Should you buy an Alpha Technology ASIC for Litecoin mining?

alpha technology viper

Short answer, probably not unless you point it to another Scrypt-based token like dogecoin.  I’ll show you the math and hypothetical situations below, but quick story.

This past spring I helped build a couple simple Sapphire 7950-based mining rigs in Shanghai for a few friends.  At the time the new Vapor-X cards cost around $300 each and could be tweaked to run at around 600 kh/s (in line with these hardware expectations). [Note: This was also just before Cryptobadger, who has a great series of how-to guides, highly recommended if you’re interested in doing-it-yourself.]

Fast forward to early December, virtually all physical stores in any big city throughout China were sold out of the following Radeon models: 7950, 7970, R280, R280X.  My friends spent hours calling up and chatting to online shops from Taobao and Tmall to try and locate any supplier with product.  But all were backlogged for the next couple of weeks.  Why?  What had happened is that the price of litecoin tokens had popped on exchanges (namely BTCe and OKCoin) by a factor of 10x in less than 3 weeks ($2 to $20).  Yet the difficulty rating was still (temporarily) at around a mere 1,000 meaning that the return-on-investment for even a small rig composed of 7950s was relatively quick.  However that capital expenditure / token profit information traveled rather quickly, ending up on a variety of domestic evening newscasts.  And thus, there was a mad dash to get these GPUs.  As a consequence, I spent one early December weekend during this time combing the PC malls in Changning district trying to find any owner who could supply a couple dozen 7950s all in an effort to help some of my friends build a litecoin mining farm.  Yet each laoban explained (with a smile) that some large buyer had bought the remaining stock en masse — store by store.

We didn’t build that farm and in the short-run that may be okay.  While some miners simply look at the short-term seigniorage of flipping a few blocks, long-term mining operations probably will hold onto whatever tokens with a view that the tokens will appreciate by an order of magnitude.  Thus, while the collective hashrate for the capital expenditures for the 50 GPU cards my friends wanted to buy would have certainly been considered a profitable investment at the 1,000 difficulty rating, the longer term capital risks are substantially higher because the spread in crypto mining, like other commodity gathering, tends towards equilibrium (e.g., the cost of mining eventually equals the financial returns).  That is to say, the extra units of profitability (or unprofitablity) sends a signal to market participants to either continue one particular activity (like mining) or to shut down mining operations altogether.  You see this frequently in other capital intensive resource gathering spaces such as petroleum extraction as well as precious metals (e.g., if the revenue / barrel increases, other competitors will invest in new extraction techniques and/or open fields for development yet if the revenue / barrel decreases, competitors may shut off all production in a particular field).1

Again, crypto mining involves a scarce resource (block discovery in which the coin or token are part of) and in order to mine you need capital investment, in the form of a GPU.  Thus the same issues of supply, demand, price discovery and profitability now exist.2

ASIC mining

In 2011, Scrypt was adopted as the proof-of-work mechanism used by the Litecoin protocol.  It was purposefully chosen by Charlie Lee due the understanding that it was more resistant (not necessarily immune) to GPU and ASIC mining than the SHA256d proof-of-work used by the Bitcoin protocol.  And after two years into this altcoin experiment this assumption seems to have empirically played itself out as there have been no known litecoin ASICs.

Yet now that litecoin tokens are trading at ~$25+ each, the return-on-investment for physical design engineers (the people who actually design integrated circuits) to develop an ASIC has become within the realm of profitability for even something designed to be resistant such as litecoin.  That is to say, some group of investors believes that the capital costs of hiring a team to design, fab and sell an ASIC to litecoin miners is profitable (otherwise they wouldn’t do it).

At the end of last month, Alpha Technology in the UK announced that they were at the finishing stages of design for two products, a 5 MH/s and 25 MH/s ASIC for litecoin (remember, the ASIC you buy and use for bitcoin mining cannot be used for litecoin mining because it is designed specifically to work on one particular proof-of-work).  The 5 MH/s is expected to need 100W and the 25 MH/s version is targeted at 600W.

