I have a new piece up over at CoinDesk: What Block Chain Analysis Tells Us About Bitcoin.  Note: the title of this blog post was the original title of the CD article (we switched it so that the average reader would find it more of interest).

I really have to thank John Ratcliff for his time, effort and talent for fusing blockchain data with a visualization engine.  Also special thanks to Jonathan Levin for his analysis of what is going on (I have quoted him several times now, including my recent mining piece regarding China).

My own view (not necessarily anyone else’s) is that this data shows that while bitcoin was, on paper, built to be an electronic cash system (a payments system), that in practice it is primarily used as a store-of-value.  Yet in a twist, even the run-up of a $1,000 token last fall did not bring the long-term savers out of their cold sleep.  And more to the point, it is doubtful that even if some of these old holders wanted to sell that in practice they could not because liquidity is very thin and they would likely create huge pay walls in order books that would take days and weeks to plough through.

Thus the question is, what could incentivize long-term holders to actually use the network as a payment platform, to exchange their tokens for wares?  My own view is nothing will in the short-run.  BitPay, Circle and Coinbase are all neat, innovative and have smart people working for them but in their current form they basically just serve early adopters with large quantities of bitcoins to dispose of.  The transactional volume only spikes during price rallies which essentially means that on-chain bitcoins only move in the midst of large market movements.  What this likely means is that, sans the black market, very few people buy bitcoins to spend on conventional goods and services; real economic activity and commerce is still quite low.

As a consequence, if entrepreneurs are looking to capitalize somewhere in this market segment, they may want to incorporate this thesis into their business plan: that most activity involves savings, thus you should build products and financial instruments to hedge the savings from volatility.

Perhaps this is just a temporary phenomenon.  Maybe, as some advocates hypothesize, if and when prices reach a stable value at several thousand dollars this behavior will change.  Fortunately for all interested parties, the blockchain shows us what is actually happening.  It is the real asset.

Update:  Here is John Ratcliff’s latest pie chart based on the same methodology from the article:

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Zavain Dar is an investor with Innovation Endeavors and adjunct lecturer at Stanford teaching a Symbolic Systems course which covers the burgeoning segment of digital currencies and decentralized applications.

Today he had three guest speakers, Max Levchin (one of the original founders of PayPal, now with Affirm) and Matt & Robby from Counterparty (I wrote about Counterparty in Chapter 3).

Below are some notes from their discussions.  All errors are my own.  These are mostly paraphrased statements they made (i.e., these are not 100% word-for-word statements).

Max Levchin

Max presented both a bullish and bearish case for cryptocurrencies such as Bitcoin.

On the bearish side he did not consider it a viable currency because of its continual volatility [note: David Evans published a paper last month that found BTC was 18x more volatile than the Euro in 1Q 2014] and because it does not have any government backing yet (he discussed a hypothetical future scenario later below).

On the bullish side, he thinks the underlying protocol was interesting because it solved the Byzantine General’s problem in an elegant way vis-a-vis a distributed ledger which creates a trustless system of interaction.

One subsequent hurdle he saw with the mining aspect is that it consumed enormous amounts of energy (he compared “miners” as a type of Congress and the core dev team as a type of Federal Reserve — or in other words, neophytes perhaps without the necessary experience or background in economics and international politics).  Again, he was not trying to be antagonistic but descriptive.  He also did not find the code quality that he has looked at to be particularly high.

He observed that the scripting language it used (comparing it to Forth and Lua) as interesting and concise and found the m-of-n transaction system to be innovative (he cited Shamir’s Secret Sharing concept and two-man rule).

One area he found of future interest is that of a “smart agent” (which is essentially what Mike Hearn would call an “agent” and Vitalik Buterin calls a “decentralized autonomous organization”).  Max foresees a period in the future — perhaps not necessarily with the Bitcoin protocol itself — in which a smart agent sells a service in bitcoin and receives bitcoin as revenue for service; propagating and cloning itself based on its performance through AWS clusters.  He mentioned reading about some of these proto-ideas in scifi literature (name dropped “Game of Life” though this is not really scifi).

Max then segued into a discussion on, how based on actual numbers, Bitcoin as a payments platform will likely not uproot existing players, despite the much ballyhooed “2.5% + $.20” (also called a swipe fee) that anti-establishmentarians like to espouse.

Based on his description, if fraud rates ever reached 1% Visa, MasterCard and others will kick you off their network.  And in practice, they will likely put pressure on a merchant with increasingly higher fraud rates prior to reaching 1% — thus incentivizing merchants to get their house in order… or else.

Fraud itself only accounts for 0.07% (yes, 7 bps — see “Credit Card Issuer Fraud Management, Report Highlights”) of the cost that is factored into this total of 2.5% — he noted that this reflects that most people and most customers are quite honest (give yourself a pat on the back society).

He then mentioned that what is concerning are scalable fraud — that most theft is small-time purchases that are written off.  The bigger issues that companies like Visa have to be on the lookout for are those originating in Eastern Europe that can scale yet even with that, the actual costs dovetail into the 2.5% cost.

