrencies such as bitcoins. The regulatory framework is still quite nebulous but again, going back to “excessive” in the introduction above, it is unclear why this is deemed “anti-bitcoin” when mining and trading activity is still allowed to take place. Inconsistent and unhelpful, yes. Anti? Maybe, maybe not.
Also on page 265 they mention Temasek Holdings, a sovereign wealth fund in Singapore that allegedly has bitcoins in its portfolio. When I was visiting there, I spoke with a managing director from Temasek two weeks ago and he said they are not invested in any Bitcoin companies and the lunchroom experiment with bitcoins has ended.
On page 268 the authors discuss “wallets” once more this time in relation with Mt.Gox: “All the bitcoins were controlled by the exchange in its own wallets” and “Reuters reported that only Karpeles knew the passwords to the Mt. Gox wallets and that he refused a 2012 request from employees to expand access in the event that he became incapacitated.”
On page 275 the authors use a good nonce, “übercentralization.”
On page 277 they write, “While no self-respecting bitcoiner would ever describe Google or Facebook as decentralized institutions, not with their corporate-controlled servers and vast databases of customers’ personal information, these giant Internet firms of our day got there by encouraging peer-to-peer and middleman-free activities.”
In the notes on the margin I wrote “huh?” And I am still confused because each of these companies attempts to build a moat around their property. Google has tried 47 different ways to create a social network even going so far as to cutting off its nose (Google Reader, RIP) to spite its face all with the goal of keeping traffic, clicks and eyeballs on platforms it owns. And this is understandable. Similarly Coinbase and other “universal hosted wallets” are also trying to build a walled garden of apps with the aim of stickiness — finding something that will keep users on their platform.
On page 277 they also wrote that, “Perhaps these trends can continue to coexist if the decentralizing movements remains limited to areas of the economy that don’t bleed into the larger sectors that Big Business dominates.”
What about Big Bitcoin? The joke is that there are 300,027 advocacy groups in Bitcoinland: 300,000 privkey holders who invested in bitcoin and 27 actual organizations that actively promote Bitcoin. There is probably only one quasi self-regulating organization (SRO), DATA. And the advocacy groups are well funded by VC-backed companies and investors, just look at CoinCenter’s rolodex.
On page 280 they write, “Embracing a cryptoccurency-like view of finance, it has started an investment program that allows people invest directly in the company, buying notes backed by specific hard assets, such as individual stores, trucks, even mattress pads. No investment bank is involved, no intermediary. Investors are simply lending U-Haul money, peer-to-peer, and in return getting a promissory note with fixed interested payments, underwritten by the company’s assets.”
This sounds a lot like a security as defined by the Howey test. Again, before participating in such an activity be sure to talk with a legal professional.9
On page 281 they use the term “virtual currencies” for the 11th time, this time in reference to MasterCard’s lobbying efforts in DC for Congress.
On page 283 a small typo, “But here’s the rub: because they are tapped” — (should be trapped).
On page 283 they write, “By comparison, bitcoin processors such as BitPay, Coinbase, and GoCoin say they’ve been profitable more or less from day one, given their low overheads and the comparatively tiny fees charged by miners on the blockchain.”
This is probably false. I would challenge this view, and that none of them are currently breaking even on merchant processing fees alone.
In fact, they likely have the same user acquisition costs and compliance costs as all payment processors do.
For instance, in October 2014, Brian Armstrong and Fred Ehrsam, co-founders of Coinbase, did a reddit AMA. At the 21:12 minute mark (video):
Q: Is Coinbase profitable or not, if not, when?
A: It’s happened to be profitable at times, at the moment it’s not; we’re not burning too much cash. I think that the basic idea here is to grow and by us growing we help the entire ecosystem grow — without dying. So not at the moment but not far.
It’s pretty clear from BitPay’s numbers that unless they’ve been operating a high volume exchange, they are likely unprofitable.
Why? Because, in part of the high burn rate. What does this mean?
Last week Moe Levin, former Director of European Business Development at BitPay, was interviewed by deBitcoin, below is one detailed exchange starting at 1:57m:
Q: There was a lot of stories in the press about BitPay laying off people, can you comment on that?
A: Yea, what happened was we had a high burn rate and the company necessarily needed to scale back a little bit on how many people we hired, how many people we had on board, how much we sponsored things. I mean things were getting a little bit out of hand with sponsorships, football games and expansion — more care needed to be put on how and where we spent the money.
