18 Months of Token Presales: A Review

[Note: This was originally published on January 6, 2015 at Melotic.com and is not an endorsement nor should it be construed as investment advice. Conduct thorough due diligence.]

Below are a bakers dozen projects undertaken in the past 18 months that used some form of crowdsale (ICO, ITO):

  • Mastercoin raised 4,740 BTC in August 2013
  • NXT raised 21 BTC in November 2013
  • Maidsafe raised 7,368 BTC and “95,000 MSC” / BitAngels ‘loan’ in April 2014
  • Swarm raised 1,252 BTC in June 2014
  • Bitshares AGS raised 5,621 BTC and 415k Protoshares in July 2014
  • Viacoin raised 610 BTC in July 2014
  • Ethereum raised 31,529 BTC in August 2014
  • StorJ raised 910 BTC in August 2014
  • SuperNET raised 1,201 BTC and “4,536 BTC equivalent” in Sept 2014
  • Peertracks (Bitshares music) raised ~1,436 BTC in November 2014
  • Bitbay raised 5,000 BTC in November 2014
  • Ziftr raised around “2,000” BTC (more than $650k) in Dec 2014
  • Gems raised 2,600 BTC in Dec 2014

The noticeable trend is that despite claims of their upcoming demise, neither appcoins nor altcoins stopped being created. Perhaps this will change in the future, but portions of the cryptocurrency community as a whole seems to want to continue to try and fund projects in this way.


Developing new features costs man-hours and even with a highly skilled team, it can be cost prohibitive. For instance, last October, Blockstream raised $21 million from 40 investors to create new extensibility to Bitcoin’s blockchain through a two-way peg called “sidechains.”

On the face of it would seem as if this type of infrastructure (reusing a tested system like Bitcoin’s blockchain) would incentivize altcoin developers to move or start their project on one of these chains. But from a funding perspective, it may be cost prohibitive in that development teams need to be paid and historically have found pre-sales, pre-mining and pre-allocations – such as those above – as a way to fund continued development.

How to compete with that?

For example, according to Coinmarketcap there are currently 10 “coins” that have a ‘marketcap’ larger than $10 million (recall that Jonathan Levin’s definition of a ‘narrow money stock’ is probably more appropriate). While some coins are more liquid than others, it is unlikely that an entity like Blockstream could provide a similar amount of funding for those projects (perhaps they or others will set up a fund for this at a later date to do that).

Either way, the merits of sidechains (there are multiple proposals, of which Blockstream’s is the farthest along) is a topic for another time.

What about other methods of distribution such as “proof of burn”?

  • Counterparty “burned” 2,130 BTC in January 2014 which effectively removed 0.01% of the monetary base.
  • Dogeparty “burned” 1.85 billion dogecoin during 28 days in August/September 2014. Roughly equivalent to 2.01% of the monetary base at that time.

What about airdrops and giveaways?

  • XRP (from Ripple Labs) was distributed through the Computing For Good project where a user could earn points for contributing to the World Computing Grid. Because XRP were pre-allocated, this allows for a different distribution. It ended in May 2014 due to abuse by botnets. And over the course of the endeavor, roughly 0.002 XRP were awarded per WCG point.
  • Stellar initially gave away up to 6,000 stellar per verified Facebook account but was quickly abused via oDesk / Mechanical Turk (a large majority of accounts were generated via abuse). For instance, Everett Forth received 2 million on launch day.
  • Ribbit.me airdropped ~200 million RibbitRewards in December 2014 to 13,730 users.
  • Let’s Talk Bitcoin grandfathered in previous contributors (e.g., writers, show hosts) to receive LTBCoins. 51 million LTBCoins were handed out in its first distribution on June 27, 2014.

What does 2015 hold for these methods of fundraising and distribution? Perhaps they will indeed terminate as predicted, or perhaps market participants will use a different method of fundraising that has not been tried.

Send to Kindle

The Composition of Metacoins on the Bitcoin Network

[Note: This was originally published on December 24, 2014 at Melotic.com]

Earlier this year, on March 24, “Dexx” – a user on Bitcoin Talk – published a pie chart illustrating the composition of some metacoins.

Over the past six months we have kept in contact and he has updated the chart showing the progress and trend of multisig outputs.

Below is the original chart:

Uan23Z9There were 5,176 meta-coin transactions

  • There were 35,508,561 transactions in total
  • There were 9,819,223 unspent outputs

On July 29, 2014:

41vkzkhTaken at height 312999

  • There were already 46,948 meta-coin transactions
  • There were 43,442,280 transactions in total
  • There were 12,444,288 unspent outputs

On December 9, 2014:

mJ2qWVHTaken at height 333507

  • There were identifiable 152,699 meta-coin transactions
  • There were 53,527,466 transactions in total
  • There were 15,426,367 unspent outputs

This only includes the transactions Dexx was able to identify such as Proof of Existence, Open Assets, Coinspark, Block Sign and the use of OP_RETURN (note: there is still an active discussion between using 40 bytes and 80 bytes). Open Assets and Coinspark are a type of colored coin implementation and both Proof of Existence and Block Sign are a type of notary service (here is an album view).