He then mentioned the history of how gambling, or rather the illegal processing of payments related to gambling came into being.  He also touched on the evolution of cashback rewards, VeriFone, the competitive fight with interchange fees, AMEX black card (also called the “Centurion Card” which can be used at new lounges in airports).  None of the credit card companies are on closed loop solutions: AMEX lends their brand to other cards (ala “white labeling”).

Perhaps one notable – hypothetical – point that blockchain enthusiasts may find of interest is CanadaCoin (or Cancoin as he called it).  Basically in his view, a country like Canada could utilize a cryptoledger by experimenting with well-defined revenue segments such as real estate taxes, connecting those moving parts (payments, transfers, etc.) with a distributed ledger.

The tl:dr version of Max’s talk: he finds the Bitcoin protocol to be very interesting, potentially seeing its use-cases emerge with interchanges (not to be confused with fiat exchanges) but finds the actual bitcoin token and its mining/development system to be no bueno.  As a consequence he does not see bitcoin as a payment platform competing against established players who despite opinions to the contrary actually are squeezing out lots of utils — and that most cryptocurrency advocates don’t actually understand how the numbers break down (e.g., what fraud actually accounts for).

Counterparty

Robby and Matt work as volunteers for Counterparty.  Counterparty is a “2.0” platform that sits on top of and uses the Bitcoin blockchain (as described in Chapter 3).

They discussed several capabilities of the platform:

• Currency creation (creating your own brand)
• Creating digital assets for crowdfunding (like LTBCoin)
• Ability to trade any asset peer-to peer (contracts for difference, binary options)

They call themselves an embedded consensus system (because it uses the consensus system of Bitcoin and is embedded onto it).  One new piece of tech they are working on is a “Vennd” (digital vending machine).  Both of them answered a number of questions from the audience related to how the decentralized exchange (which has been active since January) allows order matching and native escrow by the protocol.

Another point of interest was their discussion of CODA and the various legal issues surrounding the exchange of instruments and potential interaction with organizations like the CFTC and SEC.

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Got an email over the weekend from someone that watched my presentation (video).  He was asking me about the specific situation in which someone resells a bitcoin or smart contract that had previously been stolen.

I am not a lawyer, but the underlying principle for this issue is called nemo dat.  In the US there is an exception related to legal tender that has been sold and resold.  If you are concerned about this issue, especially as it relates to digital currencies, smart contracts and smart property be sure to speak with an attorney.  I can recommend some.

The correction in that video is related to remittances, I slipped and said $30 billion for received remittances in China.  The actual number is $60 billion.  I mention more in Chapter 6 (the top three are $71 billion for India, $60 billion for China and $26 billion for the Philippines).

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The original white paper mentions “peer-to-peer electronic cash system” as part of its title and further details this idea in the first section, yet relative to its media exposure there is little on-chain activity and subsequent data that validates this purpose (yet).  Perhaps this will change, more on that later.

In my paper (pdf) which covers this topic, I mention Square as an example of a company that has grown enormously without the benefit of the same “free” publicity that Bitcoin has received over the past 4 years.  I should point out that I am aware that Square itself is in a tight position and may not have a successful exit.¹ The example still stands however as shown below:

This chart comes from Google trends based on dates between January 2009 and January 2014.  Bitcoin (“the currency”) is in blue and Square, Inc. is in Red.  What this illustrates is the low conversion rate (CVR) that the Bitcoin platform has had thus far.  This is not to say it will fail as a platform, rather that it has enormous adoption and on-ramping challenges (such as edge based security).

Some of the other challenges were issues that Square has faced all along and were concisely described in a post a few years ago (the stats are slightly different but the hurdles remain the same): Square will “do better” than PayPal? Yeah.. and Pigs Fly

The following chart illustrates this issue as it relates to Bitcoin:

This chart is based on the past year of on-chain data culled by Blockchain.info: the number of transactions excluding the 100 most popular addresses (such as gambling sites like Satoshi Dice).

What this means is that over the past 6 months, there has been essentially no new on-chain transactional volume.  Despite the tens of thousands of merchants that BitPay and others have on-ramped, most users (or rather holders) of bitcoin are unwilling to actually spend it.  Almost all of the additional activity occurs on the edges, in “trust-me” silos which defeats the purpose of having a blockchain.  I have discussed this issue several times this past month (such as the last section of my paper).