Q: Can you elaborate on the burn rate? Tim Swanson wrote a piece on BitPay in April, published this piece about the economy, the BitPay economy. Posted this piece on the burn rate and actual figures, have you read that piece? Can you comment on that?
A: Yes, it is especially hard for a company to build traction when they start off. Any start up is difficult to build traction. It’s doubly hard, the hardness is amplified when a company enters a market with competitors that have near unlimited resources because the other companies can either blow you out of the water or have better marketing strategies or they can do a ton of different things to make your startup more irrelevant. Standard in any company but it is doubly difficult when you enter a market like that. In the payments industry, forget about Bitcoin for a second, in the payments industry and the mobile commerce, ecommerce, company-to-company payments industry there are massive players with investments and venture backed companies in the billions. Competing at that stage is tricky and it necessarily requires a burn rate that is much higher than the average startup because of how you need to compete in this space. What is also important is that the regulation costs a lot of money for the startups in the Bitcoin economy. It’s the perfect storm of how a startup will be hit with a ton of expenses early on and that can hurt the growth of a company. Even though a lot of the money that went into it was growth capital it takes a while to get the balance right between spending and growing.
On page 284 they write, “That leads us to one important question: What happens to banks as credit providers if that age arrives? Any threat to this role could be a negotiating chip for banks in their marketing battle with the new technology.”
This is a good question and it dovetails with the “Fedcoin” discussion over the past 6 months.10
On page 285 they write, “With paper money they can purchase arms, launch wars, raise debt to finance those conflicts, and then demand tax payments in that same currency to repay those debts.”
This is a common misconception, one involving lots of passionate Youtube videos, that before central banks were established or fiat currencies were issued, that there was no war or “less war.” On page 309 they quote Roger Ver at a Bitcoin conference saying, “they’ll no longer be able to fund these giant war machines that are killing people around the world. So I see bitcoin as a lever that I can use to move the world in a more peaceful direction.”
Cryptocurrencies such as Bitcoin will not end wars for the same reason that precious metals did not prevent wars: the privkey has no control over the “wet code” on the edges. Wars have occurred since time immemorial due to conflicts between humans and will likely continue to occur into the future (I am sure this statement will be misconstrued on reddit to say that I am in support of genocide and war).
On page 286 they write, “Gil Luria, an analyst at Wedbush Securities who has done some of the most in-depth analysis of cryptocurrency’s potential, argues that 21 percent of U.S. GDP is based in “trust” industries, those that perform middlemen tasks that blockchain can digitize and automate.”
In looking at the endnote citation (pdf) it is clear that Luria and his team is incorrect in just about all of the analysis that month as they rely on unfounded assumptions to both adoption and the price of bitcoin. That’s not to say some type of black swan events cannot or will not occur, but probably not for the reasons laid out by the Wedbush team. The metrics and probabilities are entirely arbitrary.
For instance, the Wedbush analysts state, “Our conversation with bitcoin traders (and Wall Street traders trading bitcoin lead us to believe they see opportunity in a market that has frequent disruptive news flow and large movements that reflect that news flow.”
Who are these traders? Are they disinterested and objective parties?
For instance, a year ago (in February 2014), Founders Gridasked 50 Bitcoin “experts” what their bitcoin price predictions were over the next year. The end result — all but a couple were completely, very wrong (see this spreadsheet for a line-by-line itemization). Later, in May 2014, CoinTelegraph asked (video) more than 30 Bitcoin “experts” as to what their bitcoin predictions were for the end of 2014. Once again, all but a couple were completely, very wrong.
Or in short, no one has a very good track record of predicting either prices or adoption. Thus it is unclear from their statements why a cryptocurrency such as Bitcoin will automatically begin performing the tasks that comprise 21% of US economic output based on “trust.”
On page 288 they write, “So expect a backlash once banks start shutting back-office administrative centers in midtown Manhattan or London’s Canary Wharf when their merchant customers start booking more customer sales via cryptocurrency systems to avoid the 3 percent transaction fees.”
I think there is a lot of conflation here. For starters, back-offices could be reformed with the integration of distributed ledgers, but probably not cryptocurrency systems (why would a trusted network need proof-of-work?). Secondly, the empirical data thus far suggests that it doesn’t matter how many merchants adopt cryptocurrencies as payments, what matters is consumer adoption — and thus far the former out paces the latter by several an enormous margin. Third, that 3% is broken down and paid to a variety of other participants not just Visa or MasterCard. Fourth, the US economy (like that of Europe and many other regions) is consumer driven — supply does not necessarily create its own demand.