Dexx originally used the term “multisig transactions” but later replaced it with “unspent outputs.”

Some other closing analysis from Dexx:

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

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

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

What does this look like on a day to day basis?

GjZA2rYOver the past several months – according to Blockscan – Counterparty transactions have sometimes accounted for roughly 3% of all traffic on the Bitcoin network.

In the future, observers and researchers may find that coin mixing (via Coinshuffle, Coinjoin, Darkwallet, etc.) as well as P2SH are comprising ever larger shares of the network as well.

Note: there is also continual discussion over the role and use of bare multisig as data carrier.

Happy Holidays!

Send to Kindle

Measuring Interest and Not User Adoption

[Note: This was originally published on October 20, 2014 at Melotic.com]

Earlier this month CoinDesk published their quarterly State of Bitcoin report.

One stat (on slide 6) that was used to purportedly illustrate growth in user adoption was the increase in the amount of wallets created. According to their figures, there was a 21% increase from June to September this year (5.4 million to 6.5 million respectively).

The problem is however, opening up a wallet or creating a wallet does not constitute growth or adoption, it may simply show interest. Remember: in order to use the Bitcoin network users have to use bitcoins – or more technically speaking, unspent transaction outputs (UTXOs). Wallet creation is a zero-cost economic activity, it is negligible to do so and is not an accurate metric for actually measuring adoption (the use of UTXOs). For a lengthier answer, be sure to read Chapter 4.

On this point, two weeks ago Brian Armstrong, co-founder of Coinbase expressed similar skepticism towards wallet creation numbers, stating: “signups is a poor metric for market share” and had one specific alternative “KYC’ed accounts linked to bank+identity.”

Yet there is a problem with this as well. Both my wife and I have KYC’ed accounts on Coinbase, though neither of us have ever used it (yet). Similarly, I have probably created a handful of wallets over the past year over at Blockchain.info to test out sending several satoshi and never re-used the address. In fact, it is considered ‘best practices’ for end users to not re-use the same address, this is one of the reasons why Electrum and other clients provide multiple addresses to send UTXOs to and from. Another explanation is that some pools switch to dynamic payout addresses which also increases number of new addresses. Thus it should be expected that the amount of “addresses used” or in this case, “wallets created” has increased (recall, there is no such thing as an actual “wallet,” this is just nomenclature to help users better grasp the abstraction that are UTXOs).

Thus, actual bitcoin users (and holders) are probably not a significant fraction of the 6.5 million “wallets” opened through September. That is to say, if a bitcoin user is defined as someone who controls the privkey to a UTXO, it may be the case that bitcoin holders number somewhere between 250,000 to 500,000 globally and has remained in this range for the past six months (see also Android wallet plateau in Chapter 8).

How to measure actual users?

This is an ongoing question, one that has spurred numerous answers. I have written about it at least twice in both books. Some valid metrics include the change in Total Output Volume, Bitcoin Day’s Destroyed and fees to miners. In addition, the Top 500 Richlist is another way to measure on-chain users.

According to their continuously updated Distribution by Address, as of block 320,000 approximately 99.08% of all UTXOs reside on 329,451 addresses. The remaining 0.92% of all satoshis reside on more than 46 million addresses largely in the form of spam, mining rewards, unclaimed tips, etc.

What does this mean?

In April I published a draft of a working paper which used data from block 295,000. At that time, I looked at this slightly differently, noting that 99.08% of used addresses contained less than 1 bitcoin. Andrew Poelstra (andytoshi) corrected this statement, noting that:

“[T]he claim that 99.08% of all addresses contain less than one Bitcoin is an extreme understatement. In fact it is impossible for more than 21 million distinct addresses to correspond to UTXOs containing 1 bitcoin, but there are 1048 addresses. So it will always be the case that at least (100 ‐ 10^ ‐ 38)% of addresses contain less than one bitcoin.”

So what did the actual distribution look like? And what has changed since April? At that time 99.14% of all UTXOs resided on 301,901 addresses. So in the past 5 months there has been a diffusion of less than 1% of those UTXOs to other addresses.

This does not mean there is no activity, or no velocity. Without a full traffic analysis we cannot determine where these UTXOs end up flowing to. Yet it is clear that there has not been a 21% growth in user base during this time frame, otherwise the distribution would have likely changed dramatically (recall that on-chain users cannot participate on the network without at least 5460 satoshi, or the ‘dust limit’ so those marginal holders should not technically be viewed as users).