Jason Kuznicki has attempted to describe the lack of growth in on-chain transactions in graphical form.  His chart, above, reflects the daily total transaction value of the bitcoin economy, denominated in U.S. dollars, divided by the total market capitalization of the bitcoin economy on that day, denominated in U.S. dollars. Between December 2012 and December 2013, he points out, the velocity of bitcoins remained within a very narrow band.² The notable two largest peaks are in April 2013 during enormous global media attention of the platform creating a temporary bubble and at the end of November 2013 when Bitcoin Black Friday (BBF) was held. BBF was the busiest ecommerce day of the year for the network, which achieved 1.5 transactions per second (compared with the average of 0.7 transactions per second and its theoretical maximum of 7 transactions per second).³

Kuznicki notes that:

The key here is that nothing seems to be happening all that dramatically in bitcoin’s velocity of money over time. It’s not circulating more rapidly over time, which is what one should expect if it were taking off as a currency, and if more and more transactions were of the form of people passing bitcoins around for stuff. Instead, most transactions (that is, most that don’t go dollar-to-bitcoin-and-then-stop) are likely to be money-to-bitcoin-to-stuff, after which the merchant reverts to the dollar as soon as possible. If the bitcoin economy were becoming independent, we might expect a takeoff in the velocity of money, but we’re definitely not seeing it yet.

Again, this is not to suggest that Bitcoin will fail as an experiment or that it will not succeed in certain niches (i.e., store of value for Argentinians).  Perhaps it is a chicken-egg problem in which as more merchants enter the space, there will be more incentives to actually spend it.  However, barring the success of sidechains, I am doubtful that Bitcoin itself will be used as a payments platform on par with PayPal or Visa any time soon.

1. See With IPO Hopes Fading, Square And Box Face Reality Of Commodity Products from TechCrunch and Mobile-Payments Startup Square Discusses Possible Sale from The Wall Street Journal [↩]
2. One reviewer noted that “Velocity analysis is really important. For something that purports to be a currency, it is the key metric of success with respect to its role as a medium-of-exchange. There is likely a correlation between the fx rate and tx volume due to speculative demand. However it is uncertain that the price chart of fx and USD tx volume proves that. In the future, a researcher could equally tell the story that the fx rate is being driven by increasing tx demand. Without a way to distinguish block tx due to fx settlements and block tx due to trade in real goods (and of course estimating tx due to change, same-person wallet transfers, etc), these series are likely ambiguous.” [↩]
3. BitPay alone processed 6,926 bitcoin-based transactions on November 29^th last year up from 99 transactions on the same day the year before, see BitPay Drives Explosive Growth in Bitcoin Commerce from BusinessWire [↩]

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Last night I gave a presentation covering the new sidechains “blockchain 2.0” project from Austin Hill and Adam Back. I also covered some of the challenges of information security on the edges of the Bitcoin network.

The talk is based largely on a paper I finished drafting this month called: “Learning from Bitcoin’s past to improve its future” (pdf)

Below is a video of the presentation as well as the corresponding slides. All errors are my own. Many thanks to: Dave Babbitt, Preston Byrne, Hudson Cashdan, Joseph Chow, Petri Kajander, Taariq Lewis, Jonathan Levin, Andrew Miller, Pieter Nooren, John Ratcliff, Robert Sams, Koen Swinkels and Andy Toshi for their feedback and constructive criticism.

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Below are some paraphrased notes from the new “blockchain 2.0” interview conducted by Adam B. Levine (editor-in-chief of Let’s Talk Bitcoin) between Adam Back and his business partner Austin Hill.

Be sure to listen to the full interview (and here is my write-up from the previous post as well).