There is one more point, but first the authors quote Chris Dixon from Andreessen Horowitz, “On the one hand you have the bank person who loses their job, and everyone feels bad about that person, and on the other hand, everyone else saves three percent, which economically can have a huge impact because it means small businesses widen their profit margins.”
There are two reasons for why it could be temporarily cheaper to use Coinbase:
1) VC funding and exchange activity subsidizes the “loss-leader” of payment processing;
2) because Coinbase outsources the actual transaction verification to a third party (miners), they are dependent on fees to miners staying low or non-existent. At some point the fees will have to increase and those fees will then either need to be absorbed by Coinbase or passed on to customers.
On page 290 they quote Larry Summers, “So it seems to me that the people who confidently reject all the innovation here [in blockchain-based payment and monetary systems] are on the wrong side of history.”
Who are these people? Even Jeffrey Robinson finds parts of the overall tech of interest. I see this claim often on social media but it seems like a strawman. Skepticism about extraordinary claims that lack extraordinary proof does not seem unwarranted or unjustified.
On page 292 they write, “But, to borrow an idea from an editor of ours, such utopian projects often end up like Ultimate Frisbee competitions, which by design have no referees — only “observers” who arbitrate calls — and where disputes over rule violations often devolve into shouting matches that are won by whichever player yells the loudest, takes the most uncompromising stance, and persuades the observer.”
This is the exact description of how Bitcoin development works via reddit, Twitter, Bitcoin Talk, the Bitcoin Dev mailing list, IRC and so forth. This is not a rational way to build a financial product. Increasing block sizes that impact a multi-billion dollar asset class should not be determined by how many Likes you get on Facebook or how often you get to sit on panels at conferences.
Final chapter (conclusion):
On page 292 they write, “Nobody’s fully studied how much business merchants are doing with bitcoin and cryptocurrencies, but actual and anecdotal reports tend to peg it at a low number, about 1 percent of total sales for the few that accept them.”
My one quibble is that they as journalists were in a position to ask payment processors for these numbers.
Fortunately we have a transparent, public record that serves as Plan B: reused addresses on the Bitcoin blockchain.
As describedin detail a couple weeks ago, the chart above is a log scale measuring the amount of bitcoins that both BitPay (in green) and Evolution (in red) received starting January 16, 2014. The drop off at the end in March 2015 is related to the exit scam that Evolution underwent (and the drop off for BitPay is related to a limitation in WalletExplorer’s data).
As we can see here, based on the clusters labeled by WalletExplorer, on any given day BitPay processes about 1,200 bitcoins (the actual number is probably about 10% higher).
The chart above are self-reported transaction numbers from Coinbase. While it is unclear what each transaction can or do represent, in aggregate it appears to be relatively flat over the past year.11 Perhaps that will change in the future.
On page 295 they write, “Volatility in bitcoin’s price will also eventually decline as more traders enter the market and exchanges become more sophisticated.”
As Christopher Hitchens once remarked, that which can be asserted without evidence, can be dismissed without evidence. Those making a positive claim (that volatility will decline) are the party that needs to prove this and they do not in this book. Perhaps volatility will somehow disappear, but not for the non-technical reasons they describe.
At the bottom of page 295 they write, “Even so, we will go out on a limb here and argue that encryption-based, decentralized digital currencies do have a future.”
Again, there is no encryption in cryptocurrencies, only cryptographic primitives. Also, as described in the introductory notes above, virtual currencies are not synonymous with digital currencies.
Also on page 295 they write, “Far more important, it solves some big problems that are impossible to address within the underlying payment infrastructure.”
Yes, there are indeed problems with identity and fraud but it is unclear from this book what Bitcoin actually solves. No one double-spends on the Visa network. No one has, publicly, hacked the Visa Network (which has 42 firewalls and a moat). The vulnerabilities and hacks that take place are almost always at the edges, in retailers such as Home Depot and Target (which is unfortunately named). This is not to say that payment rails and access to them cannot be improved or made more accessible, but that case is not made in this book.
On page 296 they write, “Imagine how much wider the use of cyptocurrency would be if a major retailer such as Walmart switched to a blockchain-based payment network in order to cut tens of billions of dollars in transaction costs off the $350 billion it sends annually to tens of thousands of suppliers worldwide.”