Again, it is known that certain entities like Bitstamp and Coinbase are large bitcoin holders and they may have on-boarded a number of new users internally. And that some of the addresses containing large amounts of UTXOs likely belong to these types of companies. Yet if there was a 21% growth in the user base over the past 3 months (let alone the 5 month window above), there would likely be other ways to measure and observe this activity as described below.

How to measure adoption?

Due to its pseudonymous nature, one way of measuring adoption is not wallets or price (this largely reflects changes in speculative demand) but in transactional demand. To gauge this metric there are several datum from the blockchain that could be correlated:

In contrast, not a single metric on slide 6 of the CoinDesk report actually measures user adoption. Rather, they all are indicators of interest.

  • According to Google Trends, Bitcoin as a term has remained almost flat since this past spring. Perhaps this will change, but interest is not the same as adoption.
  • Hashrate is not an accurate measure of user growth or adoption as it measures hashrate not usage (and in fact, the amount of actual miners has likely decreased since the advent of ASICs).
  • Github repos may potentially be an accurate if these updates/requests were substantial changes, yet as I have explained elsewhere – most of the innovation has been outsourced to altchains which can afford experimentation (e.g., smaller community, less impact if it fails). Instead, changes to the core protocol are relatively slow and conservative (understandably). To quote Chapter 4:

Similarly, if a serious flaw and vulnerability was found in the core Bitcoin code base (bitcoind) which caused a cascade of hard forks that destroyed Bitcoin entirely, the github commit component would precisely measure the wrong thing, inputs, rather than an accurate attribute: healthy production code. In fact, that measure would spike, leading observers to believe that this collapse is good news for Bitcoin.

  • In terms of merchant adoption, while this has indeed increased, merchants are still dependent on a fixed slice of liquidity (roughly 10% of all mined coins are liquid in any given month). Furthermore, because there is no “circular flow of income,” the vast majority of coins are usually immediately converted back into fiat. Thus, again, merchant adoption should not be conflated with user adoption.
  • VC funding is an indicator of interest and changes in sentiment, but not necessarily growth or adoption (unless these VC deals are done in bitcoin, which some of them are, perhaps this will increase in time).
  • While ATMs will likely continue to be purchased, built and installed, it is unclear at this time if there will be non-marginal growth from these on/off ramps. ATM owners have overhead costs (amortizing machine costs, maintaining a physical presence and compliance), costs that may be added onto the end user and perhaps lowering the demand (due to price elasticities) in certain regions and corridors. These changes in demand could be viewable on-chain through the metrics above.
  • Lastly, “Merchant’s annual revenue” is misleading because that is unrelated to how much revenue they generate from digital currencies. Perhaps digital currencies will eventually impact the bottom line, but total revenue is not a reflection in user adoption of digital currencies.

While future posts may look into these slides more it is necessary to point out that these interest metrics above could turn into user adoption (depends on what the “bitcoin sales cycle” turns out to be).

Readers are also encouraged to look through Sarah Meiklejohn’s research on this topic entitled, A Fistful of Bitcoins: Characterizing Payments Among. Men with No Names. Combing through and correlating this type of data may also be a good research project for students this fall and winter.

Send to Kindle

Why Market Prices Do Not Double With a Block Reward Halving

[Note: This was originally published on October 15, 2014 at Melotic.com]

For a little background to this post, see my previous post on block reward halving and the scrypt alliance.

One of the common misconceptions within the virtual currency space stated by many advocates is that when a proof-of-work blockchain has a block halving, for some reason the market price is supposed to immediately double. Yet in practice, it rarely, if ever does on that date.

There are a couple reasons for why this is the case.

To be clear, when a block reward halving takes place, it is the future money supply – monetary stock creation rate – that divides in half. The current existing monetary supply does not divide by 50% (see Jonathan Levin’s explanation for defining bitcoin as narrow money stock).

Again, it is not as if the entire monetary stock divides in half overnight, it is just the block reward that does. If half of the money supply was destroyed or permanently lost, then ceteris paribus, it could have a non-negligible impact. For example, in late February and early March of this year, news related to Mt. Gox’s collapse suggested that up to 850,000 bitcoins may not exist.

That is to say that one potential outcome of Mt. Gox’s bankruptcy is that they were fraudulent operating, perhaps by running in an undeclared fractional reserve-like manner and some, many or all those coins simply did not exist. Consequently, market prices actually jumped for several days on this news, with speculators considering the possibility that the total money supply in circulation was smaller than what the market had previously factored in.

