I recently created a thread that on Twitter regarding the lower-bound estimates for how much electricity the Bitcoin blockchain consumed using publicly available numbers.
The first part of this post is a slightly modified version of that thread.
The second part of this post, below part 1, includes additional information on Bitcoin Cash, Ethereum, Litecoin, and Monero using the same type of methodology.
The original nested thread started by explaining why a proof-of-work (PoW) maximalist view tries to have it both ways.
You cannot simultaneously say that Bitcoin is – as measured by hashrate – the “most secure public chain” and in the same breath say the miners do not consume enormous quantities of energy to achieve that. The fundamental problem with PoW maximalism is that it wants to have a free energy lunch.
All proof-of-work chains rely on resource consumption to defend their network from malicious attackers. Consequently, a less resource intensive network automatically becomes a less secure network.1 I discussed this in detail a few years ago.
Part 1: Bitcoin
Someone recently asked for me to explain the math behind some of Bitcoin’s electricity consumption, below is simple model using publicly known numbers:
the most common mining hardware is still the S9 Antminer which churns out ~13 terahashes/sec
Thus the hashrate pointed at the Bitcoin network today is about 50,000,000 terashashes.
Dividing one from the other, this is the equivalent of 3,846,000 S9s… yes over 3 million S9s.
While there is other hardware including some newer, slightly more energy efficient gear online, the S9 is a good approximate.
Because the vast majority of these machines are left on 24/7, the math to estimate how much energy consumption is as follows:
in practice, the S9 draws about 1,500 watts
so 1,500 x 24 = 36kWh per machine per day
Note: here’s a good thread explaining this by actual miners.
In a single month, one S9 will use ~1,080 kWh.
Thus if you multiply that by 3,846,000 machines, you reach a number that is the equivalent of an entire country.
for a single day the math is: ~138.4 million kWh / day
annually that is: ~50.5 billion kWh / year
For perspective, ~50.5 billion kWh / year would place the Bitcoin network at around the 47th largest on the list of countries by electricity consumption, right between Algeria and Greece.
But, this estimate is probably a lower-bound because it doesn’t include the electricity consumed within the data centers to cool the systems, nor does it include the relatively older ASIC equipment that is still turned on because of local subsidies a farm might receive.
In Iceland, the finance minister has warned that cryptocurrency mining – which uses more power than the nation’s entire residential demand – could severely damage its economy.
Recent analysis from a researcher at PwC places the Bitcoin network electricity consumption higher, at more than the level of Austria which is number 39th on that list above. Similarly, a computer science professor from Princeton estimates that Bitcoin mining accounts for almost 1% of the world’s energy consumption.2
Or to look at it in a different perspective: the Bitcoin network is consuming the same level of electricity of a developed country – Austria – a country that generates ~$415 billion per year in economic activity.
Based on a recent analysis from Chainalysis, it found that Bitcoin – which is just one of many proof-of-work coins – handled about $70 million in payments processed for the month of June. Yet its cost-per-transaction (~$50) is higher than at any point prior to November 2017.
You don’t have to be a hippy tree hugger (I’m not) to clearly see that a proof-of-work blockchains (such as Bitcoin and its derivatives) are currently consuming significantly more resources than they create. However this math is hand-waved away on a regular basis by coin lobbyists.
The figure also didn’t include the e-waste generated from millions of single-use ASIC mining machines that are useful for about ~12 months; or the labor costs, or building rents, or transportation, etc. These ASIC-based machines are typically discarded and not recycled.
In addition to e-waste, many mining farms also end up with piles of discarded cardboard boxes and styrofoam (source)
Part 2: Bitcoin Cash
With Bitcoin Cash the math and examples are almost identical to the Bitcoin example above. Why? Because they both use the same SHA256 proof-of-work hash function and as a result, right now the same exact hardware can be used to mine both (although not simultaneously).3
So what do the numbers look like?
The BCH network hashrate has been hovering around 4 – 4.5 exahashes the past month. So let’s use 4.25 exahashes.
Note: this is about one order of magnitude less hashrate than Bitcoin so you can already guesstimate its electricity usage. But let’s do it by hand anyways.
An S9 generates ~13 TH/s and 4.25 exahashes is 4.25 million terahashes.
After dividing: the equivalent of about 327,000 S9s are used.
Again, these machines are also left on 24/7 and consume about 36 kWh per machine per day. So a single S9 will use ~1,080 kWh per month.
327,000 S9s churning for one day: ~11.77 million kWh / day
Annually this is: ~4.30 billion kWh / year
To reuse the comparison above, what country’s total electricity consumption is Bitcoin Cash most similar to?
How much economic activity does Moldova and Cambodia generate with that electricity consumption? According to several sources, Cambodia has an annual GDP of ~ $22 billion and Moldova has an annual GDP of ~$8 billion.
For comparison, according to Chainalysis, this past May, Bitcoin Cash handled a mere $3.7 million in merchant payments, down from a high of $10.5 million in March a couple months before.
Also, the Bitcoin Cash energy consumption number is likely a lower-bound as well for the reasons discussed above; doesn’t account for the e-waste or the resources consumed to create the mining equipment in the first place.
This illustrates once again that despite the hype and interest in cryptocurrencies such as Bitcoin and Bitcoin Cash, there is still little real commercial “activity” beyond hoarding, speculation, and illicit darknet markets. And in practice, hoarding is indistinguishable from losing a private key so that could be removed too. Will mainstream adoption actually take place like its vocal advocates claim it will?
Discarded power supplies from Bitcoin mining equipment (source)
At the time of this writing, the Ethereum network is still largely dominated by large GPU farms. It is likely that ASICs were privately being used by a handful of small teams with the necessary engineering and manufacturing talent (and capital), but direct-to-consumer ASIC hardware for Ethereum didn’t really show up until this summer.
There are an estimated 10 million GPUs churning up hashes for the Ethereum network, to replace those with ASICs will likely take more than a year… assuming price stability occurs (and coin prices are volatile and anything but stable).
For illustrative purposes, what if the entire network were to magically switch over the most efficient hardware -the Innosilicon A10 – released next month?
Innosilicon currently advertises its top machine can generate 485 megahashes/sec and consumes ~ 850 W.
So what is that math?
The Ethereum network is ~300 TH/s which is around 300,000,000 megahashes /sec.
Quick division: that’s the equivalent of 618,557 A10 machines.
Again, each machine is advertised to consume ~850 W.
in a single day one A10 consumes: 20.4 kWh
in a month: ~612 kWh
So what would 618,557 A10 machines consume in a single day?
– about 12.6 million kWh / day
– about 4.6 billion kWh / year
That works out to be between Afghanistan or Macau. However…
Before you say “this is nearly identical to Bitcoin Cash” keep in mind that the Ethereum estimate above is the lowest of lower-bounds because it uses the most efficient mining gear that hasn’t even been released to the consumer.
In reality the total energy consumption for Ethereum is probably twice as high.
Why is Etherum electricity usage likely twice as high as the example above?
Because each of the ~10 million GPUs on the Ethereum network is significantly less efficient per hash than the A10 is. 4 Note: an example of a large Ethereum mine that uses GPUs is the Enigma facility.
For instance, an air-cooled Vega 64 can churn ~41 MH/s at around 135 W which as you see above, is much less efficient per hash than an A10.
If the Ethereum network was comprised by some of the most efficient GPUs (the Vega 64) then the numbers are much different.
Starting with: 300,000,000 MH/s divided by 41 MH/s. There is the equivalent to 7.32 million Vega GPUs generating hashes for the network which is more in line with the ~10 million GPU estimate.
one Vega 64 running a day consumes ~3.24 kWh
one Vega 64 running a month: ~77.7 kWh
If 7.32 million Vega equivalent GPUs were used:
in a day: ~ 23.71 million kWh
in a year: ~8.65 billion kWh
That would place the Ethereum network at around 100th on the electricity consumption list, between Guatemala and Estonia.
In terms of economic activity: Guatemala’s GDP is around $75 billion and Estonia’s GDP is around $26 billion.
What is Ethereum’s economic activity?
Unlike Bitcoin and Bitcoin Cash, the stated goal of Ethereum was basically to be a ‘censorship-resistant’ world computer. Although it can transmit funds (ETH), its design goals were different than building an e-cash payments platform which is what Bitcoin was originally built for.
So while merchants can and do accept ETH (and its derivatives) for payment, perhaps a more accurate measure of its activity is how many Dapp users there are.
There are a couple sites that estimate Daily Active Users:
State of the Dapps currently estimates that there are 8.93k users and 8.25K ETH moving through Dapps
DappRadar estimates a similar number, around 8.37k users and 8.57K ETH moving through Dapps
Based on the fact that the most popular Dapps are decentralized exchanges (DEXs) and MLM schemes, it is unlikely that the Ethereum network is generating economic activity equivalent to either Guatemala or Estonia.5
For more on the revenue Ethereum miners have earned and an estimate for how much CO2 has been produced, Dominic Williams has crunched some numbers. See also this footnote.6
According to Malachi Salacido (above), their mining systems (in the background) are at a 2 MW facility, they are building a 10 MW facility now and have broken ground on a 20 MW facility. Also have 8 MW of facilities in 2 separate locations and developing projects for another 80 MW. (source)
Part 4: Litecoin
If you have been reading my blog over the past few years, you’ll probably have seen some of my Litecoin mining guides from 2013 and 2014.
If you haven’t, the math to model Litecoin’s electricity usage is very similar to both Bitcoin and Bitcoin Cash. From a mining perspective, the biggest difference between Litecoin and the other two is that Litecoin uses a hash function called scrypt, which was intended to make Litecoin more “ASIC-resistant”.
Spoiler alert: that “resistance” didn’t last long.
Rather than diving into the history of that philosophical battle, as of today, the Litecoin network is composed primarily of ASIC mining gear from several different vendors.
One of the most popular pieces of equipment is the L3+ from Bitmain. It’s basically the same thing as the L3 but with twice the hashrate and twice the power consumption.
So let’s do some numbers.
Over the past month, the Litecoin network hashrate has hovered around 300 TH/s, or 300 million MH/s.
Based on reviews, the L3+ consumes ~800 W and generates ~500 MH/s.
So some quick division, there are about 600,000 L3+ machines generating hashes for the Litecoin network today.
As an aggregate:
A single L3+ will consume 19.2 kWh per day
So 600,000 will consume 11.5 million kWh per day
An annually: 4.2 billion kWh per year
Coincidentally this is roughly the same amount as Bitcoin Cash does as well.
So it would be placed around 124th, between Moldova and Cambodia.
Again, this is likely a lower-bound as well because it assumes the L3+ is the most widely used ASIC for Litecoin but we know there are other, less efficient ones being used as well.
What about activity?
While there are a few vocal merchants and a small army of “true believers” on social media, anecdotally I don’t think I’ve spoken to someone in the past year who has used Litecoin for any good or service (besides converting from one coin to another).
We can see that — apart from the bubble at the end of last year — the daily transaction volume has remained roughly constant each day for the past 18 months. Before you flame me with a troll account, consider that LitePay collapsed before it could launch, partly because Litecoin still lacks a strong merchant-adopting ecosystem.
In other words, despite some support by merchant payment processors, its current usage is likely as marginal as Bitcoin and Bitcoin Cash.
Genesis Mining facility with Zeus scrypt mining equipment (source)
Part 5: Monero
The math around Monero is most similar to Ethereum in that it is largely dominated by GPUs.
In fact, earlier this year, a large number of Monero developers convinced its boisterous userbase to fork the network to prevent ASICs from being used. This resulted in four Monero forks and basically all of them are dominated by high-end GPUs.
For the purposes of this article, we are looking at the fork that has the highest hashrate, XMR. Over the past month its hashrate has hovered around 475 MH/s.
Only 475 MH/s? That may sound like a very diminutive hashrate, but it is all relative to what most CPU and GPU hashrate performance is measured in Monero and not other coins.
For example, MoneroBenchmarks lists hundreds of different system configurations with the corresponding hashrate. Similarly there are other independent testing systems that provide public information on hashrates.
Let’s take that same Vega 64 used above from Ethereum. For Monero, based on tweaking itgenerates around 2000 hashes/sec and consumes around 160 W.
So the math is as follows:
475,000,000 hashes/sec is the current average hashrate
A single Vega 64 will generate about 2000 hashes/sec
The equivalent of 237,500 Vega 64s are being used
Each Vega 64 consumes about 3.84 kWh per day
So 237,500 Vega 64s consume 912,000 kWh per day
And in a year: 332 million kWh
The 332 million kWh / year figure is a lower-bound because like the Ethereum Vega 64 example above: it doesn’t include the whole mining system, all of these systems still need a CPU with its own RAM, hard drive, and so forth.
As a result, the real electricity consumption figure is much closer to Haiti than Seychelles, perhaps even higher. Note: Haiti has a ~$8.4 billion economy and the GDP of Seychelles is ~$1.5 billion.
So what about Monero’s economic activity? Many Monero advocates like to market it as a privacy-focused coin. Some of its “core” developers publicly claimed it would be the best coin to use for interacting with darknet markets. Whatever the case may be, compared to the four above, currently it is probably the least used for commercial activity as revealed by its relative flat transactional volume this past year.
A now-deleted image of a Monero mining farm in Toronto (source)
Above were examples of how much electricity is consumed by just five proof-of-work coins. And there are hundreds of other PoW coins actively online using disproportionate amounts of electricity relative to what they process in payments or commerce.
This article did not dive into the additional resources (e.g., air conditioning) used to cool mining equipment. Or the subsidies that are provided to various mining farms over the years. It also doesn’t take into account the electricity used by thousands of validatingnodes that each of the networks use to propagate blocks each day.
It also did not include the huge amount of semiconductors (e.g. DRAM, CPUs, GPUs, ASICs, network chips, motherboards, etc.) that millions of mining machines use and quickly depreciate within two years, almost all of which becomes e-waste.7 For ASIC-based systems, the only thing that is typically reused is the PSU, but these ultimately fail as well due to constant full-throttle usage.
In summation, as of this writing in late August 2018:
Bitcoin’s blockchain likely uses the same electricity footprint as Austria, but probably higher
Bitcoin Cash’s blockchain is at least somewhere between Moldova and Cambodia, but probably higher
Ethereum’s blockchain is at least somewhere between Guatemala and Estonia, but probably higher
Litecoin’s blockchain is at least somewhere between Moldova and Cambodia, but probably higher
One of Monero’s blockchains is at least somewhere between Haiti and Seychelles, but probably higher
Altogether, these five networks alone likely consume electricity and other resources at an equivalent scale as The Netherlands especially once you begin to account for the huge e-waste generated by the discarded single-use ASICs, the components of which each required electricity and other resources to manufacture. Perhaps even higher when costs of land, labor, on-going maintenance, transportation and other inputs are accounted for.
The Netherlands has the 18th largest economy in the world, generating $825 billion per annum.
I know many coin supporters say that is not a fair comparison but it is. The history of development and industrialization since the 18th century is a story about how humanity is increasingly more productive and efficient per unit of energy.
Proof-of-work coins are currently doing just the opposite. Instead of being more productive (e.g., creating more outputs with the same level of inputs), as coin prices increase, this incentivizes miners to use more not less resources. This is known as the Red Queen Effect.89
For years, proof-of-work advocates and lobbying organizations like Coin Center have been claiming that the energy consumption will go down and/or be replaced by renewable energy sources.
But this simply cannot happen by design: as the value of a PoW coin increases, miners will invest more capital in order to win those coins. This continues to happen empirically and it is why over time, the aggregate electricity consumption for each PoW coin has increased over time, not decreased. As a side-effect, cryptocurrency mining manufacturers are now doing IPOs.10
Reporters, if you plan to write future stories on this topic, always begin by looking at the network hashrate of the specific PoW coin you are looking at and dividing it by the most common piece of mining hardware. These numbers are public and cannot be easily dismissed. Also worth looking at the mining restrictions and bans in Quebec, Plattsburgh, Washington State, China, and elsewhere.
To front-run an example that coin promoter frequently use as a whataboutism: there are enormous wastes in the current traditional financial industry, removing those inefficiencies is a decades-long ordeal. However, as of this writing, no major bank is building dozens of data centers and filling them with single-use ASIC machines which continuouslygenerate random numbers like proof-of-work coins do. That would be rightly labeled as a waste.
In the aggregate, U.S. PCS systems process approximately 600 million transactions per day, valued at over $12.6 trillion.
It shouldn’t take the energy footprint of a single country, big or small, to confirm and settle electronic payments of that same country. The fact of the matter is that with all of its headline inefficiencies (and injustices), that the US financial system has — the aggregate service providers still manage to process more than three orders of magnitude more in transactional volume per day than all of the major PoW coins currently do.11 And that is just one country.
Frequent rejoinders will be something like “but Lightning!” however at the time of this writing, no Lightning implementation has seen any measurable traction besides spraying virtual graffiti on partisan-run websites.
Can the gap between the dearth of transactional volume and the exorbitantly high cost-per-transaction ratio be narrowed? Does it all come down to uses? Right now, the world is collectively subsidizing dozens of minuscule speculation-driven economies that in aggregate consumes electricity on par with the 18th largest real economy, but produces almost nothing tangible in exchange for it.
What if all mining magically, immediately shifted over to renewable energy?
Izabella Kaminska succinctly described how this still doesn’t solve the environmental impact issues:
Renewable is displacement. Renewable used by bitcoin network is still renewable not used by more necessary everyday infrastructure. Since traditional global energy consumption is still going up, that ensures demand for fossil continues to increase.
To Kaminska’s point, in April a once-shuttered coal power plant in Australia was announced to be reopened to provide electricity to a cryptocurrency miner. And just today, a senator from Montana warned that the closure of a coal power plant “could harm the booming bitcoin mining business in the state.”
It is still possible to be interested in cryptocurrencies and simultaneously acknowledge the opportunity costs that a large subset of them, proof-of-work coins, are environmental black holes.12
If you’re interested in discussing this topic more, feel free to reach out. If you’re looking to read detailed papers on the topic, also highly recommend the first two links listed below.
If the market value of a coin decreases, then because hashrate follows price, in practice hashrate also declines. See also a ‘Maginot Line’ attack [↩]
Another estimate is that Bitcoin’s energy usage creates as much CO2 as 1 million transatlantic flights. [↩]
There have been proposals from various developers over the years to change this hash function but at the time of this writing, both Bitcoin and Bitcoin Cash use the same one. [↩]
And because many of these mining systems likely use more-powerful-than-needed CPUs. [↩]
Note: Vitalik Buterin highlighted this discrepancy earlier this year with the NYT: The creator of Ethereum, Vitalik Buterin, is leading an experiment with a more energy-efficient way to create tokens, in part because of his concern about the impact that the network’s electricity use could have on global warming. “I would personally feel very unhappy if my main contribution to the world was adding Cyprus’s worth of electricity consumption to global warming,” Mr. Buterin said in an interview. [↩]
At 8.65 billion kWh * $0.07 / kWh comes to around $600 million spent on electricity per year. Mining rewards as of this writing: 3 ETH * $267 / ETH * 6000 blocks / day equals to $4.8 million USD / day. Or ~$1.7 billion per year. This includes electricity and hardware. Thanks to Vitalik for double-checking this for me. [↩]
Just looking at the hash-generating machines, according to Chen Min (a chip designer at Avalon Mining), as of early November 2017, 5% of all transistors in the entire semiconductor industry is now used for cryptocurrency mining and that Ethereum mining alone is driving up DRAM prices. [↩]
As described in a Politicoarticle this past spring: “To maintain their output, miners had to buy more servers, or upgrade to the more powerful servers, but the new calculating power simply boosted the solution difficulty even more quickly. In effect, your mine was becoming outdated as soon as you launched it, and the only hope of moving forward profitably was to adopt a kind of perpetual scale-up: Your existing mine had to be large enough to pay for your next, larger mine.” [↩]
Following the dramatic drop in coin prices since January, Nvidia missed its revenue forecast from cryptocurrency-related mining: Revenues from miners were $289 million in Q1, which was about 10% of Nvidia’s revenue. The forecast for Q2 was $100 million and the actual revenues ended up being $18 million. [↩]
On average, the Bitcoin network confirms about 300,000 transactions per day. A lot of that is notcommercial activity. Let’s take the highest numbers from Chainalysis and assume that each major cryptocurrency is processing at least $10 million in merchant transactions a day. They aren’t, but let’s assume that they are. That is still several orders of magnitude less than what US PCS systems do each day. [↩]
The ideological wing within the cryptocurrency world has thus far managed to convince society that negative externalities are ‘worth the cost.’ This narrative should be challenged by both policy makers and citizens alike as everyone must unnecessarily bear the environmental and economic costs of proof-of-work blockchains. See also the Bitcoin Energy Consumption Index from Digiconomist and also Bitcoin is not a good fit for renewable energy. Here’s why. [↩]
[Note: the content below was originally sent to clients and contacts on a private weekly note from Post Oak Labs on July 15, 2018.]
Earlier this week, the Mueller investigation indicted a dozen GRU officers as part of its investigation into the 2016 elections.
In the indictment, the DoJ alleges that these officers used bitcoin to finance some of its operations. This was not limited to simply exchanging bitcoins for services, but also mining them. It is unclear how many bitcoins were mined or which specific mining pool was involved.
If you have read my articles and papers in the past, this is an issue I and others have raised with respect to FMI: the possibility of illicit actors not only running infrastructure but profiting and having the ability to launder proceeds of crime. See “know your miner” in Chapter 3.
For example, in early 2015, after publishing Consensus as a service, several coin journalists chain’splained to me that it is not a problem if North Korea or other actors were running mining pools that regulated institutions used to process financial instruments. This was back in the heyday of maximalism — the view that everything would run on top of Bitcoin, laws be damned.
Turns out, they were probably wrong because financial institutions likely would be violating AML / OFAC / sanctions check requirements if they were sending payments to pools/miners that were sanctioned and/or located in sanctioned countries. Vendors such as Symbiont eventually shifted to non-public chain infrastructure because of this legal constraint too (though they originally started by using Bitcoin).
An ironic thing that most of the ideological bitcoin proponents miss is: that savvy state actors could be using the infrastructure nominally built by anarchists… in order to carry out the state-sponsored activities (such as what the GRU allegedly did, but also less sophisticated operations).
Why did the GRU use bitcoins? According to the indictment, to avoid direct relationships with traditional financial institutions. We can only speculate at this time for other reasons but consider that if you mine a coin, a 3rd party cannot immediately track the purchase of newly minted coins… because they haven’t been purchased. This is one reason why “virgin” coins carry a premium over others. For instance, Blocktrail provided the service (although it has since removed its announcement).
In the future, perhaps mining equipment manufacturers could be subpoenaed to learn their customer list, but keep in mind that there is a secondary market for miners as well, and some of those have ended up in both North Korea and Russia.
Anyone have a guess for how much state-sponsored activity comprises cryptocurrency networks today?
[Disclaimer: The views expressed below are solely my own and do not necessarily represent the views of my clients. I currently own no cryptocurrencies.]
As a follow-on to my previous book reviews, an old colleague lent me a copy of Cryptoassets by Chris Burniske and Jack Tatar.
Overall they have several “meta” points that could have legs if they substantially modify the language and structure of multiple sections in the book. As a whole it’s about on par with the equally inaccurate “Blockchain Revolution” by the Tapscotts.
As I have one in my previous book reviews, I’ll go through and provide specific quotes to backup the view that the authors should have waited for more data and relevant citations as some of their arguments lack definitive supporting evidence.
In short: hold off from buying this edition.
If you’re interested in understanding the basics of cryptocurrencies but without the same level of inaccuracies, check out the new The Basics of Bitcoins and Blockchains by Antony Lewis. And if you’re interested in the colorful background of some of the first cryptocurrency investors and entrepreneurs, check out Digital Gold by Nathaniel Popper.
Another point worth mentioning at the beginning is that there are no upfront financial disclosures by the authors. They do casually mention that they have bitcoin once or twice, but that’s about it.
I think this is problematic because it is not being transparent about potential conflicts of interest (e.g., promoting financial products you may own and hope to see financial gain from).
For instance, we learned that Chris Burniske carried around a lot of USD worth of cryptocurrencies on his phone from a NYTarticle last year:
But a particularly concentrated wave of attacks has hit those with the most obviously valuable online accounts: virtual currency fanatics like Mr. Burniske.
Within minutes of getting control of Mr. Burniske’s phone, his attackers had changed the password on his virtual currency wallet and drained the contents — some $150,000 at today’s values.
Some quick math for those at home. The NYT article above was published on August 21, 2017 when 1 BTC was worth about $4,050 and 1 ETH was worth about $314. So Burniske may have had around 37 BTC or 477 ETH or a combination of these two (and other coins).
That is not a trivial amount of money and arguably should have been disclosed in this book and other venues (such as op-eds and analyst reports).1 In the next edition, they should consider adding a disclosure statement.
A final comment is that several reviewers suggested I modify the review below to be (re)structured like a typical book review — comparing broad themes instead of a detailed dissection — after all who is going to read 38,000+ words?
That is a fair point. Yet because many of the points they attempt to highlight are commonly repeated by promoters of cryptocurrencies, I felt that this review could be a useful resource for readers looking for different perspective to the same topics frequently discussed in media and at events.
Note: all transcription errors are my own.
On p. xi, the authors wrote:
When embarking on our literary journey, we recognized the difficulty in documenting arguably the world’s fastest moving markets. These markets can change as much in a day – up or down – as the stock market changes in a year.
It is only mentioned in passing once or twice, but we know that market manipulation is a real on-going phenomenon. The next edition could include a subsection of cryptocurrencies and ICOs that the CFTC and SEC – among other regulators – have identified and prosecuted for manipulation. More on that later below.
On p. xiv, Brian Kelly wrote in the Foreword
The beauty of this book is that it takes the reader on a journey from bitcoin’s inception in the ashes of the Great Financial Crisis to its role as a diversifier in a traditional investment portfolio.
A small quibble: Satoshi actually began writing the code for Bitcoin sometime in mid-2007, before the GFC took place. It may be a chronological coincidence that it came out when it did, especially since it was supposed to be a payment system, which is just one small function of a commercial bank.23
On p. xv Kelly writes:
As with any new model, there are questions about legality and sustainability, but the Silicon Valley ethos of “break things first, then ask for forgiveness” has found its way to Wall Street.
There are also two problems with this:
Both the SEC and CFTC – among other federal agencies – were set up in the past because of the behavior that Kelly thinks is good: “break things first, then ask for forgiveness” is arguably a bad ethos to have for any fiduciary and prudential organizations.4
Any organization can do that, that’s not hard. Some have gotten away with it more than others. For instance, Coinbase was relatively loose with its KYC / AML requirements in 2012-2014 and has managed to get away with it because it grew fast enough to become an entity that could lobby the government.
On p.xv Kelly writes
“Self-funded, decentralized organizations are a new species in the global economy that are changing everything we know about business.”
In point of fact, virtually all cryptocurrencies are not self-funded. Even Satoshi had some kind of budget to build Bitcoin with. And basically all ICOs are capital raises from external parties. Blockchains don’t run and manage themselves, people do.
On p. xv Kelly writes:
“These so-called fat protocols are self-funding development platforms that create and gain value as applications are built on top.”
The fat protocol thesis has not really born out in reality, more on that in a later chapter below. While lots of crytpocurrency “thought leaders” love to cite the original USV article, none of the platforms are actually self-funded yet. They all require external capital to stay afloat because insiders cash out for real money.5 And because there is a coin typically shoehorned at the protocol layer, there is very little incentive for capable developers to actually create apps on top — hence the continual deluge of new protocols each month — few actors want to build apps when they can become rich building protocols that require coins. More on this later.6
On p. xxii the authors write:
“… and Marc Andreessen developing the first widely used web browser, which ultimately became Netscape.”
A pedantic point: Marc Andreessen was leader of a team that built Mosaic, not to take away from that accomplishment, but he didn’t single handedly invent the web browser. Maybe worth rewording in next edition.
On p. xxiii they write:
Interestingly, however, the Internet has become increasingly centralized over time, potentially endangering its original conception as a “highly survivable system.”
This is a valid point however it glosses over the fact that all blockchains use “the internet” and also — in practice — most public blockchains are actually highly centralized as well. Perhaps that changes in time, but worth looking at “arewedecentralizedyet.”
On p. xxiii they write:
Blockchain technology can now be thought of as a general purpose technology, on par with that of the steam engine, electricity, and machine learning.
This is still debatable. After all, there is no consensus on what “blockchains” are and furthermore, as we have seen in benchmark comparisons, blockchains (however defined) come in different configurations. While there are a number of platforms that like to market themselves as “general purpose,” the fact of the matter is that there are trade-offs based on the user requirements: always ask who the end-users and the use-cases a blockchain was built around are.
On p. xxiv they cite Don and Alex Tapscott. Arguably they aren’t credible people on this specific topic. For example, their book was riddled with errors and they even inappropriately made-up advisors on their failed bid to launch and fund their NextBlock Global fund.
On p. xxiv the authors write:
Financial incumbents are aware blockchain technology puts on the horizon a world without cash – no need for loose bills, brick-and-mortar banks, or, potentially, centralized monetary policies. Instead, value is handled virtually through a system that has no central authority figure and is governened in a centralized and democratic manner. Mathematics force order in the operations. Our life savings, and that of our heirs, could be entirely intangible, floating in a soup of secure 1s and 0s, the entire system accessed through computers and smartphones.
This conflates multiple things: digitization with automation.7 Retail banking has and will continue its march towards full digital banking. You don’t necessarily need a blockchain to accomplish that — we see that with Zelle’s adoption already.8
Also, central banks are well aware that they could have some program adjust interest rates, but discretion is still perceived as superior due to unforeseen incidents and crisis. 9
On p. xxv they write:
The native assets historically have been called cryptocurrencies or altcoins but we prefer the term cryptoassets, which is the term we will use throughout the book.
The term seems to have become a commonly accepted term but to be pedantic: most owners and users do not actually utilize the “cryptography” part — because they house the coins in exchanges and other intermediaries they must trust (e.g., the user doesn’t actually control the coin with a private key).10
And as we continue to see, these coins are easily forkable. You can’t fork physical assets but you can fork and clone digital / virtual ones. That’s a separate topic though maybe worth mentioning in the next edition.
On p. xxv they write:
It’s early enough in the life of blockchain technology that no books yet have focused solely on public blockchains and their native cryptoassetss from the investing perspective. We are changing that because investors need to be aware of the opportunity and armed both to take advantage and protect themselves in the fray.
Might be worth rewording because in Amazon there are about 760 books that pop up when “investing in cryptocurrencies” is queried. And many of those predate the publication of Cryptoassets. For instance, Brian Kelly, who wrote the Forward, published a fluffy coin promotion book a few years ago.
On p. xv they write:
Inevitably, innovation of such magnitude, fueled by the mania of making money, can lead to overly optimistic investors. Investors who early on saw potential in Internet stock encountered the devastating dot-com bubble. Stock in Books-A-Million saw its price soar by over 1,000 percent in one week simply by announcing it had an updated website. Subsequently, the price crashed and the company has since delisted and gone private. Other Internet-based high flyers that ended up crashing include Pets.com, Worldcom, and WebVan. Today, none of those stocks exist.
So far, so good, right?
Whether specific cryptoassets will survive or go the way of Books-A-Million remains to be seen. What’s clear, however, is that some will be big winners. Altogether, between the assets native to blockchains and the companies that stand to capitalize on this creative destruction, there needs to be a game plan that investors use to analyze and ultimately profit from this new investment theme of cryptoassets. The goal of this book is not to predict the future – it’s changing too fast for all but the lucky to be right- but rather to prepare investors for a variety of futures.
Even for 2017 when the book was publish, this statement is lagging a bit because there were already several “coin graveyard” sites around. Late last month Bloomberg ran a story: more than 1,000 coins are dead according to Coinopsy.
It is also unclear, “that some will be big winners.” Maybe modify this part in the next version.11
On p. xxvi they write:
“One of the keys to Graham’s book was always reminding the investor to focus on the inherent value of an investment without getting caught in the irrational behavior of the markets.”
There is a healthy debate as to whether cryptocurrencies and “cryptoassets” have any inherent value either.12 Arguably most coins traded on a secondary market depend on some level of ‘irrational’ behavior: many coin holders have short time horizons and want someone else to help push up the price so they can eventually cash out.13
On p. 3 they write:
In 2008, Bitcoin rose like a phoenix from the ashes of near Wall Street collapse.
The Bitcoin whitepaper came out on October 31, 2008 and Satoshi later said that he/she had spent the previous 18 months coding it first before writing it up in a paper. The authors even discuss this later on page 7. Worth removing in next edition.
On p. 3 they write:
Meanwhile, Bitcoin provided a system of decentralized trust for value transfer, relying not on the ethics of humankind but on the cold calculation of computers and laying the foundation potentially to obviate the need for much of Wall Street.
This is not quite true. At most, Bitcoin as it was conceived and as it is today — is a relatively expensive payment network that doesn’t provide definitive settlement finality.15 Banks as a whole, do more than just handle payments — they manage many other services and products. So the comparison isn’t really apples-to-apples.
Note: banks again as a whole spend more on IT-related systems than nearly any other vertical — so there is already lots of “cold calculation” taking place within each of these financial institutions.16
Now, maybe blockchain-related ideas replace or enhance some of these institutions, but it is unlikely that Bitcoin itself as it exists today, will do any of that.
On p. 5 they write:
What people didn’t realize, including Wall Street executives, was how deep and interrelated the risks CMOs posed were. Part of the problem was that CMOs were complex financial instruments supported by outdated financial architecture that blended and analog systems.
There were a dozen plus factors for how and why the GFC arose and evolved, but “outdated financial infrastructure” isn’t typically at the top of the list of culprits. Would blockchain-like systems have prevented the entire crisis? There are lots of op-eds that have made the claim, but the authors do not really provide much evidence to support the specific “blended” argument here. Perhaps worth articulating in its own section next time.
Speaking of which, also on p. 5 they write:
Whether as an individual or an entity, what’s now clear is that Satoshi was designing a technology that if existent would have likely ameliorated the toxic opacity of CMOs. Due of the distributed transparency and immutable audit log of a blockchain, each loan issued and packaged into different CMOs could have been documented on a single blockchain.
This seems to conflate two separate things: Bitcoin as Satoshi originally designed it in 2008 (for payments) and later what many early adopters have since promoted it as: blockchain as FMI.18
Bitcoin was (purposefully) not designed to do anything with regulated financial instruments, it doesn’t meet the PFMI requirements. He was trying to build e-cash that didn’t require KYC and was difficult to censor… not ways to audit CMOs. If that was the goal, architecturally Bitcoin would likely look a lot different than it did (for instance, no PoW).
And lastly on p. 5 they write:
This would have allowed any purchaser to view a coherent record of CMO ownership and the status of each mortgage within. Unfortunately, in 2008 multiple disparate systems – which were expensive and therefore poorly reconciled – held the system together by digital strings.
Interestingly, this is the general pitch for “enterprise” blockchains: that with all of the disparate siloed systems within regulated financial institutions, couldn’t reconciliation be removed if these same systems could share the same record and facts on that ledger? Hence the creation of more than a dozen enterprise-focused “DLT” platforms now being trialed and piloted by a slew of businesses.
This is briefly discussed later but the next edition could expand on it as the platforms do not need a cryptocurrency involved.19
On p. 7 they write:
By the time he released the paper, he had already coded the entire system. In his own words, “I had to write all the code before I could convince myself that I could solve every problem, then I wrote the paper.” Based on historical estimates, Satoshi likely started formalizing the Bitcoin concept sometime in late 2006 and started coding around May 2007.
Worth pointing out that Hal Finney and Ray Dillinger — and likely several others – helped audit the code and paper before any of it was publicly released.
On p. 8 they write:
Many years later people would realize that one of the most powerful use cases of blockchain technology was to inscribe immutable and transparent information that could never be wiped from the face of digital history and that was free for all to see.
There appears to be a little hyperbole here.
Immutability has become a nebulous word that basically means many different things to everyone. In practice, the only thing that is “immutable” on any blockchain is the digital signature — it is a one-way hash. All something like proof-of-work or proof-of-stake does are decide who gets to vote to append the chain.