• When people talk about building on top of TCP, this is the way to do it, which is the interoperability using existing bitcoins themselves to move them.  If I have a bitcoin to buy for small payments like a cup of coffee, I move it into a sidechain that has higher transactions per second and then move the change back into the main Bitcoin network and then put it into a different side chain to invest it a Bitcoin denominated derivative against US dollars or buy electronic shares or something like that.  Bitcoin is used as interoperability level moving across the pegs, allows open innovation in a neutral sense without creating a new scarcity race.
• Building the infrastructure so these sidechains can take advantage of the global hashrate through merged mining but with some additional extensions. But there are some core services that you do want such as good PKI for the registry, digitally signing for sidechains and new asset issuers, clear disclosure if people can move assets between chains, wallets can tell what properties of the side chains (when you get asset from the side chains, you are aware).  We don’t see a justification for a lot of these altcoins switching out the proof of work besides Adam’s contribution with hash cash, it ignores $250 million in ASICs and datacenter that bitcoin is self-funded as a platform for verification.  We think trying to bootstrap a new global hashrate infrastructure is kind of pointless.  Makes more sense to use what is out there Namecoin has achieved 80-85% of Bitcoin hashrate through merged mining.
• It is a preferable approach to these other 2.0 projects because it is an interoperable approach so you can move money around and interoperate between different networks, different side chains.  The typical TCP analogy people use here is inaccurate as they just send watermarked bitcoins; with TCP you send users messages point to point, if you send it over the bitcoin network it’s an n-squared broadcast and the things sent on the bitcoin network should be about the minimum amount of data necessary to ensure the bitcoin properties, that the value transfer can be tracked, that smart contracts can be evaluated like multisig and so on.  Any data like “this is my email address,” or “this is a receipt,” does not belong on the bitcoin network.  That is what the payment protocol is for, point to point to people. [BIP 70 is the payment protocol]  I think some of the people building on top of Bitcoin are doing it in a naïve way, which is a disruption to Bitcoin.  For example, even Colored Coins which is quite neutral and clean, no digital scarcity race, but has scalability issues because if transaction volume reached a significant volume it could saturate the Bitcoin network.  Right now the transactional limit is 7 transactions per second, increasing block size incurs centralization risk because you need a highspeed link, decent bandwidth if it gets too large.
• It also breaks with colored coins, Adam showed Austin, David Chaum’s ecash server he had come up with coloring DigiCash coins and watermarking them and even last year he still thought it was the best approach to add extensions but saw that with SPV wallets, Colored Coins don’t work with SPV wallets and we live in a world where mobile wallets are a predominate device so if Bitcoin is going to reach its full potential for interacting with billions of people, Colored Coins just doesn’t work in that scenario because you cannot have a full node on a smartphone.  On top of which nobody had contemplated how will this capability of watermarking work?  If people color different assets the same color, who is the arbiter (e.g., ‘blue’ for both a share and copyright registration)?  So there were ideas but no one had really thought out, with SVP, with some sort of asset registry, whether you do that in a distributed basis like Namecoin does or you that in a centralized PKI signed registry service, need supporting infrastructure to make it work.  People got enamored and went off and watermarked a bunch of things.  How can we allow for some of the properties of native marking, new asset issuance, extensions to the scripting, build on a neutral platform.  The principles from our project: permissionless innovation, decentralize wherever possible, decentralize and distributed.
• A lot of people are interested in the potential for user created assets and smart contracts, they see that can be used a lot in the future, trustless escrow.  Colored Coins, Mastercoin, Bitshares and Ethereum have come in and add stories, creating networks.  Pegging technology is the next step of technological improvement in an interoperable way.  Built on top of Bitcoin in a way that does not result in spamming or watermarking bitcoin transactions that makes every transaction a bid/ask, saturating Bitcoin.  You don’t need to do that.  Sidechain that is pegged to bitcoin, so there is no counterparty risk, no escrow agent holding your bitcoin.  Your bitcoin can move between networks which are tied, in that sense they are merged mined.  People can do their innovation in interoperable way.  Early days in TCP/IP, if every time somebody wanted to make media streaming, webpages, online shopping, each time they make a fork of TCP protocol, made a few changes so it is an incompatible network and said “great we’ve done online shopping,” yet none of these things talk to each other, you have to pull them out and put them back in to achieve anything.   So you get network effect by having interoperable systems.   So if we have different people working on micropayments, online shares, high frequency trading, to do all these things on different networks that are open networks, preserve the freedom to innovate, fully interoperable and operate with two-way pegs, best of both worlds: freedom to innovate, avoid the silo effect, and we avoid these self-defeating selfish ‘newshares’ that some things get built on top of.
• We don’t want to see another Mt. Gox, exchanges have had a high failure rate (theft, incompetence, internal malfeasance).  New players are doing security audits, but these are in off-blockchain, trust-me model, holding private keys.  We need to extend trustless blockchain into new parts of the ecosystem but you can only do that if the blockchain can scale to have more of every interaction depend on the blockchain.  Some exchanges were doing more than 7 transactions per second.  There was a practical limit to go off-chain.  Creates an IOU situation where someone promises not run away with bitcoins.
• Smart contracts off: build infrastructure, services, exchanges, payment processors — build components in a decentralized way, build service in a trustless way (smart contracts).  And almost all the system players are not using it.  Somewhat an artifact of the transaction limit.  Can switch coins using an atomic swap.  It is a known property, but not widely used.  So an exchange can simply be matching orders and not touch the coins.  Remove the need for audit, audit is after-the-fact-reactive.  If we had audits every 6 months on Mt. Gox, that doesn’t mean the situation would have been avoided.  The point with bitcoin is you have a real-time audit, if someone tries to do something outside of a smart contract, it is a priori prevents this.  By architecting these things where you don’t have to trust them, you trade with air-gapped wallets — exchanges just handle order matching.
• New model: Exchanges can compete on marketing, building liquidity, volume, customer service, regulatory compliance, making it easier for you to file your taxes, a whole bunch of things they can innovate on.  But the basic security model isn’t: trust us with your assets.  It is trust us with creating the best market place where you can find the best liquidity and the fastest and best customer service.  But you never need trust us with your assets.