This is important, because if the demand of an asset remains the same while the supply is reduced, then ceteris paribus, the price of the asset could rise. The price may only change dramatically if previously unknown information becomes available but the halving does not fall into that category as it is known well in advance.

And as I briefly explored in my last post, perhaps altcoins and altchains are a type of substitute good. If this is the case, if the elasticity of demand for a good (a coin) changes due to the availability of a substitute good, then during this timeframe consumers (or speculators) may switch to other chains (technically this is called price elasticity of demand, or PED). There are several other determinants which readers may also be interested in.

If true, then perhaps during a block halving, what we may be observing is shifts of the demand curve as speculators move towards more profitable chains (since supply is fixed). And in the case of mining, the activity of mining itself is essentially taking out a “long” position on the coin itself. Or in other words, one distinct class of speculators in bitcoin, litecoin and dogecoin are the “long” positions of miners (e.g., to recoup the sunk costs and operating expenses, mining is essentially a market signal for “bullish” sentiment). Miners are a type of speculator and consequently this in turn intersects with the hash rate protection challenge discussed in an earlier post.

Theory and practice

In practice, no virtual asset – including bitcoin – has continually seen price doublings immediately after a block reward halving. In point of fact, in November 2012, bitcoin’s price did not double immediately after the halving (see Chapter 15 for more details).

This again is a challenge and an existential problem for all coins, including bitcoin. As Ray Dillinger aptly noted earlier in May regarding the survivability of altcoins:

It doesn’t halve its remaining coin supply more often than it can double its value. That’s kind of hard to predict, but at this point I think the double-value time for cryptourrency is up to about a year, maybe two. It’ll get longer until it catches up to double-value period for the rest of the economy, which is 7 to 15 years depending on the industry. This is important because whenever the block reward goes down, the hash rate goes down in the same proportion; and when the hash rate gets too low, the blockchain becomes vulnerable to an attack which can destroy its value completely. Expect any coin that mines out its coin supply too fast, to collapse. I think even Bitcoin is going to be too fast in the long run; there’ll come a point when its double-value time is slower than its block-reward halving time and alts will start sucking up the hashing power making bitcoin vulnerable to attacks.

Will bitcoin’s price double again two years from now during its next block reward halving? It is unknowable what the price will be in the interim but historically it seems unlikely this would happen on that specific date.

What is another consequence of having a fixed, inelastic supply?

Again, when supply is fixed and its creation rate known, the only way to reflect changes in demand is through price. In bitcoin’s case, Robert Sams explained several months ago on a panel that this is a problem:

I think the issue [of] should you have more elastic supply or not…really comes down to the fact that if you have a fixed supply of something, the only way that changes in demand can be expressed is through the change in price. And people have expectations of increased demand so that means those expectations, expectations of future demand get translated into present day prices. And the inelastic supply creates volatility in the exchange rate which kind of undermines the long term objective of something like cryptocurrency ever becoming a unit of account. And forever it will be a medium of exchange that’s parasitic on the unit of account function of national currencies. So I do think the issue does need to be addressed.

This topic is continuously debated and is an issue highlighted by Yanis Varoufakis, a political economist at the University of Texas and the University of Athens. According to Jeffrey Robinson’s new book, Varoufakis says that speculative demand for bitcoin far outstrips transactional demand:

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

While Varoufakis is discussing the circular flow of income, the last sentence in particular is germane to this conversation.

As described above, block rewards are fixed and known in advance. What is unknown in advance however is both the demand (from speculators) and in particular miners (the labor force).  If these assets have a fixed supply rate, the only way to reflect changes in demand is through price signals.

Correspondingly, speculative demand is at odds with transactional demand. Expectations of future demand (or lack thereof) in turn creates shocks and volatility which in turn disincentivizes transactional demand on all chains. There are proposed solutions to this, but those are for later posts and will likely require a new ledger altogether.

For additional perspective I contacted Jonathan Levin, co-founder of Coinometrics, and according to him:

In economics we have a concept called rational expectations where agents use all the available information to decide their actions in equilibrium. In this framework the halving in the block rewards would have been anticipated and factored into the price. You are right to emphasize that when doing a demand and supply analysis, it is not the coins produced on a daily basis that matter but rather the entire stock of bitcoins in circulation. In that way the price of bitcoin should not double for a halve in the hashrate, in fact the effect should be negligible. This is considering just transactional demand and total supply. With goods/commodities this is likely to hold true but in currencies or cryptocurrencies this may be different. There are issues of security and speculation.

Now if we consider that the market price is actually the price that the users wish to sustain in order to have sufficient network security (tenuous). Then we may make an argument that the price of bitcoin should double. People who are speculating that this will have real effect may be buying up coins which moves the price closer to that equilibrium.