Also, as mentioned above, there are well over 1,000 dead coins so it is actually relatively common for ‘digital history’ to effectively be wiped out.
On p. 8 they write:
A dollar invested then would be worth over $1 million by the start of 2017, underscoring the viral growth that the innovation was poised to enjoy.
Hindsight is always 20-20 and the wording above seems to be a little unclear with dates. As often as the authors say “this is not a book endorsing investments,” other passages seem do just the opposite: by saying how smart you would’ve been if you had bought at a relative low, during certain (cherry picked) dates.
Also, what viral growth? What are the daily active and monthly active user numbers they think are occurring on these chains? In later chapters, they do cite some on-chain activity but this version lacks specific DAU / MAU that would strengthen their arguments.20 Worth revisiting in the next edition.
On p. 8 they write:
Diving deeper into Satoshi’s writings around the time, it becomes more apparent that he was fixated on providing an alternative financial system, if not a replacement entirely.
This isn’t quite right. The very first thing Satoshi tried to build was a marketplace to play poker which was supposed to be integrated with the original wallet itself.
A lot of the talk about “alternative financial system” is arguably revisionist propaganda from folks like Andreas Antonopoulos who have tried to rewrite the history of Bitcoin to conform with their political ideology.
Readers should also check out MojoNation and what that team tried to accomplish.
On p. 9 they write;
While Wall Street as we knew it was experiencing an expensive death, Bitcoin’s birth cost the world nothing.
There are at least two issues that can be modified for the future:
Wall Street hasn’t died, maybe parts of the financial system are replaced or removed or enhanced, but for better and worse almost 10 years since the collapse of Lehman, the collective financial industry is still around.
Bitcoin cost somebody something, there were opportunity costs in its creation. And as we now know: the ongoing environmental impact is enormous. Yet promoters typically handwave it away as a “cost of doing anarchy.” Thus worth rewording or removing in the next edition.
On p. 9 they also wrote:
It was born as an open-source technology and quickly abandoned like a motherless babe in the world. Perhaps, if the global financial system had been healthier, there would have been less of a community to support Bitcoin, which ultimately allowed it to grow into the robust and cantankerous toddler that it currently is.
This prose sounds like something from Occupy Wall Street and not something found in literature to describe a computer program.
For example, there are lots of nominally open source blockchains, hundreds or maybe even thousands.21 That’s not very unique (it is kind of expected since there is a financial incentive to clone them).
And again, Satoshi worked on it for at least a couple years. It’s not like he/she dropped it off at an orphanage after immediate gestation. This flowery wording acts like a distraction and should be removed in the next edition.
On p. 12 they write:
Three reputable institutions would not waste their time, nor jeopardize their reputations, on a nefarious currency with no growth potential.
There is a bit of an unnecessary attitude with this statement. The message also seems to go against the criticism earlier in the book towards banks. For instance, the first chapter was critical of the risks that banks took leading up to the GFC. You can’t have it both ways. In the next edition, should either remove this or explain what level or risk is appropriate.
Also, what is the “growth potential” here? Do the authors mean the value of a coin as measured in real money? Or actual usage of the network?
Lastly, the statement above equates the asset value growth (USD value increases) with a bank’s interest. Bank’s do not typically speculate on the price, they usually only care about volumes which make revenues. A cryptocurrency could go to $0.01 for all they care; and if people want to use it then they could consider servicing it provided the bank sees an ability to make money. For example, UK banks did not abandon the GBP even though it lost 20% of its value in 2016 following the Brexit referendum.
On p. 12 they write:
Certainly, some of the earliest adopters of Bitcoin were criminals. But the same goes for most revolutionary technologies, as new technologies are often useful tools for those looking to outwit the law.
This is a “whataboutism” and is actually wrong. Satoshi specifically says he/she has designed Bitcoin to route around intermediaries (like governments) and their ability to censor. It doesn’t take too much of a stretch to get who would be initially interested in that specific set of payment “rails” especially if there is no legal recourse.22
On p. 12 they also write:
We’ll get into the specific risks associated with cryptoassets, including BItcoin, in a later chapter, but it’s clear that the story of bitcoin as a currency has evolved beyond being solely a means of payment for illegal goods and services. Over 100 media articles have jumped at the opportunity to declare bitcoin dead, and each time they have been proven wrong.
The last sentence has nothing to do with the preceding sentence, this is a non sequitur.
Later in the book they do talk about other use cases but the one that they don’t talk about much is how — according to analytics — the majority of network traffic in 2017 was users moving cryptocurrencies from one exchange to another exchange.
For example, about a month ago, Jonathan Levin from Chainalysis did an interview and mentioned that:
So we can identify, it is quite hard to know how many people. I would say that 80% of transactions that occur on these cryptocurrency ledgers have a counterparty that is a 3rd party service. More than 80%.
Maybe mention in the second edition: the unintended ironic evolution of Bitcoin has had… where it was originally designed to route around intermediaries and instead has evolved into an expensive permissioned-on-permissionless network.23
On p. 13 they write:
It operates in a peer-to-peer manner, the same movement that has driven Uber, Airbnb, and LendingClub to be multibillion-dollar companies in their own realms. Bitcoin lets anyone be their own bank, putting control in the hands of a grassroots movement and empowering the globally unbanked.
Not quite. For starters: Uber, Airbnb, and LendingClub all act as intermediaries to every transaction, that’s how they became multibillion-dollar companies.
Next, Bitcoin doesn’t really let anyone be their own bank because banks offer a lot more products and services beyond just payments. At most, Bitcoin provides a way of moving bitcoins you control to someone else’s bitcoin address (wallet). That’s it.24
And there is not much evidence that Bitcoin or any cryptocurrency for that matter, has empowered many beyond relatively wealthy people in developed or developing countries. There have been a few feel-good stories about marginalized folks in developing countries, but those are typically (unfortunately) one-off theatrics displaying people living in squalor in order to promote a financial product (coins). It would be good to see more evidence in the next edition.
For more on this topic, recommend listening to LTB episode 133 with Richard Boase.
On p. 13 they write:
Decentralizing a currency, without a top-down authority, requires coordinated global acceptance of a shared means of payment and store of value.
Readers should check out “arewedecentralizedyet” which illustrates that nearly all cryptourrencies in practice have some type of centralized, top-down hierarchy as of July 2018.
On p. 13 they write:
Bitcoin’s blockchain is a distributed, cryptographic, and immutal database that uses proof-of-work to keep the ecosystem in sync.
Worth modifying because the network is not inherently immutable — only digital signatures have “immutability.”25 Also, proof-of-work doesn’t keep any “ecosystem” in sync. All proof-of-work does is determine who can append the chain. The “ecosystem” thing is completely unrelated.
On p. 15 they write:
There is no subjectivity as to whether a transaction is confirmed in Bitcoin’s blockchain: it’s just math.
This isn’t quite true.26 Empirically, mining pools have censored transactions for various reasons. For example, Luke-Jr (who used to run Eligius pool) thinks that SatoshiDice misuses the network; he is also not a fan of what OP_RETURN was being used for by Counterparty.
Also, humans control pools and also manage the code repositories… blockchains don’t fix and run themselves. So it’s not as simple as: “it’s just math.”
On p. 15 they write an entire paragraph on “immutability”:
The combination of globally distributed computers that can cryptographically verify transactions and the building of Bitcoin’s blockchain leads to an immutable database, meaning the computers building Bitcoin’s blockchain can only do so in an append only fashion. Append only means that information can only be added to Bitcoin’s blockchain over time and cannot be deleted – an audit trail etched in digital granite. Once information is confirmed in Bitcoin’s blockchain, it’s permanent and cannot be erased. Immutability is a rare feature in a digital world where things can easily be erased, and it will likely become an increasingly valuable attribute for Bitcoin over time.
This seems to have a few issues:
As mentioned several times before in this review, “immutability” is only a characteristic of digital signatures, which are just one piece of a blockchain. Recommend Gwern’s article entitled “Bitcoin-is-worse-is-better” for more details.
Empirically lots of blockchains have had unexpected and expected block reorgs and hard forks, there is nothing fundamental to prevent this from happening to Bitcoin. See this recent article discussing a spate of attacks on various PoW coins: Blockchain’s Once-Feared 51% Attack Is Now Becoming Regular
The paragraph above ignores the reality that well over 1,000 blockchains are basically dead and Bitcoin itself had a centralized intervention on more than one occasion, such as the accidental hardfork in 2013 and the Bitcoin block size debate from 2015-2018.
On p. 15 they introduce us to the concept of proof-of-work but don’t really explain its own origin as a means of combating spam email in the 1990s.
For instance, while several Bitcoin evangelists frequently (mistakenly) point to Hashcash as the original PoW progenitor, that claim actually legitimately goes to a 1993 paper entitled Pricing via Processing or Combatting Junk Mail by Cynthia Dwork and Moni Naor. There are others as well, perhaps worth adding in the next edition.27
On p. 16 they write:
Competition for a financial rewad is also what keeps Bitcoin’s blockchain secure. If any ill-motivated actors wanted to change Bitcoin’s blockchain, they would need to compete with all the other miners distributed globally who have in total invested hundreds of millions of dollars into the machinery necessary to perform PoW.
This is only true for a Maginot Line attack (e.g., attack via hashrate).28 There are cheaper and more effective out of band attacks, like hacking BGP or DNS. Or hacking into intermediaries such as exchanges and hosted wallets. Sure the attacker doesn’t directly change the blocks, but they do set in motion a series of actions that inevitably result in thefts that end up in blocks further down the chain, when the transactions otherwise wouldn’t have taken place.
On p. 17 they write:
The hardware runs an operating system (OS); in the case of Bitcoin, the operating system is the open-source software that facilitates everything described earlier. This software is developed by a volunteer group of developers, just as Linux, the operating system that underlies much of the cloud, is maintained by a volunteer group of developers.
This isn’t quite right in at least two areas:
Linux is not financial market infrastructure software; Bitcoin originally attempted to be at the very least, a payments network. There are reasons why building and maintaining FMI is regulated whereas building an operating system typically isn’t. It has to do with risk and accountability when accidents happen. That’s why PFMI exists.
On p. 17 they discuss “private versus public blockchains”:
The difference between public and private blockchains is similar to that between the Internet and intranets. The internet is a public resource. Anyone can tap into it; there’s not gate keepers.
This is wrong. All ISPs gate their customers via KYC. Not just anyone can set up an account with an ISP, in fact, customers can and do get kicked off for violating Terms of Service.
“The Internet” is just an amalgamation of thousands of ISPs, each of whom have their own Terms of Service. About a year ago I published an in-depth article about why this analogy is bad and should not be use: Intranets and the Internet.
On p. 18 they write:
Public systems are ones like BItcoin, where anyone with the right hardware and software can connect to the network and access the information therein. There is no bouncer checking IDs at the door.
This is not quite right. The “permissionless” characteristic has to do with block making: who has the right to vote on creating/adding a new block… not who has the ability to download a copy of the blockchain. Theoretically there is no gatekeeper for block making in Bitcoin. Although, there are explicit KYC checks on the edges (primarily at exchanges).
In practice, the capital and knowledge requirements to actually create a new mining pool and aggregate hashpower that is sufficiently capable of generating the right hash and “winning” the scratch-off lottery is very high, such that on a given month just 20 or so block makers are actually involved.29
While there is no strict permissioning of these participants (some come and go over the years), it is arguably a de facto oligopoly based on capital expenditures and not some type of feel-good meritocracy described in this book.30
On p. 18 they write:
Private systems, on the other hand, employ a bouncer at the door. Only entities that have the proper permissions can become part of the network. These private systems came about after Bitcoin did, when enterprises and businesses realized they liked the utility of Bitcoin’s blockchain, but weren’t comfortable or legally allowed to be as open with he information propagated among public entities.
This is not nuanced enough. What precisely is permissioned on a “permissioned” blockchain is: who gets to do the validation.
While there are likely dozens of “permissioned” blockchain vendors — each of which may have different characteristics — the common one is that the validators are KYC’ed participants. That way they can be held accountable if there is a problem (like a fork).
For example, many enterprises and businesses tried to use Bitcoin, Ethereum, and other cryptocurrencies but because these blockchains were not built with their use cases in mind, unsurprisingly found that they were not a good fit.
This is not an insult: the “comfort” refrain is tiring because there have been a couple hundred proofs-of-concept on Bitcoin – and variants thereof – to look into whether those chains were fit-for-purpose… and they weren’t. This passage should be reworded in the second edition.
On p. 18 they write:
Within financial services, these private blockchains are largely solutions by incumbents in a fight to remain incumbents.
Maybe that is the motivation of some stakeholders, but I don’t think I’ve ever been in a meeting in which the participants (banks) specifically said that. It would be good to have a citation added in the next edition. Otherwise, as Hitchens said: what can be presented without evidence can be dismissed without evidence.
On p. 18 they write:
While there is merit to many of these solutions, some claim the greatest revolution has been getting large and secretive entities to work together, sharing information and best practices, which will ultimately lower the cost of services to the end consumer. We believe that over time the implementation of private blockchains will erode the position held by centralized powerhouses because of the tendency toward open networks. In other words, it’s a foot in the door for further decentralization and the use of public blockchains.
This is a “proletariat” narrative that is frequently used in many cryptocurrency books. While there is a certain truth to an angle – collaboration of regulated entities that normally compete with one another – many of the vendors and platforms that they are piloting are actually “open.”
Which brings up the euphemism that some vocal public blockchain promoters like to stake a claim in… the ill-defined “open.” For instance, coin lobbyists such as Coin Center and coin promoters such as Andreas Antonopoulos regularly advertise that they are experts and advocates of “open” chains but their language is typically filled with strawmen.
For instance, enterprise-specific platforms such as Fabric, Corda, and Quorum are all open sourced, anyone can download and run the code without the permission of the vendors that contribute code or support to the platforms.
Thus, it could be argued that these platforms are “open” too… which they are.
But it is highly unlikely that ideological advocates would ever defend or promote these platforms, because of their disdain and aversion to platforms built by financial organizations. 31
Lastly, this “foot in the door” comment comes in all shapes and sizes; sometimes coin promoters use “Trojan horse” as well. Either way it misses the point: enterprises will use technology that solves problems for them and will not use technology that doesn’t solve their problem.
In practice, most cryptocurrencies were not designed – on purpose – to solve problems that regulated institutions have… so it is not a surprise they do not use coin-based platforms as FMI. It has nothing to do with the way the coin platforms are marketed and everything to do with the problems the coins solve.
On p. 19 they write:
Throughout this book, we will focus on public blockchains and their native assets, or what we will define as cryptoassets, because we believe this is where the greatest opportunity awaits the innovative investor.
The authors use the term “innovative investor” a dozen or more times in the book. It’s not a particularly useful term.32
Either way, later in the book they don’t really discuss the opportunity cost of capital: what are the tradeoffs of an accredited investor who puts their money long term into a coin versus buys equity in a company. Though, to be fair, part of the problem is that most of the companies that actually have equity to buy, do not publish usage or valuation numbers because they are still private… so it is hard to accurately gauge that specific trade-off.33
On p. 19 they write about Bitcoin maximalism (without calling it that):
We disagree with that exclusive worldview, as there are many other interesting consensus mechanisms being developed, such as proof-of-stake, proof-of-existence, proof-of-elapsed time, and so on.
Proof-of-existence is not a consensus mechanism. PoE simply verifies the existence of a file at a specific time based on a hash from a specific blockchain. It does not provide consensus. This should be reworded in the next edition.
Furthermore, neither proof-of-stake or proof-of-elapsed-time are actual consensus mechanisms either… they are vote ordering mechanisms — a mechanism to prevent or control sybil attacks. 34 See this excellent thread from Emin Gun Sirer.
On p. 22 they write:
Launched in February 2011, the Silk Road provided a rules-free decentralized marketplace for any product one could imagine, and it used bitcoin as the means of payment.
This isn’t quite true. Certain guns and explosives were considered off-limits and as a result “The Armory” was spun off.
On p. 22 they write:
Clearly, this was one way that Bitcoin developed its dark reputation, though it’s important to know that this was not endorsed by Bitcoin and its development team.
Isn’t Bitcoin — like all cryptocurrences — supposed to be decentralized? So how can there be a singular “it” to not endorse something?35
On p. 22 they write:
The drivers behind this bitcoin demand were more opaque than the Gawker spike, though many point to the bailout of Cyprus and the associated losses that citizens took on their bank account balances as the core driver.
This is mostly hearsay as several independent researchers have tried to identify the actual flows coming into and going out of Cyprus that are directly tied to cryptocurrencies and so far, have been unable to.36
On p. 23 they write about Google Search Trends:
We recommend orienting with this tool even beyond cryptoassets, as it’s a fascinating window into the global mesh of minds.
Incidentally, despite the authors preference to the term “cryptoassets” — according to Google Search Trends, that term isn’t frequently used in search’s yet.
This diversity has led to tension among players as some of these cryptoassets compete, but this is nothing like the tension that exists between Bitcoin and the second movement.
Another frequent name typically used to call “the second movement” was Bitcoin 2.0.
For example, back in 2014 and 2015 I interviewed a number of project organizers and attempted to categorize them into buckets, including things like “commodities” and “assets.” See for instance my guest presentation in 2014 at Plug and Play: (video) (slides).
This label isn’t frequently used as much anymore, but that’s a different topic entirely.
On p. 25 they write an entire section entitled: Blockchain, Not Bitcoin
The authors stated:
Articles like one from the Bank of England in the third quarter of 2014 argued, “The key innovation of digital currencies is the ‘distributed ledger,’ which allows a payment system to operate in an entirely decentralized way, without intermediaries such as banks. In emphasizing the technology and not the native asset, the Bank of England left an open question whether the native asset was needed
The term blockchain, independent of Bitcoin, began to be used more widely in North America in the fall of 2015 when two prominent financial magazines catalyzed awareness of the concept.
Let’s pull apart the problems here.
First, the “blockchain not bitcoin” mantra was actually something that VCs such as Adam Draper pushed in the fall of 2015.
For instance, in an interview with Coindesk in October 2015 he said:
“We use the word blockchain now. I say bitcoin, and they think that’s the worst thing ever. It just feels like they put up a guard. Then, I switch to blockchain and they’re very attentive and they’re very interested.”
Draper seems ambivalent to the change, though he said he was initially against using it, mostly because he believes it’s superficial. After all, companies that use the blockchain as a payments rail, the argument goes, still need to interface with its digital currency, which is the mechanism for transactions on the bitcoin blockchain.
“When we talk about blockchain, I mean bitcoin,” Draper clarifies. “Bitcoin and the blockchain are so interspersed together, the incentive structure of blockchain is bitcoin.”
Draper believes it’s mostly a “vernacular change”, noting the ecosystem has been through several such transitions before. He rifles off the list of terms that have come and gone including cryptocurrency, digital currency and altcoin.
“It’s moved from bitcoin to blockchain, which makes sense, it’s the underlying tech of all these things,” he added. “I think in a lot of ways blockchain is FinTech, so it will become FinTech.”
If you’re looking for more specific examples of companies that began using “blockchain” as a euphemism for “bitcoin” be sure to check out my post: “The Great Pivot.”
The authors also fail to identify that there were lots of early stage vendors and entrepreneurs working in the background on educating policy makers and institutions on what the vocabulary was and how the various moving pieces worked throughout 2015.
Check out my own paper covering this topic and a handful of vendors in April 2015: Consensus-as-a-service. This paper has been cited dozens of times by a slew of academics, banks, regulators, and so forth. And contra Draper: you don’t necessarily need a coin or token to incentivize participants to operate a blockchain.37
On p. 26 they write:
A private blockchain is typically used to expedite and make existing processes more efficient, thereby rewarding the entities that have crafted the software and maintain the computers. In other words, the value creation is in the cost savings, and the entities that own the computers enjoy these savings. The entities don’t need to get paid in a native asset as reward for their work, as is the case with public blockchains.
First, not all private blockchains are alike or commoditized.
Two, this statement is mostly true. At least those were the initially pitches to financial institutions. Remember the frequently cited Oliver Wyman / Santander paper from 2015? It was about cost savings. Since then, the story has evolved to also include revenue generation.
For more up-to-date info on the “enterprise” blockchain world, recommend reading:
On the other hand, for Bitcoin to incentivize a self-selecting group of global volunteers, known as miners, to deploy capital into the mining machines that validate and secure bitcoin transactions, there needs to be a native asset that can be paid out to the miners for their work. The native asset builds out support for the service from the bottom up in a truly decentralized manner.
This may have been true in January 2009 but is not true in July 2018. There are no “volunteers” in Bitcoin mining as running farms and pools have become professionalized and scaled in industrial-sized facilities.
Also, that last sentence is also false: virtually every vertical of involvement is dominated by centralized entities (e.g., exchanges, hosted wallets, mining manufacturing, etc.).
On p. 27 they write:
Beyond questioning the need for native cryptoassets – which would naturally infuriate communities that very much value their cryptoassets – tensions also exist because public blockchain advocates believe the private blockchain movement bastardizes the ethos of blockchain technology. For example, instead of aiming to decentralize and democratize aspects of the existing financial services, Masters’s Digital Asset Holdings aims to assist existing financial services companies in adopting this new technology, thereby helping the incumbents fight back the rebels who seek to disrupt the status quo.
Ironically, virtually all major cryptocurrency exchanges now have institutional investors and/or partnerships with regulated financial institutions.38 Like it or not, but the cryptocurrency world is deep in bed with the very establishment that it likes to rail at on social media.
Also, Bitcoin again is at most a payments network and does not actually solve problems for existing financial service providers on their many other lines of business.
On p. 27 they write:
General purpose technologies are pervasive, eventually affecting all consumers and companies. They improve over time in line with the deflationary progression of technology, and most important, they are a platform upon which future innovations are built. Some of the more famous examples include steam, electricity, internal combustion engines, and information technology. We would add blockchain technology to this list. While such a claim may appear grand to some, that is the scale of the innovation before us.
If you’re not familiar with hyperbole and technology, I recommend watching and reading the PR for the Segway when it first came out. Promoters and enthusiasts repeatedly claimed it would change the way cities are built. Instead, it is used as a toy vehicle to shuffle tourists around at national parks and patrol suburban malls.
Maybe something related to “blockchains” is integrated into various types of infrastructure (such as trade finance), but the next edition should provide proof of some actual user adoption.
For example, the authors in the following paragraph say that “public blockchains beyond Bitcoin that are growing like gangbusters.”
Which ones? In the approximately 9 months since this book was published, most “traction” has been issuing ICOs on these public blockchains. Currently the top 3 Dapps at the time of this writings, run decentralized exchanges… which trade ICO tokens. Now maybe that changes, that is totally within the realm of possibility.39 But let’s take the hype down a few notches until consistent measurable user growth is observed.
On p. 28 they write:
The realm of public blockchains and their native assets is most relevant to the innovative investor, as private blockchains have not yielded an entirely new asset class that is investable to the public.
The wording and attitude should be changed for the next edition. This makes it sound as if the only real innovation that exists are network-based coins that a group of issuers continually create and that you, the reader, should buy.
By downplaying opportunities being tackled by enterprise vendors, the statement glosses over the operating environment enterprise clients reside in and how they must conduct unsexy due diligence and mundane requirements gathering because they have to follow laws and regulations otherwise their customers won’t use their specific platforms.
These same vendors could end up “tokenizing” existing financial instruments, it just takes a lot longer because there are real legal consequences if something breaks or forks.40
On p. 28 and 29 they ask “where is blockchain technology in the hype cycle.”
This section could be strengthened by revisiting and reflecting on the huge expectations that these coin projects have raised and were raising at the time the book was first being written. How were expectations eventually managed?
Specifically, on p. 29 they write:
While it’s hard to predict where blockchain technology currently falls on Gartner’s Hype Cycle (these things are always easier in retrospect), we would posit that Bitcoin is emerging from the Trough of Disillusionment. At the same time, blockchain technology stripped of native assets (private blockchain) is descending from the Peak of Inflated Expectations, which it reached in the summer of 2016 just before The DAO hack occurred (which we will discuss in detail in Chapter 5).
The first part is probably wrong if measured by actual usage and interest (as shown by the Google Search image a few sections above).41
The second part of the paragraph is probably right, though the timing was probably a little later: likely in the last quarter of 2016 when the first set of pilots turned out to require substantially larger budgets. That is to say, in order to be put platforms into production most small vendors with short runways realized they needed more capital and time to integrate solutions into legacy systems. In some cases, that was too much work and a few vendors pivoted out of enterprise and created a coin or two instead.42
On p. 31 they write:
Yes, the numbers have changed a lot since. Crypto moves fast.
This isn’t a hill I want to die on, but historically “crypto” means cryptography. Calling cryptocurrencies “crypto” is basically slang, but maybe that’s the way it evolves towards.
On p. 32 they write:
Historically, crypotassets have most commonly been referred to as cryptocurrencies, which we think confuses new users and constrains the conversation on the future of these assets. We would not classify the majority of cryptoassets as currencies, but rather most are either digital commodities (cryptocommodities), provisioning raw digital resources, or digital tokens (cryptotokens), provisioning finished digital goods and services.
They have a point but a literature review could have been helpful at showing this categorization is neither new nor novel.
In 2014, an academic paper was published that attempted to categorize Bitcoin from an ontological perspective. Based on the thought process presented in that paper, the Dutch authors concluded that Bitcoin is a money-like informational commodity. It isn’t money and isn’t a currency (e.g., isn’t actually used).434445
On p. 32 they write:
In an increasingly digital world, it only makes sense that we have digital commodities, such as computer power, storage capacity, and network bandwidth.
This book only superficially explains each of these and doesn’t drill down into why these “digital commodities” can’t be priced in good old fashioned money or why an internet coin is needed. If this is a good use case, is it just a matter of time before Blizzard and Steam get on board? Maybe worth looking at what entertainment companies do for the next edition.
On p. 33 they write about “why crypto” as shorthand for “cryptoassets” instead of “cryptography.”
For historical purposes, Matt Blaze, the most recent owner of crypto.com, provides a good explanation that could be included or cited next edition: Exhaustive Search Has Moved.
On p. 35 they write:
Except for Karma, the problem with all these attempts at digital money was that they weren’t purely decentralized — one way or another they relied on a centralized entity, and that presented the opportunity for corruption and weak points for attack.
This seems to be conflating two separate things: anonymity with electronic cash. You can have one without the other and do.46
Also, the BIP process is arguably a weak point for attack.47
On p. 35 they write:
One of the most miraculous aspects of bitcoin is how it bootstrapped support in a decentralized manner.
The fundamental problem with this statement is that it is inaccurate.48 Large amounts of centralization continues to exist: mining, exchanges, BIP vetting, etc.
On p. 35 they write:
Together, the combination of current use cases and investors buying bitcoin based on the expectation for even greater future use cases creates market demand for bitcoin.
Is that a Freudian slip?
Speculators buy bitcoin because they think can sell bitcoins at a higher price because a new buyer will come in at a later date and acquire the coins from them.49
For example, last month Hyun Song Shin, the BIS’s economic adviser and head of research, said:
“If people pay to hold the tokens for financial gain, then arguably they should be treated as a security and come under the same rigorous documentation requirements and regulation as other securities offered to investors for a return.”
In the United States, recall that one condition for what a security is under the Howeyframework is an expectation of profit.
Whether Bitcoin is a security or not is a topic for a different post.50
On p. 36 they write:
For the first four years of Bitcoin’s life, a coinbase transaction would issue 50 bitcoin to the lucky miner.
On November 28, 2012, the first halving of the block reward from 50 bitcoin to 25 bitcoin happened, and the second halving from 25 bitcoin to 12.5 bitcoin occurred on July 9, 2016. The thrid will happen four years from that date, in July 2020. Thus far, this has made bitcoin’s supply schedule look somewhat linear, as shown in Figure 4.1.
Technically incorrect because of the inhomogeneous Poisson process and the relatively large amounts of hashrate that came online, the first “4 year epoch” was actually less than 4 years.
Whereas the genesis block was released in January 2009, the first halving should have occurred in January 2013, but instead it took place in November 2012. Similarly, the second halving should have — if rigidly followed — taken place in November 2016, but actually occurred in July 2016 because even more hashrate had effectively accelerated block creation a bit faster than expected.
On p. 36 they write:
Based on our evolutionary past, a key driver for humans to recognize something as valuable is its scarcity. Satoshi knew that he couldn’t issue bitcoin at a rate of 2.6 million per year forever, because it would end up with no scarcity value.
Maybe Satoshi did or did not think this way, but irrespective of his or her view, having a finite amount of something means there is some amount of scarcity… even if it is a relatively large amount. Now this discussion obviously leads down the ideological road of maximalism which we don’t have time to go into today.52 Suffice to say that bitcoin is fundamentally not scarce due to its inability to prevent forks that could increase or decrease the money supply.
On p. 37 they write:
Long term, the thinking is that bitcoin will become so entrenched within the global economy that new bitcoin will not need to be issued to continue to gain support. At that point, miners will be compesnated for processing transaction and securing the network through fees on high transaction volumes.
This might happen but hasn’t yet.
For instance, Kerem Kaskaloglu (see p. 71) created a cartoon model to show what this should look like.
Notice how reality doesn’t stack up to the idealized version (yet)?
On p. 39 they write about BitDNS, Namecoin, and NameID:
Namecoin acts as its own DNS service, and provides users with more control and privacy.
In the next edition they should mention how Namecoin ended up having one mining pool that consistently had over 51% of the network hashrate and as a result, projects like Onename moved over to Bitcoin and then eventually its own separate network altogether (Blockstack).
On p. 41 they write:
This is an important lesson, because all cryptocurrencies differ in their supply schedules, and thus the direct price of each cryptoasset should not be compared if trying to ascertain the appreciation potential of the asset.
One way to strengthen this section is to provide a consistent model or methodology to systemically value a coin that doesn’t necessarily involve future demand from new investors. Maybe in the second edition they could provide a way to compare or at least say that no valuation model works yet, but here is a possible alternative?
On p. 42 they write:
A word to the wise for the innovative investor: with a new cryptocurrency, it’s always important to understand how it’s being distributed and to whom (we’ll discuss further in Chapter 12). If the core community feels the distribution is unfair, that may forever plague the growth of the cryptocurrency.
If a cryptocurrency or “cryptoasset” is supposed to be decentralized, how can it have a singular “core” community too?
In practice, most retail buyers of coins don’t seem to care about centralization or even coin distribution. Later in the book they mention Dash and its rapid coin creation done in the first month. Few investors seem to care. 53
On p. 42 they write:
Ripple has since pivoted away from being a transaction mechanism for the common person and instead now “enables banks to send real-time international payments across network.” This focus plays to Ripple’s strengths, as it aims to be a speedy payment system that rethinks correspondent banking but still requires some trust, for which banks are well suited.
If readers have time, I recommend looking through the marketing material of OpenCoin, Ripple Labs, and Ripple from 2013-2018 because it has changed several times.54 Currently there are a couple of different products including xRapid and xCurrent which are aimed at different types of users and as a result, the passage above should be updated.
On p. 43 they write:
Markus used Litecoin’s code to derive Dogecoin, thereby making it one more degree of separation removed from Bitcoin.
This is incorrect. Dogecoin was first based off of Luckycoin and Luckycoin was based on a fork of Litecoin. The key difference involved the erratic, random block reward sizes.
On p. 45 they write about Auroracoin.
Auroracoin is a cautionary tale for both investors and developers. What began as a seemingly powerful and compelling use case for a cryptoasset suffered from its inability to provide value to the audience it sought to impact. Incelanders were given a cryptocurrency with little education and means to use it. Unsurprisingly, the value of the asset collapsed and most considered it dead. Nevertheless, cryptocurrencies rarely die entirely, and Auroracoin may have interesting times ahead if its developer team can figure out a way forward.
Over 1,000 other coins have died, so “rarely” should be changed in the next edition
Why does a decentralized cryptocurrency have a singular development team, isn’t that centralization?
On p. 46 they write:
Meanwhile, Zcash uses some of the most bleeding-edge cryptography in the world, but it is one of the youngest cryptoassets in the book and suitable only for the most experienced cryptoasset investors.
In the next edition it would be helpful to specifically detail what makes someone an experienced “cryptoasset” investor.
On p. 46 they write:
Adam Back is considered the inspiration for Satoshi’s proof-of-work algorithm and is president of Blockstream, one of the most important companies in the Bitcoin space.
While Hashcash was cited in the original Satoshi whitepaper, recall above, that the original idea can be directly linked to a 1993 paper entitled Pricing via Processing or Combatting Junk Mail by Cynthia Dwork and Moni Naor. Also, it is debatable whether or not Blockstream is an important company, but that’s a different discussion altogether.
On p. 46 they write:
Bitcoin and the permissionless blockchain movement was founded on principles of egalitarian transparency, so premines are widely frowned upon.
What are the founding principles? Where can we find them? Maybe it exists, but at least provide a footnote.55
On p. 47 they write:
While many are suspicious of such privacy, it should be noted that it has tremendous benefits for fungibility. Fungibility refers to the fact that any unit of currency is as valuable as another unit of equal denomination.
Monero’s supply schedule is a hybrid of Litecoin and Dogecoin. For monero, a new block is appended to its blockchain every 2 minutes, similar to Litecoin’s 2.5 minutes.
In the next edition I’d tighten the language a little because a new monero block is added roughly or approximately every 2 minutes, not exactly 2 minutes.
On p. 48 they write:
By the end of 2016, Monero had the fifth largest network value of any cryptocurrency and was the top performing digital currency in 2016, with a price increase over the year of 2,760 percent. This clearly demonstrates the level of interest in privacy protecting cryptocurrency. Some of that interest, no doubt, comes from less than savory sources.
That is a non sequitur.
Where are the surveys of actual Monero purchasers during this time frame and their opinions for why they bought it? 56
For instance, in looking at the two-year chart above, how much on-chain activity in 2016 was due to speculators interest in “privacy” versus coin flipping? It is impossible to tell. Even with analytics all you will be able to is link specific users with purchases. Intent and motivation would require surveys and subpoenas; worth adding if available in the next edition.
On p. 48 they write:
Another cryptocurrency targeting privacy and fungiblity is Dash.
Is Dash really fungible though? That isn’t explored in this section. Plus Dash has a CEO… how is that decentralized?
On p. 49 they write:
In fact, Duffield easily could have relaunched Dash, especially considering the network was only days old when the instamine began to be widely talked about, but he chose not to. It would have been unusual to relaunch, given that other cyrptocurrencies have done so via the forking of original code. The creators of Monero, for example, specifically chose not to continue building off Bytecoin because the premine distribution had been perceived as unfair.
How is this not problematic: for a “decentralized” cryptocurrency to be controlled and run by one person who can unilaterally stop and restart a chain?
It actually is common, that’s the confusing part. Why have regulators such as FinCEN and the SEC not provided specific guidance (or enforcement) on the fact that one or a handful of individuals actually are unlicensed / non-exempted administrators of financial networks?
On p. 49 they write:
The Bitcoin and blockchain community has always been excited by new developments in anonymity and privacy, but Zcash took that excitement to a new level, which upon issuance drove the price through the roof.
Putting aside the irrational exuberance for Zcash itself, why do the authors think so many folks are vocal about privacy and anonymity?
Could it be that a significant portion of the coins are held by thieves of exchanges and hosted wallets who want to launder them? Here are a few recent examples:
Through his time at DigiCash and longstanding involvement in cryptography and cryptoassets, Zooko has become one of the most respected members in the community.
Let’s put aside Zooko and Zcash. The phrase, “the community” frequently appears in this book and similar books. It is an opaque, ill-defined (and cliquish) term that is frequently used by coin promoters to shun certain people that do not promote specific policies (and coins).57 It’s a term that should be clearly defined in the next edition.
On p. 50 they write:
While it is still early days for Zcash, we are of the belief that the ethics and technology chops of Zooko and his team are top-tier, implying that good things lie in wait for this budding cryptocurrency.
The statement above seems like an endorsement. Did either of the authors own Zcash just as the book came out? And what are the specific ethics they speak of? And why do the authors call it a cryptocurrency instead of a “cryptoasset”?
On p. 51 they write:
For example, the largest cryptocommodity, Ethereum, is a decentralized world computer upon which globally accessible and uncensored applications can be built.