Again this is conflating several things. Walmart does not need a proof-of-work blockchain when it sends value to trusted third parties. All the participants are doxxed and KCY’ed. Nor does it need to convert fiat -> into a cryptocurrency -> into fiat to pay retailers. Instead, Walmart in theory, could use some type of distributed ledger system like SKUChain to track the provenance of items, but again, proof-of-work used by Bitcoin are unneeded for this utility because parties are known.
Also, while the authors recognize that bitcoins currently represent a small fraction of payments processed by most retailers, one of the reasons for why they may not have seen a dramatic improvement in their bottom line because people — as shown with the Wence Casares citation above (assuming the 96% figure is accurate) — do not typically purchase bitcoins in order to spend them but rather invest and permanently hold them. Perhaps that may change in the future.
On page 297 they write, “But now bitcoin offers an alternative, one that is significantly more useful than gold.”
That’s an unfounded claim. The two have different sets of utility and different trade-offs We know precious metals have some use-value beyond ornamentation, what are the industrial usages of bitcoin? In terms of security vulnerabilities there are trade-offs of owning either one. While gold can be confiscated and stolen, to some degree the same challenge holds true with cryptocurrencies due to its bearer nature (over a million bitcoins have been lost, stolen, seized and destroyed).12 One advantage that bitcoin seems to have is cheaper transportation costs but that is largely dependent on subsidized transaction fees (through block rewards) and the lack of incentives to attack high-value transactions thus far.
On page 300 they write, “As you’ll know from having read this book, a bitcoin-dominant world would have far more sweeping implications: for one, both banks and governments would have less power.”
That was not proven in this book. In fact, the typical scenarios involved the success of trusted third parties like Coinbase and Xapo, which are banks by any other name. And it is unclear why governments would have less power. Maybe they will but that was not fleshed out.
On page 301 they write, “In that case, cryptocurrency protocols and blockchain-based systems for confirming transactions would replace the cumbersome payment system that’s currently run by banks, credit-card companies, payment processors and foreign-exchange traders.”
The authors use the word cumbersome too liberally. To a consumer and even a merchant, the average swipeable (nonce!) credit card and debit card transaction is abstracted away and invisible. In place of these institutions reviled by the authors are, in practice, the very same entities: banks (Coinbase, Xapo), credit-card companies (Snapcard, Freshpay), payment processors (BitPay, GoCoin) and foreign-exchange traders (a hundred different cryptocurrency exchanges). Perhaps this will change in the future or maybe not.
On page 305 they write about a “Digital dollar.” Stating, “Central banks could, for example, set negative interest rates on bank deposits, since savers would no longer be able to flee into cash and avoid the penalty.”
This is an interesting thought experiment, one raised by Miles Kimball several months ago and one that intersects with what Richard Brown and Robert Sams have discussed in relation to a Fedcoin.
On page 306 they write about currency reserves, “we doubt officials in Paris or Beijing are conceiving of such things right now, but if cryptocurrency technology lives up to its potential, they may have to think about it.”
This is wishful thinking at best. As described in Chapter 13, most proponents of a “Bitcoin reserve currency” are missing some fundamental understanding of what a reserve currency is or how a currency becomes one.
Because there is an enormous amount of confusion in the Bitcoin community as to what reserve currencies are and how they are used, it is recommended that readers peruse what Patrick Chovanec wrote several years ago – perhaps the most concise explanation – as it relates to China (RMB), the United Kingdom (the pound) and the United States (the dollar):
There are four main factors that set the Pound and the Dollar apart as viable and attractive reserve currencies. Each was necessary. They were liquid. They were available. And they were perceived as safe. I’m going to run through each of these conditions in turn. I will consider how they applied to the Pound and the Dollar, and to what extent they are satisfied by China’s Renminbi.
(1) Necessity. The fundamental purpose of a reserve currency is to settle external obligations. The greater quantity and variety of obligations a particular currency can settle, the more useful it is as a reserve currency. The currency of a country that produces little of note and lacks funds to lend or invest is not nearly as useful as one whose home economy produces many goods and services desired around the world, serves as an important source of capital, and has many commercial partners who also find its currency relevant to meeting their own obligations. This idea — that the dominant reserve currency derives its status from its connection with the dominant national economy in an interconnected world – is what underlies Roubini’s reasoning that the Renminbi may be next in line to replace the Dollar.
