Explaining trading volumes in China

CoinDesk recently reached out to me to ask and see if I had any views on the divergent Bitcoin trading volumes between China relative to the rest of the world.  The piece they ran included a few of my comments as well as some from several other traders and exchange operators, “China’s Market Dominance Poses Questions About Global Bitcoin Trading Flows.”

Readers may also be interested in a few other comments I provided them, a few of which are slightly edited (removed some names and numbers):

  • I should preface this by saying that the OTC/off-chain liquidity/inventory is something that is not being factored into most of the overall discussion on trade volume.  I know that all the mining farms in China have liquidity partners (usually with the big three exchanges) and I could introduce you to one in particular who might be willing to talk on the record, or at least give you color.  The reason I mention this is because if you can some how dig up the OTC/dark inventory numbers, the aggregate volume might actually be larger in USD than RMB (at least, that would be my guess).
  • To answer your first two questions I think it bears mentioning that there really hasn’t been any new VC-backed exchange that has setup in the US in the past 6 months or so (itBit moved its SG operations to NYC).  Perhaps once the legal issues are more defined this can change.
  • In addition to having no fees on trades, I think this short comment on reddit describes some of the internal structural differences at the Chinese exchanges for question #3.
  • They’re busily trying to answer question #4 with a variety of value-added services like margin trading and issuing of derivative products as well as integrating with API services and even building out support for mining contracts (BTCChina apparently just acquired a mining pool/farm to do just that).
  • As far as your last question, I think it would be fair to say that public/open consumer-based exchanges are centered in China, but based on the OTC numbers that I hear throughout each month, USD is still probably bigger.  For instance, BitPay sells around XXXX BTC a day to its liquidity partners. That’s usually more than ______ does (at least this past summer).  Their daily sales are chopped/sliced up and sold to liquidity partners.  Charlie Shrem briefly touched on this a week or so ago.

Tim, why don’t you send yourself to a provably unspendable address?

Jeffrey Robinson is the author of over 20 books  This past week he published a new book that looks at the history and some characters of the Bitcoin ecosystem called “BitCon: The Naked Truth About Bitcoin.”  Earlier this summer he contacted me and asked me several questions, the answers of which appear in several spots in the book.

If you are tired of the continuous pumping on reddit, Twitter and conferences you will likely enjoy his challenges to cliche arguments.

For instance he pointed out that all the wars in the 16th, 17th and 18th century were not funded by central banks therefore it is unlikely that in the event Bitcoin did somehow take over the world, it probably would not make war disappear.  The term he uses to identify “true believers” that make such argument is Planet-Bitcoin — a place where this vocal group of people reside.  Speaking of which, probably the best quip throughout the book was at the end when a “true believer” calls him a “currency denier.”   Is that a thing now?

Two errors that stood out that I noticed: the Icelandic government actually ignored auroracoin entirely (it was just some random people that did the “airdrop”).  The other part is he stated, “So much so that amateurs have been thrown overboard by mining pools who can afford the ever-increasingly gigantic […]”  Technically these are farms not pools.

Two economic terms that are frequently glossed over by many digital currency advocates:

Recreating a circular flow of income when there are already dozens of competing currencies (e.g., USD, euro, yen) that currently fulfill this task will always be an ongoing hurdle for Bitcoin-like digital currencies.

Regarding my last quote in the book, I should point out that Ripple may not necessarily be a “better” protocol, it just solves different needs in different circumstances.  Though for some of the purposes for which Bitcoin is being shoe horned for, Ripple may be a better solution of the two.  However this is an empirical issue, we cannot know a priori and a TCO analysis should be undertaken by each enterprise.  As far as the fate of Bitcoin — that it can survive because its big holders will subsidize it — perhaps this could be the case, but it is also hard to say how long “whales” or big holders will be willing to subsidize any chain.  It is also unclear how many coins that purported whales actually control still (versus how much they have cashed out) — I have heard all sorts of ownership numbers and if you add them all up, they total more than 13.2 million coins that have been mined so someone at these conferences is embellishing.

A taste of quotes

While the user adoption, merchant adoption and transactional volume numbers will likely change in the coming weeks and months, it is a quick read and below are some choice quotes that stuck out to me.