How is it a commodity? Maybe it is and while they use a lot of words in this chapter, they never really precisely why it is in a way that makes much sense. Recommend modifying the first few pages of this chapter.
On p. 52 they write about “smart contracts” and mention Nick Szabo.
For a future edition I recommend diving deeper into the different uses and definitions of smart contracts. Also could be worth following Tony Arcieri suggestion:
I really like “authorization programs” but people really seem married to the “smart contract” terminology. Never mind Martin Abadi’s work on authorization languages (e.g. Binder) predates Nick Szabo’s “smart contracts” by half a decade…
For instance, there has been a lot of work done via the Accord Project with Clause.io and others such as IBM and R3. Also worth looking into Barclay’s and UCL’s effort with the Smart Contract Templates. A second edition that aims to be up-to-date should look at these developments and how they have evolved from what Abadi and Szabo first proposed.
On p. 53 they mentioned that Counterparty “was launched in January 2014.” Technically that is not true. The fundraising (“proof-of-burn”) took place in January and it was the following month that it “launched.”
On p. 54 they write:
The reason Bitcoin developers haven’t added extra functionality and flexibility directly into its software is that they have prioritized security over complexity. The more complex transactions become, the more vectors there are to exploit and attack these transactions, which can affect the network as a whole. With a focus on being a decentralized currency, Bitcoin developers have decided bitcoin transactions don’t need all the bells and whistles.
This is kind of true but also misses a little history.
For instance, Zerocoin was first proposed as an enhancement directly built into Bitcoin but key, influential Bitcoin developers who maintained the repository, pushed back on that for various technological and philosophical reasons. As a result, the main authors of that proposal went on to form and launch Zcash.58
On p. 56 they write:
Buterin understood that building a system from the ground up required a significant amount of work, and his announcement in January 2014 involved the collaboration of a community of more than 15 developers and dozens of community members that had already bought into the idea.
I assume the authors mean, following the Bitcoin Miami announcement in January 2014, but they don’t really say. I’m not sure how they arrive at the specific headcount numbers they did above, would be good to add a footnote in the future.
On p. 56 they write:
The ensuing development of the Bitcoin software before launch mostly involved just two people, Satoshi and Hal Finney.
This assumes that Satoshi is not Hal Finney, maybe he was. But it should also include the contributions of Ray Dillinger and others.
On p. 56 they write:
Buterin also knew that while Ethereum could run on ether, the people who designed it couldn’t, and Ethereum was still over a year away from being ready for release. So he found funding through the prestigious Thiel Fellowship.
This is inaccurate.
After reading this, I reached out to Vitalik Buterin and he said:59
That’s totally incorrect. Like the $100k made very little difference.
So that should be corrected in the next version.
On p. 57 they write:
Ethereum democratized that process beyond VCs. For perspective on the price of ether in this crowdsale, consider that at the start of April 2017, ether was worth $50 per unit, implying returns over 160x in under three years. Just over 9,000 people bought ether during the presale, placing the average initial investment at $2,000, which has since grown to over $320,000.
There are a few issues with this:
Ethereum did a small private and a larger public sale. We do have the Terms and Conditions of the public sale but we do not know how many participated in the private sale and under what terms (perhaps the T&Cs were identical).
Over the past 12 months there has been a trend for the “top shelf” ICOs to eschew a public sale (like Ethereum did) and instead, conduct private placement offerings with a few dozen participants at most… typically VCs and HNWIs.
There are lots of dead ICOs. One recent study found that, “56% of crypto startups that raise money through token sales die within four months of their initial coin offerings.” Ethereum is definitely an exception to that and should be highlighted as such.
On p. 57 they write:
The extra allocation of 12 million ether for the early contributors and Ethereum Foundation has proved problematic for Ethereum over time, as some feel it represented double dipping. In our view, with 15 talented developers involved prior to the public sale, 6 million ether translated to just north of $100,000 per developer at the presale rate, which is reasonable given the market rate of such software developers.
Who are these 15 developers, why is that the number the authors have identified?
Also, how much should FOSS developers be compensated and/or the business model around that is a topic that isn’t really addressed at all in this book, yet it is a glaring omission since virtually all of the projects they talk about are set up around funding and maintaining a FOSS team(s). Maybe some findings will be available for the next version.
On p. 57 they write:
That said, the allocation of capital into founders’ pockets is an important aspect of crowdsales. Called a “founder’s reward,” the key distinction between understandable and a red flag is that founders should be focused on building and growing the network, not fattening their pockets at the expense of investors.
Because coins do not typically provide coin holders any type of voting rights, it is legally dubious how you can hold issuers and “founders” accountable.60
That is why, as mentioned above, there has been an evolution of terms and conditions such that early investors in a private placement for coins may have certain rights and that the founders have certain duties that are all legally enforceable (in theory).
Because no one is publishing these T&Cs, it is hard to comment on what are globally accepted practices… aside from allowing early investors liquidity on secondary markets where they can quickly dump coins.61
Without the ability to legally hold “founders” accountable for enriching themselves at the expense of the project(s), the an interim solution has been to get on social media and yell alot… which is really unprofessional and hit or miss. Another solution is class action lawsuits, but that’s a different topic.
Also, I put the “founders” into quotes because these seem to be administrators of a network, maybe in the next edition they will be described as such?
On p. 58 they write:
Everyone trusts the system because it runs in the open and is automated by code.
There is lots of different types of open source code that runs on systems that are automated. For instance, the entire Linux, Apache, and Mozilla worlds predate Bitcoin. That isn’t new here.62
Readers and investors shouldn’t just trust code because someone created a GitHub repo and said their blockchain is open and automated.63
On p. 59 they write:
Most cryptotokens are not supported by their own blockchain.
This is actually true and problematic because it creates centralization risks and the ability for one party to unilaterally censor transactions and/or act as administrators.
For instance, a few days ago, Bancor had a bug that was exploited and about $13.5 million in ETH were stolen… and Bancor was able to freeze the BNT. That’s because BNT is effectively a centrally administered ERC20 token on top of Ethereum.
Ignoring for the moment whether or not BNT is or is not a security, this is not the first time such issuance and centralization has occurred. See the colored coin mania from 2014-2015.
On p. 60 they write about The DAO:
Over time, investors in these projects would be rewarded through dividends or appreciation of the service provided.
They mention regulators briefly later on – about SEC views – but most of the content surrounding crowdsales was non-critical and borderline promotional.64 Might be worth adding more meat around this in the next edition.
On p. 61 they write about The DAO:
The hack had nothing to do with an exchange, as had been the case with Mt. Gox and other widely publicized Bitcoin-related hacks. Insted, the flaw existed in the software of The DAO.
However, a hard fork would run counter to what many in the Bitcoin and Ethereum communities felt was the power of a decentralized ledger. Forcefully removing funds from an account violated the concept of immutability.
Just a few pages earlier the authors were saying that the lead developer behind Dash should have restarted the network because that was common and now they’re saying that doing a block reorg is no bueno. Which is it?
Why should the reader care what a nebulously defined “community” says, if it is is not defined?
The reason we have codes of conduct, terms of service, and EULAs is to specifically answer these types of problems when they arise.
Since public blockchains are supposed to be anarchic, the lack of formal governance is supposed to be a feature, right? That’s a whole other topic but suffice to say that these two sentences should be reworded in the next edition to incorporate the wisdom found in the Lexicon paper.
On p. 62 they write:
Many complained of moral hazard, and that this would set a precdent for the U.S. government or other powerful entities to come in someday and demand the same of Ethereum for their own interests. It was a tough decision for all involved, including Buterin, who while not directly on The DAO developer team, was an admistrator.
This is the first and only time they point out that key participants collectively making governance decisions are administrators… a point I have been highlighting throughout this review.
I don’t think it is fair to label Vitalik Buterin as a singular administrator, because if he was, he wouldn’t have had to ask exchanges to stop trading ether and/or The DAO token. Perhaps he was collectively involved in that process, but mining pool operators and exchange managers are arguably just as important if not more so. See also: Sufficiently Decentralized Howeycoins
On p. 62 they write:
While hard fork are often used to upgrade a blockchain architecture, they are typically employed in situations where the community agrees entirely on the beneficial updates to the architecture. Ethereum’s situation was different, as many in the community opposed a hard fork. Contentious hard forks are dangerous, because when new software updates are released for a blockchain in the form of a hard fork, there are then two different operating systems.
A few things:
Notice the continued use of an ill-defined “the community”
How is agreement or disagreement measured? During the Bitcoin block size debate, folks tried to use various means to express interest, most of which resulted in sybil attacks such as retweets and upvotes on social media by an army of bots.
Is any fork non-contentious. Surely if we looked hard enough, we could always find more than a handful of coin owners and/or developers that disagreed with the proposal. Does that mean you should ignore them? Whose opinion matters? These types of questions were never really formally answered either in the case of the Bitcoin Segwit / Bitcoin Cash fork… or in the Ethereum / Ethereum Classic / The DAO fork. Governance is pretty much an off-chain popularity contest, just like voting for politicians.65
On p. 63 they write:
The site for Ethereum Classic defines the cryptoasset as “a continuation of the original Ethereum blockchain–the classic version preserving untampered history; free from external interference and subjecitve tampering of transactions.”
This could be revised since Ethereum Classic itself has now had multiple forks.
As mentioned in a previous post last year:
Ethereum Classic: this small community has held public events to discuss how they plan to change the money supply; they video taped this coordination and their real legal names are used; only one large company (DCG) is active in its leadership; they sponsor events; they run various social media accounts
There has been lots of external interference, that’s been the lifeblood of public blockchains… because they don’t run themselves, people run and administer them.
Continuing on p. 63 they write:
While many merchants understably complain about credit card fees of 2 to 3 percent, the “platform fees” of Airbnb, Uber, and similar platform services are borderline egregious.
Maybe they are, maybe they are not.66 What is the right fee they should be? Miners take a cut, exchanges take a cut, developers take a cut via “founder’s funds.”
The next edition should give a step-by-step comparison to show why fee structures are egregious (maybe they are, it just is not clear in this book).
On p. 64 they wrote about Augur. Incidentally, Augur finally launched in early July while writing this review. I have an origin story but will keep that for later.
On p. 65 they wrote about Filecoin:
For example, a dApp may use a decentralized cloud storage system like Filecoin to store large amounts of data, and another cryptocommodity for anonymized bandwidth, in addition to using Ethereum to process certain operations.
A couple thoughts:
That’s the theory, though Filecoin hasn’t launched yet — why do they get the benefit of the doubt yet other projects don’t?
There is no price or use comparison in this chapter or elsewhere… the book could be strengthened if it provided more evidence of adoption because we have seen that running decentralized services such as Tor or Freenet have been less than spectacular.
On p. 65 they write:
Returning to the fundamentals of investment theory will allow innovative investors to properly position their overarching portfolio to take advantage of the growth of cryptoassets responsibly.
It is still unclear what an “innovative investor” is — at least the way these authors describe it.67
On p. 69 Tatar writes:
Not only did I decide to inveset in bitcoin, I decided to place the entirety of that year’s allocation for my Simplified Employee Pension (SEP) plan into bitcoin. When I announced what I had done in my article “Do Bitcoin Belong in your Retirement Portfolio?,” it created a stir online and in the financial planning community.
This was one of just a couple places where the authors actually disclose that they own specific coins, next edition they should put it up front.
On p. 70 Tatar writes:
Was I chasing a similar crash-and-burn scenario with bitcoin? Even my technologically and investment savvy son, Eric, initially criticized me about bitcoin. “They have these things called dollar bills, Dad. Stick to using those.”
Eric is probably right: that the authors of this book accepted traditional money for their book (Amazon doesn’t currently accept cryptocurrencies).
Based on their views presented in this book, the authors probably don’t spend (many) coins they may have in the portfolio, instead holding on to them with the belief that other investors will bid up the price (measured in actual money).
On p. 77 they write about the GFC prior to 2008:
Becoming a hedge fund manager became all the rage for business-minded students when it was revealed that the top 25 hedge fund managers earned a total of $22.3 billion in 2007 and $11.6 billion in 2008.
Coincidentally a similar “rage” for running cryptocurrency-related funds has occured in the past 18 months, especially for ICOs.
More than two hundred “funds” quickly popped up in order to gobble up coins during coin mania. At least 9 have closed down through April and many more were down double digits due to a bear market (and not hedging).
On p. 83 they write:
Bitcoin is the most exciting alternative asset in the twenty-first century, and it has paved the way for its digital siblings to enjoy similar success.
It is their opinion that this is the case, but the authors don’t really provide a lot of data to reinforce it yet, other than the fact that there have been some bull runs due to exuberance.68 Worth rewording in the next edition.
On p. 83 they write:
Because bitcoin can claim the title of being the oldest cryptoasset…
Similarly, I (Chris) didn’t even consider investing in bitcoin when I first heard about it in 2012. By the time I began considering bitcoin for my portfolio in late 2014, the price was in the mid $300s, having increased 460,000-fold from the initial exchange rate.
I believe this is the only time in the book that Burniske discloses any coin holdings.
On p. 85 they make some ridiculous comparison with the S&P 500, DJIA, NASDAQ 100… and Bitcoin.
The former three are indices of multiple regulated securities. The latter is just one coin that is easily influenced and manipulated by external unaccountable parties. How is that an apples to apples comparison?
On p. 87 they continue by comparing Bitcoin with Facebook, Google, Amazon, and Netflix.
Again, these are regulated securities that reflect cash flows and the financial health of multinational companies… Bitcoin has no cash flows and isn’t (yet) setup to be a company… and isn’t regulated (no KYC/AML at the mining farm or mining pool level).
Bitcoin was originally built to be an e-cash transmission network, a decentralized MSB.69 How is comparing it with non-MSBs a useful comparison?
On p. 88 they write:
Remember that, as of January 2017, bitcoin’s network value was 1/20, 1/22, 1/3, and 1/33 that of the FANG stocks respectively. Therefore, if bitcoin is to grow to a similar size much opportunity remains.
This whole section should be probably be modified because these aren’t apples-to-apples comparisons. FANG stocks represent companies that have to build and ship multiple products in order to generate continuous revenue.
With Bitcoin, it is bitcoin that is the product, nothing else is being shipped nor is revenue being generated70
Maybe the price of a bitcoin — as measured with actual money — does reach a 1:1 or even surpass the stocks above. But a new version of this book could be strengthened with an outline on how it could do so sustainably.
The authors do have a couple narrow, daily volatility charts in the book, but none that provide a similar wideview comparison with something that is remotely comparable (Bitcoin versus Twitter doesn’t make any sense).
On p. 101 they write:
Cryptoassets have near-zero correlation to other captial market assets.
In contrast, the past few years have been more nuanced: bitcoin’s volatily has calmed, yet it retains a low correlation with other assets.
That first part is untrue, as shown by the chart above from JP Koning. The second part is relative.72
On p. 107 they write:
The Securities and Exchange Commission has thus far steered clear of applying a specific label to all cryptoassets, though in late July 2017 it did release a report detailing how some cryptoassets can be classified as securities, with the most notable example being The DAO.
That’s pretty much the extent of the authors analysis of the issue. Granted they aren’t lawyers but this is a pretty big deal, maybe in the next edition beef this up?
On p. 107 they write:
While it’s a great validation of cryptoassets that regulators are working to provide clarity on how to classify at least some of them, most of the existing laws set forth suffer from the same flaw: agencies are interpereting cryptoassets through the lens of the past.
From this wording it seems that the authors want laws changed or modified to protect their interests and the financial interests of their LPs. This isn’t the first or last time that someone with a vested interest lobbies to get carve outs, exceptions, or entire moratoriums.
Maybe that it is deserved, but it’s not well-articulated in this chapter other than to basically call regulators “old-fashioned” and out of touch with technology.73 Could be worth rethinking the wording here.
On p. 107 they write:
Just as there is diversity in equities, with analsts segmenting companies depending on their market capitalization, sector, or geography, so too is there diversity in cryptoassets. Bitcoin, litecoin, monero, dash, and zcash fulfill the three definitions of a currency: serving as a means of exchange, store of value and unit of account.
This is empirically incorrect. None of these coins functions as a unit of account, they all depend on and are priced in… actual money.74
There are lots of reasons for why this is case but that is beyond the scope of this review. 7576
On p. 110 they write about ETFs:
It should be noted that when we talk about asset classes we are not doing so in the context of the investment vehicle that may “house” the underlying asset, whether that vehicle is a mutual fund, ETF, or separately managed account.
They don’t really discuss it in the book, but just so readers are aware, there have been about 10 Bitcoin-only ETFs proposed in the US, all of which have been rejected by the SEC (or applications were voluntarily removed).
Curious to know why? See the March 10, 2017 explanation from the SEC.
Note: this hasn’t stopped sponsors from re-applying. In the process of writing this review, the CBOE filed for a Bitcoin ETF.
On p. 111 they write:
Much of the thinking in this chapter grew out of a collaboration between ARK Invest and Coinbase through late 2015 and into 2016 when the two firms first made the claims that bitcoin was ringing the bell for a new asset class.
Just to be clear: the joint paper they published in that time frame was a bit superficial as it lacked actual user data from Coinbase exchanges (both GDAX and the consumer wallet). I pointed that out back then and this book is basically an expanded form of that paper: where is specific usage data on Coinbase? The only way we have learned any real user numbers about Coinbase is from an IRS lawsuit.
For instance, a future edition should try to differentiate on-chain activity that is say, gambling winnings or miners payouts from exchange arbitrage or even coin shuffling. Their analysis should be redone once they remove the noise from the signal (e.g., not all transactional activity is the same).
This is a real challenge and not a new issue. For instance, see: Slicing data.
On p. 112 they write:
Cryptoassets adhere to a twenty-first century model of governance unique from all other asset classes and largely inspired by the open source software movement. The procurers of the asset and associated use cases are three pronged. First, a group of talented software developers decide to create the blockchain protocol or distributed application that utilizes a native asset. These developers adhere to an open contributor model, which means that over time any new developer can earn his or her way onto the development team through merit.
There is no new governance model.
In practice, changes are done via social media popularity contests. We saw that with the Bitcoin blocksize debate and Ethereum hard fork. And in some ways, strong vocal personalities (and cults of personality) is how other FOSS projects (like Python) are managed and administered.
The fluffy meritocracy feel-goodism is often not the order of the day and we see this in many projects such as Bitcoin where the commit access and BIP approval process is limited to a small insular clique.
The 4 point plan above is a much more accurate break down of how most coin projects are setup.
On p. 112 they write:
However, the developers are not the only ones in charge of procuring a cryptoasset; they only provide the code. The people who own and maintain the computers that run the code–the-miners–also have a say in the development of the code because they have to download new software updates. The developers can’t force miners to update software. Instead, they must convince them that it makes sense for the health of the overall blockchain, and the economic health of the miner, to do so.
But in many projects: developers and miners are one in the same. This is why it is so confusing to not have seen additional clarity or guidance from FinCEN because of how centralized most projects are in practice.
These companies often employ some of the core developers, but even if they don’t, they can assert significant influence over the system if they are a large force behind user adoption.
Maybe that is the case for some cryptocurrencies.78 Should “core” developers be licensed like professional engineers are?
Also, isn’t their statement above evidence that most projects are fairly centralized because the division of labor results in specialization?
On p. 113 they write:
These users are constantly providing feedback to the developers, miners, and companies, in whose interest it is to listen, because if users stop using the cryptoasset, then demand will go down and so too will the price. Therefore, the procurers are constantly held accountable by the users.
Except this isn’t what happens in practice.
Relatively little activity takes place at all on most of these coin platforms and most of what does occur involves arbitrage trading and/or illicit activity.
This activity seems to have little direct connection to the price of the coin because the price of the coin is still largely determined by the whims of speculative demand.
For instance, above is a two-year transactional volume chart for bitcoin. The price of bitcoin in the summer of 2016 was in the $600-$700 range whereas it is 10x that today. Yet daily transaction volume is actually lower than it was back then. Which means: the two are separate phenomenon.
Also, arguably the only direct way coin owners can — in practice — hold maintainers accountable is via antics on social media. That is why control of a specific reddit, Telegram, or Twitter account is very important and why hackers target those channels in order to influence prices.
On p. 113 they write about supply schedules:
For example, with oil, there’s the famous Organization of the Petroleum Exporting Countries (OPEC), which has had considerable control over the supply levels of oil.
Inadvertently they actually described how basically all proof-of-work coins operate: via a small clique of known miners and mining pools. A cartel?
While these miners have not yet increased or decreased the supply of bitcoins, mining is a specialized task that requires certain capital and connections in order to be successful at. These participants could easily collude to change the money supply, censor transactions, etc. and there would be no immediate legal recourse.
On p. 115 they write:
Cryptoassets, like gold, are often constructed to be scarce in their supply. Many will be even more scarce than gold and other precious metals. The supply schedule of cryptoassets typically is metered mathematically and set in code at the genesis of the underlying protocol or distributed application.
How to measure scarcity here?
Despite what alchemists tried for centuries to do: aside from particle accelators, on Earth the only way of increasing the supply of gold and silver is via digging it out of the ground. For cryptocurrencies, it is relatively easy to fork and clone both code and chains. Digital scarcity for most — if not all — public chains, seems to be is a myth.
In the next edition, maybe remove the “backed by maths” trope? None of these chains run themselves, they all depend on humans to run the equipment and maintain the code.
On p. 115 they write:
As discussed earlier, Satoshi crafted the system this way because he needed initially to bootstrap support for Bitcoin which he did by issuing large amounts of the coin for the earliest contributors. As Bitcoin matured, the value of its native asset appreciated, which means less Bitcoin is over eight years old, it provides strong utility to the world beyond as an investment, which drive demand.
Satoshi likely mined around 1 million bitcoins for himself/herself. Because of how centralized and small the network originally was in 2009, he/she probably could have unilaterally stopped the network and relaunched it and effectively removed that insta-mine. 79
In addition, there was almost no risk to either be a developer or a miner… the entry/exit costs were very low… so why did he issue large amounts of coins for these contributors?80
Also, how does it provide strong demand beyond investment? How many people do the authors know regularly use Bitcoin itself for retail payments?81
Also, through Bitcoin’s evolution, arguably some of its utility was removed by going down a specific block size path. The counterargument is that payments will be done via some other networks (such as Lightning) attached to Bitcoin, but as of this writing, that hasn’t panned out.
One last comment about this passage, FOSS is historically charity work and difficult to build a sustainable operation. A couple notable exceptions are Red Hat and SUSE (which was just acquired by EQT).
On p. 115 they write:
The Ethereum team is currently rethinking that issuance strategy due to an intended change in its consensus mechanism.
In the second edition is it possible to be consistent on this one point: how is an “official” or “centralized” development team congruent with the idea of having a “decentralized ecosystem”?
Also, the administrators of Ethereum Classic modified the money supply last year and most folks were blasé. Where is the relevant FinCEN guidance?
On p. 115 they write:
Steemit’s team pursued a far more complicated monetary policy with its platform, composed of steem (STEEM), steem power (SP), and steem dollars (SMD).
They have also chosen to modify their monetary policy post-inception.
The authors of this book need to be consistent in their wording because in other places they criticize centralized financial institutions but do not criticize centralized monetary supply decision of coin makers. Also, again, why or how does a decentralized project have a singular team?
On p. 116 they write:
Crypotassets can be likened to silicon. They have come upon the scene due to the rise of technology, and their use cases will grow and change as technology evolves. Currently, bitcoin is the most straightforward, with its use case being that of a decentralized global currency. Ether is more flexible, as developers use it for computational gas within a decentralized world computer.
This isn’t a good analogy. Silicon exists as a naturally occurring element… whereas cryptocurrencies do not naturally arise — humans create them.
In addition, bitcoin is arguably not the most straightforward due to a long divorce and schism process the past three years. One distinct group of promoters calls it “digital gold” and another distinct group calls it a “payment system” — the two groups are almost violently opposed to one another’s existence.
On p. 116 they write:
Then there are the trading markets, which trade 24/7, 365 days a year. These global and eternally open markets also differentiate cryptoassets from other assets discussed herein.
The FX markets are open globally almost 24/6 for most of the year, so that’s not really a braggable claim.82 There are legal, regulatory, and practical reasons why most capital markets operate in the time windows they do… it is not because of some technological limitation. Worth rewording in the next edition.
On p. 116 they write:
In short, the use cases for cryptoassets are more dynamic than any preexisting asset class. Furthermore, since they’re brought into the world and then controlled by open-source software, the ability for cryptoassets to evolve is unbounded.
In the next edition, maybe remove the pomp and circumstance unless there is actual data to back up the platitudes. We can all easily conjure up lots of potential use cases for just about any type of technology, but unless they are built and used, the hype should be turned down a few notches.
Also, there are many other open sourcesoftware projects that have actually shipped frequently used productivity tools and no one is yelling from the mountain tops about how they have unbounded potential. How are internet coins any different?
On p. 117 they write:
Cryptoassets have two drivers of their basis of value: utility and speculative.
In theory, perhaps. But in practice, most coins just have potential utility because with few exceptions, most buyers typically hold with the expectation the coin will appreciate. Maybe that change in the future.
On p. 117 the write:
For example, Bitcoin’s blockchain is used to transact bitcoin and therefore much of the value is driven by demand to use bitcoin as a means of exchange.
Perhaps, though in the next edition recommend modifying the wording to include: “… as a means of exchange or investment…” Currently, we know a large portion of activity is likely movement (arbitrage) between exchanges.8384
But even ignoring this data (from analytics companies) this scenario has been diced-up elsewhere:
Speculative value is driven by people trying to predict how widely used a particular cryptoasset will be in the future.
If there are systematic surveys of actual buyers and sellers perhaps add those in the second edition.85
On p. 118 they write:
With cryptoassets, much of the speculative value can be derived from the development team. People will have more faith that a cryptoasset will be widely adopted if it is crafted by a talented and focused development team. Furthermore, if the development team has a grand vision for the widespread use of the cryptoasset, then that can increase the speculative value of the asset.
This is false.
For starters, the value of a new coin is almost entirely a function of the marketing effort from the coin issuers: that’s why nearly all ICOs carve out a portion of their funding pie to market, promote, and advertise… spreading the sexy gospel of the new coin.
This is a big bucks opaque industry, with all sorts of shenanigans that take place just to get listed on secondary markets… with coin issuers paying more than $1 million to get listed.
While $1 million or even $3 million may sound like a lot to get listed, the issuers know it is worth it because the retail speculators on the other end will at least temporarily pump the coin price up often long enough for the original insiders and investors to cash out.
Now the coin issuers may talk a big game and at eloquent length about how their grand vision: that their coin will end world hunger and save the environment, but they often have no ability to execute and build the product(s) they claimed in their whitepaper.
As mentioned above, one recent study found that, “56% of crypto startups that raise money through token sales die within four months of their initial coin offerings.”
Also, how does a decentralized cryptocurrency have an official singular development team?
On p. 118 they write:
As each cryptoasset matures, it will converge on its utility value. Right now, bitcoin is the furthest along the transition from speculative price support to uility price support because it has been around the longest and people are using it regularly for its intended utility use case.
And what is its intended use case? The maximalist vision (digital gold) or the originalist payments vision?
On p. 118 they write:
For example, in 2016, $100,000 of bitcoin was transacted every minute, which creates real demand for the utility of the asset beyond its trading demand. A great illustration of bitcoin’s price support increasingly being tied to utility came from Pantera Capital, a well-respected investment firm solely focused on cryptoassets and technology. in Figure 8.2 we can see that in November 2013 bitcoin’s speculative value skyrocketed beyond its utility value, which is represented here by transactions per day using Bitcoin’s blockchain (CAGR is the compound annual growth rate).
But this didn’t happen.
Pantera has a habit of cherry picking dates and using different types of graphs (such as log versus linear) in order to talk its book.
For instance, they conjured up and pushed the “bitcoin absorbs the value of gold” narrative back in late 2014. Then a year later, they became part of the “great pivot” by rebranding everything “blockchain” instead of bitcoin.
Putting those aside, the transactional part of the graph (Figure 8.2) from Pantera was published in early 2017 and has not held up to further scrutiny by mid-2018.
Perhaps for some unknown reason the up-and-to-the-right hockey stick graph that Pantera tried to create with its dotted lines will germinate. But for now, as of this writing, their transactional / utility thesis is incorrect.
Why? Because the assumptions were the same as the authors of this book: they assume retail or institutional users will flock to using bitcoin for non-speculative reasons, but that has not occurred yet.
On p. 119 they write:
Speculative value diminishes as a cryptoasset matures because there is less speculation regarding the future markets the cryptoasset will penetrate. This means people will understand more clearly that demand for the asset will look like going forward. The younger the cryptoasset is, the more its value will be driven by speculative vlaue, as shown in Figure 8.3. While we expect cryptoassets to ossify into their primary use cases over time, especially as they become large system that supports significant amounts of value, their open-source nature leaves open the possiblity that they will be tweaked to pursue new tangential use cases, which could once again add speculative value to the asset.
Their wording in this and other passages has definitive certainty without any hedging.
This is unfounded. Recall, what can be presented without evidence can be dismissed without evidence. This also makes a circular argument that the next edition needs to provide evidence for (or just remove it).
On p. 122 the write:
For example, currently the bond markets are undergoing significant changes, as a surprising amount of bond trading is still a “voice and paper market,” where trades are made by institutions calling one another and tangible paper is processed. This makes the bond market much more illiquid and opaque than the stock market, where most transactions are done almost entirely electronically: With the growing wave of digitalization, the bond markets are becoming increasingly liquid and transparent. The same can be said of markets for commodities, art, fine wine, and so on.
In re-reading this I can’t tell if the authors recognize that the bond market, as well as all of the other markets listed, started out in pre-electronic and even pre-industrial times.
That’s not to defend the status quo, only that if modern day trading platforms and automation existed a couple hundreds years ago, it is likely that bonds trading would have migrated much earlier than 2018… maybe even on a blockchain!
On p. 122 they write:
Cryptoassets have an inherent advantage in their liquidity and trading volume profile, because they are digital natives. As digital natives, cryptoassets have no physical form, and can be moved as quickly as the Internet can move the 1s and 0s that convey ownership.
This is conflating digitization/digitalization with blockchains. You can have one without the other and in fact, do.
For instance, with US equities, beginning in the ’60s through the ’70s, stocks were dematerialized then immobilized in CSDs and ownership is now transferred electronically.86
Perhaps there is something to be said about this market infrastructure further evolving in time with a blockchain of some kind.
For example in the US, the DTCC (a large CSD) has:
Virtually every major CSD, stock exchange, and clearing house has likewise publicly opined or participated in some blockchain-related initiatives. But that is a separate topic maybe worth looking into for the next edition.
On p. 123 they write:
Even though they are growing at an incredible clip, separation between cryptoasset markets and traditional investor capital pools still largely remains the case.
How much real money has actually entered the cryptocurrency market?
There have been several attempts to quantify it and it is still rather small, maybe up to $10 billion came in during 2017.
On p. 125 they write:
For example, in 2016, Monero experienced a sizeable increase in notoriety–largely because its privacy features began to be utilized by a well-known dark market–which sent its average trading volume skyrocketing. In December 2015, daily volume for the asset was $27,300, but by December 2016 it was $3.25M, well over a hunderfold increase. The price of the asset had appreciated more than 20-fold in the same period, so some of the increase in trading volume was due to price appreciation, but clearly a large amount was due to increased interest and trading activity in the asset.
But how do the authors know this “clearly” was the case? Did they do some random sample surveys? The next edition they need to prove their assumption, not just make them. After all, it is hard — perhaps impossible — to externally ascertain what is going on at an exchange simply by looking at self-published volumes.
Also, the exchanges that these coins trade on are still typically unregulated, with little optics into how often manipulation occurs. That is why a number of them have been subpoenaed by various governmental bodies; in the US this includes the SEC, CFTC, IRS, FBI, and even separate states acting in coordination.
On p. 129 they write:
From these trends, we can infer that this declining volatility is a result of increased market maturity. Certainly, the trend is not a straight line, and there are significant bumps in the road, depending on particular events. For example, monero had a spike in volatility in late 2016 because it experienced a significant price rise. This shows volatility is not only associated with a tanking price but also a skyrocketing price. The general trend, nonetheless, is of dampening volatility […].
This is not true either. Maybe there are cherry picked dates in which there is relatively lower volatility than normal, but this year alone prices as measured in real money, declined between 60-100% for basically all crypotocurrencies and this involved a roller coaster to achieve.
In fact, in the process of writing this review, there were multiple days in which prices increased 5-10% for most coins and then a few days later, saw the same size of loses. Erratic volatility has not disappeared.
On p. 133 they write:
Despite the many PBOC interventions, Chinese citizens used bitcoin to protect themselves against the erosion in value of their national currency.
Who in China did this?
I have spent an enormous amount of time visiting China the past several years on business trips and not once did someone say they had shifted their wealth from RMB into bitcoin because of RMB depreciation. There are many speculators and miners, but to my knowledge there has not been a formal survey of buyers and their motivations… and the result being because of RMB depreciation.
The next edition should either remove this statement or add a citation.
On p. 134 they write:
As bitcoin rose and fell, so too did these assets. This reinforces the need for the innovative investor to become knowledgeable about these assets’ specific characteristics and recognize where correlations may or may not occur.
Recommend removing “innovative investor” in this location.87
On p. 137 they write:
On its path to maturity, bitcoin’s price has experienced euphoric rise and harrowing drops, as have many cryptoassets. One of the most common complaints among bitcoin and cryptoasset naysayers is that these fluctuations are driven by the Wild West nature of the markets, implying that cryptoassets are a strange new breed that can’t be trusted. While each cryptoasset and its associated markets are at varying levels of maturity, associating Wild West behavior as unique to cryptoasset markets is misleading at best.
No it isn’t. The authors do not even define or provide some kind of way to measure “maturity.” This paragraph creates a strawman.
The burden-of-proof rests on the party making the positive claim. In this case, the party claiming that a coin is becoming mature must provide objective evidence this is taking place. Should reword in the next edition.
On p. 138 they write:
Broadly, we categorize five main patterns that lead to markets destabilizing: the speculation of crowds, “This time is different,” Ponzi schemes, Misleading information from asset issuers, Cornering.
Those are valid patterns, in full agreement here. But this edition does not help in dispelling these problems and arguably even contributes to some of the speculative frenzy.
On p. 138 they write:
Sometimes they do this to capitalize on short-term information they believe will move the market, other times they do it because they expect to ride the momentum of the market, regardless of its fundamentals. In short, they try to profit within the roller-coaster ride.
What are the fundamentals of any coin described in this book? Next edition, clearly write out 5-10 if possible.
On p. 139 they write:
As America was struggling through the Great Depression, which many pinned on the stock market crash of 1929, there was strong resentment against speculators. Every crisis loves a scapegoat.
And in Bitcoinland there is no difference. Bitcoiners love to blame: bankers, the Illuminati, naysayers, concern trolls, academics, the government, Jamie Dimon, big blockers, small blockers, weak hands, statists, other coins, China, George Soros, Warren Buffett, Mike Hearn… virtually every month there is a new boogeyman to blame something on. I’ve even been blamed many times and I’m not involved at all in the market.
On p. 143 they write:
Cheap credit often fuels asset bubbles, as seen with the housing bubble that led to the financial crisis of 2008. Similarly, cryptoasset bubbles can be created using extreme margin on some exchanges, where investors are effectively gambling with money they don’t have.
Fully agree, good point.
On p. 144 they write:
The best way to avoid getting burned in this manner is to do proper due diligence and have an investment plan that is adhered to.
Fully agree, good point.
On p. 145 they write:
The key to understanding bitcoin’s value is recognizing it has utility as “Money-over-Internet-Protocol”( MoIP)–allowing it to move large amounts of value to anyone anywhere in the world in a matter of minutes–which drives demand for it beyond mere speculation.
This might be partially true but is has the same feel-good narrative that folks like Andreas Antonopoulos have been getting paid handsomly to regurgitate. Bitcoin (the network) does not move anything beyond bitcoins (the coin). Users still have to convert bitcoins into actual money at end points.