In my mind, economics would predict the hashrate to halve as the reward halves. Essentially the argument would go if the price has not doubled the hashrate must fall.

While variables such as compliance/regulatory changes and the transition along the hashrate S-curve (CPU -> GPU -> FPGA -> ASIC) create wrinkles in this dynamic, thus far the empirical data matches the theory. And collectively this is why prices do not double on halving day.

Send to Kindle

The Collective Action Problem of Mining Fees

[Note: This was originally published on October 7, 2014 at Melotic.com]

Contrary to conventional wisdom, usage fees for many cryptocurrencies including Bitcoin, Litecoin and Dogecoin is voluntary. In fact, when Bitcoin was first released, there were no direct usage fees. The fee that users visibly see included within wallet software (such as BitcoinQT, Electrum, and Hive) is in fact, arbitrarily set by the wallet code and can – in most cases – manually be reduced to zero. That is to say, users can broadcast transactions (UTXOs) to the network for “free” and eventually a mining pool (assuming it the transaction amount is higher than the dust limit) will pick them up and include them into a block. In the meantime these transactions will float around in the mempool, sometimes for several hours waiting to be picked up and confirmed. In theory, the higher the fee a user includes, the faster it will likely be included into a block because mining pools have an incentive to package it.

Why can’t all users permanently “free ride” off of what effectively is a tragedy of the commons (Sybil protection via hashrate and access to the mempool)? There is another variable: blocks have limited space (currently set at 1 MB), are a scarce resource and thus by definition are not a public good. Fees enable users to effectively bid on this private good rationed by the labor force of miners (I describe this at length in Chapter 2). In the future, miners may actually begin to set fees themselves, as the core protocol development team is planning to “float” the fees at some point.

In practice today, “voluntary” fees (donations) represent about 0.3% of the wages a miner earns each day. How do network operators (miners) get paid then? Through block reward subsidies (inflation) which are awarded throughout the day. Nearly all hash-based proof-of-work coins use a similar method of payment in which a coinbase transaction is paid out at intervals – for Bitcoin it is roughly every 10 minutes, Litecoin every 2.5 minutes and Dogecoin every minute. As a reward for services rendered, a fixed amount of payment is sent to the miner who broadcasts the “correct” block first which is then added on top of the previous block of the longest chain (those who broadcast a different block after the fact are said to have worked on “orphaned” blocks).

In theory, based on section 6 of the original 2008 whitepaper, transaction fees are supposed to eventually replace this subsidy:

The incentive can also be funded with transaction fees. If the output value of a transaction is less than its input value, the difference is a transaction fee that is added to the incentive value of the block containing the transaction. Once a predetermined number of coins have entered circulation, the incentive can transition entirely to transaction fees and be completely inflation free.

A June 2014 paper published by Kerem Kaskaloglu attempts to illustrate the “ideal scenario” (shown below) of the seamless switch from block rewards (seigniorage subsidy) to transaction fees (donations).

bitcoin-blockreward-timelineAccording to the current narrative, a combination of increased transactional volume and higher mandatory (or perhaps marketed-based) fees will purportedly pay for the labor force to stick around in the coming years. Why is this important? Because the network currently operates almost entirely on subsidies and thus with each block reward halving, the labor force is essentially given notice that their wages have decreased 50% and many could leave for more profitable ventures. While this is not an immediate concern in October 2014 for a network like Bitcoin – which does not have a closely competing SHA-based chain to worry about attack from (yet) – other altchain designers need to be cognizant of the economic incentive model they are building before they launch a new coin.

Again this is an empirical matter, so it cannot be known a priori whether or not the transition from a subsidy to a fee will happen for Bitcoin or other coins. However what we do know is that based on the history of altcoins up to the date of this writing, an increase in fees is the exception rather than the rule. Very few altcoins have seen a markedly significant increase in usage fees over the life of their chain.

The two charts below illustrate this:

bitcoin-litecoin-transaction-feedogecoin-transaction-feesThe first chart shows the “voluntary” transaction fees from the previous 6 months for both Litecoin and Bitcoin. It is almost entirely flat which suggests a number of things including the fact that there probably has not been an increase in usage of either blockchain itself (other indices such as Bitcoin Days Destroyed and Total Volume Output would help narrow the amount of UTXOs on the move and to what extent). One exception is Counterparty, which on some days represents 3% of the Bitcoin network and whose assets may represent increasingly larger commercial transactions that are not fully measured yet.

The second chart shows the same time period but for Dogecoin. In this case, over the past 2 months there has been a steady increase in fees paid to the network, effectively doubling the spring and summer rates. At this time it is unclear why this is the case; almost all tipping is done off-chain in trusted third parties (so fees are usually not assessed) and the default fee for most Dogecoin clients are set at 1 dogecoin. We may learn later that it was due to the AuxPOW merge mine with Litecoin, asset issuance via Dogeparty, or perhaps this is a statistical outlier altogether.