On first-movers and fads:

The Dot-Com boom, and subsequent bust, of the 1990s rewrote that script. So did Betamax, mood rings, semi-automatic transmissions, floppy disks, 8-Track, Amphicars, Apple Lisa, WebTV, IBM PCjr, Zune, and the Segway.

On the externalizing the costs of mining:

Some miners even employ methods that are not exactly “cricket.” There was one in Holland who literally stole the electricity he needed to run 21 rigs. He eventually got caught. (source)

Regarding the continually misquoted numbers pulled from Coinometrics, Robinson asks co-founder Jonathan Levin for clarification:

“[…] It was right around the December price increase, so there was lots of stuff going on in the press about bitcoin, and all over social media, as well. Everyone was using social media to promote bitcoin Black Friday. It was a massive promotion and it paid off with big sales. But the numbers I’ve got for that period worked out at around 5%. So when you’re talking about comparing PayPal and Western Union with bitcoin the rest of the time, then only about 3% are for goods and services. That puts you at one-hundredth of any other network.” A good reason why, Levin says, might be because, “Bitcoin is terribly inefficient. It’s all about decentralized trust. But if you don’t need to have decentralized trust, updating a spreadsheet in a bank is far more efficient. The cost of updating the ledger is more expensive with bitcoin and takes much longer than any system in the world.” With bitcoin verifications taking up to 10 minutes, he asks, “What happens with Visa? How quickly do they reconcile their database? Instantaneously. Bitcoin introduces the ability to cut out the middleman. That’s fine. But the paradigm is that while the blockchain technology offers decentralization, it doesn’t give you a more efficient system.” That’s not bitcoin’s only “bragging rights” problem. According to Levin, “There is no correlation with the increase of merchants allowing customers to pay with bitcoin and the amount of bitcoins being used for transactions. It’s linear.”

On his use of imagery:

The New York Post’s Sunday business editor Jonathon Trugman wittily describes bitcoin as, “The Tinkertoy crypto-currency,” likening it to, “A modern-day game of three-card monte, with a little Sudoku thrown in, just to add a touch of mystique.”

On putting the theft at Mt. Gox into perspective:

If it turns out to be true that $ 400 million has been stolen, it’s more than the sum total of all the bank robberies in the US for the past seven years.

Regarding the hype of adoption and ATMs in Canada:

However, the Canadian Payments Association reported in April 2014 that while Canada is estimated to account for as much as 4% of bitcoin’s global transactions – ranking it number two in the world, behind the United States but  ahead of China – the volume of bitcoin transactions represents a mere 0.01% of Canada’s total debit and credit-based transactions.

“[…] not just that his is the largest company to do that, but a fast check of Google reveals there are actually more piano tuners just in Canada than there are businesses anywhere in the world of any size, keeping bitcoins on their books.

On the continual problem surrounding the ‘circular flow of income‘:

Dr Yanis Varoufakis, a political economist at the University of Texas and the University of Athens, says speculative demand for bitcoin outstrips transactional demand, “By a long mile. 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, he continues, 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.”

On the odds that Bitcoin will supplant the state:

Professor Stephen Mihm, who teaches economic, cultural and intellectual history of 18th and 19th century America at the University of Georgia, is convinced that bitcoin will not survive, because it cannot survive. He’s written, “Anyone who thinks that bitcoin will triumph, has to believe that it will succeed where earlier generations of private currencies failed, that bitcoin will, improbably, manage to overthrow more than centuries’ worth of accumulated state power, jealously guarded and ruthlessly enforced. That’s a preposterous fantasy, and a dangerous one if you’re an investor. Indeed, people who believe that governments of the world will let a stateless crypto-currency usurp their hard-won monetary prerogatives aren’t forecasting the future. They’re living in the past.”

More on whether or not it will supplant the state:

He says, another reason why bitcoin won’t be the one is because, “The misguided notion that you can free government from currency. Governments regulate money. They put certain constraints on it that you have to follow. So the technology that evolves must be ready to accommodate that. Most commerce will still be done in dollars. Currency is backed by the full faith and credit of a government. Bitcoin is backed by the full faith and credit of wasted computer time.” Seeing The Faithful, “Like a tribe,” he likes to think that their enthusiasm will, somehow, someday, “Help make progress towards a more rational digital currency. But, ultimately the providers of those currencies are probably going to be governments.” At this point, Borenstein argues, “No one should see blockchain technology as an end to a means. No one should look on it as a single achievement. Instead, it should be seen as a point on a spectrum. We may be long gone when bitcoin finally dies, but that doesn’t mean it’s been a success.”