Converting a large amount — greater than $10,000 — will likely require KYC and AML and maybe even sanctions checks. This adds time and money which is one of the reason why the remittance use-case didn’t really get much traction after the hype in 2014 – 2015 and why companies such as Abra had to pivot a few times.
With that said, their metapoint is valid on the edges: despite the frictions that may exist, some participants are willing to go through this experience in order to gain more anonymity for uses they might not otherwise be able to do using traditional methods.88
Over the past three years there has also been an expansion of country- and region-based payment schemes worldwide to achieve near-real-time transfers, with Europe being one of the most significant accomplishments.89
In parallel, there are on-going experimentation and scaling of private blockchain-based ‘rails’ like Swift gpi or Alipay with GCash which have a potential to surpass volumes of the Bitcoin network.90
On p. 145 they write:
When Mt. Gox was established, bitcoin finally became accessible to the mainstream.
Up until recently it was difficult for even diehard users to get onboarded onto most exchanges. And specifically in 2010 with the launch of Mt. Gox, Jed McCaleb used Paypal to help facilitate the transfer of money… until Paypal dropped Mt. Gox because of too many chargebacks. To get money into and out of Mt. Gox often was a frictionfull task, unless you lived in Japan.
On p. 149 they write:
As shown in Figure 10.4, steem’s price in bitcoin terms would fall from its mid-July peak by 94 percent three months later, and by 97 percent at the end of the year. This doesn’t mean the platform is bad. Rather, it shows the speculation and excitement about its prospects fueled a sharp rise and fall in price.
In hindsight, everything is 20-20. The same truism in their last sentence can be said just about with every coin that sees the meteoric rise that Steemit did in 2016.91
On p. 150 they write:
While zcash has since stabilized and continues to hold great promise as a cryptoasset, its rocky start was caused by mass speculation.
Do the authors own any Zcash (or other cryptocurrencies mentioned in this book besides bitcoin)?
In late 2016 there were oodles of “thought leaders” talking about how Zcash was — for a moment — valued at a trillion dollars because of the very thin supply that was trading on exchanges. It was a headscratching meme that illustrates a shortcoming to the common “market cap” valuation mehtod.92
On p. 152 they write:
The idea of valuation, which we will tackle in the next chapters, is a particularly challenging one for cryptoassets. Since they are a new asset class, they cannot be valued as companies are, and while valuing them based on supply and demand characteristics like that of commodiites has some validity, it doesn’t quite suffice.
Then why spend an entire chapter (Chapter 7) comparing coins such as bitcoin, to companies and their stock?
You can’t have it both ways. Either heavily modify Chapter 7 in the next edition, or remove this comment.
On p. 155 they write:
Given the emerging nature of the cryptoasset markets, it’s important to recognize that there is less regulation (some would say none) in this arena, and therefore bad behavior can persist for longer than it may in more mature markets.
And there are now full-time lobbyists and trade associations — sponsored by donors whom have benefited from this unregulated / underregulated market — that actively push back against sensible regulations being applied. But that’s a different conversation beyond this post.
On p. 155 they write:
As activity grows in bitcoin and crypotasset markets, investors must look beyond the madness of the crowd and recognize that there are bad actors who seek easy prey in these young markets.
Even for a book published in late 2017, this is pretty much lip service. Volumes of books can be written about the shenanigans within nearly every public ICO and high-profile coin project. The authors should either modify the statement above or ideally expand it to detail specific egregious examples besides just OneCoin.
While a truly innovative crypotasset and its associated architecture requires a heroic coding effort from talented developers, because the software is open source, it can be downloaded and duplicated. From there, a new cryptoasset can be issued wrapped in slick marketing. If the innovative investors doesn’t do proper due diligence on the underlying code of read other trusted sources who have, then it’s possible to fall victim to a Ponzi scheme.
Enough with the “heroic” adjectives, let’s not put anyone on a pedestal, especially if the platform is not being used by anyone besides speculators and illicit actors.
Secondly, a minor grammar question: other uses of “open-source” in this book have a dash and the one above does not.
Millions of dollars poured into OneCoin, whose technology ran counter to the values of the cryptoasset community: its software was not open source (perhaps out of fear that developers would see the holes in its design), and it was not based on a public ledger, so no transactions could be tracked.
First, what are the “values” that the “community” has? Are these explicity written somewhere? Who decided those?
Second, those actually don’t sound too uncommon.
For instance, one recent study found: “Security researchers have found, on average, five security flaws in each cryptocurrency ICO (Initial Coin Offering) held last year. Only one ICO held in 2017 did not contain any critical flaws.”
And remember, these projects are “open source” yet most buyers and investors didn’t bother looking at the code. OneCoin is par for the course.
On p. 159 they write:
The swift action revealed the strength of a self-policing, open-source community in pursuit of the truth.
In my most popular post last year, I went through in detail explaining how self-policing is an oxymoron in the cryptocurrency world.
For example, “the community” actively listed OneCoin on secondary markets and profited from its trading. Did exchange operators return those gains to victims? In addition, “the community” has thus far, not set up any self-regulating organization (SRO) that has any ability or teeth to enforce a code-of-conduct.
In fact, it was agencies from Sweden, the UK, and other governments that acted and cracked down on OneCoin… not a collective effort from exchanges or VCs or twitter personalities.
On p. 159 they explain googling for code on GitHub:
If nothing pops up with signs of the code on GitHub, then the cryptoasset is likely not open source, which is an immediate red flag that a cryptoasset and investment should be avoided.
Sure, but it doesn’t include the fact(s) that even in 2017 we knew that many coin projects had bugs in it… because there is no incentive to independently audit this code or to publish it in an objective manner.
For example, often when someone tries to help highlight problems, they are demonized as a “concern troll” as the coin tribes brigade their Twitter and reddit threads. There are a couple of sites like ConcourseQ that now do help highlight problems, but most “crypto thought leaders” on social media spend their time rallying retail investors to buy coins instead of busting or calling out the legitimate coin scams.
On p. 161 they write about John Law:
Fortunately, today it’s quite easy to find information on just about anyone through Google searches.
Yes and no. And that still doesn’t act as a shield against fraud. The founders of Centra had shady, criminal pasts but were still able to raise more than $30 million in an ICO. Their misdeeds only became widely known after a New York Timesarticle explored it… this was not a story that was investigated by any of the “coin media” who collectively have a vested interested not to “self-police” the market they cover.
As with most panics, the contagion spread from the Gold Exchange. Because of Gould’s cornering of the market, stock prices dropped 20 percent, a variety of agricultural exports fell 50 percent in value, and the national economy was disrupted for several months. Gould exited with a cool $11 million profit from the debacle, and scot-free from legal charges. It is all too common that character like Gould escape unscathed by the havoc they create, which then allows them to carry on with their machinations in other markets.
These kinds of panics and manipulation are part and parcel to retail traders on cryptocurrency exchanges. Scapegoats and the blame game consist of a myriad of boogeymen — but typically the culprits are never found.93
On p. 167 they write:
In addition to miners, in Dash there are entities called masternodes, which are also controlled by people or groups of people. Masternodes play an integral role in performing near instant and anonymous transaction with Dash.
Putting aside whether Dash is or is not anonymous… the fact that the authors state that humans play a direct role in running the infrastructure raises a bunch of questions that I have repeated in this review.
How are these participants held accountable? How is governance managed? Have these participants registered with FinCEN? Why or why not?
On p. 168 they write about the Bitcoin Rich List:
Another 116 addresses hold a total of 2.87 million bitcoin, or 19 percent of the total outstanding, which is sizeable. Unlike dash, however, these holders aren’t necessarily receiving half the newly minted bitcoin, and so their ability to push the price upward is less.
Should there be a thorough investigation of how any one party or set of parties can artificially move prices around based on control of the money supply? In our current real-world framework, there are frequent public hearings and audits done. When will minters of cryptocurrencies be publicly audited?
On p. 171 they write:
Each cryptoasset is different, as are the goals, objectives, and risk profiles of each investor. Therefore, while this chapter will provide a starting point, it is by no means comprehensive. It’s also not investment advice.
Throughout the book the authors have repeatedly endorsed or not-endorsed specific coins. The second edition needs to be a lot more consistent.
On p. 172 they write:
Currently, there is no such thing as sell-side research for cryptoassets, and this will require innovative investors to scour through the details on their own or rely on recognized thought leaders in the space.
This is a sad truth: it is nearly impossible to get neutral, objective research on any coin that has been created.
Why? Because all coin holders basically have an incentive to promote and advertise the coins they own and talk down other coins they perceive as competition. Paying “researchers” has happened and will continue to do so.
Also, here’s another appearance of “innovative investor” — can that be removed altogether?
And lastly, how to know who the “recognized thought leaders” are? Based on the amount of twitter followers they have? That has been gamed. Based on how popular their Youtube account is? That has been gamed.
For example, these two article explain some of this payola world:
It’s unclear if this is due to lobbying efforts or maybe the researchers owned a bunch of EOS coins. At this time, the EOS block producing and arbitrator framework are both broken. Block producers paused the network a few weeks ago and the arbitrators / constitutions will probably be scrapped.
How can this rating system be trusted?
On p. 173 they write about white papers:
Any cryptoasset worth its mustard has an origination white paper. A white paper is a document that’s often used in business to outline a proposal, typically written by a thought leader or someone knowledgeable on a topic. As it relates to cryptoassets, a white paper is the stake in the ground, outlining the problem the asset addresses, where the asset stands in the competitive landscape, and what the technical details are.
During the Consensus event this past May, someone accidentally dropped a napkin on the floor and someone loudly said: watch out, that’s the latest multimillion dollar white paper.
And that’s the situation where we are in now. Readers: the passage above was not at all critical of the real mess we are in today. For instance, Tron literally plagiarized in its whitepaper, raised a ton of money in its ICO and recently bought BitTorrent.
There is no direct connection between a “good” or “bad” whitepaper and the performance of the coin. Retail investors do not typically care and haven’t done much research. Yet another reason agencies such as the SEC will be overwhelmed in the coming years due to rampant fraud and deceit. Worth looking into the next edition.
On p. 173 they write:
Some of these white papers can be highly technical, though at the very least perusing the introduction and conclusion is valuable.
This seems like an incongruent statement compared to other advice in the book about doing deep research. Recommend revising.
On p. 174 they write:
A number of cryptoasset-based projects focus on social networks, such as Steemit and Yours, the latter of which uses litecoin. While we admire these projects, we also ask: Will these networks and their associated assets gain traction with competitors like Reddit and Facebook? Similarly, a cryptoasset service called Swarm City (formerly Arcade City) aims to decentralize Uber, which is already a highly efficient service. What edge will the decentralized Swarm City have over the centralized Uber?
And that in a nutshell is why the second edition of the book arguably needs to be slimmed down by 25%+. Virtually all of the use cases in this book are simply potential use cases and have shown little or even no traction in reality. For example, if the authors were as critical to Bitcoin and Zcash as they were to Swarm City then the second edition might be perceived as more balanced.
Specifically, in their promotion of Bitcoin as a payments platform, they have not done a deep dive into other existing payment networks, such as Visa or an RTGS from a central bank.94 They should do that in the next edition otherwise these come across as one-sided arguments.
Also, Yours switched from Litecoin over to Bitcoin Cash last year (around the time the book was published) and Swarm City is still not very active at the time this review was written.
On p. 175 they write about The Lindy Effect
The same applies to cryptoassets. The longest-lived cryptoasset, bitcoin, now has an entire ecosystem of hardware, software developers, companies, and users built around it. Essentially, it has created its own economy, and while a superior cryptocurrency could slowly gain share, it would have an uphill battle given the foothold bitcoin has gained.
This is untrue in theory and practice.
While maximalists would vocally claim that there can only be one-chain-to-rule-them-all, there is no real moat that Bitcoin has to prevent users from exiting or switching to other platforms (see discussion on substitute goods).
In practice, effectively all proof-of-work cryptocurrencies depend on external capital to stay afloat, often in the form of venture capital. ((See Robert Sams on rehypothecation, deflation, inelastic money supply and altcoins)) Part of the reason is that miners need to pay their bills in traditional currency and therefore must liquidate some or all of their coins to do so. Another issue is that because many participants think or believe that coin prices as measured in real money will increase in the future, they hold. Yet the expenses of service providers (exchanges, wallets, etc.) typically need to be paid with traditional money.
As a result, this creates sell-side pressure. And unlike the traditional FX market which has “natural” buyers in the form of international merchants and multinational corporations: there still is no “natural” buyers of cryptocurrencies outside of illicit activity (e.g., darknet market participants).
To compound this situation is that there is still no real circular flow of income, no real economy for any of these cryptocurrencies.95 And with the exception of a few cases each year, miners typically do not directly invest their coin holdings into companies, so crypotcurrency-related startups are dependent on foreign currency.
On p. 175 they write:
The demise of The DAO significantly impacted Ethereum (which The DAO was built on), but through leadership and community involvement, the major issues were addressed, and as of April 2017 Ethereum stands solidly as the second largest cryptoasset in terms of network value.
In the second edition, could the authors explicitly lay out how they define “leadership” in this context as well as what the “community” is? If it is singular and centralized, how is that fitting for an entity that is supposed to be decentralized?
Also, for readers interested in The DAO, here’s a short fiery thread on that topic.
On p. 176 they discuss “utility value and speculative value”
For bitcoin, its utility is that it can safely, quickly, and efficiently transfer value to anyone, anywhere in the world.
That may have been the original vision expressed in the whitepaper but it is not what the maximalists now claim Bitcoin is. Who’s promotion around utility is something we should take into consideration?
Also, considering how easy and common it is to hack cryptocurrency intermediaries such as exchanges, I think it is debatable that Bitcoin is “safe” for unsophisticated retail users, but that’s a separate topic.
On p. 176 they write:
The merchants wants to use bitcoin because it will allow her to transfer that money within an hour as opposed to waiting a week or more. Therefore, the Brazilian merchant buys US$100,000 worth of bitcoin and sends it ot the Chinese manufacture.
They explain a little more but the difficulties with this example starts here. The authors only focus on the bitcoins themselves, they don’t explore the actual full lifecycle that international merchants and manufacturers have to go through in order to exchange bitcoins into real money that they can use to pay bills.
That is to say: the Brazilian merchant and Chinese manufacture do not hold onto coins, so it is not just a matter of how fast they can send or receive the coins. What ultimately matters to them is how quickly they can receive the real money from a bank.
So the next edition needs to include the full roundtrip costs and frictions including the on-ramps and off-ramps into the traditional financial system. This is why many Bitcoin remittance companies struggled and ultimately had to pivot out of that cross-border use case (such as Abra). For the next edition, a side-by-side cost comparison would be helpful.96
On p. 177 they write:
That means on average each of these addresses is holding US$5.5 million worth of bitcoin, and it’s fair to assume that these balances are not those of merchants waiting for their transactions to complete. Instead, these are likely balances of bitcoin that entities are holding for the long term based on what they think bitcoin’s future utility value will be. Future utility value can be thought of as speculative value, and for this speculative value investors are keeping 5.5 million bitcoin out of the supply.
This seems like euphemisms. We understand that time preferences and discounted utility come into dramatic effect here. Maybe worth rewording?
For example, a large portion of those coins could be permanently destroyed (e.g., someone deleted the private key or threw away the hard drive). Though a significant portion could also be maximalists holding onto their coins with the hope that other investors create sufficient demand to move the price — as measured in real money — upward and upward. So they can then cash out.
If daily and weekly anecdotes on twitter and reddit are any indication, that’s arguably the real utility value of most coins, not just bitcoin. And there is some analytics to back up that argument too.
On p. 177 they write:
At the start of April 2017, there were just over 16 million bitcoin outstanding. Between international merchants needing 10 million bitcoin, and 5.5 million bitcoin held by the top 1,000 investors, there are only roughly 500,000 bitcoin free for people to use.
Citation needed. If the authors have any specific information that can share with the audience about any of these numbers, that’d be very helpful. Especially regarding the merchants needing 10 million bitcoin. If anything, there may be fewer merchants actively accepting bitcoin today than there were a couple years ago.
On p. 177 they write:
If demand continues to go up for bitcoin, then with a disinflationary supply schedule, so too will its price (or velocity).
It would be good to see what the authors think the velocity of bitcoin is. I’ve tried to track down and write about it in the past. See all of Chapter 9.
On p. 177 they write:
In other words, those investors no longer feel bitcoin has any speculative value left, and instead its price is only supported by current utility value.
As mentioned above, it would be helpful in the next edition if the authors included specific definitions and characteristics in a chart for what utility versus speculative value are.
Also, I don’t endorse the post in its entirety, but about five years ago Rick Falkvinge wrote an interesting note about the transactional value from illicit activity as it relates to Bitcoin. That has some actual data in it (though very old now).
On p. 178 they write:
For bitcoin, instead of looking at the “domestically produced goods and services” it will purchase in a period, the innovative investor must look at the internationally produced goods and services it will prucahse. The global remittances market–currently dominated by companies that provide the ability for people to send money to one another internationally–is an easy graspable example of service within which bitcoin could be used.
This whole section should probably be culled because this isn’t really a viable, scalable use case that bitcoin itself can solve.
For example, between 2014-2016, tens of millions of dollars were invested in more than a dozen “rebittance” companies (Bitcoin-focused remittance) and most either failed or pivoted.
Those that still exist had to build additional services and bitcoin were a means to an end. In all cases, these companies had to build their own cryptocurrency exchange and/or partner with several cryptocurrency exchanges in order to liquidate the coins — they need to hedge and limit their exposure to volatility. Bitcoin also doesn’t solve for the last-mile problem at all… but that is a separate topic.97
On p. 179 they write:
If each bitcoin needs to be worth $952 to service 20 percent of the remittance market and $11,430 to service the demand for it as digital gold, then in total it needs to be worth $12,382. There is no limit to the number of use cases that can be added in this process, but what is extremely tricky is figuring out the percent share of the market that bitcoin will ultimately fulfill and what the velocity of bitcoin will be in each use case.
This is highly debatable. And it is exactly what Pantera stated four years ago. Sources should be cited in the next edition; and also provide a velocity estimate for the potential use cases.
On p. 180 they write:
Taking the concepts of supply and demand, velocity, and discounting, we can figure out what bitcoin’s value should be today, assuming it is to serve certain utility purposes 10 years from now. However, this is much easier said than done, as it involves figuring out the sizes of those markets in the future, the percent share that bitcoin will take, what bitcoin’s velocity will be, and what an appropriate discount rate is.
An actual asset would certainly need these blanks filled, but Bitcoin doesn’t behave like a normal asset. For instance, it goes through enormous speculative bubbles and busts. It reached just under $20,000 per coin in mid-December last year not for any utility reason but pure speculation… yet many of the “thought leaders” at the time said it was because new buyers were going to use it for its utility.
On p. 180 they write:
Already there have been reports, such as those from Spence Bogart at Needham & Company, as well as Gil Luria at Webush, that look at the fundamental value of bitcoin.
I’ve read most of their reports, they’re nearly all based on edge-case assumptions or one-off anecdotes that never saw much traction (such as remittances). In addition, arguably both of their analysis may have been colored by their coin investments at the time they published their work. That’s not to say their material is discredited but I would discount some of their cryptocurrency-related reports.98
On p. 180 they write:
The valuations these analysts produce can be useful guides for the innovative investor, but they should not be considered absolute dictations of the truth. Remember, “Garbage in, garbage out.” We suspect that as opposed to these reports remaining proprietary, as is currently the case with much of the research of equities and bonds, many of these reports will become open-source and widely accessible to all levels of investors in line with the ethos of cryptoassets.
This has not happened. If anything, the market has been flooded with junk marketing material that masquerades as “research.” Universities are now getting funded by coin issuers and asked to co-publish papers. Even if there are no explicit shenanigans going on, there is now a shadow of doubt that hangs over these organizations.
Also, the next edition needs to define what “the ethos of cryptoassets” is somewhere up front. And dispense with “innovative investor”?99
On p. 182 they write about getting to know “the community and the developers”:
In getting to know the community better, consider a few key points. How committed is the developer team, and what is their background? Have they worked on a previous cryptoasset and in that processrefined their ideas so that they now want to alunch another?
If information cannot be found on the developers, or the developers are overtly anonymous, then this is a red flag because there is no accountability if things go wrong.
Satoshi clearly wouldn’t have been able to pass this test. Nor BitDNS originally (which later became Namecoin).
It is a double-standard to want accountability here yet promote an ill-defined “decentralization” throughout this book. You really can’t have it both ways.
Remember, the reason why administrators and operators of financial market infrastructure are heavily regulated is to hold participants legally responsible and accountable for when mistakes and accidents occur.
Cryptocurrencies were designed to be anarchic and purposefully were designed to not make a single participant accountabile. Trying to merge those two worlds creates the worst of both: permissioned-on-permissionless.
On p. 183 they write:
If Ethereum gets big enough, there may eventually be those who call themselves Ethereum Maximalists!
Yes, they exist and largely self-selected themselves into the Ethereum Classic world… you can see that by their antics on social media.
On p. 183 they write about issuance models:
Next, consider if the distribution is fair. Remember that a premine (where the assets are mined before the network is made widely available, as was the case with bytecoin) or an instamine (where many of the assets are mined at the start, as was the case with dash) are both bad signs because assets and power will accrue to a few, as opposed to being widely distributed in line with the egalitarian ethos.
Let’s tone down the talk on egalitarianism in a market fueled by greed and a perpetually high Gini coefficient.
In practice as of July 2018, many ICOs are pre-mined or pre-allocated, most as ERC20 tokens that are controlled by a singular entity (usually an off-shore foundation).100
Is this a “bad sign”? It would be helpful to see what the explicit criteria around token distribution should be in the next edition.101
On p. 183 they write:
For example, Ethereum started with one planned issuance model, but is deciding to go with another a couple years into launch. Such changes in the issuance model may occur for other assets, or impact those assets that are significatnly tied to the Ethereum network.
Those decision are made by individuals. Perhaps by the next edition we will know what FinCEN and other regulatory positions on individuals creating monetary policy and running financial market infrastructure.
On p. 184 they write:
With Dogecoin we saw that it needed lots of units outstanding for it to function as a tipping service, which justifies it currently having over 100 billion units outstanding, a significantly larger amount than Bitcoin. With many people turning to bitcoin as gold 2.0, an issuance model like Dogecoin’s would be a terrible idea.
What? Why? This passage conflates many different things.
As Jackson Palmer has repeatedly said: Dogecoin was set up as a joke, based on a meme. The authors seem to be taking its existence a little too seriously.
Dogecoin was originally based on Luckycoin which had a random money supply, so its original hashrate charts were all over the map, bipolar.
Its money supply was changed in part because it ran into an exitential crisis that it later (mostly) solved by merge mining with Litecoin in 2014
How does any of this have to do with maximalist narrative of “gold 2.0”?
On p. 186 they write:
The only way attackers can process invald transactions is if they own over half of the computer power of the network, so it’s critical that no single entity ever exceeds 50 percent ownership.
Technically this is not quite right.
The actual figure to sucessfully censor and/or reorg the chain may be as low as 33% and perhaps even 25% (dubbed “selfish mining“).102 More than 50% would mean the participants could do so repeatedly until their hashrate declines and/or a permanent fork occurs.
Aside from pressure on social media, there is nothing to prevent such “ownership” from taking place. And there is no legal recourse or accountability in the event it happens. And such “attacks” have occured on many different cryptocurrencies.103
On p. 186 they write:
In other words, miners are purley economically rational individuals–mercenaries of computer power–and their profit is largely driven by the value of the crypotasset as well as by transaction fees.
This should be reworded from the next edition because it is not true. Miners and mining pools are operated by people and they have various incentives, including to attack networks or abandon them altogether.
On p. 186 they write:
A clearly positively reinforcing cycle sets in that ensures that the larger the asset grows, the more secure it becomes–as it should be.
This is not true for proof-of-work coins.
If anything, mining and development have both trended towards centralization. For instance, it is estimated that Bitmain-manufactured hashing equipment currently generates 60-80% of the network hashrate and Bitmain-affiliated mining pools comprise about 50%+ of the current Bitcoin network. Maybe that is just momentary but singular entities on the mining side dominate many other cryptocurrencies as well. Perhaps that changes later in the year so it is worth revisiting in the next edition.
At the risk of being repetitive, more hash rate signifies more computers are being added to support the network, which signifies greater security.
This is a non sequitur. A new hashing machine capable of generating 10 times the amount of hashes as the previous machine could — ceteris paribus — result in other machines being turned off. In practice, you often have the Red Queen Effect take place (see Chapter 3).
Either way, depending on the costs of more efficient ASIC design, there could actually be fewer (or more) hashing machines added to a network depending on the expected price of the coin minus operating costs.
And in some cases, the network may become more centralized and therefore arguably less secure. Worth revising in next edition.
On p. 188 they write:
While hash rate often follows price, sometimes price can follow hash rate. This happens in situations where miners expect good things of the asset in the future, and therefore proactively connect machines to help secure the network. This instills confidence, and perhaps the expected good news has also traveled to the market, so the price start going up.
This passage has entered Rube Goldberg territory, where a series of specific events turn into a virtuous cycle in which prices go up and up but not down? How can we ever know what caused certain price increases or decreases with this type of asymmetric information occurring in the background? Suggest scrapping it in the next edition.
On p. 188 they write:
Ethereum’s mining network, on the other hand, is less built out because it’s a younger ecosystem that stores less value. As of March 2017, a 230 megahash per second (MH/s) mining machine could be purchased for $4,195, and it would take 70,000 of these machines to recreate Ethereum’s hash rate, totaling $294 million in value. Also, because Ethereum is supported by GPUs and not ASICs, the machines can more easily be constructed piecemeal by a hobbyist on a budget.
There are a few issues with this:
How do the authors measure or quantify “less built out”? Is there a line that is crossed in which Ethereum or other coins are “more built out” or the right size?
About a year ago a coin reporter asked me to detail the hypothetical lower bound costs for recreating the hashrate of the Bitcoin network. I provided those numbers based on Bitmain’s latest device… but the article instead ignored any of that and instead quoted some random conspiracy theory from a Twitter personality. Rather than rehashing the full story here, keep in mind that the geographic distribution and control of mining equipment is arguably as important as the aggregate network hashrate.
Their last sentence does not make much sense. How to define a hobbyist? If a hobbyist is defined as an individual who can afford to spend $4,195… then they can probably also buy ASIC equipment as well for other cryptocurrencies, including Ethereum today.
On p. 188 they write:
This range is a good baseline for the innovative investor to use for other cryptoassets to ensure they are secured with a similar level of cpaital spend as Bitcoin and Ethereum, which are the two best secured assets in the blockchain ecosystem.
There is another appearance of the “innovative investor,” remove in next edition?
Also, if security is solely measured by hashrate then yes, Bitcoin (BTC) and Ethereum (ETH) might be the “best secured.” But that assumes a purely Maginot Line attack and not a BGP or wrench attack.
On p. 189 they write:
Overall, hash rate is important, but so too is decentralization. After all, if the hash rate is extremely high but 75 percent of it is controlled by a single entity, then that is not a decentralized system. It is actually a highly centralized system and therefore vulnerable to the whims of that one entity.
This probably should come at the beginning of the chapter, not in this location. Also recommend adding some citations to the Onename and BGP posts.
On p. 189 they write:
It’s apparent that Litecoin is the most centralized, while Bitcoin is the most decentralized. A way to quanitfy the decentralization is the Herfindahl Hirschman Index (HHI), which is a metric to measure competition and market concentration.
HHI is used with known, legally identifiable parties. With cryptocurrencies such as Bitcoin, Litecoin, and Ethereum — the mining entities were not originally supposed to be known at all — over time they self-doxxed themselves.104
Should the Department of Justice and similar organizations coordinate and carry out HHI analysis on mining pools to prevent monopolization, oligopolization, and/or coordination? What happens if participants refuse to comply?
On p. 191 they write:
Blockchain networks should never classify as a highly concentrated marketplace, and ideally, should always fall into the competitive market place category.
Okay, but what if they don’t and no one cares? Who should enforce this?
At times, Bitcoin has been a moderately concentrated marketplace, just as Litecoin mining is currently a moderately concentrated marketplace. Litecoin recognizes the impact that large mining pools can have on the health of its ecosystem and the quality of its coin. To that point, Litecoin developers have instituted an awareness campaign called “Spread the Hashes” for those mining litecoin to consider spreading out their mining activies. The campaign recommends that litecoin computers mine with a variety of mining pools rather than concentraing solely in one.
The anthropomorphism needs to be removed in the second edition. “Litecoin” does not recognize anything because Litecoin is not a singular autonomous entity.
There are individual people, developers who work on a certain implementation of Litecoin that may promote something — and if they coordinate (which they do) then perhaps they could be classified as administrators.
Either way, this “Spread the Hashes” campaign didn’t seem to work:
As the pie chart above illustrates, just 5 entities currently account for about 90% of the network hashrate. And the largest 3 effectively could coordinate to control the network if they wanted to.
Worth noting that similar marketing campaigns to “spread the hashes” have been done on other networks. Back in 2014 when GHash.io reached the 50% mark, reddit was filled with discussions imploring miners to switch to P2Pool.
Not all nodes are made equal. A single node could have a large number of mining computers behind it, hence capturing a large percentage of the overall network’s hash rate, while another node could have mining computer supporting it, amounting to a tiny fraction of Bitcoin’s hash rate.
Sort of. There are two different nodes: nodes that fully validate and attempt to append the blockchain by submitting a proof-of-work that meets the necessary difficulty threshold… and nodes that don’t. In practice, today we call the former “mining pools” and the latter, just nodes.
For instance, in Bitcoinland there was a vicious war of words from 2015-2017 waged by several parties who did not operate mining pools, or nodes that generated proofs-of-work.105 One subset of these parties used various means and channels to insist that miners did not ultimately matter, that it was “users” who truly controlled the network and they labeled themselves “UASF.” And some of the most vocal members of this “populism wing” insisted that the nodes run by mining pools were no more important than the nodes run by some hobbyist in an apartment.
The views were irreconcilable and the ultimate result is that one group involved in that battle, forked off and created a new chain called Bitcoin Cash (BCH), whereas many of the other parties coalesced with what is called Bitcoin (BTC). There is a lot more to the story, a messy emotional divorce that still continues today.
Technically the decision to fork or not fork is made by mining pools and the nodes they each manage, but there are more nuances and politics involved that go beyond the scope of this review.
On p. 194 they write:
William Mougayar, author of The Business Blockchain, has written extensively about how to identify and evaluate new blockchain ventures and sums up the importance of developers succinctly: “Before users can trust the protocol, they need to trust the people who created it.” As we touched upon in the prior chapter, investigate the prior qualifications of lead developers for a protocol as much as possible.
Two problems with this:
I wrote a lengthy book review of Mougayar’s book and found it disappointing and do not recommend because of statements like the one above.
What were Satoshi’s qualifications? No one knows, but no one really cares either. Similarly, what were Vitalik Buterin’s qualifications? He was 19 when he announced Ethereum at Bitcoin Miami and had recently dropped out of college. Similarly, Gavin Wood was a 34 year-old developer building music-related apps prior to co-founding Ethereum. Would these two key guys been deemed qualified? What are the qualifications necessary to be a blockchain wizard?
On p. 194 they write:
Developers have their own network effect: the more smart developers there are working on a project, the more useful and intriguing that project becomes to other developers. These developers are then drawn to the project, and a positively reinforcing flywheel is created. On the other hand, if developers are exiting a project, then it quickly becomes less and less interesting to other developers, ultimately leaving no one to captain the software ship.
A couple of thoughts:
This is a nice sounding theory, but that’s not really what happens with most of these projects. Generally developers are attracted due to the compensation they can receive… they do a risk-reward analysis. I’ve met and spoken to dozens, perhaps north of 100 cryptocurrency-related teams in the past 12 months across the globe. Attracting talented developers is not nearly as easy and clear cut as the authors make it sound above.
Also, having a single “captain of the ship” seems like a single point of failure and a centralization risk. Is that part of the undefined ethos?
On p. 195 they write:
Recall that this is how Litecoin, Dash, and Zcash were created from Bitcoin: developers forked Bitcoin’s code, modified it, and then re-released the software with different functionality. Subscribers refer to people wanting to stay actively involved with the code. In short, the more code repository points, the more developer activity has occured around the cryptoasset’s code.
That’s not necessarily true, and in fact, has been gamed by coin issuers who want to make it look like there is a lot of independent activity and traction with developers… by creating spam accounts and very small changes to simple documents (like grammar).
Readers may also be interested in CoinGecko to see how this acitivity is weighted.
On p. 198 they write:
A different approach is to monitor the number of companies supporting a cryptoasset, which can be done by tracking venture capital investments. CoinDesk provides some of this information as seen in Figure 13.13. Though as we will address in Chapter 16 on ICOs, the trend in this space is moving away from venture funding and toward crowdfunding.
Actually, as mentioned a couple time earlier, there has been a noticeable divergence the past 12 months: coin sales that are done as private placements versus coin sales that have a public facing sale.
In general, most of the coins that have raised capital through private placement deals typically have less than 100 investors, many of which are the aforementioned “crypto hedge funds” and coin-focused venture funds such as Andreessen Horowitz and Union Square Ventures.
The public facing sales are generally eschewed by venture funds. If venture funds are involved in a coin that does a public sale, they typically are involved in what is called a “pre-sale” where they receive preferential terms and conditions, such as discounted coins.
Upon the conclusion of the “pre-sale” the actual public sale begins with heavy marketing on social media towards retail investors. Sometimes these sales have hundreds or even thousands of individual participants. That could be called a “crowdsale” and these participants typicallyget worse terms than those who participated in the pre-sale.
On p. 199 they write:
Another good proxy for the increased acceptance of a cryptoasset and its growing offering by highly regulated exchanges is the amount of fiat currency used to purchase it.
Maybe consider revising because we have all been told that cryptocurrencies would not only displace “fiat currency” but also topple and replace the existing financial system… how does measuring these new internet coins with old money help achieve that?
For instance, at the time of this writing none of the US-based retail exchanges with domestic bank accounts have recently listed an ICO (with the exception of ETH and ETC). This includes: itBit, Bitflyer, Coinbase, and Gemini.106 Kraken’s retail exchange uses payment processors and banking partners outside of the US.107
On p. 199 they write:
in the one-year period from March 2016 to March 2017, ether went from being traded 12 percent of the time with fiat currency to 50 percent of the time. This is a good sign of the maturation of an asset, and shows it is gaining wider recognition and acceptance.
Why is that specific ratio or percentage deemed good? The next edition should include a table explaining this in further because it is unclear why it is good, neutral, or bad.
On p. 201 they write about wallets from Blockchain.info:
Clearly, having more users that can hold a cryptoasset is good for that asset: more users, more usage, more acceptance. While the chart shows an exponential trend, there are a few drawbacks for this metric. For one, it only shows the growth of Blockchain.info’s wallet users, but many other wallet providers exist. For example, as of March 2017, Coinbase had 14.2 million wallets, on par with Blockchain.info. Second, an individual can have more than one wallet, so some of these numbers could be due to users creating many wallets, a flaw which extends to other wallet providers and their metrics as well.
In the past I have written extensively on how these headline wallet numbers are basically gimmicks and don’t accurately measure users or user activity.
Why? Because it costs nothing to open one. And often there is no KYC or AML involved in creating one as well. As a result, bots can be used to create many each day to inflate the metric.
Coinbase has actually removed usage data in the past and they still don’t define what the difference between a user or wallet is. Nor do either company provide traditional DAU / MAU metrics. It’s not hard to do and it is unclear why they don’t. The only way we have some semblance of an idea of what Coinbase user numbers were between 2013-2015 is because of the IRS lawsuit mentioned above.
On p. 201 they write about a search trend, “BTC USD,” first described by Willy Woo:
If we assume this to be true, then Woo’s analysis indicating a doubling in bitcoin users every year and an order of magnitude growth every 3.375 years. He calls this Woo’s Law in honor of Moore’s Law […] It will be interesting to see how Woo’s Law holds up over time.
How has it done? “Woo’s Law” has thus far not held up.
For instance, below is a 5 year trend chart of the same search term promoted by Woo and others last year:
As we can see above, this term has some correlation between interest in coins specifically during price bubbles. But this has not translated into large quantities of new daily users.108
The next edition of this book should remove this faux eponym because it has not withstood the test of time and doesn’t measure actual users.