• We have focused on the last two months on the core science, we gathered a number of the Bitcoin core developers from around the world. Many of whom who hadn’t even met each other.  We set up a house in California where they all came and collaborated, some of them lived in the house.  Called “The Bitcoin Mansion” – not a mansion.  A lot said that this approach was “not possible, we don’t believe in it the ability to do a two-way peg and retain all the properties and build a security wall.”  We have now proven that it is, we have gotten sign off and support from a lot of the core developers.  But even that change is going to require some time.  There is a community at large that needs to understand it, there is a proving period that needs to be there.  These guys are incredibly overlooked by ecosystem that depends on them, volunteers who are controlling some of the most important code on the planet, next to the space shuttle.  If we have space shuttles and stations blowing up, it can ruin space exploration.  If they screw up, they can ruin math-based currencies or set them back incredibly far.  So they have to be very judicious and patient in adopting changes.
• This creates contention. Whereas you look and see that particular project is cool, but you cannot afford to pay attention to a pet project. Can’t accidentally introduce a bug.  It means that innovation on core is slow, because conservative, value preserving, focus on robustness, fixing minor bugs, very careful gradual change.  Two way peg, requires moderate high risk change.  Bootstrap problem, evaluate the change or set of changes and be sure that it is safe.  But once that is done it allows people to do innovation on side-chains, explore new ideas.  If ZeroCash wants to do something on a side chain.  If in 6 months, they want to increase the block chain, they can do that.  If Bitcoin main wants to reduce the block size to increase decentralization.  Someone wants to do something, changing contracting language, tagged user assets that are SPV compatible, they can do on another side chain.  People with different views on a contracting language can do it on a different sidechain.  Frees up the space to allow open innovation very rapidly, without creating risk for Bitcoin main.  Security firewall, you can only move bitcoins in that have been moved out.  Value does not float against other chains, implemented protocol that fully preserves 21 million supply.  Only Bitcoin chain is being mined, the others are repositories where you can move bitcoins into them and back out.
• Incentive to mine these: we believe there will be, not disclosing, in discussion with a lot of the large miners and mining pools on making sure they have good incentives and good reasons to merge mine this.  And there will be an economic model that supports participation.  It won’t be based on mining rewards so obviously that leaves transaction fees but there is a transaction model that is flexible, is market based allow each of these sidechains to have their own innovations, but collectively all of them together can increase the transaction fee revenue for people who merge mining this.  From complex systems design and merchant property is that this will actually drive demand for Bitcoin, other interesting assets or contracts that can be written against bitcoin.  We have had discussions with some very large financial institutions who are looking at volumes of transactions and contracts and derivatives, futures, options contracts, that are orders of magnitude larger than the entire bitcoin asset base.  Huge.  When you start looking at embrace or extend the functionality to include part of their asset base, encoding into blockchain technology, you can start to see the demand for bitcoin will far outpace the availability and will ultimately drive up the price of bitcoin.
• Once someone bring an open network for supporting smart contracts against other assets, that opens up a wider set of transaction types so you would expect the transaction throughput to go up, dollar transaction to go up.  Bitcoin is the neutral transactional currency, therefore the amount of bitcoin denominated transactions go up, which puts up the utility value of bitcoin.
• You can do different block intervals on a sidechain, counter intuitively, because when you are merged mining with say Namecoin that means some namecoin blocks are not bitcoin blocks. And vice versa so you can have a different target, smaller faster blocks it is possible.
• Two members of the team have figured out how to scale to hundreds of thousands of transactions per second while retaining all of the properties of retaining a blockchain security model.  And those innovations will have high frequency trading, very high speed liquid markets and exchanges that are using blockchain security model and blockchain trustless infrastructures, but meet the business requirements that are necessary to do high volume. And that is definitely our projects scope to make those platforms available for people who do have, someone who wants to compete with Visa but I can see myself hitting, 20, 30, 40, 50,000 transactions per second.  Where am I going to be able to process those and be able to get instantaneous transaction verification without having to wait for the limit of the blockchain.  We think it will be possible and trustless security model of the blockchain.
• Right now combing our hair, putting on our hats and wearing fancy ties but we are getting ready to announce more details to the project so that those interested can track the project and reveal it including announcing the name, who’s on the team: happening within the next 60-90 days.  So a very short term.  We are going to be releasing, one of the principles we will be releasing from the cypherpunk days is and one of the founding principles of the project is: “we speak in code.”  So we really want our products and our software to speak and so we will be releasing software very quickly that is necessary software that is needed for bootstrapping this type of ecosystem.  There are a couple different parts to the existing blockchain to the existing ecosystem that have huge gaping problems that we can deliver immediate value without needing to wait the 12, 18 or 24 months that it might take to get some of these changes to be adopted in Bitcoin core.  Some people are aware of these problems but we believe we can deliver immediate value based off that.  Get out there, release very useful open-source free-software, some software stacks that other people can adopt into the ecosystem to secure their users accounts, secure parts of the Bitcoin ecosystem that are operating on a trust-me model.  We think we can deliver a lot of value by helping them to move to more of a trustless infrastructure.  We are going to be investing very heavily in building a team of cryptographers, programmers, working to support some of the volunteers in the Bitcoin core community to provide them resources and allow them to really accelerate some of the things they know need to be done.  Most of these guys are volunteers, have day jobs, huge weight on their shoulders: do it because they love the technology and community.  Have not received a lot of support.  Supporting them, providing more tools, more testers, more documentation resources, travel vouchers so they can meet face to face – some of the things we will be doing.