On volatility:

David Yermack, a professor at New York University’s Stern School of Business, and director of the Pollack Center for Law and Business, believes that bitcoin resembles a speculative investment similar to the Internet stocks of the late 1990s. Writing in the MIT Technology Review, he summed up bitcoin’s problems this way: “During 2013 its volatility was three to four times higher than that of a typical stock, and its exchange rate with the dollar was about 10 times more volatile than those of the euro, yen, and other major currencies. Bitcoin’s dollar price exhibits no correlation with the dollar’s exchange rates against other currencies. Nor does it correlate with the value of gold. With a currency whose value is so untethered, it is nearly impossible to hedge against risk.”

Even if volatility subsided and bitcoin somehow found a place as a global payment system, because there can only ever be 21 million bitcoins, Yermack pointed out, it is inherently deflationary. “A fixed money supply is incompatible with a growing economy. Workers would have to accept pay cuts every year, and prices for goods would gradually fall. Such conditions might lead to public unrest reminiscent of the late 19th century’s free-silver and populist movements — an ironic consequence of a currency known for its futuristic cachet.

On the talk of losing purchasing power over the past century:

Levine shrugs that off. “Talk of 1913 dollars is completely meaningless. You need a small amount of consistent inflation because the effects of deflation are so awful. Why is everyone holding onto their bitcoins instead of spending them or lending them? Because they think it will be worth more. Back in the 1800s, people put cash in the mattress because nobody was managing the currency and there were no credible markets, except in Britain. These days, only a nitwit puts cash in the mattress.” He throws back at them the classic dilemma that the Founding Father’s faced in the 18th century – the bankers versus the farmers. “Historically, the bankers wanted hard money, which meant gold, so that their dollar denominated assets would become ever more valuable. The farmers, who were always in debt, wanted cheap money, which in the 1800s meant silver, because they wanted some inflation so they could pay off all their loans. This argument starts with Hamilton and basically doesn’t end until we get off the gold standard. Bitcoin is a world where everybody wants to be a banker and nobody admits he’s a farmer.”

Is it similar to how the internet evolved?

I then asked Borenstein what he thought about The Faithful’s often quoted comparison – that the birth and development of bitcoin mirrors the birth and development of the Internet. He wasn’t having any of it. “The Internet was designed by the most open process known to man, there’s not even an organization behind it. Thousands of people are responsible for making the Internet work through endless sessions of technical minutiae where everybody agrees to do something the same way. That does not sound like bitcoin. There may be all sorts of similarities that don’t matter. The same language, the same open source modules, but I don’t see it as being anything at all like the same.” While he remains hopeful that, one day, we will see widespread use of digital currencies, he confidently predicts, “Bitcoin won’t be it. The technology must be configured in such a way as to meet the national, political and social goals of the people who are going to run that currency. You could lay that universal framework at the software level, the systems that will inevitably be out there, to make them interchangeable. If that happens, I doubt that bitcoin’s code will be very useful.”

On hype and irrational exuberance:

Tech guru John Dvorak described it perfectly in one of his columns: “The amount of money squandered during the Dot-Com era because of ‘paradigm shifts’ and ‘new economies’ is staggering. People actually believed that all retailing would be online and that all groceries would be delivered to the home as they were in the 1920s, despite changes that make delivery impractical. Who cares about reality?”

On the wisdom of trying to short exuberance:

Referring to bubbles as “spontaneous optimism,” John Maynard Keynes pointed out, “The market can stay irrational longer than you can stay solvent.”

On the difficulty of creating other derivative products:

His answer to the first question is no. His answer to the second is yes. Bitcoin mining is very expensive, he explains, and most miners barely break even. Then, because the technology is designed to produce fewer and fewer bitcoins, he is concerned with who’s going to pay for verifying each transaction? “Eventually, as the supply of bitcoin diminishes, those fees will increase to cover the cost of authenticating the transactions, and will become competitively close to the fees for international bank wires. The arithmetic is really simple. I don’t see any way around it.” Levine shares Krugman’s doubts about bitcoin as a currency – “For a while I thought it was like Pet Rocks without the rocks” – but now he wonders, “Would you be willing to take out a mortgage written in bitcoin? The volatility suggests no one would. And, what does it say about bitcoin as a currency when nobody is willing to do anything with it besides a spot transaction?”