Nevertheless, while it cannot be said for certain, it is unlikely that the voluntary fee mechanism will fully provide the type of income to incentivize the Bitcoin labor force to continue providing its services (hashing) because it is a collective action problem (Note: Robert Sams recently touched on this issue in a new article). After all, why would most or all users one day in the future collectively start to pay (potentially) several orders of magnitude more to have the same exact service (recall that the total network reward to miners for their services today ranges from $20 to $40 per transaction)? In practice the fees alone may not be enough.

While the jury is still out on the longevity of all altcoins, one argument is that some are substitute goods. If this is the case, when conditions change (such as an increase in fees) users may move over to what they perceive as a similar, cheaper service. Or in this case, a similar chain. What does a substitute good mean? One definition explains that:

This means a good’s demand is increased when the price of another good is increased. Conversely, the demand for a good is decreased when the price of another good is decreased.

Or in other words, if the fee for using the Bitcoin network increases and a user perceives that Litecoin, Dogecoin or another network is a substitute good, then they may switch over and use the other, cheaper network for their transactional needs. The increased demand of that network token then may in turn lead to higher market prices of that token. In theory this could lead to some kind of market equilibrium among chains, though in practice there are and likely will be other factors at play.

In summation, there are no real “fees” in Bitcoin as they are entirely voluntary and should probably be called “donations” (until miners require that a fee be included). These donations are entirely arbitrary and are probably not comparable to fees on other payment networks (such as Visa) which are mandatory and holistic (the interchange fee pays for all of Visa’s expenditures, no donations required). This is further described in Chapter 3 and the full costs of today’s subsidies are visibly illustrated in the Cost Per Transaction chart. For more information on interchange fees, Richard Brown recently wrote a highly recommended piece for readers.

The next post will discuss why token prices do not double for a token after a block reward halving.

Send to Kindle

The Scrypt Alliance

[Note: This was originally published on September 30, 2014 at Melotic.com]

Over the past couple years, several people have discussed one particular challenge that all hash-based proof-of-work coins face: block reward halving. In particular, the crescendo of commentary on this issue grew over the past 6 months because of the behavior observed on the Dogecoin network.

In a nutshell, each POW chain has limited trust funds by which it pays (subsidizes) miners to provide a unit of labor (hashing) which in turn protects the network from Sybil attacks. Each chain pays this subsidy – which is called a block reward – over different time schedules. Some chains, like Bitcoin and Litecoin empty the majority of their trust funds over the course of a decade (~81.25% is paid out in the first 10 years).

As a consequence, some observers such as Ray Dillinger (who will be discussed more in a later post) noted that unless the market value of a coin doubles in value by the time a next block reward halving occurs, then – ceteris paribus – half the labor force may leave because they are effectively taking a pay cut.

With Dogecoin this process is accelerated because its entire money supply (trust fund) is paid out to the labor force in the first year of existence. I originally wrote about this issue about 4 months ago (and further explored it in several chapters including 3 and 15); at the time of this writing 93.45% of its money supply has been awarded to the labor force.

As a result, over the past 9 months Dogecoin’s labor force has periodically left – roughly every two months which correlates with the block reward halving. Consequently, its hash rate – the chain’s primary defense mechanism – has decreased in tandem with the exodus of miners. This in turn leads to a vulnerability as it becomes increasingly less expensive to perform a 51%-type of attack on the network.

Are there solutions to this?

On September 11, 2014, the Dogecoin development team “flipped-on” merged mining (AuxPOW). This enabled Dogecoin to be mined alongside other scrypt-based coins such as Litecoin and potentially dozens of others. While it had been in the Dogecoin code for over a month, on that summer day, Litecoin mining farms and pools turned on support for this AuxPOW functionality.

litecoin-dogecoin-hashrateAnd as shown in the chart above, the result so far has been in line with expectations: the hash rate of Dogecoin has seen a tremendous boost – in the order of two magnitudes.

Consequently Jackson Palmer has dubbed this organizational phenomenon – for the conglomerate of coins merged with Litecoin – the “scrypt alliance.”

And while this has proven to be fairly successful this may not be sustainable in the long-run because Litecoin’s incentive structure is still contingent on block rewards.

Or as Jackson Palmer has noted, “Litecoin has essentially become the profitability layer that drives the security of Dogecoin’s network” – and other scrypt-based coins piggy backing on top of it.

Thus if the value of litecoin falls or fails to double in value, then theoretically the overall hashrate could decline once again and/or when the LTC block reward halves in Q3 of 2015.

The next post will discuss another proposed solution.