According to the announcement, the cost for the Viper 5 MH/s is £1350 ($2209) and the 25 MH/s is £5450 ($8918).  Not including electricity, taxes, shipping and pool fees, the top Viper at 25 MH/s works out to be around 2.8 khash per dollar.  This compares with a ~$300 for a new Sapphire Vapor-X 7950 @ 600 kh/s which is around 2 khash per dollar. [Note: most 7950s are no longer assembled as such and are now rebadged as R280, the big exceptions are HIS from Taiwan.  Cryptobadger has a run-down of the best cards available.]

Risks and variable factors

Despite looking legitimate through press releases and 3D renderings, the product might never come out.  Or when it does get released (probably late), the real numbers might be way off the estimates.

For example, last March a good friend of mine paid 50 BTC for 100 GHash/s ASIC from Butterfly Labs.  He received it more than 6 months later at the end of November.  If instead he had held that 50 BTC he would have been able to sell for $40,000 – 50,000 on many exchanges.  Instead, if you plug that 100 GH/s rate into a mining calculator, he will not even be able to mine 1 BTC for the next year at the current difficulty rating let alone ever be able to mine 50 BTC it cost to buy them.

So here is the likely scenario with Alpha Technology.  They will not ship for at least another two months.   Why?  The inner engineer in me asks: Has it passed verification process?3 Has it been taped out? What about maskmaking?  Those they do ship to are those who ordered first and there is a wait list (here’s a widely inaccurate waitlist).  Each minute you wait is another minute someone else will be ahead of you.

Now, assuming you were able to get the Viper 25 MH/s today, looking at the mining calculator to see how many litecoin tokens you would receive at the current difficulty (3366.7), the number is: 2408 LTC / year.4 Assuming the network hashrate does not collapse, that is the most optimal scenario you have this year.  And the highest price an LTC has gone for on an exchange so far was $50-$60 back in late November/ early December last year.  If this price level is ever reached again and the difficult rating never changed, then you would stand to make ~$125,000 which would make your $8,918 investment very fruitful!

But alas, this is not how it works.  Again, assuming the product is made and even shipped on time, the difficulty rating will continue to increase proportional to the additional hashrate.  So as more and more of these Viper’s (and/or other GPUs, FPGAs and ASICs) are added to the network, the higher the difficulty rating is adjusted to.

The next estimated difficulty rating is expected to be 3700 which knocks off 20 LTC more a month, dropping you down to around 2150 LTC / year.  But this is not the entire story.  You still need to factor in electricity costs, the transportation and shipping fees (unless you live next to the manufacturing and distribution center) as well as the pool fees.  Some pool fees, like at Coinotron which I used are 5% (it is this high in part because of the maintenance and admin costs needed to protect against DDOS attacks). 5

In all likelihood, unless you are the very first person on the list when the product ships, you would be better off either building an off-the-shelf GPU mining solution or buying LTC on an exchange and either hold for speculation and/or arbitrage.

Why?

Even if your electricity was free, you lived in the UK/India/China where they are manufactured and were the first person on the pre-order list, your first mover advantage would be quickly eroded by other Viper owners.  To give you an idea why, look at the current Litecoin Mining Pool hashrate.  If 200 other consumers bough 1 of each Viper, they would collectively add 6,000 MH/s which would place these ASICs alone as the 6th largest pool, increasing the hashrate proportionally (this is actually conservative because difficulty typically trails hashrate).

If litecoin difficulty doubled to 6,000 at current price levels ($27) and a 25 MH/s hashrate you would generate 125.7 LTC / month and earn enough monthly ($3,423) to pay for the machine in 3 months.

But instead, let’s assume for the moment that other market participants have access to similar mining calculators and how-to Cryptobadger guides.  And that over the next 6-9 months the difficulty rating jumps to 30,000 (9x the level today).  Impossible you say?  Last April when I got the initial litecoin rigs up and running, the difficulty rating was 300.  So in less than 9 months the rating has gone up 11x.

If it reaches 30,000 you would only generate 25.15 LTC / month which at ~$27 / token would generate $684 / month.  That means you would likely only generate enough litecoins (at current prices) to cover the costs for the Viper in the first year (ignoring all other pool fees, electricity costs, taxes, duties, etc.).