On MintChip and building things before there is enough demand for it:

The idea of electronic payment systems has been around for a while, but it wasn’t until 1990 that it actually got off the ground. That’s when Dr. David Everett in the UK invented the first “electronic purse.” His system was called Mondex. Developed with National Westminster Bank, it was a revolutionary idea for its day. The cash was your smart card and you spent it at point of sale terminals. For a while it got a lot of attention, then eventually, fizzled out. Everett was severely disappointed.

“I’m afraid it was way before it’s time. Just too early. In hindsight, there was nothing really broken about payment systems at the time. The Internet didn’t really exist yet. Mobile phones didn’t really exist yet. The focus we had was paying at point of sale. It was very good for the merchant, but in the end it was not so for the consumer who argued, why would I bother?” A world expert on payment systems, coding theory and cryptography for the protection of data, Everett is CEO of the Smart Card Group, technical director of Smart Card News and a man who says that his mission in life is still electronic cash. “I am an enormous believer in electronic cash.” When the Canadians asked him to help them design MintChip, he jumped at the opportunity. “MintChip was almost ten years after Mondex and I was convinced about that one too.” The idea that a Mint would produce electronic cash, “Just seemed so logical,” he says. “That’s what mints do. They mint cash.” As technical architect for the project, Everett was looking to reproduce the ease would want to do, so now you’re into merchants. Maybe a big retail chain. Say Walmart. The cost of managing cash for them is quite high, and credit and debit cards carry with them transaction fees. For big merchants, electronic cash is ideal. Here’s a way of handling payments at a fractional cost of handling cash. Walmart Dollars would work very well and if they did it, everyone would follow.” Ideally, he says, whatever the next stage is, it would not be linked to a bank account or a debit card. “We need to be unconnected. In that sense it is like bitcoin because bitcoin is unconnected. But what I want to see is a real electronic object representing cash. That’s very different from bitcoin.” For him, bitcoin is, “A new form of gold. It is electronic gold. Whereas Mondex and MintChip is equivalent to real currency, a real pound or a real dollar. I think there are a lot of nice things in the bitcoin technology, but I don’t think it’s very good for cash. It doesn’t really lend itself to immediate payments. I’m surprised bitcoin has gone as far as it has.”

On the faux news that Mastercard would be adding support for bitcoin as well as a recent patent filing:

[…] assured me Mastercard wasn’t doing anything of the kind. He explained, the application was filed to protect Mastercard’s intellectual property and did not indicate any commitment to bitcoin. “There is no obligation to ever build anything that a patent application covers.” JP Morgan had done a similar thing with a payments’ patent, putting bitcoin in there, and The Faithful reacted in kind. A spokesperson for Morgan gave me much the same answer as Mastercard. Now I brought it up with Borenstein. A man who still spends a large part of every day working on patents, he says that neither company has any intention of ever accepting bitcoins. Instead, he suggests, they harbor more sinister intentions. “Every patent has to describe all the different storage technologies it might reside on. Which really means, they’re arming themselves for a possible war. Just in case bitcoin ever poses a real threat. They’ll do what they can to wipe them out.”

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.

Cryptocurrency in the news #28

Much like “The Singularity” was en vogue 10 years ago for a slew of reasons that haven’t really materialized (i.e., “an idea before its time”), it is equally unclear how or why blockchains + the Internet of Things has been receiving so much attention. For instance, IBM recently published: “Device democracy: Saving the future of the Internet of Things.”

Let’s be quite clear: yes this technology could develop to work as stated in the next decade.  However, it is unclear why Ethereum, which has still not launched despite 8 months of non-stop marketing, is being cited as the test bed.  I am skeptical that when it does launch, that its economic model will be able to fuel the use-cases that everyone seems to throw at it.

In the meantime, other stories this past week:

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).

The Continued Existence of Altcoins, Appcoins and Commodity coins

Yesterday I gave a presentation at a Bitcoin Meetup held hosted by Plug and Play Tech Center in Sunnyvale.