But this conclusion misses something important. A reserve currency must not only be capable of settling obligations in connection with a heavy-weight economy. It must be required to. Because if you can settle those obligations, as sizeable and important as they may be, using your own currency — or the currency of another leading economy — there is no reason to hold that country’s currency as a reserve. That is precisely the case today with China.
It is unclear how or why some Bitcoin advocates can suggest that bitcoins will ever be used as a reserve currency when there is no demand for the currency to meet external trading obligations let alone in the magnitude that these other currencies do (RMB, USD, GBP).
On page 307 they write:
Under this imagined Bretton Woods II, perhaps the IMF would create its own cryptocurrency, with nodes for managing the blockchain situated in proportionate numbers within all the member countries, where none could ever have veto power, to avoid a state-run 51 percent attack.
Proof-of-work mining on a trusted network is entirely unnecessary yet this type of scenario is propagated by a number of people in the Bitcoin space including Adam Ludwin (CEO of Chain.com) and Antonis Polemitis (investor at Ledra Capital). Two months ago on a panel at the Stanford Blockchain event, Ludwin predicted that in the future governments would subsidize mining. Again, the sole purpose of mining on a proof-of-work blockchain is because the actors cannot trust one another. Yet on a government-run network, there are no unverified actors (Polemitis has proposed a similar proof-of-work solution for Fedcoin).
Again, there is no reason for the Fed, or any bank for that matter, to use a Bitcoin-like system because all parties are known. Proof-of-work is only useful and necessary when actors are unknown and untrusted. The incentive and cost structure for maintaining a proof-of-work network is entirely unnecessary for financial services institutions. Furthermore, maintaining anonymous validators while simultaneously requiring KYC/AML on end users is a bit nonsensical (which is what the Bitcoin community has done actually). Not only do you have the cost structures of both worlds but you have none of the benefits. If validators are known, then they can be held legally responsible for say, double spending or censoring transactions.
Robert Sams recently noted the absurdity of this hydra, why permissionless systems are a poor method for managing off-chain assets:
The financial system and its regulators go to great lengths to ensure that something called settlement finality takes place. There is a point in time in which a trade brings about the transfer of ownership–definitively. At some point settlement instructions are irrevocable and transactions are irreversible. This is a core design principle of the financial system because ambiguity about settlement finality is a systemic risk. Imagine if the line items of financial institution’s balance sheet were only probabilistic. You own … of … with 97.5% probability. That is, effectively, what a proof-of-work based distributed ledger gives you. Except that you don’t know what the probabilities are because the attack vectors are based not on provable results from computers science but economic models. Do you want to build a settlement system on that edifice?
Though as shown by the NASDAQ annoucement, this will likely not stop people from trial by fire.
Bertha Benz, wife of Karl Benz, is perhaps best known for her August 1886 jaunt through present day Baden-Württemberg in which she became the first person to travel “cross-country” in an automobile — a distance of 106 kilometers.
It is unclear what will become of Bitcoin or cryptocurrencies, but if the enthusiasm of the 19th century German countryside echoed similar excitement as reddit sock puppets do about magic internet money, they must have been very disappointed by the long adoption process for horseless carriages to overtake horses as the primary mode of transportation. For instance, despite depictions of a widely motorized Wehrmacht, during World War II the Teutonic Heer army depended largely on horses to move its divisions across the battlefields of Europe: 80% of its entire transportation was equestrian. Or maybe as the popular narrative states: cryptocurrencies are like social networks and one or two will be adopted quickly, by everyone.
So is this book the equivalent to a premature The Age of Automobile? Or The New Age of Trusted Third Parties?
Its strength is in simplicity and concision. Yet it sacrifices some technical accuracy to achieve this. While it may appear that I hated the book or that each page was riddled with errors, it bears mentioning that there were many things they did a good job with in a fast-moving fluid industry. They probably got more right than wrong and if someone is wholly unfamiliar with the topic this book would probably serve as a decent primer.
Furthermore, a number of the incredulous comments that are discussed above relate more towards the people they interviewed than the authors themselves and you cannot really blame them if the interviewees are speaking on topics they are not experts on (such as volatility). It is also worth pointing out that this book appears to have been completed around sometime last August and the space has evolved a bit since then and of which we have the benefit of hindsight to utilize.
You cannot please everyone
For me, I would have preferred more data. VC funding is not necessarily a good metric for productive working capital (see the Cleantech boom and bust). Furthermore, VCs can and often are wrong on their bets (hence the reason not all of them outperform the market).13 Notable venture-backed flops: Fab, Clinkle, DigiCash, Pets.com and Beenz. I think we all miss the heady days of Cracked.com.