• Some business models rely on the availability and reliability of the Bitcoin network, so following the Linux model they should hire – as they can afford – developers in the community to work on it.
• We are a “blockchain 2.0” company, although I personally care for the success of Bitcoin, it is important to distinguish between bitcoin the asset and the blockchain as a programmable distributed trust infrastructure.  And we are interested in blockchain 2.0 and blockchain 2.0 using bitcoin as a neutral transactional currency we believe is a great, offers great promise but I want to build a blockchain that could support a nation-state putting its national currency and phasing out paper dollars.  And there is a lot of reasons to do that: counterfeiting, utility value, conducting commerce in separate geographic distances.  Auditability, trust, whole bunch of potential to reinvent our financial infrastructure to better serve humankind and we have only begun that journey and I’m interested in a platform that is distributed, neutral, has all the principles of and properties of Bitcoin has embedded and imbued in it the principle that “it can’t be evil.”  And allows the world to migrate math-based assets and math-based currencies.  That is going to take time but we are interested in building that blockchain 2.0 and do that as an extension of the existing blockchain – not running off and building our own alt ecosystem and premining it and watching Adam and I get rich off having the first coins – that is not our intent.
• There is no altcoin race with this, using bitcoin purely as a transactional currency.  Systemic risk issues: if more of business starts to move their accounting and B2B payments into bitcoin and cryptocurrency issued assets and denominated national currencies, you get the benefits of the zero trust, immediate auditability features so if you are receiving insurance contract from an insurance policy and there are about to exceed their reinsurance limit that would mean your insurance policy would be immediately failing audit and that would mean your policy is invalid.  You can start to remove systemic risk from the system and avoid Enron-like situations.  Even in the long turn there would need to be iterations of smart contracting before we get those kinds of things.  But even in the long run you get a national currency issued where they would have  smart contract like an issuance contract that would specify their monetary policy, no more than 2% cost of easing or maybe subject to market metrics and that applies to them.  Even if they have the key to issue more coins and some redundant hardware air-gapped key manager, they would be physically unable to bypass the monetary policy rules because the monetary rules are bound into the genesis of the coin and all recipients of the the coin would reject them if they tried to exceed their own monetary policy.  So I think if we get to a system like that we have can have real time auditing and agree to societal rules and enforce them a priori rather than finding out 6 months later that somebody has hundreds of billions or trillions of undisclosed assets and then you have an AIG or all of these kinds of cascading failures in the system.
• History of Zero Knowledge is not archived, Youtube did not exist.  At the time we were very thumb our nose in the face of authority, we were fighting the Edward Snowden type of battles.  The NSA and CIA tried to shut us down, we were on 60 Minutes advocating crypto for all and tear down the system.  That may not be the best way to interact with these guys: is I’m coming for you, I’m going to burn down your system.  The financial services industry, the people we have talked to, have real problems themselves.  We talked to a very large buy-side financial institution who literally has hundreds of billions if not trillions of dollars’ worth of assets under management and they said from a pure compliance point of view we don’t understand our risk.  We have entire teams holding binders and contracts and asset systems and we are trying to figure out what we own and the risk is and what the underlying asset is, so if we can digitize this and have it be encoded in a way that we can actually we can make representations for compliance reasons for our own risk management, we would welcome you in.  Show both governments and financial institutions this is not about wiping them out or destroying their business, this technology is about imbuing the entire ecosystem with verifiability, trust based off distribution and math.  And some real good foundation levels where they can reinvent their business and yes, we can drive some competition in the industry.  And hopefully some more efficiencies.  Just how media companies are adapting to the internet and rebuild their businesses, we want to encourage these people to look for efficiencies.  And those that do will be much more like the Netflix of the future versus the Blockbusters of the future.  We want to help them rebuild their businesses like Netflix, not like Blockbuster and if they don’t want to adapt they face extinction
• Public auditability, typical objection to commercial basis – companies do not want their business model to be public knowledge (profit margin, volume of trade, market movements, if someone is selling a large amount of stock, they like to keep that to themselves and not have that readily to the market) and that tends to present a barrier to public audibility.  We have to preserve commercial confidentiality.  Homomorphically encrypted values, have the blockchain validate the inputs add up to the outputs without disclosing the values involved, they are encrypted in such a way that addition still works on them.  Includes zero knowledge range proof that encrypted value A is less than encrypted value B and use it to prove leverage ratios and things like that.  Can do a lot of things to preserve commercial confidentiality but allow for public auditability.  So this merely a scope that can preserve that traditional and necessary fragile privacy for individuals and commercial sensitivity for companies but all allowing public audibility
• I can see that two parties engaged in a currency swap or whatever instrument, their identities are not apparent to me at the blockchain level but they will have business records saying who they bought it from.  There are two networks involved in a transaction, the blockchain broadcast P2P network (byte minimized, scarce resource), you don’t send to that more than you need to insure the correct interpretation of the transaction.  Invoice and receipt go to the payment protocol level which is point to point communication between buyer and seller and if one of them is a business they will be keeping records or if you’re an individual they will be keeping their receipts for taxation purposes.  I think there will be identity but will keep the parties not broadcast to the peer to peer network.  Why is financial privacy wanted?  Because some people are paid their salary in bitcoin, so you can figure who this guy is because he bought a pizza in the shop or he paid you back and you see an address – it shouldn’t be reusing addresses.  If he was paid a salary and that amount of salary was encrypted, you wouldn’t know how much he was paid and he if paid you personally $10 you wouldn’t know his salary just that he hasn’t exceeded the value of the transaction.
• We will be launching a website, with job postings.  If people keep track of us on Twitter – @austinhill and @adam3us – keep watch we will be announcing the name of the website and project in the coming month.  There will be at least a place holder site with more details and jobs available.