I discussed the economic incentives for creating altcoins, appcoins, commodity coins and also covered several bitcoin 2.0 proposals.  The slides and video from the event are viewable below.  Download the deck for other references and citations.

False analogies in Bitcoinland plus Alibaba

Saw two analogies used today that are inaccurate.

Writing at Forbes, Eric Mu interviewed Jake Smith, better known as “The Coinsman.”  Jake was responding to a comment I wrote last month:

Tim Swanson, the author of The Anatomy of a Money-like Informational Commodity, recently said that you missed the “unseen calculation, the economics of extracting and securing rents on this ledger unit, which consume scarce resources from the real economy.” – Do you think he is wrong?

I think attacking mining from an environmental point of view is quite silly, because pretty much everything in the modern era relies on resource consumption, and for the vast majority of those things society has decided that the trade-off is worth it. I think Bitcoin is one of the most valuable and revolutionary inventions the world has ever seen, so even if it is using a lot of electricity I don’t think that’s a valid criticism against it. The internet uses vastly more electricity than Bitcoin, no one is bashing the internet for using resources.

Swanson’s quote would also imply that Bitcoin is not part of “the real economy”. I would say that by virtue of its existence, it is.

Further, Bitcoin’s value is derived in part from the fact that it is difficult to create.

The biggest problem with the analogy above, which is commonly used by Bitcoin advocates, is that it is not an apple’s to apple’s comparison.  In this instance, Bitcoin acts as a distributed Excel workbook, a spreadsheet application that uses the internet to distribute itself.  Thus it is incorrect to equate it with the much broader umbrella that is the entirety of the internet.

This same problem happens when people claim that Bitcoin can and/or will replace the banking system.  For instance, last month Jake interviewed Nan Xiaoning, CEO of Bitocean:

I think Satoshi had a lot of foresight in this regard. He wasn’t a dummy, I’m sure he considered different ways of distributing coins.

Some people say that bitcoin wastes a lot of electricity. But the banking industry surely uses more resources than bitcoin does. But bitcoin is a peer-to-peer system. I think using resources to guarantee its security and stability is the way it should be.

Another inaccurate analogue/comparison.  Bitcoin’s protocol does not provide any of the functionality of the banking system beyond a security lock box (that should not be confused with a distinctly different term, a savings account) and a corresponding ledger of access and usage (the debate over whether or not someone “owns” a privkey corresponding to a UTXO it is still being argued over by lawyers globally).  The current protocol does not natively allow for lending, saving, notary, underwriting debt and equity or setting of interest rates (among many other services real banks actually provide).

In both cases above the examples above miss the forest from the trees.  As Robert Sams pointed out a few days ago, the proof of work mechanism used in Bitcoin was designed to make Sybil attacks expensive.  The verification process is a marginally trivial task and can be handled (and in practice actually is handled) by mining pools via small computers such as a Pi-based box.

How specialized is the hashing (not verification) process?  A good comment on reddit yesterday noted that:

Rather than taking the whole header, they mine using something called a midstate. Due to the nonce being at the end of the header, the software hashes up to just before the nonce, and then sends that (called a “midstate”) to the mining chip. The mining chip then only needs to add a nonce, do the end of a SHA256 round, and then one more, and then check if the result is good enough. Rather than returning data, they just return nonces which look to be valid.

Instead, a more accurate way to look at this issue is from the spectrum of centralized to decentralized (which was also discussed by the Hyperledger team in an interview a couple days ago).

Centralized tools and services have certain vulnerabilities (e.g., single point of failure and potential abuse) but its cost basis is different than say, a decentralized entity.  The economics of both need to be accounted for (and are) when rolling out a new system internally (this is called the Total Cost of Ownership).

On the other end, decentralized systems are less vulnerable to some of the same issues that centralized systems are, yet to make them less vulnerable in fact requires consuming scarce resources that centralized solution do not have to (because they are trusted networks).  In the case of Bitcoin, bitcoin miners (or technically hashers) effectively destroy (or “burn”) a corresponding amount of energy (technically exergy) to protect the network from Sybil attacks on an untrusted network.  This is a real cost that cannot be ignored yet as shown above, is often handwaved away.