Only two charts related to Bitcoin were used: 1) historical prices, 2) historical network hashrate. In terms of balance, they only cited one actual “skeptic” and that was Mark Williams’ testimony — not from him personally. For comparison, it had a different look and feel than Robinson’s “BitCon” (here’s my mini review).
Both Michael and Paul were gracious to sign my book and answer my questions at Google and I think they genuinely mean well with their investigatory endeavor. Furthermore, the decentralized/distributed ledger tent is big enough for a wide-array of views and disagreement. While I am unaware of any future editions, I look forward to reading their articles that tackle some of the challenges I proposed above. Or as is often unironically stated on reddit: you just strengthened (sic) my argument.
Note: I contacted Rulli who mentioned that the project has been ongoing for about 10 years — they have been distributing value since 2005 and adopted bitcoin due to what he calls a “better payment solution.” They have 500,000 registered users and all compete for the same pot of bitcoins each month. [↩]
Additional calculations from Dave Hudson:
– Current Bitcoin network capacity: approximately 320 PH/s (320 x 10^15)
– Best case power efficiency (shipping today): approximately 0.5 J/GH (0.5 x 10^-9 J/H)
Likely power efficiency: approximately 1.0 J/GH (1 x 10^-9 J/H) = 2 x best case
– Best case power usage (sustained): 320 x 10^15 x 0.5 x 10^-9 = 160 x 10^6 W = 160 MW
Likely power efficiency: 160 x 2 = 320 MW
– Best case power usage per day: 160 x 24 = 3840 MWh = 3.84 GWh
Likely power usage per day: 320 x 24 = 7680 MWh = 7.68 GWh
– Best case power usage per year: 3.84 x 365 = 1401.6 GWh = 1.4 TWh
Likely power usage per year: 7.68 x 365 = 2803.2 GWh = 2.8 TWh
The best case example would represent the entire Bitcoin network using the best possible hardware and doesn’t account for any cooling or any other computers used in the Bitcoin network. As such it represents an impossible best version of a network of this size. The likely example is probably closer as there is older hardware still in use and most data centers need cooling of some sort.
The US Energy Information Administration estimated the US power generation capacity for 2012 at 1051 GW so the 320 MW number would represent 0.03% of the total electricity supply for the US. Assuming that we take the 320 MW figure then that would put Bitcoin at about 10% of Ireland’s electricity supply. [↩]
I am called any number of names on these threads and stylistically was equated with “Gish Gallop” and a “word soup” thesauri.
Hass McCook (“Bit_by_Bit”) weighs in at one point in the first thread saying that these claims are only valid in August 2014. McCook had similar sentiments as noted in Chapter 3. However, no word on the MV=MC issue that was brought up in that same chapter, it will always apply no matter what the efficiency of the mining equipment. This cost basis was also independently confirmed by a miner.
Today a friend pointed to a new post by Mircea Popescu which takes aim at me (not my book): “No, you don’t have something to say on the topic.” In it he claims I am a “boneheaded teenaged male approach to learning.” Not a word about the marginal costs of mining. In fact, he also claims that there is no data “per se” in the book which is curious since there is actually a lot of data in the book.
This is a common rejoinder; some vocal advocates not looking at actual data from the blockchain. In some ways their timeline looks like this:
2007: First lines of BTC code written
2008: Whitepaper revised and published
2009: Blockchain put into production
2009 – 2014: data created, but the only valid data is fiat prices, the rest is not real data “per se”
Aside from the ad hominem’s above what has been the criticism?
Peter Surda, a researcher, disagreed with my points on inelastic versus elastic money supply but didn’t go into many details in a short email exchange.
I received a number of encouraging emails from a variety of readers and was named one of thirteen “Big Thinkers” in this space, though I doubt some of the other candidates would like me to remain in company with them.
I have had some responses with a couple others, including L.M. Goodman (creator of Tezos), on Twitter this past weekend — though this is largely unrelated to the book itself.
What does this mean?
Partisanship may be impacting scholarship, especially the Myth of Satoshi variety.
No, Leah Goodman did not uncover who Satoshi was. But one thing was clear from that episode in February was that some partisans do not want the individual who created Bitcoin to be taken down from the pedestal they have put him on; they want their caricature to be immutable. Just like some historians have tried to revise history to make their heroes look impeachable, so to has the veneration of Satoshi. If Bram Cohen had anonymously released BitTorrent a decade ago, would BitTorrent have had a similar following due to its mysterious beginnings?