Sure the tokens could appreciate and increase in value, but as we continue to see, if price levels increase so too would competitor hashrate as others see a similar seigniorage opportunity.

That said, if these numbers are real, this Viper ASIC is only 40% better than GPUs in terms of hash/dollar. Of course this is just the first generation and other companies might be able to make more efficient chips. But this definitely is a positive sign that Scrypt hashing might be able to keep ASICs from totally dominating mining like it does with sha256d.

Money well spent?

One thing to constantly remind yourself is that like any investment, you should only spend money you can lose.  That is to say, as bullish as you may be on any particular asset class (including cryptocurrencies) there is always a statistical possibility that its liquid price could sink below whatever level you have bought at (e.g., underwater).  Perhaps even falling to zero.

If history is any guide (and perhaps it is not) looking back at the California Gold Rush (the 49ers) the firms who ended up financially in the black were merchants and service companies such as Samuel Brannan, Philip Armour, John Studebaker, Levi Strauss and Wells Fargo.6 Those who also made and sold mining equipment (picks, axes, shovels, sluices) had mixed results.  Yet the group of people who typically fared the worst financially were the miners themselves as they were nearly all exposed to various types of risks (upfront capital costs, land title lawsuits, inclement weather, sickness, etc.) and as a consequence, most ended up bankrupt.

Does this mean you should not purchasing crypto mining equipment?  No, but you are probably more exposed to risks with fewer potential upsides than downsides.  Your capital is tied up into a depreciating asset, a machine which unlike a GPU that can be resold, has a singular use that may or may not be delivered on time with unknown hashrate performance deltas.  Or you could be thinking, just like the first people who managed to get an Avalon batch last winter or a KnC miner when they ship new updates throughout the year (like the upcoming Neptune), perhaps you might be lucky enough to get a Viper that lives up to its paper reputation.7  But the odds are you won’t, especially if you are reading this and have not pre-ordered it.

One other option for HNWI is that you could invest in an IC design company such as Alchip which does the physical design for KnC.8 Or create your own engineering team to build ASIC machines for internal use only and sell public shares just like ASICMiner in Guangdong did last year.

Lastly, for entrepreneurs there are other areas to focus on beyond the token such as the financial instruments and applications discussed by Mike Hearn in 2012 that utilize the Bitcoin or Litecoin protocol (e.g.,  secure time-stampingproving ownership of tangible propertydecentralized DNS and new ways to sign contracts).9

Exhibit A:

Below is a very rudimentary table that utilizes this Litecoin difficulty calculator.10  The calculator is nowhere near advanced as the dynamic dashboard over at Genesis Block (which is BTC only).  In fact, this chart below does not include in its calculations the long tail of the difficulty curve.  It is an end-to-end snapshot (what it is today versus what it will be 6 months from now).  But that is unneeded as this shows you that in every instance, building GPU-based systems instead of buying the ASIC is probably more profitable in the first 6 months.  In some cases, merely buying LTC and holding is actually more profitable.

I should point out that for this activity I negated electrical costs which obviously are non-negligible especially for a large GPU farm.  Obviously an ASIC will come out per watt more efficient, so feel free to factor in whatever electrical costs you may pay on a monthly basis in your region.  I also assumed the consumer would be able to buy 32 new or used Vapor-X 7950s for $200 each and then simply build a barebone system using milkcrates as per Cryptobadger (Friendly reminder: anything that is not the GPU is not generating tokens and is therefore a money sink — you do not need fancy cases or i7 CPUs).  It is probably very difficult to locate 32 of these GPUs, let alone 42 for Scenario 4.  But you could likely find batches of used versions on eBay, Craigslist and other etailers.  They do not even need to be the Sapphire brand; see this chart for more comparisons.

The biggest difficulties for a massive GPU farm like that however will be logistics, cooling and storage.  You would need to have access to reliable power and internet sources.  You would also need to keep an eye on each of the GPUs throughout the day to make sure they are performing up to snuff (I actually used LogMeIn but I think Cryptobadger’s method is much more efficient).