Send to Kindle

A Tale of Three Coins

[Note: This was originally published on September 25, 2014 at Melotic.com]

While much attention has been given to theoretical transactions per second (TPS) for various blockchains, in practice the transaction per minute (TPM) may be a more interesting measure of actual consumer behavior. For example, in the past week the average range for TPM has been:

  • Bitcoin: 38-48 TPM
  • Litecoin: 2-3 TPM
  • Dogecoin: 37-40 TPM
  • Source: SoChain

Yet, not all TPM is equal. For instance, while self-reported numbers from payment processors suggest that there is between $2 – $4 million in commercial transactions per day, the transaction volume also includes:

  • Mining rewards
  • Gambling, mixing (sending to burner wallets) and illicit activities
  • Trading on exchanges

Without a full traffic analysis, such as the kind performed by Meiklejohn last year, the percentages of each use-case are difficult to estimate though it is likely that neither Litecoin nor Dogecoin support the same volume of commerce as Bitcoin currently does. Similarly, off-chain transactions in the form of FOREX – the buying and selling of bitcoins and litecoins in bulk through liquidity providers such as Buttercoin and Vaurum – exists in a nebulous area; is FOREX really commerce like other value transactions (e.g., exchange of houses, cars, clothing, etc.)? This is a topic for future research.

In the meantime, what lessons can altcoin designers take away from this one data point?

For instance, why has Litecoin’s userbase remained relatively flat?

  • It has different community dynamics than Dogecoin and like all coins faces uphill institutional inertia of Bitcoin. That is to say, while other large Bitcoin-focused companies could – from a technical standpoint – integrate support for Litecoin or other alts, they choose not to due to a variety of factors (e.g., perception, branding, etc.).

Why has Dogecoin succeeded at getting this far?

  • If cryptocurrencies are a startup, traction channels are key. In his new book, Traction, Gabriel Weinberg described 19 different traction channels that startups can target for new user growth. In short, Dogecoin utilized new traction channels to market (e.g., guerilla marketing via a NASCAR sponsorship and Jamaican bobsled sponsorship) whereas the Bitcoin and Litecoin communities have largely saturated its traction segments (e.g. handful of social media channels).

Opportunities and challenges of relying on other chains

Earlier this year, starting in January, the Counterparty development team held a “proof-of-burn” period for 30 days. During this time, bitcoin holders could send bitcoins to a provably unspendable address, a terminal address which did not have a corresponding private key. In return, the user was sent a new coin called XCP which would enable the user to have access to the Counterparty network – so that they could issue new assets through the Counterparty system. 2,130 bitcoins were “burned” during this period which amounted for 0.01% of the monetary base of bitcoin at that time.

Nearly 8 months later, a new project attempted to do the same process: Dogeparty. Using a fork of Counterparty but placed on top of the Dogecoin network (instead of the Bitcoin) network, the Dogeparty team began its “proof of burn” phase on August 14. It lasted for 28 days and by the end of September 11, roughly 1.85 billion dogecoins were “burned.” This was roughly equivalent to 2.01% of Dogecoin’s monetary base at that time.

What does this look like visually?

dogecoin-hashrate-three-monthAbove is a chart that illustrates the transactional volume of the Dogecoin network. The two black vertical bars represent the begging and end of the “burn” phase for dogeparty.

One would think that moving 2% of the monetary base in a 28-day period would result in a more pronounced visual (e.g., a steep linear increase) but this again, shows the difficulty in fingerprinting and doing forensics on the blockchain: without a full traffic analysis it is difficult to distinguish mining rewards, gambling, mixing, commerce and coins being “burned.”

A final statistic that may be of interest to readers is that Counterparty transactions have grown significantly over the past 8 months and as of September 17, 2014 accounted for 3% of the Bitcoin transaction volume (XCP 2,499 versus BTC 79,784).

Send to Kindle

Why Are Altcoins Still Being Created?

[Note: This was originally published on September 18, 2014 at Melotic.com]

One of the common talking points in social media related to cryptocurrencies today is that there is an impending collapse of altcoins – that anything non-Bitcoin will be squeezed out of the marketplace soon. This is not the venue for that debate.

Instead however, one question that could be asked is, why are additional coins being added to the market in the first place?

There are at least four reasons for why this “extinction” of coins will probably not occur anytime soon and people will continue to create altcoins:

Scarce labor and lack of compensation for working on Bitcoin core. There is currently a public goods problem: because there is no overall patron to Bitcoin, therefore there is no one to pay for continued development of the code. Those that do contribute code do so as an act of charity. Over the past two years, some solutions have arisen to plug this hole: organizations (e.g., the Bitcoin Foundation) and companies (e.g., Bitpay) have begun hiring and paying developers to continue development on the code. In addition, a new project called, “Lighthouse” is attempting to allow users to create “smart contracts,” such as an assurance contract (e.g., crowdfunding), which interacts directly with the blockchain. It is hoped that programs like this will allow users to pay developers to continue working on projects like Bitcoin (though it can be used for any number of other time-locked-based projects). In the meantime, however, those with scare labor have an incentive to work on an altcoin that can pay them for their abilities.