On p. 202 they write:
Figure 13.17 shows the hyper growth of Ethereum’s unique address count. With Ethereum, an address can either store a balance of either, like Bitcoin, or it can store a smart contract. Either denotes an increase in use.
The next edition should include a caveat because it is unclear from this chart alone what kind of use is taking place. Is it coin shuffling, miner payouts, gambling payouts, Crypokitty activity, etc.? Maybe it is just someone spamming the network?
For instance, according to DappRadar which tracks 650 ethereum Dapps, over the past 24 hours there have only been 9,926 users sending 43,652 transactions. That may sound intriguing but… nearly about 2/3rd of all these users are using decentralized exchanges (DEX). If trading and arbitraging are the “killer apps” of cryptocurrencies, then the next edition of this book could be a lot slimmer than it is now.
As described in “Slicing data,” not all transactions are the same and a deep dive needs to be done to fully describe the behavior taking place.
But this is just an estimate from Blockchain.info and is likely widely exaggerated because Blockchain.info — like most wallet providers — probably has no idea what the intent behind those transactions are. We need data from all of the exchanges, payment processors, and merchants that accept coins in order to conclusively know what activity was commercial versus non-commercial in nature.
For instance, a large portion of those transactions could simply be “change address.”
Not to get too technical, but with Bitcoin, in order to manually send X amount of bitcoin on-chain, users typically must enter a “change address” unless the whole amount of UTXO is consumed. It’s kind of like a bank teller moving money from one till to another between shifts. No new economic activity is actually taking place in the bank or in the real economy, but in this specific chart above, there is no way to differentiate “change address” activity with real commercial activity and so it all gets mixed and muddied.
On p. 204 they write:
If the network value has outpaced the transactional volume of that asset, then this ratio will grow larger, which could imply the price of the asset has outpaced its utility. We call this the crypto “PE ratio,” taking inspiration from the common ratio used for equities.
Except, without a thorough deep dive from an analytics provider who has mapped out activity into all of the exchanges, payment processors, and merchants — it is very difficult to actually differentiate the noise from the actual transactional utility.109
Here the authors take all on-chain transaction volume at face value. The next edition should scrap this section unless they get access to a thorough deep dive.
On p. 204 they write:
One would assume that an efficient price for an asset would indicate a steadiness of network value to the transaction volume of the asset. Increasing transactional volume of an asset should be met by a similar increase in the value of that asset. Upside swings in pricing without similar swings in transaction volume could indicate an overheating of the market and thus, overvaluation of an asset.
In Figure 13.22 the top line is called the resistance line, indicating a price that bitcoin is having trouble breaking through. Often these lines can be numbers of psychological weight, in this case the $300 mark.
I looked it up and couldn’t find a definition for what “psychological weight” is, so this should either be defined in the book or removed in the next edition.110
On p. 209 they write:
You’ll find many instances of newer cryptoassets experiencing wild price swings after their creation, but over time these younger assets begin to follow the rules of technical analysis. This is a sign that these assets are maturing, and as such, are being followed by a broader group of traders. This indicates they can be more fully analyzed and evaluated using technical analysis, allowing the innovative investor to better time the market and identify buy and sell opportunities.
Technical analysis may have its uses but by itself it is basically cargo cult science.
Since cryptoassets are digital bearer instruments, they are unlike many other investments that are held by a centralized custodian. For example, regardless of which platform an investor uses to buy stocks, there is a centralized custodian who is “housing” the assets and keeping track of the investor’s balance. With cryptoassets, the innovative investor can opt for a similar situation or can have full autonomy and control in storage. The avenue chosen depends on what the innovative investor most values, and as with much of life there are always trade-offs.
This is true: there are many choice. But in practice, as noted above by Jonathan Levin, a significant majority of transactions typically involves a 3rd party intermediary.
Why? Because Securing a bearer instrument can be a major hassle, as a result companies like Coinbase and Xapo offer custodial services. While re-introducing an intermediary helps with coin management that kind of defeats the purpose of having a pseudonymous bearer asset in the first place.111 But that’s a different discussion.112
On p. 212 they write:
Anyone with a computer can connect to Bitcoin’s network, download past blocks, keep track of new transactions, and crunch the necessary data in pursuit of the gold hash. Such open architecture is one of Bitcoin’s strongest points.
It may sound like a irrelevant nitpick but this is not unique to Bitcoin. Nearly every cryptocurrency listed on Coinmarketcap has the same set of “features.” Similarly, many enterprise vendors also are open source and anyone could set up their own network with the software. Future editions should include a more nuanced definition of “open.”
On p. 213 they write:
The first computer – or mining rig – with ASIC chips that were specifically manufactured for the process was connected in January 2013.
The citation the authors included was for Avalon. This is true insomuch as these systems were available for purchase to the general retail public. But the first known ASIC-mining system was launched in late 2012: ASICMiner privately run out of Hong Kong (from BitQuan and BitFountain). 113
On p. 214 they write:
For perspective, the combined compute power of Bitcoin’s network is over 100,000 times faster than the top 500 supercomputers in the world combined.
This type of stat is frequently repeated throughout the Bitcoin world but it is not an apples-to-apples comparison and should be removed in the next edition. The supercomputers are largely comprised of CPUs and GPUs which — as their names suggest — are flexible and capable of handling many different types of general purpose tasks.
ASICs on the other hand, are focused and specialized: capable of doing just one set of tasks over and over. ASICs found in a Bitcoin mining farm are not even capable of creating blocks to propagate on the network: they simply generate hashes. That is how limited they are in functionality.
On p. 214 they write:
Conceptually, mining networks are a perfect competition, and thus as margins increase, new participants will flood in until economic equilibrium is once again achieved. Thus the greater the value of the asset, the more money miners make, which draws new miners into the ecosystem, thereby increasing the security of the network. It’s a virtuous cycle that ensures the bigger the network value of a cryptoasset, the more security there is to support it.
I think this could be rewritten in the next edition to be closer with what happens in practice.114
For instance, as coin prices decrease, margins are squeezed and “marginal” operators exit, leaving fewer overall miners. In the past this has led to bankruptcies, such as KnC and HashFast.
Does this lead to a less secure network?
Maybe, maybe not. Depends on how we define secure and insecure. Pure hashrate is just one attribute… geographical location, amount of participants, and diversity of participants could be others as well. For example, see the discussion earlier on selfish-mining.
On p. 215 they write:
Before investing in a cloud-based mining pool, conduct research on the potential investment. If it sounds too good to be true, it probably is.
This is good advice.
Also worth mentioning that “cloud-based mining” kind of the defeats the purpose of pseudonymous mining. If you have to trust the infrastructure provider to manage and operate the hashing equipment, why not just buy the coins? Why take that risk and also have to divulge your identity?
Incidentally, NiceHash is one of the most well-known cloud mining services available today. It partly cemented its notoriety (this is not an endorsement) as its mining units have been rented and used to attack several different cryptocurrencies. A site called Crypto51.app categorizes the costs of doing a brute force attack on dozens of coins and even lists the amount of hashrate NiceHash has in order to perform a hypothetical attack.
On p. 216 they write:
However, Ethereum will potentially switch to proof-of-stake early in 2018, as it is more efficient from an energy perspective, and therefore many claim is more scalable.
Quick note: this transition has been delayed again until at least the end of 2018 and more likely sometime in 2019 (although it has been moved many times before as well).
On p. 217 they write:
To this end, today numerous quality exchange are available to investors looking to gain and transact the more than 800 cryptoassets that currently exist.
In the next edition it is worth clarifying and defining what “quality” means because just about every retail / consumer-facing exchange has had its share of problems, including hacks and thefts.115 This is one of the reasons the SEC has denied ETF proposals.
With that said, there are a number of OTC trading desks run by reputable financial organizations that enable investors to trade, however, typically the minimum order size (buy/sell) is $100,000.116
On p. 218 they write:
Cryptoasset transactions are irreversible; therefore chargebacks are impossible. While an irreversible transaction may sound scary, it actually benefits the efficiency of the overall system. With credit card chargebacks, everyone has to bear the cost, whereas with cryptoassets only those who are careless bear the cost.
Two comments worth considering for the next edition:
Transactions in cryptocurrencies are possible through block reversals, which can and do happen. Often times they are relatively expensive to do, but during a “51% attack” it can occur, thus it is not impossible. In fact, as part of the Nano class action lawsuit, one of the suggested remedies is a roll-back.
As far as credit card chargebacks: this is largely borne by the merchant (not everybody). In fact, charge backs are largely a consumer-friendly feature, a type of insurance.117
On p. 221 they discuss insurance at exchanges.
At this time, no retail cryptocurrency exchange actually insures a users coin deposit. As a result, most custodians and intermediaries have had to self-insure (e.g., create their own insurance entity). There are institutional products (vaults) which are attempting to get 3rd party insurance.
Prior to the hack, Bitfinex had settled with the CFTC for $75,000 primarily because its cold storage of bitcoin ran afoul of CFTC regulations. The move to place all clients’ assets into hot wallets is cited by many as due to the fine and CFTC regulations. Either way, this hack proved that no matter the security protocols put in place, hot wallets are always more insecure than properly executed cold storage because the hot wallet can be accesssed from afar by anyone with an Internet connection.
This passage should be revised in the next edition for a few reasons:
First, as mentioned earlier, Bitcoiners like to find a good boogeyman and in this hacking incident, they blamed the CFTC.
For instance, I reached out to Zane Tackett who — at the time — was head of communications for Bitfinex.
According to Tackett: “We migrated to the bitgo setup before any discussions or anything with the CFTC happened”
I then publicly pointed out, to Antonopoulos and others, that the CFTC blame game was false. But instead of deleting that tweet and focusing on who actually hacked Bitfinex, the ideological wing of the Bitcoin tribe continues to push this false narrative.
Tackett even explicitly answered this question in detail on reddit that same day.
So either Tackett is lying or Antonopoulos is wrong. In this case, it is likely the latter.
The second point worth adding to the passage above in the book is that after nearly two years we still haven’t been told exactly what happened with the hack and theft. This, despite the fact that Bitfinex has said on more than one occasion that it would provide an audit and public explanation.
An ETF is arguably the best investment vehicle to house bitcoin.
This is debatable. Last year Jack Bogle – founder of Vanguard, a firm that popularized broad market index ETFs – implored the public to avoid bitcoin like the plague for several reasons. Critics say he is out of touch, but even if that were true that doesn’t mean his expert views on structuring ETFs should be dismissed.
On p. 238 they write:
Regardless of what people expected going into the SEC decision most everyone was taken aback by the rigidity of the SEC’s rejection. Notably the SEC didn’t spend much time on the specifics of the Winklevoss ETF but focused more on the overarching nature of the bitcoin markets. Saying that these markets were unregulated was an extra slap to the Winklevosses, who had spent significant time and money on setting up the stringently regulated Gemini exchange. In focusing on the bitcoin markets at large, the rejection implied that an ETF will not happen in the United States for some time.
For the next edition, this paragraph should probably be removed.
The facts of the Bitcoin markets today are as follows:
Mining is the process of minting new coins as well as processing transactions and… is largely unregulated in any jurisdiction.
Many exchanges, in particular those outside the US, comply with a hodge podge of regulations, often without the same strict KYC / AML / sanctions checks required for US exchanges.
Gemini and the Winklevoss have no ability to police these unregulated trading venues and unregulated coin minters. That probably won’t change in the near future.
Perhaps the SEC will eventually approve an ETF, but they arguably were not being rigid — they were being practical. In their view: why allow an unregulated asset whose underlying genesis and trading market is still very opaque and frequently is used for illicit activity?
Lastly the next edition should include a citation for who “most everyone” includes, because in my own anecdotal experience, the majority of traders at US exchanges I interact with did not think it would be allowed at that time. Note: my deep dive on the COIN ETF and its ever changing history, can be found here.
On p. 238 they write:
On Monday, naysarers were faced with the reality that bitcoin was once again back over $1,200, and the network for all cryptoassets had increased $4 billion since the SEC decision. Yes, $4 billion in three days.
A couple of thoughts:
Typo: naysarers should be naysayers
Recommend removing this sentence in the next edition because the attitude comes off as a little smug and has an ad hominem. People are allowed to have different views on the adoption of technology which is separate from what the price of a coin will be. And justifying a trading position based on price movements which are based on the mood of retail investors should probably not be the takeaway message for a mainstream book.
On p. 240 they write:
By purchasing XBT Provider, GABI strengthened the reliability of the counterparty to the bitcoin ETNs and added a nice asset to its growing bitcoin investing platform for institutions.
For the next edition, recommend removing “nice” because that is a subjective word. There are other ways to describe this acquisition.
On p. 242 they write:
It also created an independent advisory committee, including bitcoin evangelist Andreas Antonopoulos to oversee its pricing model, which utilized prices from various exchanges throughout the world.
Why is this specific person considered an expert on futures? There are a lot of articulate developers involved in promoting cryptocurrencies, but their expertise is typically not in finance. If anything, this specific person has a vocal disdain for regulators, financial institutions, and regulated instruments… just see his tweet above in Chapter 14.119
Maybe in the next edition discuss the controversy of having a futures contract that is not physically deliverable. Could also include how the CFTC has subpoenaed the four partner exchanges working with the CME: Coinbase, Kraken, itBit, and Bitstamp. These four exchanges create the price used in bitcoin futures by the CME.
On p. 249 they write:
For first-time founders who want to approach venture capitalists for an investment, often they must know someone-who-knows-someone. Having such a connection allows for a warm introduction as opposed to being among the hundreds of cold calls that venture capitalists inevitably receive. To know someone-who-knows-someone requires already being in the know, which creates a catch-22.
This is a very good point. However, it would be worth adding in the next version how most ICOs and coin sales now require knowing someone because most private sales involve roughly the same insular, exclusive set of funds and investors as the “old method” did.
On p. 252 they write:
Before we dive into the specifics of how a cryptoasset offering is carried out, the innovative investor needs to understand that the model of crowdfunding cryptoassets is doubly disruptive. By leveraging crowdfunding, cryptoasset offering are creating room for the average investor to stand alongside venture capitalists, and the crowdfunding structure is potentially obviating the need for venture capitalists and the capital markets entirely.
In the next edition, worth mentioning that this was the general pitch for ICOs starting with Mastercoin (2013) all the way up through 2016. But over the past two years and certainly in the past 12 months it has dramatically shifted back towards the traditional venture route.
One of the reasons why is because of the filtering and diligence process. Those that don’t get selected and/or those ICOs that don’t meet the requirements of this small group of funds often decide to do a public sale. And many of these ideas were half-baked and sometimes fraudulent, according to one recent report: More Than Three-Quarters of ICOs Were Scams
On p. 253 they write:
Monegro’s thesis is as follows: The Web is supported by protocols like the transmission control protocol/Internet protocol (TCP/IP), the hypertext transfer protocol (HTTP), and simple mail transfer protocol (SMTP), all of which have become standards for routing information around the internet. However, these protocols are commotidized, in that while they form the backbone of our internet, they are poorly monetized.
It could be argued that Monegro’s thesis has failed to live up to its hype thus far. And counterfactually, if “tcpipcoin” existed, it may have actually stunted the growth of the internet as Vinton Cerf and Bob Kahn would have allocated more time promoting the coin rather than the technology. We can disagree about this alternative scenario, but I have mentioned it before in Section 8.
For example, we frequently see that dozens of nonsensical conferences and meetups conducted on a weekly basis globally try to promote a shiny new protocol coin of some kind. Trying to monetize a public good with a coin thus far has not removed the traditional incentive and sustainability issues around a public good. That would also be worth discussing in the next edition.120
On p. 253 they write:
All the applications like Coinbase, OpenBazaar, and Purse.io rely on Bitcoin, which drives up the value of bitcoin.
Worth updating this because Purse.io added support to Bitcoin Cash. And OpenBazaar switched over to Bitcoin Cash altogether.
Also, Coinbase has become less maximalist over time and now provides trading support for four different coins.121 Though it probably wouldn’t be technically correct to call Coinbase or Purse a Bitcoin application. In the case of Coinbase, users use an off-chain database to interact and Coinbase controls the private key as a custodian / deposit-taking institution.
On p. 254 they write:
Interestingly, once these blockchain protocols are released, they take on lives of their own. While some are supported by foundations, like the Ethereum Foundation or Zcash Foundation, the protocols themselves are not companies. They don’t have income statements, cash flows, or shareholders they report to. The creation of these foundations is intended to help the protocol by providing some level structure and organization, but the protocol’s value does not depend on the foundation.
This is another reason to heavily modify chapter 7 in future versions because it is not an apples-to-apples comparison: coins and coin foundations are not the same thing as for-profit companies that issue regulated instruments (stocks, bonds, etc.).
Also, the very last sentence is highly debatable because of how often foundation and foundation staff are integral to the longevity of a coin.
Recall that blockchains do not maintain or market themselves, people do. And is often the case: staff and contractors of these foundations frequently use social media to promote potential upgrades as well as publicize the coins attributes to a wider audience. In many cases it could be the case that the protocol’s value does depend on the work and efforts of others including specifically those at a coin foundation.122
On p. 254 they write:
Furthermore, as open-source software projects, anyone with the proper merits can join the protocol development team. These protocols have not need for the capital markets because they create self-reinforcing economic ecosystems. The more people use the protocol, the more valuable the native assets within it become, drawing more people to use the protocol, creating a self-reinforcing positive feedback loop. Often, core protocol developers will also work for a company that provides application(s) that use the protocol, and that is a way for the protocol developers to get paid over the long term. They can also benefit from holding the native asset since inception.
There are several points here that should be modified or removed in the next edition:
For instance, with Bitcoin, due to a variety of political fights and personality conflicts, multiple “core” developers have had their access rights removed including: Jeff Garzik, Mike Hearn, Gavin Andresen, and Alex Waters. Thus it is not true that anyone can join a team. It is also unclear what those merits may be as most of the projects don’t explicitly provide those in written format yet.
In addition, internet coins are often traded on secondary markets in order to provide liquidity to coin holders such as developers. They all need access to capital markets to stay afloat. No project is self-sustainable at this time because no coin is being used as a unit of account — miners and developers must liquidate coins in order to pay their bills which are denominated in foreign currency.
Lastly, in practice, there are many coins that have died or lost any developer support yet initially they may have had a small army of programmers and media attention. According to Coinopsy, more than 1,000 coins are dead. Thus in the next edition the “self-reinforcing” loop should probably be removed too.
On p. 256 they write:
ICOs have a fixed start and end date, and often there is a bonus structure involved with investing earlier. For instance, investing at an early stage may get an investor 10 to 20 percent more of a cryptoasset. The bonus structure is meant to incentivize people to buy in early, which helps to assure that the ICO will hit its target offering. There’s nothing like bonuses followed by scarcity to drive people to buy.
This should definitely be removed. In May, the SEC released a parody website called “HoweyCoins” which explicitly points to this precise FOMO behavior as a big no-no for both issuers and investors alike.
Also recommend the inclusion of the Munchee Order in this chapter as it would help illustrate what regulators such as the SEC perceive as improper fundraising techniques. Specifically, include this in the “announcing the ICO” section.
On p. 258 and 259 they discuss the Howey Test. It is strongly recommended that these two pages be reworded and modified based on the enforcement actions and guidance from the SEC and other securities regulators.
For instance, they write:
A joint effort by Coinbase, Coin Center, ConsenSys, and Union Square Ventures with the legal assistance of Debevoise & Plimpton LLP, produced a document called, “A Securities Law Framework for Blockchain Tokens.” It is especially important for the team behind an ICO to utilize this document in conjunction with a lawyer to determine if a cryptoasset sale falls under SEC jurisdiction. The SEC made it clear in July 2017 that some cryptoassets can be considered securities.
The first sentence should probably be moved into a footnote and the second sentence removed altogether because this document did not age well.
In fact, the current version of the document – as it exists on Coinbase – informs readers in bright red that:
Please note that since this document was originally published on December 7, 2016, the regulatory landscape has changed. The information contained in this document, including the Framework may no longer be accurate. You should not rely on this document as legal advice and you should seek advice from your own counsel, who is familiar with the particular facts and circumstances of what you intend and can give you tailored advice. This Framework is provided “as is” with no representations, warranties or obligations to update, although we reserve the right to modify or change this Framework from time to time. No attorney-client relationship or privilege is created, nor is this intended to be attorney advertising in any jurisdiction.
On p. 259 they write:
Does the token sale tout itself as an investment? It should instead be promoted for its functionality and use case and include appropriate disclaimers that identify it as a product, not an investment.
This is arguably not good advice and should be removed. Why? Courts in the US will likely see through this euphemism. For other things not to do, recommend reading the ICO Whitepaper Whitepaper from Stephen Palley.
On p. 260 they write:
One of the oldest groups of angel investors in the blockchain and bitcoin space is called BitAngels. Michael Terpin of BitAngels has been active in angel investing in blockchain companies for as long as the opportunities have existed. Terpin’s annual conference, CoinAgenda, is one of the best opportunities for investors to see and hear management from blockchain startups present their ideas and business models.
For the next edition, I’d reconsider including this type of endorsement.123 There are some interesting stories that involving these specific entities worthy of a different post.
On p. 263 they write:
For instance, if Bitcoin influences how remittances are handled, what impact may that have on stocks like Western Union, a remittances kingpin? If Ethereum takes off as a decentralized world computer, will that have any effect on companies with cloud computing offerings, such as Amazon, Microsoft, and Google? If companies can get paid more quickly with lower transaction fees using the latest cryptocurrency, will that have an impact on credit card providers like Visa and American Express.
For the next edition, this paragraph — or at least argument — should come earlier, perhaps even in Chapter 7 (since there is a discussion of specific publicly traded companies).
Another thing that should have been added to this section is actual stock prices for say, the past five years of the companies mentioned: Western Union, Visa, and American Express.
I have included those three below:
If the narrative is that Bitcoin or the “latest cryptocurrency” will erode the margins and even business models of existing payment providers, then at some point that should be reflected in their share prices.
As shown above, that does not seem to be the case (yet).
Perhaps that will change in the future, but consider this: all three of the companies above have either directly invested in and/or are collaborating in blockchain-related platforms — most of which do not involve any coin. Perhaps these firms never use a blockchain. In fact, maybe they find blockchains to be unhelpful as infrastructure altogether.
That is possible, hence the need to update this chapter to reflect the actual realities.
In addition, the other three companies listed by the authors have publicly discussed various blockchain-related efforts beyond just pilot offerings.
For instance, both Amazon and Microsoft have supported blockchain-as-a-service (BaaS) offerings in production for over a year. Google has been a laggard but has internal projects attempting to leverage some of these ideas as well.
On p. 266 they write:
In 2016, the father-son team of Don and Alex Tapscott published the book Blockchain Revolution: How the Technology behind Bitcoin Is Changing Money, Business, and the World, and William Mougayar published the book, The Business Blockchain: Promise, Practice, and Application of the Next Internet Technology.
I wrote lengthy reviews of both. The short summary is that both were fairly superficial in their dive into use cases and vendors. The Mougayar book felt like it could use a lot more detailed meat. The Tapscott book was riddled with errors and unproven assertions. Would reconsider citing them in the next edition (unless they each dramatically update their content).
On p. 266 they write:
For companies pursuing a DLT strategy, they will utilize many of the innovations put forth by the developers of public blockchains, but they don’t have to associate themselves with those groups or share their networks. They pick and choose the parts of the software they want to use and run it on their own hardware in their own networks, similar to intranets (earlier referred to as private, permissioned blockchains).
These are pretty broad sweeping comments that should be modified in the next edition. Not every vendor or platform provider uses the same type of chain or ledger. These are not commoditized (yet).
There are many nuances and trade-offs for each platform. For the next edition, it would be helpful worth doing a comparison of: Fabric, Pantheon, Quorum, Corda, and other enterprise-focused platforms. In some cases, they may have an on-premise requirement and in others, nodes can run in a public cloud.
We see many DLT solutions as band-aids to the coming disruption. While DLT will help streamline existing processes–which will help profit margins in the short term–for the most part these solutions operate within what will become increasingly outdated business models.
Perhaps that it is true, but again, this language is very broad sweeping and definitive. It needs citations and references in the next edition.
On p. 267 they write:
The incumbents protect themselves by dismissing cryptoassets, a popular example being JPMorgan’s Jamie Dimon, who famously claimed bitcoin was “going to be stopped.” Mr. Dimon and other financial incumbents who dismiss cryptoassets are playing exactly to the precarious mold that Christensen outlines:
Disruptive technologies like cryptoassets initially gain traction because they’re “cheaper, simpler, smaller.” This early traction occurs on the fringe, not in the mainstream, which allows incumbents like Mr. Dimon to dismiss them. But cheaper, simpler, smaller things rarely stay on the fringe, and the shift to mainstream can be swift, catching the incumbents off guard.
For the next edition it would be good to remove the misconceptions repeated in the statement above. Jamie Dimon was specifically dismissing the exuberance of coin mania, not the idea of enhancing IT operations with something like a blockchain.
Worth adding to future versions: JPMorgan has financial sponsored Quorum, an open-source fork of Ethereum modified for enterprise-related uses. The bank has also invested in Digital Asset. It is also a member of three industry organizations: EEA, Hyperledger, and IC3. In addition, JP Morgan has filed blockchain-related patents, has launched a blockchain-based payment network with several banking partners, and also partnered with the parent company of Zcash to integrate ZSL into Quorum.
While Jamie Dimon may not share the same bullish views about coins as the authors do, the firm he is the CEO seems to be taking “blockchains” seriously.
On p. 267 they write:
One area long discussed as ripe for disruption is the personal remittances market, where individuals who work outside of their home countries send money back home to provide for their families.
This specific use case is a bit repetitive as it has been mentioned 5-6 times before in other chapters. Should probably remove this in future editions unless there is something different to add that wasn’t already explained before.
On p. 268 they write:
It’s no stretch then to recognize that bitcoin, with its low cost, high speed, and a network that operates 24/7, could be the preferred currency for these types of international transactions. Of course, there are requirements to make this happen. The recipient needs to have a bitcoin wallet, or a business needs to serve as an intermediary, to ultimately get the funds to the recipient. While the latter option creates a new-age middleman–which potentially has its own set of problems–thus far these middlemen have provided to be much less costly than Western Union. The middleman can be a pawnshop owner with a cell phone, who receives the bitcoin and pays out local currency to the intended recipient.
This should be modified in the next versions because it is a stretch to make those claims. That is the reason why multiple Bitcoin-focused remittance companies have pivoted or branched out because “moving” bitcoins across borders is the only easy part of the entire process. For instance, the KYC / AML checks during the on- and off-ramps are costly and are required in most countries. This should be included in any analysis.
Also, there are no citations in this paragraph. And the last sentence is describing the pawnshop owner as a money transmitter / money service business which is a regulated operation. Maybe the laws change, which is possible. But for the next version, the authors should include specific corridors and the costs and margins for MSBs operating in those corridors.
Lastly, any future analysis on this topic should also include the online and app-based product offerings from traditional remittance players such as Western Union. In nearly all cases, these products and services are faster and cheaper in the same corridors relative to traditional in-person visits.
The impact of this major disruption in teh remittance market should be recognized by the innovative investor not only because of the threat it creates to a publicly traded company like Western Union (WU) but for the opportunities it provides as well.
It is strange to hear this repeated multiple times without providing quantifiable specifics on how to measure this threat.
As mentioned a few pages earlier, if competitors (including, hypothetically cryptocurrencies) were to erode the margins of publicly traded companies, we should be able to see that eventually reflected in the share price. But Western Union has been doing more or less the same as it has the past couple of years.
What about others?
Above is the five year performance of Moneygram, another remittance service provider.
What happened the past two years? Did Bitcoin or another cryptocurrency pound its share value into the ground? Nope.
What happened is that one of Alibaba’s affiliates – Ant Financial – attempted to acquire Moneygram. First announced in early January 2017, Ant Financial wanted to acquire it for $880 million. Despite approval from the Moneygram board, the deal faced scrutiny from US regulators. Then in January 2018, the deal was axed as the US government blocked the transaction on national security grounds.
This hasn’t stopped Alibaba and its affiliates with finding other areas to grow. For instance, last month Alipay (part of Ant Financial) announced it had partnered with G Cash to in the Hong Kong – Philippines corridor, using a blockchain platform for remittances. No coin was needed in this process so far.
There may be some success stories of new and old MSBs that utilize cryptocurrencies in ways that make them more competitive, those should be included in the next edition along with more metrics readers can compare.124
On p. 270 they write:
For the long term investor, careful analysis should be undertaken to understand if insurance companies are pursing DLT use cases that will provide a lasting and meaningful solution. Lastly, some of the major consulting firms may be so entrenched in incumbent ideology that they too may be blind to the coming distruption.
A few comments that should be finnesed in the next version:
Similarly, every major consulting company and systems integrator has a team or two dedicated to helping clients build and integrate applications with specific enterprise-related “blockchain” platforms. Many of them have joined related consortia too. There are too many to even list here so it is unlikely they will get collectively blind-sighted as alluded to in the passage above.
On pgs. 272 and 273 they write about consortia:
Another consortium, The Hyperledger Project, offers more open membership than R3. Remember, one of the strengths and defining aspects of an effective blockchain project is its open source ethos.
While the [EEA] consoritum will work on software outside of Ethereum’s public blockchain, the intent is for all software to remain interoperable in case companies want to utilize Ethereum’s open network in the future.
Based on the passages above the next edition should incorporate a few changes.
The Hyperledger Project (HLP) is a non-profit group that does not itself aim to commercialize or deploy or operate any technology.125 The membership dues are largely used to maintain code repositories and sponsor events which educate attendees on projects incubated within HLP. It currently has around 200 members, including R3 which was a founding member. There are more than 5 codebases that are officially incubated, the most well-known is Fabric. However, HLP seeks to maintain a neutral position on which platform its members should use. Other notable platforms incubated within HLP include Iroha and Sawtooth (Lake).
In contrast, R3 is a for-profit company that set up a consortium in order to commercialize and deploy technology within the regulated financial industry.126 Its membership model has changed over time and it is the main sponsor for Corda, an open source platform. The consortium composition initially started with 42 banks and now includes about 200 entities including insurance companies, central banks, financial market infrastructure operators, and others.
The third most known consortium is the Enterprise Ethereum Alliance (EEA). It is kind of like the combination of the two above. It is a non-profit organization and itself does not aim to commercialize or deploy or operate any technology. It seeks to be a neutral entity within the greater Ethereum ecosystem and has many different working groups that span topics similar as the other two consortia above. It has hundreds of members and the main efforts have been around formalizing an enterprise-focused specification (EEA 1.0) that other vendors can create implementations of (such as Pantheon).
Like the members of the other two consortia above, nothing prevents an EEA member from using any other platform. Thus the authors usage of “open network” is superfluous because all of the codebases in each of these three consortia is open, anyone can download and use. The key differences are: what are the trade-offs with using each platform versus what are the benefits of membership for joining the consortia. These are two separate points that could be discussed further in the next edition.
On p. 276 they write:
The CFTC Director of Enforcement, Aitan Goelman, tried to clarify his opinion with this satement, “While there is a lot of excitement surrounding bitcoin and other virtual currencies, innovation does not excuse those acting in this space from following the same rules applicable to all participants in the commodity derivatives markets.” It is clearly confusing that the Direct of Enforcement of the agency that ruled bitcoin a commodity also called it a “virtual currency.”
For the next edition the authors should remove the unnecessary attitude in the last sentence.
Up through 2017, most US and even foreign regulators used the term “virtual currency” — not as a slight against Bitcoin or cryptocurrencies, but because that was the catchall term of art used for many years.
For instance, in March 2013, FinCEN released its guidance and it was entitled: “Application of FinCEN’s Regulations to Persons Administering, Exchanging, or Using Virtual Currencies”
Throughout the guidance, the term “virtual currency” is used more than 30 times.
And one relevant passage – especially for this book review – involves the definition of an administrator. According to FinCEN’s guidance:
“An administrator is a person engaged as a business in issuing (putting into circulation) a virtual currency, and who has the authority to redeem (to withdraw from circulation) such virtual currency.”
As it relates to the CFTC, earlier this year a federal judge in New York ruled that: “virtual currencies can be regulated by CFTC as a commodity.”
The ruling (pdf) specifically uses the phrase “virtual currency” not as a slight, but as a term of art. Perhaps other terms are used over time. For instance, in its new customer advisory issued this week, the CFTC mentioned potential scams that describe themselves as “utility coins” or “consumption coins.” Worth revisiting in the next edition.
On p. 280 they write:
Here’s another Burniske-Tatar Rule: Don’t invest in bitcoin, ether, or any other cryptoasset just because it’s doubled or tripled in the last week. Before investing, be able to explain the basics of the asset to a friend and ascertain if it fits well given the risk profile and goals of your investment portfolio.
This is good advice. And while the eponymous rule was coined several chapters ago, future editions should probably drop the name of that rule… because similar advice with slightly different wording has existed for decades (e.g., don’t invest more than you can afford to lose, do your own research, etc.).
On p. 282 they write:
Are millenials turning to bitcoin and cryptoassets for their investment? Is a Vanguard fund or a small investment in Apple any better? Whereas the Vanguard fund has a minimum investment amount and buying an equity will require commission, millennials see cryptoasset markets as a way to begin investing with a modest amount of money and in small increments, which is is often not possible with stocks or funds.
They also include a footnote that reads:
Each bitcoin can be divided into 100 million units, making it easy to buy 1/2, 1/10, 1/100 or 1/1000 of a bitcoin
Would recommend removing this passage altogether because there really aren’t many good surveys that indicate who actually bought coins versus who was just interested in them.
For instance, a flawed Finder.com survey that is still being cited, says that 8% of Americans have invested in cryptocurrencies.127 While it says the majority of investors are “millenials,” the survey doesn’t ask the most important question: does the investor control the private key. If you do not control the private key then you do not control the coin, someone else does.
In addition, there are online brokerages that do allow investors to invest with modest amounts, the most notable being Robinhood (which coincidentally also allows users to purchase several different cryptocurrencies). There are also a variety of spare change investment apps and robo-advisor products that allow users to have some exposure to regulated capital market too.
Lastly, regarding the footnote they provide: due to the fees required by Bitcoin miners, in practice over the past several months 1/1000 of a bitcoin is typically the minimum transaction fee. This is one reason why many investors simply leave coins on cryptocurrency exchanges: so they don’t have to pay fees to move them to other wallets.128
On p. 282 they write:
The important point is that at least they’re doing something to invest their funds and build the groundwork for a healthy financial future. We have seen firsthand millenials who have learned about investing from buying cryptoassets and have implemented investing approaches, such as taking profits at certain price points, seeking diversification into multiple assets, and so on.
This should probably be removed too because the same thing can be said to a new cohort of investors twenty years ago, such as the ones that invested in dotcom-related companies. Who remembers Beenz?
I fully expect some reaction towards this review along the lines that it was too picky or too pedantic. Perhaps this a little true but consider: what is the right size for a thorough book review in the age of so-so fact-checking?129 Also, most of my previous reviews were about the same length, or at least used the same page-by-page model.
There is obvious room for disagreement in areas involving opinions, but there are many technical and non-technical mistakes that the authors made, not just a small handful. By highlighting these, not only could the next edition be significantly improved but it helps readers new to this space get a better understanding of what the prevalent themes versus realities are.
The goal of this review was not to be overbearing but to be dispassionate about supposed common wisdom promoted in the cryptocurrency world.
For example, just the other day I noticed in a chatroom the following statement from a maximalist:
HODLer = DAU. Bitcoin has the most DAUs on any protocol.
Several people in the room agreed with those this statement and they are not alone. If the reader is interested in learning about the sociology and subculture of many Bitcoin enthusiasts, its worth skimming reddit and twitter occasionally to see how passionate coin investors think.130
But for businesspeople who are not part of the inner sanctum of Bitcoinland, the statement above from the chatroom may make you shrug.