Still, I would speculate that in all likelihood, the Viper is unlikely to be delivered to your door within the next 90 days.  If that is the case your two profitable options (based on this chart) are to buy and hold LTC and/or build a rig or two (depending on if you can get them used and what your electrical costs are).

One last note, I do not predict that LTC price levels will reach the numbers listed in this chart this year (if ever).  These are for illustrative purposes only.  In contrast, if price levels do continue to increase I would expect the difficulty rating to increase in a corresponding manner and that the lopsided disconnect in the last column would never germinate.  Baseline difficulty is 3300 and starting LTC price is $27.

Investment Option ETA Setup cost in USD and LTC Difficulty increases same as 6 mo. historical avg and LTC stays at current price Difficulty increases same as 6 mo. historical avg and LTC increases at 6 mo. historical avg Difficulty increases less than 6 mo. historical avg and LTC increases at 6 mo. historical avg Difficulty increases more than 6 mo. historical avg and LTC increases at 6 mo. historical avg Difficulty increases same as 6 mo. historical avg and LTC increases at less than 6 mo. historical avg Difficulty increases same as 6 mo. historical avg and LTC increases at more than 6 mo. historical avg
Difficulty x4 @ 13200, LTC @ $27 on July 6th 2014 Difficulty x4 @ 13200, LTC x9 @ $243 on July 6th 2014 Difficulty x2 @6600, LTC x9 @ $243 on July 6th 2014 Difficulty x8 @ 26400, LTC x9 @ $243 on July 6th 2014 Difficulty x4 @13200, LTC x4.5 @ $121.5 on July 6th 2014 Difficulty x4 @13200, LTC x13.5 @ $364.5 on July 6th 2014
Scenario 1 Preorder 25MH/s Viper today  1/6/2014 Delivered in April $8900 or 329.6 LTC (no fees) Begin April 6th and after 3 months hashing = $4,890 or 171.45 LTC $41,662 or 171.45 LTC $83,324 or 342.9 LTC $20,511.63 or 84.81 LTC $20,831.17 or  171.45 LTC $62,493.52 or 171.45 LTC
Scenario 2 Preorder 25MH/s Viper today  1/6/2014 Delivered in July $8900 or 329.6 LTC (no fees) 0 0 0 0 0 0
Scenario 3 Buy mining rig with OTS GPUs worth $8900 today Start mining in 1-2 weeks $8900 or 329.6 LTC (no fees) 32 Vapor 7950s (Milkcrates) after 6 months hashing =  $7512 or 263.34 LTC $63,991.62 or 263.34 LTC $127,983.24 or 526.68 LTC $31,995.81 or 131.67 LTC  $31,995.81 or 263.34 LTC $95,987.43 or 263.34 LTC
Scenario 4 Buy mining rig with OTS GPUs @ 25 MH/s today Start mining in 1-2  weeks $8900 or 329.6 LTC (no fees) 42 Vapor 7950s (Milkcrates) after 6 months hashing =  $9780 or  342.9 LTC $83,324.7 or 342.9 LTC $166,649.4 or 685.8 LTC $41,662.35 or 171.45 LTC $41,662.35 or 342.9 LTC $124,987.05 or 342.9 LTC
Scenario 5 Invest $8900 (cost of Viper) into LTC today Buy and hold 329.6 LTC $8,900 $80,092.8 or 329.6 LTC $80,092.8 or 329.6 LTC $80,092.8 or 329.6 LTC $40,0046.4 or 329.6 LTC $120,139.2 or 329.6 LTC

See also: Why it is impossible to profitably mine bitcoin (BTC) with GPUs — but still quite profitable to mine litecoins (LTC)