Depreciating capital goods (ASICs) incentivize pointing towards other profitable chains after 4-6 month window. Mining equipment, or more technically, hashing equipment, has a limited profitable shelf life. Once this window closes the owner of the equipment can either sell it to a new buyer (e.g., move it from China to Russia) or point the equipment to another, profitable chain. There is then an incentive for farm and pool operators to create and develop new coins that can utilize their equipment. This cycle could run into a wall, once the top of the “S-curve” in fabrication limitations of chip manufacturing arrives (e.g., due to diminishing marginal returns the jump in performance from 28nm to 20nm is not as large as the jump from 130nm to 65nm).

Open source turnkey solutions (e.g., create a new coin instantly via a script) make it easier to tinker with blockchain attributes now more than ever. Building, breaking, learning and reiterating are the zeitgeist of digerati and altcoins allow this recursive derivation to take place quickly. How do faster block timings, like Geistgeld, impact orphan rates? Can a demurrage, like Freicoin, incentivize spending? Can privacy-focused zero knowledge proofs (e.g., Zerocoin, Zerocash, Darkcoin) be integrated into and scaled at a global level via distributed consensus? These questions are being tested out on a daily basis by a variety of coins, providing feedback to developers in a way that could not occur with Bitcoin due a number of factors but primarily because of the paramount desire to not break several billion dollars in assets.

Market participants generally like choices and the freedom to try out alternative attributes. Historically, market-based signaling mechanisms spur new entrants in an open market even decades after a first-mover creates the industry. The aerospace industry was not closed to competition after the original Wright Brothers flight at Kitty Hawk (even though they sued their competition) nor did the automobile industry become impenetrable after the 106 km jaunt by Bertha Benz in August 1888. Time and again profits serve as signals to the rest of the industry, which in turn incentivize (or discentivize) entry. This includes building new: boats and trains, credit card systems, social media, portable media players, televisions, mining for resources, operating systems and even protocols themselves. So as long as developers have the freedom to tinker and the motivation to do so, altcoins will likely to continue to be created.

Send to Kindle

Understanding the Current Tradable Ecosystem

[Note: This was originally published on September 11, 2014 at Melotic.com]

Altcoins, appcoins, commodity coins – what are they? These are sometimes confusing, often undefined terms that have been received increased exposure by various media outlets.

Since the release of Namecoin in April 2011, hundreds and perhaps thousands of alternative coins (“altcoins”) have been created. Many of these altcoins are near duplicates – in both features and code base – as Bitcoin. A minority of others include new attributes, hash functions and extensibility characteristics providing room for additional metadata, changes in block timing, asset issuance and enhanced privacy. Notable examples of those listed on Melotic include Darkcoin which includes “DarkSend,” a type of CoinJoin implementation, Counterparty, which enables users to to issue assets tracked on top of the Bitcoin ledger, and Blackcoin, which uses proof-of-stake in place of proof-of-work in an experiment to reduce capital expenses.

Appcoins is a term that describes coins that give users access to decentralized applications similar to how gift cards and loyalty programs (e.g., frequent flier miles) give users access to specific facets and elements of goods and services. For instance, StorJ is attempting to decentralize cloud storage by incentivizing owners of idle capacity (both bandwidth and storage) to share their nodes in return for an appcoin, Storjcoin X, which was issued using Counterparty. Users wanting access to these resources in turn need to exchange a specific appcoin, in this case, storj, to use it. LTBcoin is another asset issued through the Counterparty platform and is used as the official advertising token of the Let’s Talk Bitcoin content network (e.g., rewarded for proof of content/activity). Other projects under development aim to accomplish similar tasks including crowd funding abilities over the coming months.

Commodity coins are the newest evolution of cryptoledgers, linking blockchains with specific assets in the real world. For example, DigitalTangible issues a gold backed coin (represented by an actual 1/10 troy ounce of gold) linked via Bitcoin – through a Counterparty asset – to a custodian that holds the gold (which can be physically delivered). Urocoin is attempting to peg 1 metric ton of urea to a cryptoledger (in this case, one that uses the X11 proof-of-work hash function), enabling users to trade coins and in this case, a commodity with a global reach. Other potential projects include linking other agriculture output (such as potatoes) and other precious metals to digital coins managed by a blockchain.

Send to Kindle