After all, HODLing a dollar doesn’t make you a dollar user. HODLing a barrel of oil doesn’t make you a oil user. HODLing a brick of gold doesn’t make you a gold user. HODLing a digitized Pokemon card doesn’t make you a Pokemon user. HODLing a Stradivarius violin doesn’t make you a violin player. HODLing an Olympic medal doesn’t make you an Olympic athlete. And so forth. The valuation of an auction house isn’t measured by the amount of rare collectibles it sells in a day, why should internet coins and their platforms be an exception to that rule?131
Inactivity isn’t how activity is measured. Or to look at this argument from another angle: HODLing is not ‘active’ anything. If all an investor did was buy bitcoin and then lose their keys, they would accomplish the same thing described in the chatroom.132
Sure it is possible to redefine what Bitcoin or cryptocurrencies are supposed to do, but that’s after the fact. For example, if Satoshi had wanted to explicitly build “digital gold” he/she would likely have mentioned it in the original paper at least once and even architected Bitcoin to be something different than what it looked like in 2009.133 As mentioned above, the first app he looked at building was for poker.
This is definitely a topic worth including in the next edition, but I digress.134
Other general areas for improvement:
Add a glossary.
Add financial disclosures of coins owned by each author.
Provide specific definitions for vague terms like “the community,” “administrator,” and the attributes of a target investor; ditch the “innovative” investor nomenclature.
Chapter 7 probably should be removed until more accurate comparisons can be found and Chapter 17 seemed a bit unfocused and covered a wide array of topics instead of just one or two… even dropping in thoughts about regulators. Future versions likely need an entire set of chapters focused on regulations, not just mentioned in passing.
Based on the incorrect view of financing mentioned in Chapter 5, interview Vitalik Buterin and other co-founders regarding how Ethereum was bootstrapped.
In one of the future regulatory chapters, would be good to have a discussion around PFMI, CBDCs, and settlement finality.
Provide a lot more references and citations regarding cryptocurrency-focused use cases, especially remittance providers. This seemed to be the most repeated use case but nary a mention of a specific Bitcoin remittance company, its valuation, or volume corresponding to the use case.
Have a book or paper you’d like me to look at? Feel free to send it across. Also, it just came out but this one sounds like a doozy already. See my other book reviews.
To be fair, Burniske is not the only analyst-turned-VC who has not publicly disclosed his trading positions of coins, but that’s a separate topic. [↩]
One reviewer mentioned: “Likely it was partially intentional to release in late 2008 / early 2009, but did in fact coincide mainly with internal constraints. We could also argue that the GFC commenced in mid-2007 when BNP Paribas froze two mortgage-backed security funds which became the catalyst of the summer 2007 credit crunch, but that is neither here nor there. I also debate the argument that it was ‘intended’ as anything other than a solution to the double-spend problem, be it a payments system or an investment.” [↩]
As an aside, Brian Kelly, frequently promotes various coins on CNBC. Unclear what his trading positions are on each coin at the time of recording. While that may not be illegal, it’s arguably not classy. [↩]
One reviewer mentioned: “This was literally the ethos that led to the GFC. Securitization and Mark-to-model were heralded as “innovation” and championed for their ability to move faster than the academic foundation and until 2007 seen as a way to ‘completely engineer risk out of from the system.'” [↩]
One reviewer mentioned: “The authors also miss that “value” is still a function of ‘the market’, i.e. supply and demand. Simply by fixing supply does not equalize demand. I also take massive issue with the governance in “a [de]centralized and democratic manner.” Are the authors able to write C++ or GOLang protocol code for Bitcoin Core or GETH? Likely not. So if anything this walks us towards a new form of governance, except where we elect leaders in the US who ultimately appoint Fed governors in cryptocurrencies there are generally no elections. Long story short, in all cases, it ain’t democratic and it probably remained at least partially centralised at a given point in time.” [↩]
See Central bank digital currencies from the BIS. I know, I’ll get spammed by all the “sound money” promoters out there who insist that Bitcoin will replace central banks — it’s a religious zeal to many. [↩]
For example, about a month ago, Jonathan Levin from Chainalysis did an interview and mentioned that: “So we can identify, it is quite hard to know how many people. I would say that 80% of transactions that occur on these cryptocurrency ledgers have a counterparty that is a 3rd party service. More than 80%.” [↩]
For instance, on p. xxvi they list “the top 50” coins at the end of 2016 and don’t disclose if they own any specific ones at all, but talk about many of them in positive ways. Adding a disclosure would be helpful. [↩]
The Economist wrote a nice short article on this behavior — the greater fool – last year. [↩]
For example, on p. 9 they write: “Shortly thereafter, Satoshi vanished. Some speculate it was for the good of Bitcoin. After all, being the creator of a technology that has the potential to replace much of the current financial system is bound to eventually invoke the wrath of powerful government and private sector forces.” This seems like a strawman. Bitcoin was designed for just one simple thing: payments. The financial system is an interwoven network of hundreds of regulated and unregulated goods and services, not just payments. Also, this paragraph, like a few others later, has elements of conspiratorial boogeymanism. Just around the corner, the government is preparing to shut down Bitcoin! Nothing like that has happened in the past 9+ years. In fact, the opposite has been true as most jurisdictions have been pretty accommodating, arguably even too lenient on the issuance and usage of cryptocurrencies, but that is a topic for a different post. [↩]
One reviewer mentioned: “Are the authors aware that CMOs first appeared in 1983, and that in many countries where they were heavily utilised including in the late 2000s they worked as advertised? In fact many CMOs in the US performed as modelled. The issue was, and is, always liquidity, over-leverage and most of all deteriorating lending standards. Cryptocurrencies will most likely be looked at as catalysts of these risks should their notional rise substantially, not their saviour.” [↩]
One reviewer commented: “Are they arguing that people would have been more able to pay their mortgages or that home values wouldn’t have fallen if CMOs were on a blockchain?” [↩]
One reviewer explained: “When someone claims that blockchain would have prevented the mortgage crisis, they are revealing their ignorance of their ignorance. I worked with some of that CMO data. One former colleague works for one of the large consulting firms ‘blockchain’ practices. He posted something about how blockchain would address the problems with mortgage servicing . When I privately asked him how it would do so,and that the problems with mortgage servicing that I was aware of were either failure to do certain required activities or their failure to record that they did them, as opposed to someone changing the record after it was entered, he did not respond.” [↩]
For example, at the time of this writing, Coinmarketcap tracks 1641 different types of coins and tokens. Many of these are likely ERC20 tokens and thus rely on Ethereum itself and are not independent blockchains. [↩]
Worth re-reading the recent DoJ indictment of GRU officers as the DoJ provides a reason for why Bitcoin was used versus other transmission methods. [↩]
Someone should create a website that tracks all of the gigantic bullish claims from Bitcoin promoters on how it will topple banks and destroy governments. There are at least more than 100 such public predictions each month. [↩]
But “be your own payment processor” isn’t a catchy phrase. [↩]
Some literature describes the proof-of-work process used in Bitcoin as a “scratch-off puzzle.” [↩]
One reviewer mentioned: “A model that I like to describe this with is how the main professional soccer leagues are selected in Europe and other regions. For example, France specifically has an annual selection of the “League 1” after the Coupe de French. Basically any team can enter, but practically there is minimal turnover because a team from a town of 5,000 people is unlikely to reasonably beat a team like Paris or Lyon which has multi-million euro budgets. There are few upsets, but these can generally be modeled by statistical chance.” [↩]
For example, Coin Center circulated a borderline defamatory note to ESMA with regards to Corda – even before the Corda introductory whitepaper was released – likely because its author was unfamiliar with how the platform actually worked. [↩]
It seems to be a euphemism and code word for “someone with money who should buy coins.” [↩]
Based on public information, over the past four years pretty much the only cryptocurrency-related companies that probably were profitable equity investments were: exchanges and handful of mining companies operating outside of the US (e.g., some service providers have also generated steady income including several law firms and conference organizers). [↩]
In both cases, consensus is achieved by the longest chain rule. [↩]
May not be a Freudian slip here, but keep in mind all blockchains have operators and maintainers. See “arewedecentralizedyet” for more. [↩]
It arguably could have been a self-fulfilling prophecy: investors outside of Cyprus hear news about the Cyprus bailout and bitcoin… thereby marketing bitcoin to new retail investors who then go out and buy bitcoins to try it out. [↩]
It is common to see Bitcoin promoters regularly demonize these companies who are trying to improve and automate infrastructure, vilified as a bourgeoisie activity that must be shunned. Worth revisiting to see if this changes over time. [↩]
Furthermore, in September 2014 I gave a presentation (video) (slides) that similarly tried to bucket different types of proposed coins as “commodities” and the like. And I know I wasn’t the first to try and do so. Recommend readers do a bit more digging on this topic if they’d like to see a more thorough origin story. [↩]
One reviewer mentioned: “The native tokens / coins / assets inside a ledger are “cryptocurrencies”, they are currency in the single sense that they the only form of compensation accepted by the miner / staker in a network. This cryptoasset business really only makes sense in the context of units which are not used to pay for the security of a blockchain.” [↩]
But that doesn’t necessarily excite speculators and coin holders. [↩]
There are few religious undertones here that could be removed in the next edition. [↩]
As mentioned above, The Economist wrote a nice short article on this behavior — the greater fool – last year. [↩]
The authors of this book are likely unintentionally promoting coin buying with a security-like mentality, the wording could be modified in the next edition. [↩]
One reviewer mentioned: “Unless the authors explain how ETH is worth precisely zero based on the same logic then their statement seems disingenuous. Not that I believe that is the case, but I am not the one stating that scarcity in the future is the reason for the value.” [↩]
Since the authors are making this claim, would they be willing to disclose or be transparent about their own coin holdings for the date when they published this book? [↩]
The most likely answer is: speculators bought these coins because they knew others would buy it too thus driving the price higher. [↩]
Or conversely, you are considered “one of us” if you promote the policies and antics of said coin promoters. [↩]
Note: it should be apparent at this stage that “Bitcoin developers” should be in quotes because it is certain key individuals — and centralized organizations such as “Core” — who have the power to sway decisions such as BIP approval. These are arguably administrators of financial market infrastructure. See also: In Code(rs) We Trust: Software Developers as Fiduciaries in Public Blockchains [↩]
It is these types of passages that make a reader scratch their head as to whether or not the lessons for why equity ownership — and the rights afforded to equity holders — evolved to where they have in developed countries. [↩]
This narrative needs to be buried but probably won’t. [↩]
This is a common refrain that needs to stop being repeated. [↩]
A few months before Cryptoassets was published, the SEC published a report that said they found The DAO to have all the hallmarks of a security but they never enforced any specific legal action on its creators. [↩]
On p. 63 they write: “For example, a fully functional decentralized insurance company, Airbnb, or Uber all hold great promise, and developer teams are working on similar use cases.” Why do these hold great promise? Because everyone else says that on stage? [↩]
One takeaway is that other speculators may buy your coins at a later date when the prices go up, so you should get in before they do. [↩]
One of the biggest flaws in Chapter 7 is that all of the pricing information for the coins are based on markets that are opaque and unregulated… some of whom may be considered bucket shops of yesteryear. Lack of transparency is one of the reasons why all of the Bitcoin-related ETFs have been (so far) axed by the SEC. See: Comments on the COIN ETF. [↩]
For example, later on p. 104 they write: “More surprisingly, the portfolio with bitcoin would have had lower volatility.” Because of the time period? We could probably find other things with the same or lower volatility. That seems like cherry picking. [↩]
Maybe they are both, but that still doesn’t mean that the coins, say that Placeholder Capital invested in, shouldn’t be classified as securities. [↩]
Also, these are all arguably poor stores of value because of their relatively high volatility. For instance, “number goes up” or rapid price increases is not the definition for a store of value. Claiming bitcoin is a good store of value because it sees swift increases in price appreciation as measured by actual money is a contortionist view which ignores the empirical reality of how money is used. [↩]
For example, later on p. 110 they write: “While many cryptoassets are priced by the dynamics of supply and demand in markets, similar to more traditional C/T assets, for some holder of bitcoin — like holder of gold bars — it is solely a store of value. Other investors use cryptoassets beyond bitcoin in a similar way, holding the asset in the hope that it appreciated over time.” Spoiler alert: everyone that owns internet coins hope they appreciate over time. [↩]
And there are specific projects — such as Bitcoin — in which one clique of developers waged an effective propaganda campaign against miners. For more on this, look into the actors and organizations behind the Segwit / Segwit2x / UASF online debates. [↩]
Not to rekindle the flames of the Bitcoin blocksize debate but in retrospect, several Blockstream employees and contractors were arguably more effective at swaying public opinion than Coinbase was, even though the latter generates significantly more revenue and has actual customers whereas the former is largely just a R&D dev shop. This discussion deserves its own post but neither company is very forthcoming about client or partnerbase… although Coinbase has published a bit more information over the years relative to Blockstream. [↩]
The book downplays illicit activity as if it is not a valid, reliable use case when it is. For instance, the GRU allegedly used bitcoin to finance some of its operations focused on the 2016 US elections and they did so to obfuscate their tracks. [↩]
A fundamental problem with this book is that it wants to have it both ways, with no clear goal posts for what a good or bad platform is and how to measure it. How can an investor know if a coin is any good? A table of attributes is recommended for the next edition. [↩]
Simply multiplying the amount of mined / pre-mined / pre-allocated coins by the market price to arrive at a “market cap” is a disservice to how market capitalization is actually determined. See Section 6. [↩]
As an aside, even though there is no law preventing consumers and merchants from using or accepting gold (or silver) as a means of payment in the US, basically no one does because they’d rather hold it with the expectation of future price appreciation. I am sure lots of angry trolls will point out that legal tender laws in the US do not currently include precious metals and neither are cryptocurrencies. Yet there are other economic reasons why people would rather hold onto an internet coin or a gold bar versus use it as money, and simply blaming legal tender laws is missing those. [↩]
And as mentioned in the section above, both Zelle and Swift (gpi) will likely make a lot of inroads in the same national and international areas that cryptocurrency advocates were touting… but without needing a coin. The struggle is real. [↩]
Note: both have since left those jobs. Bogart became a partner at Blockchain Capital (a venture fund focused on coins) and Luria joined D.A. Davidson [↩]
In the next edition if possible, try to include Placeholder’s research so we can have an idea of the firm’s internal thinking on these issues. [↩]
Note that selfish mining has some odd game theoretic properties which may not hold up in the real world. But if the selfish mining pool manages to stay a block ahead on average, they can reveal a longer chain whenever they see transactions they want to censor. It comes with the caveats that it’s not completely reliable in that they aren’t guaranteed to be a block ahead of the rest of the network 100% of the time (due to the inhomogenous Poisson process mentioned earlier). However, if they manage to effect a cohort of self-interested selfish miniers, they could… and that’s the equivalent of a “51% attack.” [↩]
A user can be defined as a person who controls their private keys without relying on a 3rd party intermediary. [↩]
Several analytics providers include: Chainalysis, Blockseer, Elliptic, Scorechain, and CipherTrace. [↩]
This is reminiscent of the BearWhale nonsense a few years ago. [↩]
Recall that historically, humanity went from only having to bearer assets up through the 19th century. And that for a variety of reasons these became registered and immobilized and then later dematerialized altogether. Cryptocurrencies recreates a financial order that had already existed. [↩]
Butterfly Labs began accepting pre-orders in the summer of 2012 but delivered them late in 2013… and got sued by the FTC. [↩]
Regarding ‘perfect competition,’ four years ago Jonathan Levin opined that: “Another simple thing about this is that it is unsurprising that the bitcoin network got into this mess as it is economically rational to join the biggest pool. Minimises variance and ceteris paribus reduce orphans increasing expected return per hash. The other point is that there is still hardware bottlenecks so designing the theoretically most robust system may fail due to market imperfections. Implicitly in many arguments I hear about mining people assume perfect competition. Do we need to remind people what are the necessary conditions for perfect competition? Perfect information, equal access to markets, zero transportation costs, many players ……. this is clearly not going to be a perfectly competitive decentralised market but it certainly should not favour inherently the big players.” See p. 114 of The Anatomy [↩]
Needs a larger sample size conducted in a public venue, and/or with the help of an experienced sampling organization. [↩]
This then leads to incentives to attack and hack exchanges, because they end up acting as deposit-taking institutions, aka banks. [↩]
There were probably 50% more hand-written notes or comments that I could have added that I skipped over. [↩]
The HODLing “digital gold” meme which was only passingly mentioned in this book ultimately degenerates into goldbugism but that’s a topic for a different post. HODLing arguably became a thing once the ideologues realized Bitcoin itself wasn’t a competitive payment system. An enormous amount of revisionism has taken place since 2014 regarding what Bitcoin was and is and should be. [↩]
One reviewer mentioned: “By hoarding then actively purchasing more coins to hoard, they might temporarily create an effect whereby each marginal contribution to Bitcoin through mining rewards in expanding the effective monetary base is partially neutralized. In addition to marketing campaigns, this can lead to higher USD values and may incentivize additional mining power, which in turn creates higher hashrate. However, you cannot make the same argument for gold because simply driving the price of gold up doesn’t make gold harder to find or more secure, and in fact we see the opposite.” [↩]
For instance, the supply of gold is actually elastic whereas many cryptocurrencies including Bitcoin have an inelastic money supply. Where in the whitepaper does it talk about a store of value? If that was the goal, surely it would’ve been mentioned in the whitepaper or the first few emails upon Bitcoin’s initial release. [↩]
The first several months of the year have been pretty packed with undeserved pomp and circumstance. In general the “cryptocurrency world” has lost whatever remaining marbles it had and gone backwards to repeating the same tropes from 2014. Many of the same sub-par ideas are being proposed (like colored coins) yet there were several fundamental reasons these types of ideas didn’t get off the drawing board four years ago and will not for the same reasons again.
The noise around “blockchain” hype has gotten so bad that just about anything that can be said, has been said and as a result, new projects find themselves having to make even bigger promises that they will be unable to keep. Expectation management is nigh impossible and it is a global craze (I visited Asia three times already and saw this exuberance first hand)
Along the way, I found some interesting, quiet groups: in addition to a couple stealth projects, I joined Blockseer as an advisor and Elm as a consultant.
Below are some of the activities I was involved and participated in.
[Note: I originally wrote the bulk of this article as an unpublished memo about 18 months ago. I have updated it to include new information. The views and opinions expressed in this article are mine and do not necessarily reflect the views of my clients.]
The big news this past week was that Coinbase acquired Earn.com (née 21.co, née 21e6 LLC). According to Recode, the offer “was slightly more than $100 million” but also lower than Earn.com’s most recent valuation (in 2015) which was $310 million.
From the current coverage, it is unclear what the revenue for any of the products or services for Earn.com was. Instead most stories have focused on one specific aspect: the current Earn.com CEO, Balaji Srinivasan, will join Coinbase as the CTO.
There have been a lot of questions around why Coinbase would purchase a company that seemed to have poor product-market fit with unknown KPIs. This post will look into several areas for answers.
Taking a step back
Following the official acquisition announcement from Coinbase, Srinivasan published a self-congratulatory Medium post that basically paints him as the savior of 21.co: that it was the previous management that were bad and he came in and turned it all around.1
His revisionism arguably whitewashed what happened, so let’s dive into a little bit of the company’s history.
In May 2013, 21inc (formerly 21e6 LLC) was co-founded by five men including Balaji Srinivasan. According to a story from Nathaniel Popper:
The company was also structured as an limited liability company, rather than the C Corp typical of startups, so that people could invest with their own money.
Why is that important to some investors?
According to Popper:
The 21e6 investment was attractive in part because venture capital firms generally felt that they couldn’t buy Bitcoins directly. 21e6, on the other hand, offered to pay its investors back with Bitcoin dividends, allowing the firm to get Bitcoins without buying them outright.
What does this mean?
Venture funds often have clauses restricting their partners from investing in asset classes that may be seen as a conflict of interest or something that could reduce the firm’s reputation (e.g., cannabis startups). In this case, cryptocurrencies may be seen as a direct speculative bet on a commodity or foreign exchange which could be prohibited by an investment funds by-laws.2
Altogether the 21e6 team, over three separate rounds, raised approximately $116 – 125 million – which at the time was more money than any other cryptocurrency-related company.3 The sum total varied depending on news source but Srinivasan frequently made it a point to casually insert comments such as: we are the “most funded” or “best funded” company in Bitcoin into interviews and talks during 2015-2016.
In the beginning
In its early days 21e6 focused exclusively on designing custom ASIC chips for Bitcoin mining and then integrating and deploying Bitcoin mining hardware for private, non-retail usage. This included installing hundreds of hashing systems in data centers which for several reasons eventually became uncompetitive against those based in China and the Republic of Georgia.45
Based on publicly available information and allegedly leaked slides we know that:6
It closed its Series A for $5 million in May 2013.
Investors included: Peter Thiel, David Sacks, Max Levchin, Marc Andreessen, Ben Horowitz, Naval Ravikant, Winklevoss Capital, Mark Pincus
Estimated $3.8 million revenue in 2013
In June 2013, then-CEO Matthew Pauker filed a Form D, Notice of Exempt Offering of Securities, which stated that 55 investors had already invested in its offering.7 While that may sound unusual for an early stage company to have so many investors, recall what Popper pointed out above, that individual investors could invest directly into 21e6 because of its LLC status.
It closed its Series B for approximately $65 million in December 2013.
Andreessen Horowitz (the VC fund) invested $25 million as the lead investor; and $10 million came from existing investors (such as $100,000 from Pantera)
$30 million also came in the form of “venture debt”
Estimated $41 million in revenue in 2014
19 employees in November 2014
The funds from its first two rounds were used in part to design and deploy “Gandalf” (its 2nd generation ASIC chip) and “Yoda” (its 3rd generation ASIC chip) in the aforementioned data centers.
How much capital is required to build a state-of-the-art ASIC chip? Depending on how much is done in-house or out-sourced as well as the fabrication facilities, it can be upwards of $15 – $20 million.8
First major pivot
The company rebranded from 21e6 to 21.co and announced its Series C on March 10, 2015, with $56 million led by RRE Ventures. 9
That morning, The Wall Street Journal led with the story:
This marked the beginning of its pivot from purely building mining hardware and instead marketing itself as supposedly moving into the Internet of Things (IoT) and API marketplace. Around this time you frequently saw 21.co and its supporters publicly talk about machine-to-machine (M2M) payments as being a killer app.10 One of the 21.co engineers was even interviewed on a (now deleted) podcast where he spoke about how drone owners would pay tolls denominated in bitcoin to cut across airspace over yards in your neighborhood. You know, the usual word salad and shower thoughts on social media.
When I first drafted this memo 18 months ago, based on LinkedIn profiles, 21.co had about 25 full-time employees; as of now their page says 22 employees but most of them are just people adding 21.co in their profiles without formally being affiliated with it. Most of the current employees unsurprisingly have shifted to Earn.com’s official LinkedIn profile. Its tally is 63 people but again, some of these profiles are from people who are likely unaffiliated with the organization.
Alan Chang (Jeff Skoll’s family office via Capricorn Management) in Series B
Richard Tapalaga (Qualcomm Ventures) in Series C
Gen Isayama (World Innovation Labs) in Series C
According to Nathaniel Popper, as of March 2015 when it announced the closing of its Series C round, “the company has paid back all of its investors.” It did so partially via payouts in bitcoin.
In his self-canonization this week, Srinivasan wrote that:
And with this deal, the total value of cash, cryptocurrency, and equity returned to our shareholders is now in excess of the capital invested in the company.
How much of the cryptocurrency above is from the not-yet-released Earnable Token? Get the whitepaper while you still can.
Since March 2015, there has also been noticeable churn at the top:12
Matthew Pauker, co-founder, was replaced as CEO in spring 2015 by Balaji Srinivasan
Albert Esser was the COO from December 2013 through August 2015
Replaced by John Granata from March 2016 to the present
Nigel Drego co-founder, was chief architect from May 2013 through March 2016
Replaced by Jian Li as CTO from March 2016 through 2017
Lily Liu became CFO during summer 2015 to the present
Because of the economic incentives that tilt in favor of mining countries like China, 21.co stopped its operations in the Bitcoin mining sector and those subject-matter experts seem to have left the ranks.
Second major pivot. Or part of the first?
What has it built since the pivot after Series C?
The 21 Bitcoin Computer was their first consumer-facing product that was announced on September 21, 2015 and released with great fanfare as an exclusive to Amazon Launchpad on November 16, 2015 at a price of $400. It also picked up the “toaster” nickname from the Financial Times.13
Several enthusiasts explored the component prices via a piece-by-piece breakdown and found that it likely cost around $247 to build each 21 Computer.14 It was subsequently nicknamed the “Pitato” because the main component at its heart was basically a Raspberry Pi, a popular DIY kit that sells for less than $200.
The only other notable piece of tech was a custom built ASIC chip that could be used for mining. However, ever before it had shipped, the mining chip was already uncompetitive and obsolete. Even if you had free electricity you likely would not generate enough bitcoin in order to recoup the full cost of buying the 21 Computer, especially since the few satoshi you generated would be stuck as dust.15
What were the maths behind this?
In September 2015, after it was announced, Vitalik Buterin crunched the numbers and worked out that:
So you’re paying $399 upfront and getting $0.105 per day or $38.3 per year, and this is before taking into account network difficulty increases, the upcoming block halving (yay, your profit goes down to $0.03 per day!) and, of course, the near-100% likelihood that you won’t be able to keep that device on absolutely all of the time. I seriously hope they have multiple mining chips inside of their device and forgot to mention it; otherwise you can outcompete this offering pretty easily by just preloading a raspberry pi with $200 of your favorite cryptotokens.
Why the relatively large markup for a device? Part of it is that Amazon Launchpad gets a 25% cut.
But like just about all things Bitcoin, sales numbers were so bad that they were never disclosed and it was eventually discontinued. Prior to its discontinuation, 21.co representatives approached multiple well-known Bitcoin developers to help resell the devices. In short, these developers were offered to buy 21.co devices at wholesale prices and expected to resell them at the retail price. It is unclear how many (if any) developers did so.
For real, the second major pivot
On April 1, 2016, 21.co launched an app “marketplace” and initially seeded it with 50 apps that were built in-house. At the time, the only way to externally measure usage or traction is to manually observe the amount of ratings (stars) an app had each day. Interestingly, in early July 2016 the amount of apps stood at 95 whereas six weeks later it fell to 76 and basically fluctuated for the remainder of the year.
In May 2016, Srinivasan took the stage at Consensus and announced his vision of a “machine payable web” and introduced several ideas but notably did not mention the Bitsplit which was rumored to have been in the works for over a year.16
Throughout the remainder of the year, 21.co sponsored and hosted meetups and had an active Slack room, and most of the ideas that were used or borrowed as API and app ideas, languished due to… a lack of users.17 If you are new to my site, one reoccurring observation is that in general: cryptocurrency owners typically are not actual users, but that’s a whole different discussion.
The 21.co Marketplace now redirects to the Earn.com homepage.
On October 27, 2017, 21.co emailed its users that it was ending server-side support for three things: the Bitcoin Computer, 21 command line interface (CLI), and marketplace. 18
Three days later, 21.co announced that it was rebranding as Earn.com and pivoting away from its second vision as a VC-backed quasi protocryptojacking play towards taking on Amazon Mechanical Turk, but with Bitcoin. It also announced a non-ICO ICO called Earnable Token, which as you can tell from its name: was earnable from doing the same kind of tasks as you could before like: filling out surveys or answering bots who email you.
Earn.com also migrated the unique profile pages it first introduced with 21.co, which is basically a static page that users can claim and use a bit like LinkedIn, but with more Bitcoin-related spam.19
This last part is of particular interest in today’s regulatory climate because Earn.com, which hosts these user-controlled accounts, has accidentally assisted and enabled the promotion of alleged unregistered securities (ICOs) as a business line. Recall that Google, Facebook, Snap, Twitter, Mailchimp, and other tech companies have reduced or removed the ability for ICOs and cryptocurrency promoters to solicit retail investors, Earn.com has done the opposite and been a refuge. At what point is this an unsuitable risk profile for a “bank” like Coinbase?20
What does that mean?
In its January 2018 update, Earn.com announced that:
This week we were thrilled to announced the launch of Earn.com Airdrops — a new way for blockchain entrepreneurs to give 100,000+ Earn.com users a free trial of any new coin or token. Airdrops allows token projects to instantly bootstrap your new blockchain project with 100,000+ cryptocurrency early adopters.
We announced our first Airdrop partner, CanYa — a decentralized marketplace for services — as well as the next three upcoming Airdrops: Bloom, Bee Token, and Vezt. Sign up for an account on Earn.com, verify your account, and download the Earn.com mobile apps on iOS or Android apps to become eligible.
I am not a lawyer but in the past – like the dotcom era – companies (including startups) have attempted to give away equity in some very creative ways… and depending on the circumstances, it can be a no-no.21 That’s not to say that the tokens above are securities or that any airdrop is a violation of securities laws. But highlighting this type of feature has inadvertently led to Earn.com becoming a magnet for ICO issuance and promotion.
Where’s the beef?
What was the long term deliverable for roughly $125 million in nearly 5 years?
Throughout 2016 – including at Consensus in NYC – Srinivasan explained that they will announce a “surprise” in the coming months, maybe all of the aforementioned products and chips were the alpha phase of a much larger operation? Maybe they were, but we probably won’t find out.
Either way, it is worth keeping in mind that between 2013-2016, cryptocurrency-specific startups collectively received a little more than $1 billion in external funding, with nearly 15% of that funneled into just one startup. One who has had to pivot multiple times to find the right product-market fit and tech-market fit. Keep in mind too that other companies such as Bitfury and Bitmain were able to make superior chips and do so initially without major venture backing.22
If the most funded, best connected startup continually struggled to see consumer traction, what are the prospects for less funded and less connected cryptocurrency startups? This is worth revisiting in another long-read, especially in seeing what the $125 million was actually spent on (salaries? chips? toasters?).
One of the investors in 21.co responded to Nathaniel Popper above claiming that Srinivasan wasn’t actively involved in the first two years.
Does it matter? Sure, when you are claiming successes and denying failures that should or shouldn’t be attributed to you.
Below is a quick series of interrelated anecdotes.
In December 2014, Srinivasan and I both attended and presented at what would become the second of three round table events organized by R3 (a family office then called R3 CEV). This was prior to the formal creation of the DLG consortium.23 Unfortunately I do not have his presentation, but the layout and design were nearly identical to the leaked slides that have circulated for years — just with different content. For instance, the design of his slides at a public talk in the spring of 2015 is pretty close to the other two decks.
In January 2015, I was unexpectedly shown a long set of slides for a company called 21e6, most of which look similar to what has been leaked in the past and linked to above.24
Later that same month – due to a variety of circumstances – I met up with Srinivasan in Palo Alto and he quickly paged through the leaked presentation and stated it was an older deck from October / November 2014.
While there is a little more to our subsequent interactions, I think the key part here and the only reason I brought up this personal anecdote is the fact that Srinivasan was able to dismiss the deck of having any relevance on the current fundraising 21e6 was doing (remember, this was less than two months before the round was publicly announced).25
So while he may not have been “day to day” as he disclaims in his post, he clearly was involved in the fundraising process if not more (deck creation?). He said as much in a post published in March 2015.
So what to make of all of this news?
An exit is an exit, right?
What ultimately appears to have happened is that Andreessen Horowitz took one of its floundering portfolio companies and merged it with another portfolio company… and declared it a great success.2627
There also appear to be a few parallels with Juicero.28 For those unfamiliar, Juicero is a now-defunct Silicon Valley-based startup that built and sold a custom $400 machine that would squeeze juice packets. It raised $120 million and unceremoniously shut down last year after reporters showed that the hands from mere humans were capable of squeezing the same juice packets.
In much the same way, during the second pivot of 21.co, no one really bothered to buy the “Pitato” because users could easily do the math: that it was far more effective to either buy bitcoins outright or buy and use more capable mining hardware.
Why hasn’t anyone written about this before?
Most of the knowledge above is public, or at least, pretty well known if you have spent much time in Bitcoinland. Other reasons involve some tinfoil hat theories around retaliation.29
Funnily enough, back in March 2015 I had a long email exchange with Michael Casey and Paul Vigna over at The Wall Street Journal regarding 21.co and other several other topics.
Tim Swanson, a consistently skeptical digital-currency consultant who makes a habit of challenging bitcoiners’ unbridled optimism, is unequivocal. 21′s plan is “a dumb idea,” he says, adding that “the investors deserve to get what’s coming to them.”
And while a few of those investors probably did, it is Coinbase share holders that likely got it on the chin this week.30 If you’re looking for more memorable gems, be sure to read this older WSJ article. It is chocked-full of hubris, kind of like Juicero.31
In closing, raise your hand if you’d like to get paid every time you respond to an email and moreso to a cold email? I know I would.
So maybe with all of the kinks, toasters, pivot denialism, and chest thumping there is still a future for a pay-to-respond model to thrive. Maybe Coinbase can turn the ICO sanctuary of Earn.com into a legitimate mainstream product that is integrated with various webmail providers and social media platforms. Or maybe this ends up like ChangeTip, whose platform was basically used to spam coin dust on Twitter… to ultimately shutting down after an acquihire from Airbnb.
Either way, there was a bit more to this story than what was let on in Srinivasan’s original Medium post on Monday.