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Some very exciting news is being made public.  Adam Levine, editor-in-chief of Let’s Talk Bitcoin (LTB), interviewed Adam Back and Austin Hill for a new endeavor dubbed “blockchain 2.0” — I recommend everyone to listen to this interview.

Below is my write-up I did for LTB (note the copy on LTB is missing the footnotes which I have included below).

Blockchain 2.0 – Let a Thousand Chains Blossom

Adding on-chain utility and extensibility in a scalable way sums up the core ideas of the “2.0” next-generation cryptoledger space.  This is a segment that has grown rapidly to include eight announced and funded projects, each vying to create new use-cases utilizing a trustless blockchain or in Ripple’s case, a consensus ledger.

And now we can add one more to the list, an unnamed entrant financed by Austin Hill and articulated by Adam Back.  Hill is a well-established tech investor and in addition to other projects, spent almost $4 million in the ‘90s trying to develop and commercial electronic cash and anonymity systems through a company called Zero Knowledge Systems.  Back, likewise, is a domain expert, creator of the Hashcash proof-of-work mechanism used with Bitcoin and all other SHA256d-based alt derivatives.

This past week, Adam Levine interviewed the two gentlemen and learned that Hill and Back have created a company that includes several Bitcoin core developers working on a project momentarily dubbed “Blockchain 2.0” (the actual name and website will be released soon).

Some backstory: at one point Back worked for about 4 years with Hill at Zero Knowledge Systems and while Hill was familiar with Bitcoin, it was not until Back approached Hill (who was in retirement) and explained the extensibility merits and use-cases that Hill began to take it seriously.  Thereupon, they spent a week in a boardroom, mapping out the business plan and adopted the motto: “can’t be evil.”  In, Hill’s words based on his previous experience with Zero Knowledge Systems, “We believe trust is not earned because we’re good guys but trust was based on the protocols, the whitepaper and cryptography – where we were not asking for trust.”

They then rented a home in California for a couple months earlier this year with several other core developers and looked at ways to add new extensions to the existing blockchain – build a company around it – all the while providing backward and forward compatibility with the Bitcoin blockchain.  Again, this is not the “typical” alt because instead of creating another series of independent networks it will in will utilize merged mining and atomic transactions to extend the feature set via interoperable sidechains (more on that later).¹

Why is this important?  Because as Back noted, the pace of current development on the core protocol is purposefully slow to prevent bugs and vulnerabilities.  And according to him these sidechains will allow experimental development to take place without impacting the main codebase, allowing the ecosystem to experience a faster pace of invention, scalability, faster transaction throughput, multi-asset issuance and even extensions to smart contract scripting.

How is this done?  According to Back, last December he spoke on Let’s Talk Bitcoin with Andreas Antonopolous and mentioned a one-way peg system, however it turned out to have undesirable limitations.² Greg Maxwell then proposed a two-way pegging method that enables Bitcoin to connect with a sidechain which is a mathematically-controlled peg between Bitcoin main and the other chain network.³ Thus, according to Hill there can be continuous deployment and interaction with sidechains optimized for multiple purposes – that multiple sidechains can compete on features such as having larger block sizes (up from 1MB), which while leads to increased centralization, provides higher transactions per second.  And if users feel uncomfortable with the level of centralization, users can unilaterally move tokens from one chain back to Bitcoin main.

So in essence, while there are multiple chains no new bitcoins are created – that protecting the digital scarcity of the finite amount of tokens (ultimately 21 million) is a core point to this project.  And that by linking chains they have set Bitcoin up as a “transactional currency for all the innovation and all new assets so you can potentially issue shares in a sidechain, that specializes in smart contracts shares, derivatives, user assets, ultimately backed by bitcoin, pegged to bitcoin,” explained Back.

Why not create start from the beginning, from a fresh slate like several other projects?  According to Back, in his view artificial scarcity is “fairer if we use the existing scarcity rates.”  And that he is not convinced that some other alts have a strong technical ground to build from as they “start a new scarcity race that creates an interoperability silo […] in order to get into to it you have to swap coins.”  Thus, Back sees the extensibility as adding “direct support for issued assets, extended smart contracts, all while using Bitcoin itself as the transactional currency.  We feel that is a neutral choice.  It is not starting a new currency owned by one company, a project, small group of developers or early speculators.”