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  1. The Mountain Pass rare earth mineral mine is an example of a mine that was recently restarted due to these economic conditions of supply, demand and profitability. []
  2. While you can read through the developmental history of both Bitcoin (the network) and bitcoin (the token), the original miners and early adopters from 2009 and 2010 mined for a variety of reasons and motivations.  Perhaps accumulation and appreciation were among those, yet the first “real” exchange didn’t occur until May 21st, 2010 — a $25 pizza was exchanged for 10,000 BTC.  See This Pizza Cost $750,000 from Motherboard. []
  3. See Automate and Control the Functional-Verification Process from Chip Design, Interview: Adnan Hamid Addresses Trends In Chip Verification from Electronic Design and Chip verification made easy by Laurent Fournier []
  4. Difficulty rating for Bitcoin adjusts every 2016 clocks or roughly every 2 weeks []
  5. Not to mention there is always the potential downtime in the even there is a net outage or electrical problem where the machine is located.  Unless you put it in a colocation, your machine’s uptime will be directly effected by where you live. []
  6. Contrary to popular myth Sears & Roebucks did not exist at this time and in fact was founded much later in its modern form in 1893.  It was Richard Sears’ father, James who went to California during the gold rush and failed to become rich. []
  7. See Engineering the Bitcoin Gold Rush: An Interview with Yifu Guo, Creator of the First Purpose-Built Miner from Motherboard and That Swedish Bitcoin Mining Company Has Sold $28 Million-Worth Of Its New Mining Hardware from Business Insider []
  8. See Alchip, KnCMiner team up for Bitcoin mining machine with 28nm ASIC from DigiTimes []
  9. There may also be other opportunities for a startup to focus on: hedging exposure, quantifying and qualifying risks and perhaps even insuring or re-insuring []
  10. I recommend reading through this Litecoin community thread which includes a very detailed chart based on estimated hashrates and difficulties. []

Interview with Litecoin’s Charlie Lee & Warren Togami

I’ve mentioned Litecoin throughout this past year and while most altcoins are complete scam pump-and-dumps, the Litecoin community continues to grow and reach new milestones.

Here is the latest interview from a few days ago with the core dev team (Charlie is the creator, used to work at Google and is now over at Coinbase; Warren is the creator of Fedora and is over at Redhat). [Reddit has the topic time codes]

I also recommend looking through this Litecoin dev reddit AMA from this past October.  Very interesting timeline and goals.

See also: Ex-Googler Gives the World a Better Bitcoin from Wired

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Cryptocurrency Cat-and-Mouse games in China

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

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

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

Too long; didn’t read

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

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

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

Cat-and-mouse

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

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

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

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

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

Bots again

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

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

Notes in the margin

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

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

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

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

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

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

How to detect if a cryptocurrency exchange is fudging numbers

Huobi versus incumbents

Crypto volumes in China

This picture has been making the rounds.  The top section is the volume of LTC at OKCoin.  The middle of BTC volume at BTCChina and the bottom is the BTC volume at Huobi.  The yellow line is when the PBOC stepped in and told 3rd party payment processors / intermediaries they could no longer transfer RMB into crypto exchanges.

In the last post I mentioned that there are speculative reports that exchanges in China (and probably globally) are fudging their volume numbers (e.g., why the sudden dramatic drop-off at certain sites relative to others).

Why is this done?  Before answering that I should point out that it is quite simple to create a server-side app that dynamically reports a volume number during specific periods of the day (e.g., higher during the work day to mimic traditional stock exchange peaks and troughs).  Exchanges currently have an incentive to fudge these numbers in an effort to attract eyeballs by claiming they have the biggest volume.  This then becomes a self-fulfilling prophecy as market participants (e.g., speculators, day traders, etc.) discover this volume number through a news source and then setup accounts to begin trading on the exchange.

How can you tell whether or not this is the case in China or elsewhere?   Merely looking at blockchain.info would be pointless because the transactions at exchanges are internal and do not affect the blockchain until there is a deposit or withdrawal.  And after all, lots of investors like day traders never actually withdraw their bitcoins each and every day due to transaction fees.  Thus the only verifiable way is to actually go inside an exchange and look at their accounting / exchange database to see the true turnover.

How to fake (some) numbers

Because exchanges merely self-report whatever they want to, ultimately this kind of fakery is easy to spot if you publicly expose your market depth.