I hold no ill-will to the person or group that comprised Satoshi, but it is clear from the evidence cited in chapters 9 and 10 that he, she or they did not consult an actual economist or financial professional before they created their static rewards and asymptote money supply. This is a mistake that we see in full force today in which the quantity of money available has shrunk due to theft, scams, purposeful burning, accidental destruction, etc. Satoshi recreated a deflationary inelastic economy and much to the chagrin of the self-appointed purity police, it is not being used the way he expected it to (actual commerce) and is instead being used for things it is relatively useful for (e.g., donating to Wikileaks, gambling).
What other economic and environmental issues are still being ignored?
Jake Smith, creator of Coinsman recently published a new article on mining in China. Yet despite being, in his own words, a “true believer” and interviewing other “true believers” in the mining space, he missed the unseen calculation, the economics of extracting and securing rents on this ledger unit which consume scarce resources from the real economy. This is not something that it is unknown, there is an economic formula to explain it: MV=MC (as described copiously in Chapter 3). There is nothing magical or mysterious about mining as other people in the reddit thread point out how mining is currently an environmental albatross or as Fred Trotter dubs it, a “black hole.”
While it is unclear as to the motivations of some of the “true believers” are, they collectively did underestimate the costs of consumer protection and/or did not put it as a top priority for mass consumer adoption. But why would they? Consumer protection is usually expensive, its unglamorous and its centralized (which apparently is a “no-no”).
For example, generally speaking, most people do not like having their possessions stolen. And in the event something is stolen, in practice, individuals prefer to take out insurance and even sue those responsible for damage (torts). If instead of promoting and building illicit markets (like Dark Market and Dark Wallet), these same developers and early investors had funded a start-up that helped track down these stolen funds, or start a non-profit to help get stolen coins, it would have been an amazing public relations coup.
To be balanced, theft takes place across the spectrum of services. It also happens on the edges of Visa’s network. The difference is Visa offers insurance which is built into their cost structure (highly recommend reading Richard Brown’s recent post). Insurance alone is just another product and has nothing to do with the protocol. And this specific point (for the individual user) could be resolved sooner or later (e.g. Xapo already offers some home-made insurance). However, insurance does not change the economics behind Bitcoin, especially since lost coins are permanently and constantly removed from the money supply.
Then again, there is a built in incentive to allow this theft to occur — stolen coins need mixers and exits which could potentially benefit developers and investors of those services; and simultaneously as more coins drop out of circulation this increases the value for those holding the remaining supply.
In addition, a vocal group of these “true believers” do not think Bitcoin has an image problem. Yet it has a massive PR problem, for similar (albeit smaller) reasons that Tylenol had in 1982: customers and their families do not like getting burnt. The only group I am aware of that tried to immediately help the victims of the Mt. Gox debacle was Goxcoin (here’s the LTB interview of it). In contrast, thread after thread on reddit was filled with bullies saying “no big deal.” It is a big deal to normal people with real responsibilities beyond downvoting skeptics on reddit and pumping stories about Bitcoin curing cancer and ending wars. And Mt. Gox liabilities won’t be resolved for at least another year. Instead of cyber bullying merchants into adopting bitcoin payments, these same hectors could have created a company catering towards recovering stolen property (e.g., loss recovery specialists). It was a lost opportunity.
In contrast, Blockchain.info has a mixing service called SharedCoin based off the CoinJoin feature from Greg Maxwell. Blockchain.info recently crossed the 2 million ‘My Wallet’ mark but as I noted in Chapter 4, the vast majority of these likely go unused. This past spring, one of their representatives claimed that they receive about 15 million visitors a day, but what this actually is, is largely API traffic (external websites pulling charts from their site). They probably do not have close to 2 million users let alone 15 million visitors.
How few? We have an idea based on their own internal numbers, MyWallet transactions is flat over the past 12 months. If there were 2 million or 15 million users, we would probably see a gigantic uptick in usage elsewhere on the blockchain (e.g., TVO would skyrocket, tx fees to miners would skyrocket, etc.).
What this all means is that, while they do not release actual user numbers, that at least a minority of wallets are probably ‘burner wallets,’ dumped immediately by individuals wanting to mix coins. This is great for those who need to mix coins but not so great for consumers who just had their coins stolen. How to resolve this going forward?