[Note: as an aside, most miners, mining farms and mining manufactures do not pay for their capex or opex in bitcoins, nor is this likely going to change anytime soon.  Instead they must rely on and permaborrow the unit of account of fiat (typically a USD or RMB) to effectively measure and allocate resources.  This unit of account issue — wherein economic activity within the Bitcoin world is measured with the unit of account that is fiat to create this network — was also broached by Robert Sams several months ago.]

Furthermore, as I mentioned in chapter 8, if the TCP/IP analogy was correct then the marginal revenue for ISPs would split in half every 4 years.  And that through competition the marginal cost of protecting and sending packets would equal the marginal value of those packets.  This would not be an effective way to run a business let alone design a network topology.

In the real world, the marginal costs of running an ISP, which is centralized, have to be less than the marginal revenue otherwise they go bankrupt as they could not pay for overhead.  So yes, in fact, ISPs do try to actually mitigate the leakage, wastes and otherwise inefficiencies in its own internal network and they do this through a myriad of ways.

Bitcoin’s existence is on the other side of the spectrum.  Bitcoin was purposefully designed to make it cost prohibitive to spam ownership change on a public, untrusted network — the complete opposite in organization that an ISP is designed to operate as.  The average person would likely see this as inefficient, but that is because up until the past decade — with the advent of Bittorrent and other distributed systems — the public at large was unfamiliar with how these systems are designed.  And as Sams pointed out, using the word “efficient” versus “inefficient” may not be the most accurate terminology, because each model has different attack vectors they have to account for.

Thus again, it is not about being pro or anti proof-of-work.  Rather it is acknowledging that proof of work requires a certain economic model that have real costs that scale with token value and in the case of Bitcoin, is not environmentally “greener” than some centralized solutions (e.g., ApplePay).

The case of Alibaba

Over the past couple of days some Bitcoiners have recently claimed that the recent dip in market prices for bitcoins is because of the Alibaba IPO; “Alibaba’s US IPO May Have Crashed the Bitcoin Price.”

Not only does this show that several vocal Bitcoiners are unfamiliar with how real IPOs work (underwriters typically represent the lion’s share of additional equity ownership and the date is fixed weeks and months ahead of time) but that it illustrates how some Bitcoiners like to blame people and go on a witch hunt when prices decline but then reassure themselves that they are investment geniuses when prices trend northerly.

In point of fact, the Alibaba IPO was not a surprise to anyone, the investors are all large financial institutions and not hoi polloi.  The IPO was oversubscribed and not even well heeled, well connected HNWIs could get into an allotment — only banking institutions were able to because of the enormous demand.  And none of those institutions are: 1) large bitcoin holders and 2) needed to sell bitcoins to raise funds to buy Alibaba shares.

Perhaps this will change in the future, but that is not the case in this instance (be sure to also check out Izabella Kaminska’s lively twitter feed).

Why do prices fluctuate #2?

Yesterday CoinDesk asked for my take on the current downtrend in market prices.  Incidentally, nearly a month ago, this same question was sent to me (here was my response then).  I sent them a statement and they published a couple of the comments in a new article, “Downward Pressures Persist as Bitcoin’s Price Declines to Near $400.”

Readers may be interested in a few of the other comments I mentioned to CD below:

Charlie Shrem made some interesting comments about OTC liquidity earlier today.  However, the fact that merchants and some miners are not dealing with exchanges directly, does not mean they cannot move the price.  That is what we are seeing now — it may not matter how many people are “buying off-chain” or “off-market” because no one wants to lose money.

And in other cases, an OTC buyer can affect exchange via “buy pressure.”  If he begins buying directly from an OTC provider, avoiding an exchange, the exchange loses its buy wall thus affecting price.  The sell pressure forces the price down and once a large buyer goes “off-market,” he is weakening the buy pressure.  If all the buyers and sellers are “off-market,” we can say that exchange price and price discovery is distorted.  As my friend Raffael Danielli recently said, “Information is never off-chain and ultimately information makes the price.”  Consequently today information spreads very quickly and if a broker can make money because he facilitates “off-chain” transaction and knows “better” what the real price is then game theory dictates he should take advantage off this (investment banks do the same with OTC).

So in addition to partnership agreements, they probably also sell somewhere else to mitigate exposure to this volatility.  In addition, many miners have to finance their operations and at current prices of $410, roughly $1.6 million is created every day via block rewards and it has to go somewhere.  Fewer people buying?  Down we go.