Would that be a Bitcoin-powered bus that the management team was thrown under? [↩]
Over the past several years, multiple venture funds have had their by-laws amended or re-written to allow them to purchase cryptocurrencies and directly invest into ICOs. [↩]
In March 2015, 21inc announced that it had raised a total of $116 million, however according to Nathaniel Popper’s account of their history, they had raised about $125 million. For one reason or another, historically many cryptocurrency companies do not typically reveal their active user numbers or revenue figures. Instead they prefer talking about how much outside funding they have raised. And 21.co was not an exception to this. [↩]
There are several reasons why this was the case. With the right guanxi: a combination of electricity, land, and taxes could be cheaper in certain parts of China versus the US. In addition, 21e6 and other US-firms were consistently unable to manufacture mining machines and operate farms at a similar scale as their peers. Part of this was logistics as well: large portions of the supply chain were based overseas (primarily in Guangdong and Taiwan). I have written about this in multiple different posts over the past several years, such as this piece. [↩]
One of the interesting things that Srinivasan’s article confirms was a rumor I first heard two years ago from one of their mining competitors: that 21e6 had signed leases with data centers whose energy rates were so abysmal that you might as well just bought coins instead as it would basically be impossible to recoup those costs. Another unconfirmed rumor was around immersion cooling: that between 2014-2015 21e6 had experimented and burnt through a large quantity of chip inventory in a radical attempt to reduce the cooling needs and costs of mining chips. [↩]
Form D – note that the domains 21e6.com and .net and .org all registered around March/April 2013. [↩]
Why Are Computer Chips So Expensive? from Forbes. In addition to non-recoverable engineering, there are also component costs and testing thereof: PCB, SMT, power supply, fans, integration. Testing and trouble-shooting cannot be ignored. For instance, Hashfast was an example of a company who built a relatively fast chip but had problems with managing the power source and consequently went bankrupt. [↩]
At the time it was frequently reported that 21.co had raised $116 million but that was the sum total of all funding rounds. The Series C was ~$56 million. [↩]
Srinivasan did talk about micropayments as early as March 2014. [↩]
In May 2015 it was reported that Cisco may invest or may have invested in 21inc. Padma Warrior, former Chief Technology and Strategy Officer at Cisco, was rumored to be a key individual involved in that deal. Note: as of August 2016, a site redesign on 21.co removed investors and corporate information from the homepage. [↩]
This is mainly because an earlier 21e6 pitch stated that the company would integrate mining chips in always-on consumer electronics and appliances. [↩]
One reviewer commented: “I’d say one more thing worth adding is that it’s worth critiquing not just the feasibility of the Pitato but also the ethics. Because Pitatoes are inherently less efficient than regular mining farms due to economies of scale, the only way that they could be competitive relative to just buying bitcoin is if they were using free electricity; that is, basically all profitable usage of Pitatoes would be people using other people’s electricity in workplaces, universities, Starbucks, hotels, homes if the landlord pays for it, etc. I predict that if it actually became popular, then we’d see all the places that provide free electricity today become much more cautious about it, which could greatly reduce convenience for everyone but bitcoin miners.” [↩]
In one of its incarnations, Bitsplit was basically a euphemism for socializing CPU labor and privatizing some of the gains… now commonly called cryptojacking. [↩]
One reviewer said: “That earn.com pivot was done through the 21.co meetups that would host with Bitcoin engineers trying to buils apps on the 21 computer, which was eventually bricked. The idea for paying engineers for github pull requests led to earn.com’s business model.” [↩]
Note: in between the second and third pivot, during January 2017, Srinivasan deleted his tweets and interviewed for the top job at the FDA in Washington DC. [↩]
One reviewer commented that: “My personal view is that the current Earn.com concept is fundamentally legitimate and probably will see some usage (I can totally imagine consultants charging $50 for replying to emails, as that’s a very low-transaction-cost way to get one-time advice from people), but it deserves to exist as one of the 173 configurable settings in an email provider or social media service, not an independent multi-hundred-million dollar company. Perhaps the Coinbase acquisition actually will be utility-improving, in that gives the Earn.com team an ability to try to be useful by making gadgets for an existing company that has a userbase and services, rather than trying to build their own ecosystem which never made any sense (though it’s still a pretty disappointing end relative to Balaji’s original hype and aspirations).” [↩]
The line of reasoning is as follows: some startups attempted to randomly give away shares to strangers via various gimmicks but ultimately had to either take it back and/or were sued. If certain ICOs are deemed securities, you might not be able to just give them away to anonymous people. Reminder: I am not a lawyer, talk to a securities lawyer. [↩]
One competitor noted that: “21e6’s decision to go the Intel fabrication route was a non-starter. [↩]
Someone should remind me to talk about the dinner conversation that evening as well. [↩]
Coincidentally a few days prior to receiving those slides, I spoke with a NYC-based investor who was asking about the pros and cons of embedded ASICs for mining cryptocurrencies. Specifically: should the fund invest in a startup designing embedded ASICs for bitcoin mining. I provided my view point (the answer was no, still is a no). During this same time frame there was a big meme being pushed by many Bitcoin boosters: that mining would somehow become re-decentralized via some unknown magic bullet. Some of these promoters believed that 21.co would be the one to do it, without much evidence that the company could (or that anyone could). Note: there have been multiple other attempts at building and shipping embedded ASIC mining chips including from Midea and Bitfury. None have been successful by any measure. [↩]
Remind me to mention the coincidence at Chipotle. [↩]
Another reviewer said: “This is acquisition theater, everyone is just trying to save face because this wasn’t a great idea, had wasteful execution, and the hype and hoopla reflects poorly on all involved. The players fundamentally misunderstood the tech, the economics and use cases. I get that a VCs job is to make unsubstantiated bets on tech entrepreneurs they like. But here, an outright $116m investment in Bitcoin would have yielded X billions. And the “we returned all capital” probably because of BTC dividends and its price hike than cash returns.” [↩]
What are the repercussions for publicly asking critical questions regarding bold claims such as those from a fireside chat with both Srinivasan and Andreessen? Being blocked on ol’ Twitter. [↩]
Since we are going into the anecdote highway: in March 2015, at the Stanford Blockchain Workshop event, I approached Adam Ludwin after his panel discussion. On the panel he had mentioned that there could be a “redecentralization” of mining through an upcoming “Silicon Valley moment.” I assume he was talking about 21e6’s plan for mining chips being integrated into always-on devices because he was affiliated with one of its investors. When I told him I had seen a 21e6 deck and that it was making some very wild, likely incorrect assumptions, he basically said: we will see about that. Well, we have seen that once again: the difficulty rating rises with prices thereby diluting existing hash generating devices making them obsolete. [↩]
Some of the comments from the 21.co spokesperson are enjoyable. These hashing devices still wouldn’t be profitable at the current prices today because the difficulty rating has increased in proportion to the price yet all of the hashing units inside phone chargers and toasters had a fixed unit of labor. It’s a no-win situation for device owners as they would still have to pay for both the depreciating capital good (the device) as well as the electricity. [↩]
A couple hours after publishing this, a reader reached out and mentioned that: “I’m a proud owner of a Pitato. You forgot to mention that Balaji taught a course at Stanford about cryptocurrency and basically used it to promote 21co and Pitato to students. He gave it for free to students but all the labs were on this hardware. IMO it’s a conflict of interests for him as a professor <-> manager. The instructional material and repo is still online: (1) (2) (3) (4)”. Note: I don’t think this is a conflict of interest, professors and lecturers sometimes have their students purchase a book they may have authored/co-authored as they are the subject-matter expert. [↩]
As mentioned in my previous post, below are five thoughts for what could take place in 2018, categorized by degree of likelihood: most likely –> least likely.
(1) Continued mania
The euphoria around cryptocurrencies and ICOs continues due almost entirely because of retail sentiment, not just because of institutional action. Every valuation model that has been proposed to gauge what the price of a certain coin will be, fails almost entirely because of the inability to model sentiment. Contra Chris Burniske (note: he did not really disclose that he owned bitcoins while covering cryptocurrencies as an analyst), there are no ‘fundamentals’ to nearly any coin, in fact, many of the “top” coins don’t even do what they claim to do.
Want proof? Look at the most talked about ICOs and altcoins and airdrops that were created in 2013-2014. How many of them have actually delivered what they marketed? Basically none. Yet, if they are still listed on an exchange, odds are they are trading at near all-time highs because retail investors really don’t care about functionality or utility: they want narratives that paint pictures of Moonlambos in their near future.
This phenomenon is best described as “coin nihilism”:
So as long as there is free-entry to create and market a cryptocurrency to the masses, coin domination (who is the king of the castle) will be fluid. The only entities capable of changing that is law enforcement via coordinated regulatory action (e.g., debanking of exchanges due to regulatory guidance).1
Or as one of my OTC trader friends recently remarked:
“This is why crypto is doomed for pump and dump because the market can’t react to increased demand with more supply. So if interest fades you just keep getting clobbered with new supply like 2014 redux.”
When you have free-entry and no gatekeepers when it comes to creating money supply, people will just create a new coin as it always has more financial upside.
Besides governments, what else could stop the pump train? Hackers seem focused on low-hanging fruit – no one bothers to actually attack technical weaknesses in a blockchain. “Early adopters,” old guard (OG) whales cashing out faster than demand can absorb the coin supply may be the only other large counterbalance to the mania.2
Both criminal and civil lawsuits will continue to be filed against issuers and developers of both cryptocurrencies and ICOs. On the criminal side, the wrinkle will be that it will not just be securities and/or commodities regulators. Law enforcement agencies involved with monitoring money transmission (such as FinCEN and FINTRAC) will announce more than one criminal suit against developers who either enabled money laundering to take place on their platforms and/or failed to comply with some other area of BSA (or other regional equivalent).3
Rather than go through the laundry list of all the areas for regulatory and law enforcement action, check out (attorney) Christine Duhaime’s explanation.
With that said, while a case could be made that entities like Bitcoin Core – and its vocal surrogates – behave a lot like administrators, there are few indications that the any development team will be sued right now.
(3) Pumpers and VCs are going to pump and won’t be held accountable
Pretty much the most popular twitter personalities nowadays are the shills and pumpers who benefits from one anothers antics. It’s a non-stop contest to see who can say the most outrageous things about what cryptocurrencies will do to the world. The winner gets to cash out on a secondary market and buy a Swiss resort. The loser who said Junkcoin would only jump 10x instead of 100x also gets to cash out and retire in the Hamptons.
How many of the most egregious examples of investors and advisors that promoted these will be held accountable? Probably very few even though the SEC put out a press release specifically around the promotion of ICOs… we still regularly see ads for ICOs on social media (e.g., “general solicitation”).
For those hoping that techbros and their apologists will be held accountable, this is probably not that year. This includes lobbying groups involved in disinformation campaigns for their own ideological purposes.
If we were to aggregate the amount of revenue generated by enterprise-focused DLT vendors, based on the known RFPs that were won last year and are currently being bid on, I’d guesstimate that about $100 – $200 million is at play this year. This is based on the fact that most RFPs seem to be for less than $10 million. It’ll take at least 6-12 months to build an MVP and then even longer to get approval for additional phases.
As mentioned in my previous post: unfortunately our sample size of big infrastructure builds on the enterprise side is still limited. Examples include the the DA / ASX deal (which took 2 years for a final decision to be made). Another large one is the DTC trade, the vendor of which is IBM. If built and put into production, these will eventually recoup costs but the bigger revenue will likely come from actual enterprise-licenses: seats to use the network.
For an inside perspective, I reached out to one of my close friends working at a DLT vendor who provided the following view:
This year’s revenue is one thing. There is also recurring revenue (run vs build). There is also the fact that last year some/many deals were “bought” for marketing and credential building purposes (so they are subsidized). But I think this year suppliers are less willing to buy the business and bid low on price. We (the industry) could be in steady state production by year end for some implementations. I think $100-200m is broadly right for revenue to play for this year.
His estimate included Q/A support and SLAs.
I also would predict that, just like last year, there will be very few new enterprise-focused vendors entering the market from the early stage startup world. And that enterprise vendors struggle as a whole to attract and retain junior developers because they have to compete with cryptocurrency-related projects that may provide higher compensation during this bull market.
(5) Cryptocurrencies as financial market infrastructure
I think this is the least likely theme to occur this – and we should thank the gods – is using a cryptocurrency (anarchic) chain as FMI. Despite the mud that coin lobbyists and evangelists throw at enterprise-focused DLT vendors, cryptocurrency networks are systemic risks to the financial world and should be avoided at this time.
It is one thing to have a coin bubble driven by unsophisticated retail investors. It is another to have a coin bubble because of leverage and integration with some real financial instruments. And it is another to have a coin bubble – and the mission critical systems of the world’s financial intermediaries – directly impacted by these coin fluctuations and not be able to hold any of the validating nodes accountable… because they are pseudonymous miners in a jurisdiction that doesn’t recognize the standing of a foreign lawsuit.
If you are reading this, you are probably not terribly sympathetic to anyone who loses their shirt at this time for buying some random coin. On the other hand, you would be justified if you are worried that a national payment or securities depository is being run on top of Bitcoin via some kind of colored coin Rube Goldberg system. Reducing systemic risks to the financial world has been a top priority of financial regulators since 2008.
At the time of this writing, none of the existing cryptocurrencies being built seems to have gone through or respects a PFMI check-off. Or maybe that is a risk regulators and regulated financial institutions will be willing to take?
As a friend recently said, with cryptocurrencies you always have to expect the unexpected. People are quick to forget the bear market of 2014-2015. Will the irrational exuberance die down once most of these cryptocurrency and ICO projects fail to deliver on their promises? Maybe not, but then again, check out the coin rankings over time on these four charts.
I am actually kind of optimistic for new ideas being tested out in certain ecosystems, like Ethereum (note: this is not an endorsement of Ethereum or ETH/ETC). Now that proof-of-stake, via Casper, is being brought out of the lab and onto a testnet, we might be able to scratch off the environmental impact issue that is a blight on proof-of-work networks. CryptoKitties, via ERC721, is a neat demonstration of how to potentially create non-fungible property (assuming courts recognize it as such). I have been giving this some thought on other areas that this could be reused and commercialized. Note: there is an entire, virtual zoo of copy cats that has now arrived, including puppies and other animals.
What do you think, will heads begin to roll as law enforcement learns what shenanigans are going on? Will an ETF-based on bitcoin futures be approved? It seems likely that the CME and CBOE will add futures trading for ether, what about other coins? Coinbase and several other former bitcoin-only exchanges have already announced that they will add more altcoins and everybody is guessing which one will be next. Will 2018 be a repeat of 2014 with altcoin mania again dominating mindshare?
One reviewer who works at an OTC desk commented: “Almost all of the OTC trading counterparties and exchange we have use just a couple banks. It would be trivial to cut the spigot off overnight. Also if I’m a regulator and want to go after the toxic sludge flowing through the fiat side of this world I hit one of these banks that provides the liquidity.” [↩]
One trader at an OTC desk commented that: “Real institutional liquidity, beyond what we have now, would help. I’d argue part of the reason why things get so out of hand so fast is because the market infrastructure isn’t there to handle it correctly.” [↩]
One reviewer at an exchange commented: “I think regulatory scrutiny is actually gonna land next year from CFTC and SEC in a real way. The CFTC in particular has a duty now to police spot, wait till we get the first settlement of CME or CBOE where someone intentionally puts the auction in the tank or DoS’s the exchanges.” [↩]
Most traders only brag about their winning trades, not their losses. [↩]
[Note: I neither own nor have any trading position on any cryptocurrency. I was not compensated by any party to write this. The views expressed below are solely my own and do not necessarily represent the views of my employer or any organization I advise. See Post Oak Labs for more information.]
2017 taught us many things, including the fact that no one reads (or writes) or pays for long-form content any more. Even with lovable memes and animated gifs, keeping an audience’s attention is hard.
Already too distracted to read further? How about a quick video from JP Sears on how to appropriately Bitcoin Shame your friends and family:
The other takeaway for 2017 is that, if in doubt, open up hundreds of social media accounts and shill your way to riches. The worst thing that could happen is no one buys your coin. The best thing that happens is that someone buys your coin and you can then convert the coin into real money, retire, and act like you are super-wise thought leader with oodles of entrepreneurial and investing experience.
Some other stories with revisiting from the past year:
If we were being intellectually honest we would say that the only goal post anyone cared about this year was that the price of cryptocurrencies, as measured in real money, and how high they soared.1 And that the main reason this occurred is because Bob knew Alice and Carol were both going to buy a lot of say, bitcoin, thereby pushing up the price, so he did too. The Economistcalled it “the greater fool theory.” But The Economist are great fools for not buying in at $1, so let’s ignore them.
Basically none of the feel-good goals about lowering remittance fees or increasing financial inclusion promoted in previous years by enthusiasts have really materialized. In fact, at-risk users and buyers in developing economies probably got screwed on the ICO bandwagon as insiders and sophisticated investors who were given privileged early access to pre-sales, dumped the coins on secondary markets and hoi polloi ended up holding the bag on dozens of quarter-baked ICOs.2
Oh, but transaction fees for Bitcoin are at all-time highs, that’s a real milestone right?
There are many reasons for this, including the fact that Bitcoin Core’s scaling roadmap has thus far failed to achieve its advertised deadlines (see section 5 below).3 Maybe that will change at some point.
Shouldn’t higher fees be a cause for celebration with “champaign” (sic)? 4
Some Bitcoin Core representatives and surrogates have created an ever expanding bingo card of scapegoats and bogeymen for why fees have gone up, ranging from:
blaming Roger Ver and Jihan Wu as demonic-fueled enemies of Bitcoin
to labeling large chunks of transactions as ‘spam attacks’ from nefarious Lizard-led governments5
to flat out bitcoinsplaining: higher fees is what to expect when mass adoption takes place!
I’m sure you’ll be on their bingo card at some point too.
Just like Visa and other widely used payment network operators charge higher and higher rates as more and more users join on… oh they don’t.6 But that’s because they censor your freedom loving transactions! Right?
So what’s the interim solution during this era of higher fees? Need to send a bitcoin payment to someone?
You know how supermarkets used to hold items on layaway? They still do, but it’s not as common to use, hence why you googled the term. Well, in light of high fees, some Bitcoin Core developers are publicly advising people to open up a “tab” with the merchant. You know, just like you do with your favorite local bartender.
Fun fact: the original title of the Satoshi whitepaper was, Bitcoin: a peer-to-peer electronic layaway system.
This faux comparison didn’t age well. In 2014 this was supposed to be a parody. (Source)
For example, the ad above was promoted far and wide by Bitcoin enthusiasts, including Andreas Antonopoulos who still tries to throw sand in Western Union’s eye. Seriously, watch the linked video in which Antonopoulos claims that Bitcoin will somehow help the poor masses save money such that they can now invest in and acquire clean water. It’s cringe worthy. Did Bitcoin, or Bitcoin-related businesses, actually do any of the things he predicted? Beyond a few one-time efforts, not really.7 Never mind tangible outcomes, full steam ahead on the “save the world” narrative!
Many enthusiasts fail to incorporate in their cartoonish models: that the remittance and cross border payment markets have a set of inflexible costs that have led the price structure to look the way it does today, and a portion of those costs, like compliance, have nothing to do with the costs of transacting.8 There may be a way of reducing those costs, but it is disingenuous (and arguably unethical) to pull on the heart strings of those living on subsistence in order to promote your wares.9
Rather than repeat myself, check out the break down I provided on the same Western Union example back in 2014. Or better yet, look at the frequently updated post from Save on Send, who has the best analysis bar none on the topic.
Back to loathing about ‘adoption’ numbers: few people were interested in actual usage beyond arbitrage opportunities and we know this because no one writes or publishes usage numbers anymore.10 I’ll likely have a new post on this topic next quarter but for a quick teaser: BitPay, like usual, still puts out headline numbers of “328% growth” but doesn’t say what the original 2016 baseline volume was in order to get the new number today.
I don’t strive to pick on BitPay (to be fair they’re like the only guys to actually publish something) but unfortunately for them, the market still has not moved their way: Steam recently dropped support for Bitcoin payments and a Morgan Stanley research note (below) showed that acceptance from top 500 eCommerce merchants dropped from 5 in 2016 to 3 in 2017.11
“This is possibly the saddest bitcoin chart ever” – BI. Source: Morgan Stanley
Due to a lack of relevant animated gifs, a full break down on the topic wouldn’t fit in this article. But just a quick note, there were a number of startups that moved decisively away from their original stated business case of remittances and instead in to B2B plays (BitPesa, Bitspark) or to wallets (Abra). 12 These would be worth revisiting in a future article.13
So what does this all have to do with “legitimization”?
If you haven’t seen the Godfather trilogy, it’s worth doing so during or after the holiday break.14
This year we have collectively witnessed the techbro re-enactment of Godfather: Part 3 with the seeming legitimization of online bucket shops and dodgy casinos, aka cryptocurrency intermediaries, you wouldn’t talk about in polite company.
All of the worst elements of society, like darknet market operators, hate groups, and malware developers, effectively got eff you money and a cleansing mainstream “exit” courtesy of financial institutions coming in and regulators overwhelmed by all of the noise.15 Just like in No Country for Old Men, the bad guy(s) sometimes win. This isn’t the end of that story but the takeaway for entrepreneurs and retail investors: don’t work or build anything. Just shill for coins on social media morning, noon, and night.
(2) Red Scares
I am old enough to remember back in 2013 when Bitcoin “thought leaders” welcomed Chinese Bitcoin users. In late 2013, during the second bull run of that year, there were frequent reddit threads about how mainland Chinese could use Bitcoin to route around censorship and all the other common civil libertarian tropes.
Guess what happened? On December 5th, 2013, the People’s Bank of China and four other ministries issued guidance which restricted activities that domestic banks could do with cryptocurrencies, thereby putting spot exchanges in a bit of a bind, causing panic and subsequently a market crash. Within days there were multiple “blame China” threads and memes that still persist to this day. Case in point: this thread titled, “Dear China” which had Mr. Bean flipping off people in cars, was voted to the top of /r/bitcoin within a couple months of the government guidance. Classy.
As I detailed in a previous post, earlier in the autumn, several state organs in China finally closed down the spot exchanges, which in retrospect, was probably a good decision because of the enormous amounts of scams and deception going on while no one in the community was policing itself.16 In fact, some of the culprits that led Chinese exchanges into the dishonesty abyss are still around, only now they’re working for other high-profile Bitcoin companies. 17 Big surprise!
For example, Reuters did an investigation into some of the mainland exchanges this past September, prior to the closure of the spot exchanges. They singled out BTCC (formerly BTC China) as having a checkered past:
Internal customer records reviewed by Reuters from the BTCChina exchange, which has an office in Shanghai but is stopping trading at the end of this month, show that in the fall of 2015, 63 customers said they were from Iran and another nine said they were from North Korea – countries under U.S. sanctions.
It’s unclear how much volume BTCC processed on behalf of North Koreans, one former employee says the volumes were definitely not zero.18 These were primarily North Koreans working in China, some in Dandong (right across the border).
For perspective: North Korea has been accused of masterminding the WannaCry ransomware attack and also attacking several South Korea exchanges to the tune of around $7 million this year. Sanctions are serious business, check out the US Department of Treasury resource center to learn more.19
Isn’t China the root of all problems in Bitcoinland?
In this bull market it is unclear why Paul has to resort to PR stunts, like making fearmongering tweets or opening a strike/call option at LedgerX with the bet that bitcoin will be worth $50,000 next year.20 There are many other ways to better utilize this capital: rethink investing in funds run by managers who are not only factually wrong but who spread fake rumors around serious issues like nationalization.
For instance, I don’t normally publicly write about who I meet, but this past July, while visiting Beijing I sat down with about a dozen members of their ‘Digital Money‘ team (part of the People’s Bank of China group involved in exploring and researching blockchain-related topics). 21 They had already spoken with my then-current employer as well as many other teams and companies (apparently the Zcash team saw them the very next day). While I don’t want to be perceived as endorsing their views, based on my in-depth discussion that day, this Digital Money team had clearly done their homework and heard from all corners of the entire blockchain ecosystem, both cryptocurrency advocates and enterprise vendors. They were interested in the underlying tech: how could the big umbrella of blockchain-related technology improve their financial market infrastructure?
Look at it another way: the Chinese government (or any government for that matter) has no need to nationalize Bitcoin, what value would it bring to them? It would just be a cost center for them as miners don’t run for free.22 In contrast, their e-RMB team, based out of Shenzhen, has been experimenting with forks/clones of Ethereum. This is publicinformation.
But what about Jihan and Bitmain? Aren’t they out to kill Bitcoin?
I can’t speak on his intentions but consider this: as a miner who manufacturers and sells SHA256 hardware that can be used by both Bitcoin and Bitcoin Cash (as well as any SHA256 proof-of-work coin), Bitmain benefits from repeat business and satisfied customers. It is now clear that the earlier Antbleed campaign effort to demonize Bitmain was a massive PR effort to create a loss of confidence in Bitmain as it was promoted by several well known Bitcoin Core supporters and surrogates to punish Bitmain for its support for an alternative Bitcoin scaling roadmap and client. In fact, as of this day, no one has brought forth actual evidence beyond hearsay, that covert ASICBoost is/was taking place. Maybe they did, but you’d need to prove this with evidence.
Speaking of PR campaigns and mining…
(3a) Energy usage / mining
Over the past two months there have probably been more than a dozen articles whitewashing proof-of-work mining energy consumption numbers. Coin Center, a lobbying group straight out of Thank You for Smoking, has its meme team out on continuous social media patrols trying to conduct damage control: no one must learn that Bitcoin mining isn’t free or that it actually consumes resources!
The title of the article above is complete clickbait BS. Empirically proof-of-work mining is driving miners to find regions of the world that have a good combination of factors including: low taxes, low wages, low energy costs, quick time-to-market access (e.g., being able to buy and install new hashing equipment), reliable energy, reliable internet access, and low political turmoil (aka stability).23 Environmental impact and “clean energy” are talking points that Van Valkenburgh allege, but don’t really prove beyond one token “we moved to renewables!” story. The next time Coin Center pushes this agenda item, be sure to just ask for evidence from miners directly.24.
Another example is in a recent Bloomberg Viewcolumn from Elaine Ou (note: the previous company that she co-founded was shut down by the SEC). She wrote:
Digital currency is wasteful by design. Bitcoin “miners,” who process transactions in return for new currency, must race to solve extremely difficult cryptographic puzzles. This computational burden helps keep the transaction record secure — by raising the bar for anyone who would want to tamper with it –- but also requires miners to build giant farms of servers that consume vast amounts of energy. The more valuable bitcoin becomes, the more miners are willing to spend on equipment and electricity.
Mining a proof-of-work coin (such as Bitcoin) can only be as ‘cheap‘ or ‘efficient’ as the block reward is worth. As the market price of a coin increases so too does the capital expended by miners chasing seigniorage. This, we both agree on.
In the long run, proof-of-work miners will invest and consume capital up to the threshold in which the marginal costs of mining (e.g., land, labor, electricity, taxes, etc.) roughly equals the marginal revenue they receive from converting the bitcoins into foreign currency (aka real money) to pay those same costs. This, we also both agree on.
What Ou makes a mistake on is in her first sentence: digital currencies are not all wasteful, only the proof-of-work variety are. Digital currency != cryptocurrency.25
I know, I know, all other digital currencies that are not proof-of-work are crap coins and those who make them are pearl-clutching morons. Contra Ou and Coin Center, it is possible for central banks, and even commercial banks, to issue their own digital currency — and they could do so without using resource intensive proof-of-work.26 The Bank of International Settlements recently published a good paper on the various CBDC models out there, well worth a read. And good news: no mountains of coal are probably used in the CBDC issuance and redemption process.27
Back to proof-of-work coins: a hypothetically stable $1 million bitcoin will result in a world in which miners as a whole expend up to $1 million in capital to mine. If the network ever became cheaper to operate it would also mean it is cheaper to permanently fork the network. You can’t have both a relatively high value proof-of-work coin and a simultaneously non-resource intensive network.
While it is debatable as to whether or not Bitcoin mining is wasteful or not, it empirically does consume real resources beyond the costs of energy and the externalization of pollution onto the environment. The unseen costs of hash generation for a $20,000 bitcoin is at least $13 billion in capital over a year that miners will eventually consume in their rent-seeking race albeit from a combination of resources.
I quickly made the chart (above) to illustrate this revenue (or costs depending on the point of view).28 These are the eight largest proof-of-work-based cryptocurrencies as measured by real money market prices.
There are a few caveats: (1) some of the block rewards adjust more frequently than others (like XMR); (2) some of the coins have relatively low transaction fees which equates to negligible revenue so they were not included; (3) the month of December has seen some very high transaction fees that may or may not continue into 2018; (4) because block generation for some of these is based on an inhomogeneous Poisson process, blocks may come quicker than what was supposed to be “average.”
How to interpret the table?
The all-time high price for Bitcoin was nearly $20,000 per coin this year. If in the future, that price held stable and persisted over an entire year, miners would receive about $13 billion in block rewards alone (not including transaction fees). Empirically we know that miners will deploy and consume capital up to the point where the marginal costs equals the marginal value of the coin.29 So while there are miners with large operating margins right now, those margins will be eaten up such that about $13 billion will eventually be deployed to chase and capture those rewards. Consequently, if all 8 of these proof-of-work coins saw their ATH extended through 2018, ceteris paribus, miners would collectively earn about $32.6 billion in revenue (including some fees).
There are a variety of sites that attempt to gauge what the energy consumption is to support the network hashrate. Perhaps the most frequently cited is Digiconomist. But Bitcoin maximalists don’t like that site, so let’s put together an estimate they cannot deny (yes, there are climate change denialists in the cryptocurrency world).
For the month of December, the network hashrate for Bitcoin hovered around 13.5 exahash/second or 13.5 million terahash/second (TH/s).
To get a lowerbound on how many hash-generating machines are being used, let’s look at a product called the S9 from Bitmain. It is considered to be the most “efficient” off-the-shelf product that public consumers can order in volume.30 This mining unit generates around 13.5 TH/s.
So, if we were to magically wave our hands and replace all of the current crop of Bitcoin mining machines into the most efficient off-the-shelf product, we’d need about 1 million of these to be manufactured, shipped, installed, and maintained in order to generate the equivalent hashrate that the Bitcoin network has today. Multiply 1 million S9’s times the amount of energy individually used by a S9 and you’d get a realistic lowerbound energy usage for the network today.31
Note: this doesn’t factor in land prices, energy costs, wages for employees, building the electrical infrastructure (e.g., installing transformers), and many other line items that are unseen in the chart above. It also doesn’t include the most important factor: as more mining hashrate is added and the difficulty rating adjust upward, it dilutes the existing labor force (e.g., your mining unit does not improve or become more productive over time).
The tweet above is not a rare occurrence. If you are reading this, you probably know someone who tried to mine a cryptocurrency from an office computer or maybe their computer was the victim of ransomware.
You may not think of much of the externalization and socialization of equipment degradation that is taking place, but because mining is a resource intensive process, the machines used for that purpose depreciate far faster than those with normal office usage.32 To date, no one has done a thorough analysis of just how many work-related computers have been on the receiving end of the mining process but we know that employees sometimes get caught, like the computer systems manager for the New York City Department of Education or the two IT staffers in Crimea.33
Even if miners eventually fully utilize renewable energy resources, most hash-generating machines currently deployed do not and will not next year. These figures also do not factor in the fully validating nodes that each network has that run out of charity (people run them without any compensation) yet consume resources. According to Bitnodes, Bitcoin has around 11,745 nodes online. According to EtherNodes, Ethereum has around 26,429 nodes online.
So is there an actual upperbound number?
There is, by dividing hashpower by cost and comparing to costs of various known processor types. For instance, see this footnote for the math on how two trillion low-end laptop CPUs could be used.34 ‘35
Just looking at the hash-generating machines, according to Chen Min (a chip designer at Avalon Mining), as of early November, 5% of all transistors in the entire semiconductor industry is now used for cryptocurrency mining and that Ethereum mining alone is driving up DRAM prices.
This is not to say you should march in the streets demanding that miners should forgo the use of coal power plants and only use solar panels (which of course, require consumption of resources including semiconductors), there are after all, many other activities that are relatively wasteful.
But some Bitcoin and cryptocurrency enthusiasts are actively whitewashing the environmental impact of their anarchic systems and cannot empirically claim that their proof-of-work-based networks are any less wasteful or resource intensive than the traditional foreign capital markets they loathe.
In point of fact, while the traditional financial markets will continue to exist and grow without having to rely on cryptocurrencies for rationally pricing domestic economic activity, in 2018, as in years prior, Bitcoinland is still fully dependent on the stability of foreign economies providing liquidity and pricing data to the endogenous labor force of Bitcoin. Specifically, I argue in a new article, that miners cannot calculate without using a foreign unit of account; that economic calculations on whether or not to deploy and consume capital for expanding mining operations can only be done with stable foreign currency.36
Keep in mind that cryptocurrencies such as Bitcoin only clear (not settle) just one coin (or token) whereas traditional financial markets manage, transact, clear and settle hundreds of different financial instruments each day. 37 For comparison, the Federal Reserve estimates that on any given day about 600 million payment, clearing, and settlement transactions take place in the US representing over $11 trillion in value.38 But this brings up a topic that is beyond the scope of this article. Next section please.
(4) MIT’s Digital Currency Initiative
On the face of it, MIT’s DCI effort makes a lot of sense: one of the world’s most recognized institutions collaborating with cryptocurrency developers and projects worldwide.
But beneath the slick facade is a potential conflict of interest that has not been looked at by any media outlet. Specifically, around its formal foray into building tools for central bank digital currency (CBDC). Rob Ali, a well-respected lawyer turned research scientist (formerly with the Bank of England), was hired earlier this year by DCI to build and lead a team at MIT for the purpose of continuing the research he had started at the BoE. This is no secret.
Less known is how this research has now morphed into a two-fold business:
DCI charges central banks about $1 million a year to be a partner.39 What this allows the central bank to do is send staff to MIT and tap into its research capabilities. This includes MIT representatives co-authoring a couple of papers each year focused on topics that the central bank is keen to explore. Multiple central banks have written checks and are working together with DCI at this time.
Building and licensing tools and modules to central banks and commercial banks. DCI has hired several Bitcoin developers whom in turn have cloned/forked Bitcoin Core and Lightning. Using this code as a foundation, DCI is building IP it aims to license to central banks who want to build and issue central bank digital currency.
Where is the conflict of interest?
DCI is housed within MIT’s Media Lab, whose current director is Joi Ito. Ito is also the co-founder and director of Digital Garage. Digital Garage is an investor in Blockstream and vocal advocate of Lightning; coincidentally Blockstream is building its own Lightning implementation. Having made several publiccomments in favor of Bitcoin Core’s hegemony, Ito also appears to be a critic of alternative blockchain implementations.
In looking at his publicly recorded events on this topic Ito does not appear to disclose that the organizations he co-runs and invests in, directly benefit from the marketing efforts that Bitcoin Core and Lightning receive. Perhaps this is just miscommunication.
I’m all for competition in the platform and infrastructure space and think central bank digital currencies are legit (again check out this BIS paper) but this specific DCI for-profit business should probably be spun off into an independent company. Why? Because it would help reduce the perception that Ito – and others developers involved in it – benefits from these overlapping relationships. After all, Bitcoin Core arguably has a disproportional political clout that his investment (Blockstream) potentially benefits from if/when Lightning goes into production.40 And again, this is not to say there shouldn’t be any private-public partnerships or corporate sponsorships of academic research or that researchers should be prohibited in investing in companies, rather just a recommendation for disclosure and clarity.
(5) Lightning Network
If you haven’t seen The Money Pit (with Tom Hanks), it is well worth it for one specific reason: the contractors and their staff who are renovating Hanks’ home keep telling Hanks that it will be ready in two weeks.
And after those two weeks are over, Hanks is informed yet again that it will be ready in another two weeks.
The Lightning Network, as a concept, was first announced via a draft paper in February 2015. Its authors, Tadge Dryja and Joseph Poon, had initially sketched out some of the original ideas at their previous employer Vaurum (now called Mirror).
Lightning, as it is typically called, is commonly used in the same breath as “the scaling solution,” a silver bullet answer to the current transactional limitations on the Bitcoin network.41 Nearly three years later, after enormous hype and some progress, a decentralized routing version still has not gone into production. Maybe it will eventually but not one of its multiple implementations is quite ready today unless you want to use a centralized hub.42 Strangely, some of the terminology that its advocates frequently use, “Layer 2 for settlement,” is borderline hokum and probably has not been actually vetted to see if it fulfills the requirements for real “settlement finality.”43
And like multiple other fintech infrastructure projects, some of its advocates repeatedly said it would be ready in less than 6 months, several times. For instance:
On October 7, 2015, Pete Rizzo interviewed multiple developers including Tadge Dryja and Joseph Poon regarding Lightning. Rizzo wrote that: “In interview, Dryja and Poon suggested that, despite assertions project development could take years, Lightning could take as little as six months to be ready for launch.”
On April 5, 2016, Kyle Torpey interviewed Joseph Poon regarding expected time lines, stating that: “Lightning Network co-creator Joseph Poon recently supplied some comments to CoinJournal in regards to the current status of the project and when it will be available for general use. Poon claimed a functional version of the Lightning Network should be ready this summer.”
A month later, on May 5, 2016, Kyle Torpey interviewed Adam Back regarding his roadmap. Torpey wrote that: “While all of these improvements are being implemented on Bitcoin’s base layer, various layer-2 solutions, such as the Lightning Network, can also happen in parallel. The Lightning Network only needs CHECKSEQUENCYVERIFY (along with two other related BIPs) and Segregated Witness to be accepted by the network before it can become a reality on top of the main Bitcoin blockchain.”
On November 12, 2016, Alyssa Hertig interviewed several developers including Pierre-Marie Padiou, CEO of ACINQ, one of the startups trying to building a Ligthning implementation. According to Padiou: “The only blocker for a live Lightning implementation is SegWit. It’s not sure how or when it will activate, but if SegWit does activate, there is no technical thing that would prevent Lightning from working.”
Segregated Witness (SegWit) was activated on August 24, 2017. More than four months later, Lightning is still not in production without the use of hubs.
Not to belabor the point, just this past week, one of the executives at Lightning Labs (which is building one of the implementations) was interviewed on Bloomberg but wasn’t asked about their prior rosy predictions for release dates. To be fair, there is only so much they could cover in a six minutes allocation.
“Building rock solid infrastructure is hard,” is a common retort.
Who could have guessed it would take longer than 6 months? Yes, for regular readers of my blog, I have routinely pointed out for several years that architecting and deploying financial market infrastructure (FMI) is a time consuming, laborious undertaking which has now washed out more than a handful of startups attempting to build “enterprise” blockchains.
For example, Lightning as a concept predates nearly every single enterprise-focused DLT vendor’s existence. While not an equal comparison (they are trying to achieve different goals), there are probably ~5 enterprise-focused, ‘permissioned’ platforms that are now being used in mature pilots with real institutional customers and a couple could flip the “production” button on in the next quarter or so.4445
For what it is worth, enterprise DLT vendors as a whole did a very poor job managing expectations the past couple of years (which I mentioned in a recent interview). And they certainly had their own PR campaigns during the past couple of years too, there is no denying that. Someone should measure and quantify the amount of mentions on social media and news stories covering enterprise vendors and proposals like Lightning.46
Better late than never, right? So what about missed time frames?