Incidentally in May, Roger Ver (an angel investor including in Blockchain.info) was extorted by a hacker who had figured out a vulnerability in Ver’s security. Ver put a 37.6 bitcoin bounty on the hacker and the hacker eventually backed down; Wired and CoinDesk each did an article on it. Yet during the same month, coins were stolen from others and when the users came to reddit for help, they were ridiculed for not having done the 27 steps to make a paper wallet. No Wired article was written for them and in turn — speculatively — their coins could have been mixed on a site like Blockchain.info. As a result, why would normal consumers ever want to use Bitcoin after that experience?
Perhaps user behavior and therefore the data will change in the future. Consequently blockchains in general will probably find other niches beyond what Bitcoin is being shoehorned to do today. This includes, other chains and platforms that may be able to help firms like Wageni Tech accomplish its goals in Kenya by helping farmers move, manage and track produce to market in an attempt to bypass middlemen and introduce transparency. Bitcoin may be able to do that one day, but maybe not at the current $40 per transaction cost structure. Start-ups such as Pebble, Hyperledger, Tezos, Tendermint, Dogethereum (Eris), Salpas, SKUChain, Stellar and several other funded projects in stealth mode may be able to as well (remember, Google was the 15th search engine and the iPod was at least the 9th MP3 player).
This is not to say that “Bitcoin” has collapsed or will collapse, nor is this to single out Ver (he has done a lot to try and create value in this space and even donated 1,000 bitcoins to FEE last year). Instead it may continue to evolve into is something called Bitcoin-in-name-only, (or BINO as I refer to it in chapter 16) and it probably will continue to be used for what most risk-tolerant consumers use it for today: as a speculative commodity and as a way to pay for things that credit cards cannot be used for.
I have a new article up over at Let’s Talk Bitcoin which attempts to answer that question.
The feedback I have received so far (including the comments at LTB) makes it pretty clear that many adopters simply do not understand how, in general, economics or finance works or how developing countries struggle with credit expansion. And that is fine, but can be disastrous when making what amounts to investment decisions. Again, a vocal minority (majority?) of these adopters think they will be lounging on yachts and private islands because the price of bitcoin reaches $1 million.
And that likely will never play out for a variety of reasons that I have described in numerous articles.
Below is a list of pieces and papers that I have published covering these issues over the past three months in chronological order:
Bitcoin Hurdles: the Public Goods Costs of Securing a Decentralized Seigniorage Network which Incentivizes Alternatives and Centralization (pdf)
Learning from Bitcoin’s past to improve its future (pdf)
How did the term Byzantine Generals Problem come to exist? Here’s an answer from the creators:
The Byzantine Generals Problem (with Marshall Pease and Robert Shostak) ACM Transactions on Programming Languages and Systems 4, 3 (July 1982), 382-401. PDF
I have long felt that, because it was posed as a cute problem about philosophers seated around a table, Dijkstra’s dining philosopher’s problem received much more attention than it deserves. (For example, it has probably received more attention in the theory community than the readers/writers problem, which illustrates the same principles and has much more practical importance.) I believed that the problem introduced in  was very important and deserved the attention of computer scientists. The popularity of the dining philosophers problem taught me that the best way to attract attention to a problem is to present it in terms of a story.
There is a problem in distributed computing that is sometimes called the Chinese Generals Problem, in which two generals have to come to a common agreement on whether to attack or retreat, but can communicate only by sending messengers who might never arrive. I stole the idea of the generals and posed the problem in terms of a group of generals, some of whom may be traitors, who have to reach a common decision. I wanted to assign the generals a nationality that would not offend any readers. At the time, Albania was a completely closed society, and I felt it unlikely that there would be any Albanians around to object, so the original title of this paper was The Albanian Generals Problem. Jack Goldberg was smart enough to realize that there were Albanians in the world outside Albania, and Albania might not always be a black hole, so he suggested that I find another name. The obviously more appropriate Byzantine generals then occurred to me.
The main reason for writing this paper was to assign the new name to the problem. But a new paper needed new results as well. I came up with a simpler way to describe the general 3n+1-processor algorithm. (Shostak’s 4-processor algorithm was subtle but easy to understand; Pease’s generalization was a remarkable tour de force.) We also added a generalization to networks that were not completely connected. (I don’t remember whose work that was.) I also added some discussion of practical implementation details.