Another way is if you, the exchange operator, run your own bots which arbitrage to make extra profit yet your bots do not pay any fees.  Whether that is actually fake is arguable (see below), however since the trades are actually conducted this kind of activity is typically not practiced in many “real” securities exchanges (e.g., akin to NASDAQ operating the exchange and yet maintaining an internal trading desk whereupon it does not have to pay fees).

And another way is to simply mirror other exchanges and if you are mirroring, you may be fudging the numbers to disguise it, or not. You might execute the mirrored trades or just have them for show.  In fact, you do not copy all the orders exactly, you randomize the quantities and prices slightly.  The trick is to randomize the numbers, but keep your risk low by minimizing arbitrage opportunities (this can all be done via an HFT system).

So again, sites like BTC123.com aggregate Chinese volume numbers and assume that the self-reported numbers are valid.  Maybe they are, but there is no real transparency currently.  And I’m not sure how you can add transparency either.  And more seriously, how can you (the exchange) going forward publish accurate information and get the same audience that has been misinformed in the past to believe you once again?

It should also be noted, it is not always clear what is or is ethical / fake with this speculation.  As suggested above with the NASDAQ example, the lines between the trading exchange and the banking institutions that utilize it may be blurry (e.g., conflict of fiduciary responsibilities in the event you have duties at both).1.

Blatantly lying about your volume is obviously fraud.  But is trading in your own exchange (with bots or otherwise) wrong?  Is mirroring (as long as you are willing to execute the mirrored trades) wrong?  It is not clear whether that is wrong / fake, perhaps at some point a guideline of best-practices will become adopted industry wide that clarifies this.

At the end of the day, what counts is whether or not I can get a fill at or close to market price.  Thus, as a trader, I care if you just make up the ticker numbers.  But I may not care about mirrored trades, as long as I can still trade against them.  One last point: using bots and/or mirroring trades enough to have large volume is expensive and risky.  It takes millions of dollars to copy the same volume as the major exchanges and increases as the price of tokens increases.  And in all likelihood, many investors only have accounts with one exchange.  Otherwise the arb opportunities could not be so relatively frequent as they have been the past 6 months.

Market makers

Perhaps the only other individuals who have the ability to test and audit volume numbers are market makers.  This could be a HNWI or a coordinated group of day traders consisting of as little as a few bored housewives who have money to burn (e.g., xiaosan).  What a market maker could do is video tape the entire buying and selling of chunks of 30-50 or more BTC to see whether or not the buy and sell orders are filled (e.g., if the liquidity does not exist, the orders could not be filled).  Note: this type of empirical activity can only be done going forward in time.  Unless you have access to a Psychohistory device, there is no way to verify who was fibbing in the past.

If you are willing and able to fulfill this pro bono role, you could test out volume claims at the three exchanges listed above throughout the forthcoming days and weeks and report your findings which would either way qualify one variable known unknown.

In fact, it would be in the exchange owners best interest to implore investigative journalists to  randomly place and fill buy / sell orders throughout a series of video taped interviews.  Specifically, large orders at several random hours each day (that are unannounced to anyone at the exchange).  This then could be repeated over a period of weeks to prevent any kind of rigging (e.g., exchange owners depositing and withdrawing cash simultaneously as known trades occur).

Finding volunteers for such a task would be difficult but it would likely work with roughly $100,000 based on current token prices (~$750).  Any large trader (who is willing to show you the their trades) could tell you whether the market volume is legitimate.  And ultimately, if you can fill a $100,000 trade, it is legit to you, regardless of what fakery the exchange operator may be doing.

[Special thanks to David Veksler and Scott Freeman for their thoughts and comments constructing this post.]

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  1. To clarify, this activity is not related to the actions of Bernie Madoff.  He committed fraud and violated his fiduciary responsibilities but not by using an internal desk at an exchange.  On the other hand, if the exchange utilizes its knowledge of customers book orders to front run, this could bring legal liabilites to the exchange.  Nor does this imply that HFT systems (small or large like the new one built by the NYSE in New Jersey) tied into cryptotrading are axiomatically front-running as they are unable to see other customer buy/sell orders. []