People are always rationalizing things in a down turn.  Maybe an early adopter bought a house or car and cashed out a couple of million worth the past couple of days.  Or maybe some of the dev teams that recently raised funds via crowdsales need to sell in order to fund development.  Just because the ticker price says $410 doesn’t mean every bitcoin in the world is worth $410.  It is temporal and the public market is still very illiquid, so start cashing out and see what happens to market prices.  Again, it is only as valuable as another party is willing to pay for it.  And in theory, it will only stop once the marginal cost of creating new coins equals the current price (MV=MC), which Robert Sams wrote about earlier this week..  Though in practice, some miners can operate at loss to recover at least some funds — however it would be in their best interest to simply turn off their equipment instead and buy bitcoins with the expectation of price appreciation.  It also depends on how much they’re leveraged at places like Paymium, BTCJam and Bitfinex.

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.

Cryptocurrency in the news #27

One of the most interesting story this week is commentary from Robert Sams, “Some Crypto Quibbles with Threadneedle Street,” who discusses the marginal costs of mining and addresses some of the statements from last weeks Bank of England papers.

Also, a couple of interesting emails/thread from the past from Gavin Andresen and Mike “Hearn: My first message to Satoshi…

Below are stories and posts from over the past week that are related to digital currencies.  Linking does not constitute endorsement of service, coin or project.

[Note: creating a “Better Business Bureau” or Consumer Reports of Bitcoin is in its nascent stage via Proof-of-Developer and Coinist and Coin Source Trust Index.]

Cryptocurrency in the news #26

Closing tabs.  Some China related news scattered below as well.

The Bank of England published a couple of papers that have been making the rounds.  One area of contention, by some, is a section in the 2nd paper The sustainability of digital currencies’ low transaction fees which discusses some of the issues brought up in Chapter 3.

Link is not an endorsement of service or coin.

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.

Cryptocurrency in the news #25

Closing tabs.

If you’re interested in a blast from the past — to see just how fast the cryptocurrency space has moved in the past 16 months, look at the list of Panelists and Speakers from the San Jose 2013 conference and the projects they were working on.  Or is the more appropriate word, “pivoting?”

Below are links of interest and are not an endorsement for services:

Does Smart Contracts == Trustless Multiparty Monetary Computation?

My friend, Zaki Manian, who is working on a very interesting project called SKUChain (discussed in chapter 16), thinks we should reframe how we perceive or rather how we should define ‘smart contracts.’

In his view:

Here is my proposal.

We stop calling the idea ” smart contracts” and we start calling the idea “Trustless Multiparty Monetary Computation”. That should also tell the lawyers that we don’t really need them here at the moment….

Programming Language researchers use the term “contracts” as a way of formally reasoning about multi-part or distributed computation. But PL researchers also understand that this is idea has deep formal connections with reasoning about the relationship between people and organizations.

Here is the relevant prior art.
The SPJ paper from 2000

Some implementation of the SPJ’s ideas

This was in response to the panel discussion last weekend and was brought up by Adam Krellenstein from Counterparty.

If anyone is interested in discussing this further, let me know and I’ll put you in touch with Zaki or others.

Cryptocurrency in the news #24

Closing tabs.

Got an email asking me more about the War of Spanish Succession related to gold.  My point on that panel wasn’t so much that France only used gold, but their finances were directly tied to specie (technically the French livre was in two forms: silver écu and gold Louis d’or; see also Livre tournois).  The reason I brought it up at all is because of the meme today, that Bitcoin would somehow prevent war because it neutralizes the states ability to expand its money supply, etc..  It won’t though.  Probably a better historical example are European countries from mid-19th century which adopted some form of a gold standard, yet then went on to wage a global war eventually dropping the peg altogether.  Be sure to read a new article from The Economist that discusses this, “Not floating, but flailing.”

Thanks to Izabella Kaminska (follow her on Twitter) and Zaki Manian for a couple links.

Also, be sure to check out Izabella’s thread today on Coinbase.  Based on a conversation with one lawyer I had two weeks ago it looks like a big legal challenge for Coinbase (and others in their vertical) is that they’re acting as depository institutions without having gone through the necessary “Safety & Soundness” tests which opens them up to legal action from a variety of state/federal agencies.