In addition, the company identifies itself as a “blockchain” technology company what this means in Hill’s view is:

We are a “blockchain 2.0” company, although I personally care for the success of Bitcoin, it is important to distinguish between bitcoin the asset and the blockchain as a programmable distributed trust infrastructure.  And we are interested in blockchain 2.0 and blockchain 2.0 using bitcoin as a neutral transactional currency we believe is a great, offers great promise but I want to build a blockchain that could support a nation-state putting its national currency and phasing out paper dollars.

There are at least 84 uses of a cryptoledger and counting.  And Hill’s team sees that bigger picture.

Go where the capital is

Over the past five years between $200 million to $1 billion worth of capital investments in computing hardware in the form of “mining” (or really, “hashing”) has been made, nearly all of which is largely underutilized.⁴  That is to say, the actual utility created over the past five years has been at the edges of the network in off-chain, trusted silos (or as Hill calls it “trust-me” silos).  Yet as developmental economics describes – and Bitcoin is in some respects a developing economy – productively utilizing and efficiently reorganizing capital is a necessary condition for growth and continued development.⁵ The Bitcoin network has enormous amounts of capital, but with low usage rates.  How to tap into that?

They contacted many of the large mining pools and will attempt to merge mine these new sidechains and thereupon utilize atomic-transactions (which is a proven process used in databases for decades) to move tokens between the chains.

While not necessarily endorsing their project, this is certainly one of the most productive uses of the hashrate deadweight.  That is to say, irrespective of how hashrate is being centralized, it is being underutilized as it merely tracks one ledger entry representing one data point (which was intentional day 1).  And while it is uncertain as to how the pool operators will react to these changes, if Namecoin is any indication, it is possible to provide new use-cases via sidechains, using the same hardware and thereby mitigating some of the bootstrapping risks of securing a proof-of-work-based network.⁶

Key takeaways based on the interview:

•          Working with mining pools to discuss further utilization and expansion of merged mining
•          Merged mining will create sidechains “firewalled” off from Bitcoin main
•          Two-way pegging via atomic transactions will enable movement between sidechains
•          Sidechains might not have blocks, will include transaction fees to incentivize miners
•          Sidechains will be used for experimenting with expanding extensibility features including user-issued assets, smart contracts, HFT, and a plethora of financial instruments
•          Team made up of several Bitcoin core developers in addition to other cryptographers and programmers
•          Looking for practical use-cases of blockchain technology such as internal uses at enterprises and institutions, not solely related to bitcoin the cryptocurrency
•          Launching website soon and some production code within the next 60-90 days

Also, while this type of project will likely be controversial in some corners due to the capital and time invested in alternative platforms, this project provides yet another competitive wrinkle in the ever growing “2.0” space.  Thus, it will be interesting to see how they use these methods within a production environment to bring utility back to Bitcoin main.⁷

To learn more about the project, following Hill and Back on Twitter at @austinhill and @adam3us respectively.

Endnotes

1. How does merged mining work? from StackExchange [↩]
2. E77 – The Adam Back Interview from Let’s Talk Bitcoin [↩]
3. The entire discussion dev thread [Bitcoin-development] is there a way to do bitcoin-staging? is a very interesting conversation and at the end Greg Maxwell discusses the potential behind two-way pegging. [↩]
4. The lower limit is an estimate from Gil Luria at Wedbush Securities, see Following the Money: Trends in Bitcoin Venture Capital Investment by Garrick Hileman. [↩]
5. See Total factor productivity [↩]
6. What are Namecoins and .bit domains? from CoinDesk [↩]
7. Coincidentally, last week I published a paper (PDF) outlining some of the limitations of Bitcoin from a “public goods” perspective; it was by happenstance that Hill and Back’s team independently have answers and solutions to many of these known challenges and hurdles detailed within. [↩]

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Gideon Greenspan recently posted on the Colored Coins dev list:

We developed this to help with debugging. but it might be of wider interest to people here, to see what others are up to:

http://coinsecrets.org/

It shows you all OP_RETURNs in the block chain, hex and ASCII, going back to the first one (block 228596).

Some of the more interesting ones:

http://coinsecrets.org/?to=287731.000001
http://coinsecrets.org/?to=271007.000000
http://coinsecrets.org/?to=268081.000000
http://coinsecrets.org/?to=268060.000002 (rick-rolling)
http://coinsecrets.org/?to=251768.000000
http://coinsecrets.org/?to=228596.000000 (first one ever)

See also:  Hidden surprises in the Bitcoinblockchain and how they are stored: Nelson Mandela, Wikileaks, photos, and Python software by Ken Shirriff

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Yesterday a report from Goldman Sachs was released that identified at least 3 segments in which a cryptocurrency like Bitcoin can reduce costs: retailers, online merchants and remittance.  Below is an image of a chart that my friend Tuur Demeester tweeted about:

Overall, while GS found some benefits that Bitcoin brings, it also mentioned several challenges and risks. The takeaway according to TechCrunch is that, “Bitcoin likely can’t work as a currency, but … the ledger-based technology that underlies it could hold promise.”

See also: the report at Scribd and coverage from CoinDesk

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