In a recent (unscientific) poll I did via Twitter (the most scientific voting platform ever!) found that of the more than 1,600 voters, 81% of respondents thought that relatively inexpensive anonymous Lightning usage won’t really be good to go for at least 6+ months.
Just as Adam Back proposed a moratorium on nebulous “contention” for six months (beginning in August), I propose a moratorium on using the term “Lightning” as a trump card until it is actually live and works without relying on hubs. But don’t expect to see the crescendo of noise (and some signal) to die down in the meantime, especially once exchanges and wallets begin to demonstrate centralized, MSB-licensed implementations.47
With that suggestion, I can see it now: all of the Lightning supporters flaming me in unison on Twitter for not being a vocal advocate. Sure beats shipping code! To be even handed, Lightning’s collective PR effort was just one of many others (hello sofachains!) that could be scrutinized. A future post could look at all funded infrastructure-related efforts to improve cryptocurrency networks. Which ones, if any, showed much progress in 2017. 48
Interested in reading more contrarian views on the Lightning Network? See Gerard and Stolfi (and Stolfi2x) (and Stolfi3x). Let’s revisit in 6 months to see what has been launched and is in production.
(6) Objective reporting and analysis
Without sugar coating it: with the exception of a few stories, coin media not only dropped the ball on critically, objectively covering ICO mania this past year, but was largely complicit in its mostly corrupt rise. This includes The Information, which is usually stellar, but seems to have fallen in the tank with the ICO pumpers. That is, unless you’re a fake advisor and then they’ve got your number.
It took some time, but eventually mainstream and a few not-so-mainstream coverage has brought a much needed spotlight on some of the shady actions that took place this year. There were also a number of good papers from lawyers and academics published throughout 2017.
Note: that the SEC’s order against the Munchee ICO also relied on highlighting specific claims in the white paper.
Unfortunately 2017 will probably go down as the year in which several generations of nerds turned into day-trading schmucks, with colorful technical charts and all.50 This included even adopting religious slogans like: Buy the dip! Weakhands! HODL! We are the new 1%! The dollar is crashing! It’s not a bubble, it’s an adoption curve!
A few parting bits of advice: unfollow anyone that says this time things are different or the laws of economics have changed or calls themselves a “cryptolawyer” or who previously got shutdown by the SEC or who doesn’t have a LinkedIn page. Rethink donating or investing funds to anyone who makes up rumors about mining nationalization or who was fired for gambling problems or has a communications team solely dedicated to designing memes for Twitter.51
Cryptocurrencies aren’t inherently bad and ideas like ERC721 are even cool.52 But as neat as some of the tech ideas may be, magic internet coins sure as heck continue to attract a lot of Scumbag Steves who are enabled by participants that have turned a blind eye. It’s all good though, because everyone will somehow get a Moonlambo after the final boss is beaten, right?
I will have a separate post discussing predictions for 2018 but since we are reflecting on 2017, below are a few other areas worth looking into now that you’re a paper zillionare:
We have real empirical observation of hyperdeflation occurring: in which it is more rational to hoard the coin instead of spend it. As a result, Bitcoin-focused companies that have accumulated bitcoin are still raising capital from external financial markets denominated in foreign currency instead of deploying (consuming) their own bitcoin. And these same startups are receiving valuations measured, not in terms of bitcoin, but in terms of a foreign unit of account. What would change this trend?
Bitcoinland, with its heavy concentration of wealth, looks a lot like a feudal agrarian economy completely dependent on other countries and external financial markets in order to rationally deploy capital and do any economic calculation. Is there a way to build a dynamically adjustable cryptocurrency that does not rely on foreign capital or foreign reference rates?
How much proof-of-work related pollution has been externalized and socialized on the public at large due to subsidies in various regions like Venezuela? What are the effects, if any, on global energy markets?
As traditional financial markets add products and solutions with direct ties to cryptocurrencies (futures, options, payments, custody), by the end of 2018 how much of the transactional activity on Bitcoin’s edges will be based on non-traditional financial markets (e.g., LocalBitcoins)?
There were a lot of publicity stunts this year. Working backwards chronologically, the Andreas Antonopoulos donation could have been a publicity stunt, it also could be real. The argument goes: how is someone with a best selling book, who charges $20,000+ for speaking engagements, and who has been receiving bitcoins for years (here is the public address), still in debt. Maybe he is, maybe his family fell on hard times. But few asked any questions when an anonymous person sent what amounted to $1 million in bitcoin enabling him to reset his tax basis. (Hate me for writing this? As an experiment, earlier this month I put up a Bitcoin and Ethereum address on the sidebar of the home page, feel free to shower me with your magic coins and prove me wrong. I promise to convert it all into dirty filthy statist bucks.) A few months prior to that, Jamie Dimon was accused of everything but eating babies after he said “Bitcoin is a fraud.” Dozens of “Dear Jamie” letters were written begging him to see Bitcoin with their pure rose-tinted eyes. At what point will Bitcoin enthusiasts grow some thick skin and ignore the critics they claim don’t matter? And while we can continue to add PR stunts forever, the “fundraiser” for Luke-Jr’s home after Hurricane Irma had zero proof that it was his house, just a picture that Luke-Jr. says it was and the rest of the Bitcoin Core fan club promoting it. Trust but verify?
[Note: if you found this research note helpful, be sure to visit Post Oak Labs for more in the future.]
Many thanks to the following for their constructive feedback: VB, YK, RD, CM, WG, MW, PN, JH
Bitcoin fans basically walked onto the field before the football game, toppled the goal posts, and carried it outside the stadium declaring themselves victorious without having actually played the match. [↩]
I am sure I will be accused of being a “Bitcoin Cash shill” (which obviously I must be, there is no other explanation!) for pointing this out, but last week, one vocal Bitcoin Core supporter even proposed a commit to change the wording on Bitcoin.org surrounding low fees: “These descriptions of transaction features are somewhat open to interpretation; it would probably be best not to oversell Bitcoin given the current state of the network.” [↩]
As an actor on a classic Saturday Night Live sketch said: “You may ask how we at the Change Bank, make money? It’s simple, volume.” [↩]
I take issue with anyone claiming to be able to label transactions specifically as spam without doing an actual graph analysis. See Slicing Data for more. Proof-of-lizard is not to be conflated with lizardcoin. [↩]
Note: this is not an endorsement of Visa, I do not have any equity or financial stake in Visa. [↩]
One reviewer commented: “One problem that affects all cryptocurrencies whether proof of work or of stake: What reason do most people have for using them that won’t run afoul of social policy objectives? As long as people need to convert them to regular fiat currencies, they have a distinct disadvantage. The only exception would be in failed economies where stable fiat currencies are restricted, until those governments see a cryptocurrency as a potential substitute and ban it. It is not even clear why a government would need to issue a cryptocurrency (not a CBDC). If it wants to serve unbanked people it could open or subsidize a bank for them which is what is being attempted in a few developing countries.” [↩]
One reviewer commented: “Fully peer-to-peer without banks ultimately leads to creating a new currency. A new currency means that for international payments you have the additional costs of converting into the currency and converting out of the currency. A currency not linked to a real world economy is always going to have a more volatile price (assuming it has any price at all). Volatility in FX always, always leads to higher transaction costs for exchange because the bid offer spread has to be wider. This is before you even get into the mining proof or work model and all its inherent flaws, which again ultimately result from trying to build a financial system without banks.” [↩]
One reviewer noted that: “Transferwise, Currency Fair, Revolut, Mondo and other startups are already doing it. And they’re doing it without having to break the rules and laws banks and Western Union have to play by. They’re building actual real, potentially sustainable businesses that are useful to society. They’re just not grabbing the headlines like the greater fool / Nakamoto Scheme is. When you build a real business, your scope for false promise making behind incoherent computer science jargon is pretty small.” [↩]
I even stopped aggregating numbers 18 months ago because fewer companies were making usage numbers public: it’s hard to write about specific trends when that info disappears. Note: if you think you have some interesting info, feel free to send it my way. [↩]
BitPay has diversified its portfolio of services now, expanding far beyond the original merchant acceptance and recently closed a $30 million funding round. However, the problem with their growth claims is they are typically measured in $USD volume. So, as the value of bitcoin has grown 10-20x (as measured in USD) in the past year, it is unclear how much BitPay has really grown in terms of new customers and additional transactions. Note: the same can be said for most Bitcoin-specific companies making big growth-related claims, BitPay is just one example. [↩]
Movements occurred in other areas too, on the enterprise side, Chain was perhaps the most well known company to pivot away from that vertical. [↩]
One reviewer commented: “2017 was a good year for B2B players with some prominent funding rounds (e.g., Bitspark, Veem, BitPesa) and some claimed growth on blockchain “rails” (but also on non-blockchain) namely Veem and BitPesa. A big surprise of 2017 was a much broader awareness of cryptocurrencies, i.e., free massive PR. The Coinbase app became more popular than Venmo (and far ahead of any bank). As a result, one of the most intriguing questions right now for 2018 is if/how Coinbase could capitalize on this opportunity to become a full-fledged bank leveraging the best of banking-like services from players like Xapo, Uphold, and Luno?” [↩]
I suppose it is safe to assume that if you’re reading this, you are coin millionaire so you don’t worry about fiat-mandated holiday breaks like the rest of us. [↩]
Not all medium-to-large coin holders are the adopters you now see wearing suits on television talk shows. Most coin holders, including the abusive trolls and misogynists on social media, have seen a large pay raise, enabling the worst elements to continue their bullying attacks and illicit activities. See Alt-right utilizes bitcoin after crackdown on hate speech from The Hill [↩]
Worth pointing out that Ryan Selkis is attempting to push forward with a the self-regulatory effort called Messari. See also: The Brooklyn Project. [↩]
Earlier this year, right after the law enforcement raids in China, one of the senior executives left BTCC but still remains on the board of the parent company that operates BTCC. He quickly found a new senior role at another high-profile Bitcoin-focused company and uses his social media accounts to vigorously promote Bitcoin Core and maximalism. [↩]
As explored in a previous post, fake volumes among the Chinese exchanges was not uncommon and several of the large exchanges attempted to gain funding from venture capitalists while simultaneously faking the usage numbers. As one former employee put it: “That was an extraordinary attempt at fraud — faking the numbers through wash trading and simply printing trades, while using that data to attract investment and establish their valuation.” [↩]
Coinbase got into some problems in early 2015 when one of its investor decks highlighted the fact that cryptocurrencies, such as Bitcoin, could be used to bypass sanctions. [↩]
Ari Paul runs a small “crypto” hedge fund called BlockTower Capital (estimated to have between around $50-$80 million AUM) that like many companies in this space, faces an ongoing lawsuit. Unclear why LPs didn’t just buy and hold cryptocurrencies themselves and cut out the hysteria and management fees. [↩]
Yea, I know, “money” is already digital… I didn’t give them that name, they did. [↩]
One reviewer noted: “The fact remains that if you replace the mining process with a a centralized system for validation of transactions and up-to-date of balances you could run the whole thing on an ordinary sized server for a few thousand dollars per year. Centralisation and a more logical data model are vastly better technically speaking. And it would be far easier to add in compliance and links to banks for more robust and honest methods for exchanging between a centralized bitcoin and fiat. What would the Chinese government gain from mining?” [↩]
One of the often overlooked benefits of setting up a mining farm in China is that many of the parts and components of mining equipment are either manufactured in China and/or final assembly takes place in China. So logistically it is much quicker to transport and install the hardware on-site within China versus transport and use overseas. [↩]
I know a bunch and could maybe introduce them though some of them make public appearances at conferences so they can usually be approached or emailed. [↩]
In fact, many regulators, such as the ECB, categorize cryptocurrency as a type of “virtual currency,” separate from a “digital currency.” [↩]
There is often confusion conflating “transaction processing” and “hash generation,” the two are independent activities. Today mining pools handle the transaction processing and have sole discretion to select any transactions from the memory pool to process (historically there have been thousands of ’empty’ blocks) — yet mining pools are still paid the full block reward irrespective of how many transactions they do or not process. Hash generation via mining farms has been a discrete service for more than 5 years — think of mining pools as the block makers who outsource or subcontract the hash generation out to a separate labor force (mining farms) and then a mining pool packages the transactions into a block once they receive the correct proof-of-work. Note: “fees” to miners is a slightly different but related topic. [↩]
CBDCs have their own issues, like the risk of crowding out ordinary banks in market for deposits in a low interest rate environment but they have little in common with anarchic crytocurrencies. [↩]
Many thanks to Vitalik Buterin for his feedback and suggestions here. [↩]
There are other mining manufacturers, including some who only build for themselves, such as Bitfury. [↩]
Interestingly enough, the market price for one of these machines is around $2,000. And if you do the math, you’ll see exactly what all professional miners do: it’d only cost $2 billion to buy enough machines to generate 100% of the network hashrate and claim all the $13 billion in rewards to yourself! In other words, the seigniorage is big, fat, and juicy… and will attract other miners to come and bid up the price of mining to the equilibrium point. [↩]
There are many walk-throughs of bitcoin mining facilities, including this video from Quartz. [↩]
In the process of writing this article, a new story explained how more than 105,000 users of a Chrome extension were unknowingly mining Monero. Heroic theft of CPU cycles, right? [↩]
In theory, and practice, the upperbound is not infinite. We know from the hashrate being generated that there are a finite amount of cycles being spent repeatedly multiplying SHA256 over and over. Perhaps a possible, but improbable way to gauge the upperbound is to take the processing speed of a low-end laptop CPU (which is not as efficient at hashing as its ASIC cousins are). At 6 MH/s, how many seventh generation i3 chips would it take to generate the equivalent of 13.5 million TH/s? On paper, over 2 trillion CPUs. Note: 1 terahash is 1 million megahashes. So 1 million laptop CPUs each generating 6 MH/s on paper, would collectively generate around 6 TH/s. The current network hashrate is 13.5 exahash/s. So you’d need to flip on north of 2 trillion laptop CPUs to reach the current hashrate. In reality, you’d probably need more because to replace malfunctioning machines: a low-end laptop isn’t usually designed to vent heat from its CPU throttled to the max all day long. [↩]
One China-based miner reviewed this scenario and mentioned another method to arrive at an upperbound: “Look at the previous generation of ASICs which run at 2-3x watt per hash higher. The previous generation machines normally get priced out within 18 months. But with differing electricity costs and a high enough price, these machines get turned on. Or they go to cheap non-petrodollar countries like Russia or Venezuela. So your base load of 1 million machines will have an upperbound of 2x to 3x depending on prevailing circumstances.” [↩]
It may be also worth pointing out that the “evil Chinese miners blocking virtuous Core” narrative is hard to justify because Bitcoin’s current relatively high fees are a direct result of congestion and has consequently increased miner revenue by 33% (based on December’s fees). So in theory, it’s actually in the miners interest to now promote the small block position. Instead, in reality, most miners were and are the ones advocating for bigger block sizes, and certain Bitcoin Core representatives were blocking those proposals as describedelsewhere but we’re not going down that rabbit hole today. [↩]
One reviewer commented: “Financial instruments that either directly perform a service to our economy and even indirectly via speculation, enable price discovery for things that are important to people’s lives. Who’s lives is Bitcoin really important to right now? To this day the only markets it can claim to have any significant market share in, let alone be leader in, is illicit trade and ransomware. The rest appears to be just people looking to pump and shill.” [↩]
It’s also probably not worth trying to start a discussion about what the benefits, if any, there is for society regarding cryptocurrency mining relative to the resources it collectively consumes, as the comments below or on social media would simply result in a continuous flame war. Note: colored coins and metacoins create distortions in the security assumptions (and rewards) for the underlying networks. Watermarked tokens are neither secure nor proper for financial market infrastructure. [↩]
It is not $1 million straight, there are multiple levels and tiers. [↩]
There is an ongoing controversy around key decision makers within Bitcoin Core (specifically those who approve of BIPs) and their affiliation with Blockstream. One of Blockstream’s largest investors, Reid Hoffman, said Blockstream would “function similarly to the Mozilla Corporation” (the Mozilla Corporation is owned by a nonprofit entity, the Mozilla Foundation). He likened this investment into “Bitcoin Core” (a term he used six times) as a way of “prioritiz[ing] public good over returns to investors.” [↩]
Because it is its own separate network, it actually has cross-platform capabilities. However, historically it has been promoted and funded for initial uses on the Bitcoin network moreso than others. [↩]
Yes, I am aware of the demo from Alex Bosworth, it is a big step forward that deserves a pat on the back. Now to decentralize routing and provide anonymity to users and improve the UI/UX for normal users. [↩]
This is not an endorsement of a specific platform or vendor or level of readiness, but examples would include: Fabric, Quorum, Corda, Axcore, Cuneiform, and Ripple Connect/RCL. [↩]
While Lightning implementations should not be seen as a rival to enterprise chains (it is an apples to oranges comparison), the requirements gathering and technical hurdles needed to be overcome, are arguably equally burdensome and maybe moreso for enterprise-focused companies. Why? Because enterprise-focused vendors each need approval from multiple different stakeholders and committees first before they deploy anything in production especially if it touches a legacy system; most Lightning implementations haven’t actually formally defined who their end-customer is yet, let alone their needs and requirements, so in theory they should be able to “launch” it faster without the check-off. [↩]
For instance, CoinDesk currently has 229 entries for “lightning,” 279 entries for “DLT,” and 257 entries for “permissioned.” [↩]
It bears mentioning that Teechain, can achieve similar KPIs that Lightning can, via the use of hardware, and does so today. BitGo’s “Instant” and payment channels from Yours also attempt to achieve one similar outcome: securely transmitting value quickly between participants (albeit in different ways). [↩]
We’d need to separate that from the enterprise DLT world because again, enterprise vendors are trying to solve for different use cases and have different customers altogether. Speaking of which, on the corporate side, there is a growing impatience with “pilots” and some large corporates and institutions are even pulling back. By and large, “blockchain stuff” (people don’t even agree on a definition still or if it is an uncountable noun) remains a multi-year play and aside from the DA / ASX deal, there were not many 2017 events that signaled a shorter term horizon. [↩]
Note: both the Fedcoin and CAD-coin papers were actually completed and sent to consortium members in November 2016 then three months later, published online. [↩]
One reviewer commented: “There seems to be a whole new wave of both suckers and crooks to exploit the geeks. I have read some the Chartist analysis on forums for more traditional forms of day-trading such as FX day-trading and it is exactly the same rubbish of trying to inject the appearance of intelligence and analysis into markets that the day-traders (and those encouraging them) simply do not understand.” [↩]
A former Coinbase employee, now running a “crypto” hedge fund, was allegedly fired for gambling issues. Maybe he wasn’t but there are a lot of addicts of many strains actively involved in trading and promoting cryptocurrencies; remember what one of the lessons of Scarface was? [↩]
The past several months have been pretty productive especially in terms of education.
For instance, my “Eight Things” article had over 100,000 views in its first week alone thanks largely to landing on the front page Hacker News and reshares on social media. I may write-up an article breaking down its reception at a later date.
And interestingly, one of my older articles from 2014 recently ended up on the front of /r/DataIsBeautiful generating 15k+ views over a couple of days.
Below are some of my outward facing appearances. If you’re interested in chatting about the topics below, feel free to reach me via Post Oak Labs.
Last year, when the CME first announced that it was considering backing a Bitcoin-related futures product, it also announced the CME CF Bitcoin Reference Rate (BRR). At the time, the reference pricing data came from the following cryptocurrency exchanges: Bitfinex, Bitstamp, GDAX, itBit, Kraken and OKCoin.com (HK).
As of today, the CME has formally whittled down those six into a smaller group of four exchanges: Bitstamp, GDAX, itBit and Kraken.
They did not publicly disclose why they removed Bitfinex and OKCoin, although we can speculate:
It is likely they removed OKCoin because of the laws and regulations around cryptocurrencies in China over the past year included various types of bans. OKCoin’s mainland spot price exchange for yuan <-> cryptocurrency have been shut down. OKEX, an international subsidiary of OKCoin, replaced the China-based exchanges on its own index (including OKCoin itself).
Bitfinex’s corporate and organizational structure has been described in previous articles. Even though it has the largest trading volume and is the key player to price discovery, it has a lot of red flags around compliance and transparency (described in the links at the top) that likely made organizations such as the CME uneasy.
It bears mentioning that the proposed Winklevoss COIN ETF also went through a similar evolution in terms of how to price the instrument. The principals initially created and used the Winkdex. The Winkdex included many different cryptocurrency exchanges over time, including Mt. Gox and BTC-e. Eventually, in future amended filings to the COIN ETF, the Winkdex was completely discarded in favor of a daily auction price conducted at an exchange (Gemini) that the principals and creators of the COIN ETF owned and managed. This is chronicled in a paper I wrote last year.
So what does this have to do with the CME and how did the CME (un)intentionally weigh in on the Bitcoin block size debate?
During the recent Bitcoin Core versus SegWit2X (S2X) political battle, one of the four exchanges that constitute the CME reference rate announced which ticker symbol would be attributed to a specific chain.
GDAX (Coinbase), made the following public announcement on October 25:
In our prior blog post we indicated that at the time of the fork, the existing chain will be called Bitcoin (BTC) and the Segwit2x fork will be called Bitcoin2x (B2X).
Since then, some customers have asked us to clarify what will happen after the fork. We are going to call the chain with the most accumulated difficulty Bitcoin.
We will make a determination on this change once we believe the forks are in a stable state. We may also consider other factors such as market cap and community support to determine stability.
It’s important for us to maintain a neutral position in any fork. We believe that letting the market decide is the best way to ensure that Bitcoin remains a fair and open network.
Note: original emphasis is theirs.
There have been severalarticles that attempted to track and chronicle what all of the exchanges announced with respect to the ticker symbol and the fork. At the time of this writing, itBit, Kraken, and Bitstamp have not publicly commented on this specific fork (although they have publicly signaled specific views on other proposed forks in the past).
And this creates a challenge for any financial institution attempting to create a financial instrument that is compromised of a basket of cryptocurrency-specific prices from different, independent cryptocurrency exchanges.
Ignoring the lack of adequate market surveillance for the moment, if there is a future fork and the constituent exchanges that comprise the reference data choose different forks to be represented by the same ticker symbol, this will likely create problems for the financial product.
For instance, in a hypothetical scenario in which a fork occurs, and two of the exchanges comprising the BRR index choose one side of the fork to list as “BTC” and the other two exchanges choose the other fork to also represent “BTC,” because these forks are linked to separate different ecosystems and even economic systems the combination could impact the volatility of the product.
Or in short: there is no universal agreement or consensus from cryptocurrency exchanges comprising the BRR about what the ticker symbol, let alone the chain should be defined as.
Over the past several years the primary debate has been around scaling, specifically around block sizes. What if future forks are fought over changes to transaction fees, money supply, or KYC requirements? This isn’t idle speculation as these have been proposed in the past with both Bitcoin and other cryptocurrencies (Ethereum Classic held an event last year to focus on what the future money supply generation rate should be).
Obviously this is a situation the CME (and similar financial institutions) wants to avoid at all costs.
In order to do this, it’ll have to pick a side and either:
a) force an errant exchange on its index to fall in line or lose the free marketing; or
b) ditch it from the index
Either way, as by far the largest player in the market, in doing so it will be governing what Bitcoin is. Unlike what most Bitcoin promoters often think: traders follow liquidity not the other way around so the CME is likely to become kingmaker in Bitcoin political disputes. It is going to become a key arm in its governance. That said, as we have seen before, rather than directly get involved with the tribes and religions of development they might simply defer to the incumbent Bitcoin Core rules — so that they can remain above the politics and out of any legal liabilities.
For more detailed commentary on this topic, be sure to read the articles linked to at the top. This will be worth re-visiting once the CME and other regulated institutions fully launch their proposed products.
Acknowledgements: special thanks to Ciaran Murray for several insights articulated above.
Financial market infrastructure in just one country (Source)
What is FMI? More on that later. But first, let’s talk about Bitcoin.
If you aren’t familiar with the Bitcoin block size war and its endless online shouting matches which have evolved into legal and even death threats, then you have probably been a very productive human being and should sell hugs and not wander into a non-stop social media dance off.
Why? Because tens of thousands of man (and woman) hours have collectively been obliterated over a struggle that has illuminated that Bitcoin’s development process is anything but permissionless.
It also illuminates the poor fiduciary care that some VCs have towards their LPs. In this case, more than a handful of VCs do not seem to really care about what a few of their funded companies actually produce, unless of course the quarterly KPIs include “have your new Bitcoin meme retweeted 1,000 times once a week.”
In some documented cases, several dozen executives from VC-backed Bitcoin companies have spent thousands of hours debating this size attribute instead of building and shipping commercializable products. But hey, at least they sell cool hats and built up very large Twitter followings, right?
Fact #1: Satoshi Nakomoto did not ask anyone’s permission to launch, change, or modify the codebase she unilaterally released in 2009.
Fact #2: In 2009, when Satoshi Nakomoto issued and minted a new currency (or commodity or whatever these MLIC are) she did so without asking anyone else’s approval or for their “ack.”
In the approximately seven years since she stopped posting under her pseudonym, influential elements of Bitcoin’s anarchic community have intentionally created a permissioned developer system commonly referred to as the Bitcoin Improvement Proposal (BIP) process. “Bitcoin Core” is the name for the group that self-selected itself to vet BIPs; involvement is empirically permissioned because you can get kicked off the island.1 There are a small handful of decision makers that control access to the code repository.
For example, if you’re a developer that wants to create and launch a new implementation of Bitcoin that includes different block sizes… and you didn’t get it approved through this BIP process, guess what? You are doing permissionlessness wrong because you didn’t get permission from the BIP approval committee to do so.
Oh, but you realize that and still want to launch this new Bitcoin implementation with the help of other elements of the community, such as some miners and exchanges?
According to some vocal members of the current BIP approval committee (Bitcoin Core) and its surrogates, this is an attack on Bitcoin. Obviously this is absurd because there is no de jure or legally defined process for changing or forking Bitcoin, either the chain itself or the code.
There is no terms of service or contract which explicitly states what Bitcoin is and who controls its development process. Or more historically: if Satoshi didn’t need permission from a (non-existent) BIP approval committee to launch a cryptocurrency, then no other Bitcoin developer needs to either.
Fast forward to this current moment in time: if the Bitcoin Cash or Segwit2X forks are an attack on network because either fork did not get ack’ed (approved) by the right people on the BIP approval committee or retweeted by the right “thought leaders” on social media, then transitively every 10 minutes (when a block is generated by a miner) arguably could be an attack on Bitcoin.
Why? At any time a block maker (miner) could use a different software implementation with different consensus rules. They, like Satoshi before them, do not need permission to modify the code.
Oh, but other miners may not build on top of that block and some exchanges may not recognize those blocks as “legitimate” Bitcoin blocks?
That is certainly a risk. In fact, several exchanges are now effectively white listing and black listing — permissioning — Bitcoin-related blocks.
For instance, Bittrex, a large crypto-to-crypto exchange, has said:
The “BTC” ticker will remain the Bitcoin Core chain before the hard fork block. Bittrex will observe the Bitcoin network for a period of 24 to 48 hours to determine if a chain split has occurred and the outcome.
In the event of a chain split, “BTC” will remain the existing Bitcoin chain with 1 MB blocks until the industry and ecosystem demonstrates a clear chain preference for Bitcoin.
Bitfinex, the largest (and most nebulous) cryptocurrency exchange in the world, took this even further by stating:
The incumbent implementation (based on the existing Bitcoin consensus protocol) will continue to trade as BTC even if the B2X chain has more hashing power.
After heavy public (and private) lobbying by members and surrogates of Bitcoin Core, other exchanges have instituted similar policies favoring the incumbent.2 So what can alternative implementations to do? Bend the knee?
Daenerys Targaryen, Breaker of Chains
Historically miners have built on the chain that is both the longest and also has the most accumulated difficulty… and one that has enough profitability to pay for the electricity bills. It just happens that this collective block building activity is never called an “attack” because in general, most participants have been happy enough with the status quo.
Visions of what Bitcoin is and how it should be defined have clearly, empirically shifted over time. But since this network was purposefully designed to be self-sovereign and anarchic — lacking contracts and hooks into any legal system — no one group can claim legitimacy over its evolution or its forks.
As a result, recent war cry’s that Segwit2X is a “51% attack” on Bitcoin are a red herring too because there is no consensus on the definition of what Bitcoin is or why the previous block – in which approximately 51% of the hashrate created a block – is not an attack on Bitcoin. 3
This has now morphed into what the “BTC” ticker on exchanges represents. Is it the longest chain? The chain with the most accumulated difficulty? The chain maintained by Bitcoin Core or now defunct NYA developers? If a group of block makers can build blocks and exchanges are willing to list these coins as “BTC” then that specific chain has just as much legitimacy as any other fork other miners build on top of and exchanges may list.
Furthermore, if the BIP approval committee gets to say what software miners or exchanges should or should not use (e.g., such as increasing or decreasing the block size), that could mean that existing network is a managed and even administered. And this could have legal implications. Recall that in the past, because block making and development were originally separate, FinCEN and other regulators issued guidance stating that decentralized cryptocurrencies were exempt from money transmission laws.
Despite what the trade associations and Bitcoin lobbying groups would like the narrative to be, I recently published an article that went into this very topic in depth and have publicly asked several prominent “crypto lawyers” to provide evidence to the contrary (they have yet to do so). An argument could be made that these dev groups are not just a loose collective of volunteers.
Financial market infrastructure
I’m not defending S2X or XT or Bitcoin Unlimited. In fact, I have no coins of any sort at this time.
But even if you don’t own any bitcoins or cryptocurrencies at all, the block size debate could impact you if you have invested in the formal financial marketplace.
For example, if and when the CME (and similar exchanges) get CFTC approval to list cryptocurrency-related futures products and/or the NYSE (and similar exchanges) get SEC approval to list cryptocurrency-related ETFs, these products will likely result in a flood of institutional money.
Once institutions, regulators, and sophisticated investors enter the picture, they will want to hold people accountable for actions. This could include nebulous “general partnerships” that control GitHub repositories. Recall, in its dressing down of The DAO, the SEC defined the loose collective building and maintaining The DAO as a ‘general partnership.’ Is Bitcoin Core or other identifiable development teams a “general partnership”?
Maybe. In fact, the common refrain Bitcoin Core and its surrogates continually use amounts to arguments in favor of a purported natural monopoly.
For instance, Joi Ito, Director of MIT’s MediaLab, recently stated that:
“We haven’t won the battle yet. [But] I think the thing that is interesting is that Bitcoin Core has substantially more brain fire power than any of the other networks.”
This is problematic for a couple reasons.
First, Joi Ito is not a disinterested party in this debate. Through Digital Garage (which he co-founded) it has invested in Blockstream, a company that employs several influential Bitcoin Core devs.4 Ignoring the potential conflict of interest, Ito’s remarks echo a similar sentiment he also made last year, that Core is basically “The Right Stuff” for NASA: they are the only team capable of sending humans into space.
But this is an empirically poor analogy because it ignores technology transfer and aerospace education… and the fact that multiple countries have independently, safely sent humans, animals, and satellites into space.
It also ignores how competitive verticals typically have more than just one dominant enterprise: aerospace, automobiles, semiconductor manufacturers, consumer electronic manufacturers (smart phones), etc. Each of these has more than one company providing goods and services and even usually more than just one product development team developing those. Intel, for example, has dozens of design teams working on many new chips at any given time of the year. And they are just one of the major semiconductor companies.
Even in the highly regulated markets like financial services there is more than one bank. In fact, most people are unaware of this but banks themselves utilize what is called “Core Banking Software” and there are more than a dozen vendors that build these (see image below).
It is a bit ironic that Bitcoin Core seeks to have a monopoly on the BIP process yet even banks have more than one vendor to choose from for mission critical software securely managing and processing trillions of dollars in assets each day.5
On the enterprise (non-anarchic) blockchain side of the ecosystem, there are well over a dozen funded teams shipping code, some of which is being used in pilots by regulated institutions that are liable if a system breaks. Note: this is something I discussed in my keynote speech (slides) at the Korea Financial Telecommunications and Clearings Institute last year.
But as one vocal Core supporter in a WeChat room recently said, Bitcoin Core is equivalent to Fedwire or Swift, there is only one of each; so too does it make sense for only one Bitcoin dev team to exist.
Firstly, this conflates at least four different things: a specific codebase, with permissioned dev roles, with acceptance processes, with a formal organization.
It is also not a good analogy because there are many regulatory reasons why these two systems (Swift and Fedwire) exist the way they do, and part of it is because they were either setup by regulators and/or regulated organizations. In effect, they have a bit of a legally ring-fenced marketplace to solve specific industry problems (though this is somewhat debatable because there are some alternatives now).6
If this supporter is equating Core, the codebase, with real financial market infrastructure (FMI), then they should be prepared to be potentially regulated. Bitcoin Core and many other centralized development teams are comprised of self-appointed, vocal developers that are easy to identify (they have setup verified Twitter accounts and attend many public events), so subpoenas and RFI’s can be sent their way.
As I mentioned in my previous article: with great power comes great accountability. Depending on the jurisdiction, Core and other teams could end up with regulatory oversight since they insist on having a monopoly on the main (only) implementation and process by which the implementation is managed.7
Remember that Venn diagram at the very top? The companies and organizations that manage FMI today for central banks (RTGSs), central securities depositories (CSDs), and other intermediaries such as custodians and CCPs, have specific legal and contractual obligations and liabilities.
Following the most recent financial crisis, the G-20 and other counties and organizations established the Financial Stability Board (FSB) to better coordinate and get a handle on systemic risks (among other issues). And while the genesis of the principles for financial market infrastructures (PFMI) had existed prior to the creation of the FSB, how many of the international PFMI standards and principles does Bitcoin Core comply with?
Spoiler alert: essentially none, because Satoshi intentionally wasn’t trying to solve problems for banks. So it is unsurprising that Bitcoin isn’t up to snuff when it comes to meeting the functional and non-functional requirements of a global payments platform for regulated institutions. Fact-check me by reading through the PFMI 101 guide.
When presented with these strong legal accountability and international standards that are part and parcel with running a payment system, there is lots of hand waving excuses and justifications from Core supporters (and surrogates) as to why they are exempt but if Core wants to enforce its monopoly it can’t have it both ways. Depending on the jurisdiction they may or may not be scrutinized as FMI.
But in contrast, in looking at the evolution and development of the enterprise chain ecosystem – as I described in multiple previous articles – there are valuable lessons that can be learned from these vendors as to how they plan to operate a compliant network. I recall one conversation with several managing directors at a large US investment bank over a year ago: maybe the enterprise side should just have CLS run a blockchain system since they have all the right business connections and fulfill the legal and regulatory check boxes.
Note: CLS is a very important FMI operator. Maybe existing FMI operators will do just that. Speaking of which, will Bitcoin Core (or other dev teams) apply to participate with organizations like the FSB that monitor systemically important financial institutions and infrastructure?
Angela Walch hasargued (slides) that some coders, especially of anarchic chains, are a type of fiduciary.8 Even if this were not true, many countries have anti-monopoly and anti-trust laws, with some exceptions for specific market segments and verticals. There are also laws against organized efforts involved in racketeering; in the US these are found within the RICO Act.
Watch the Godfather trilogy
I haven’t seen a formal argument as to why Core or other development teams could meet the litmus test for being prosecuted under RICO laws (though the networks they build and administer are frequently used for money laundering and other illicit activity). But trying to use the “decentralization” trump card when in fact development is centralized and decisions are made by a few key individuals, might not work.
Look no further than the string-pulling Mafia which tried to decentralize its operations only for the top decision makers to ultimately be held liable for the activities of their minions.9 And using sock puppets and pseudonyms might not be full proof once forensic specialists are brought in during the discovery phase.10
Based on observations from how Bitcoin Core evolved and consolidated its power over time (e.g. removing participants who have proposed alternative scaling solutions), the focus on what Bitcoin is called and defined has landed in the hands of exchanges and really just highlights the distance that Bitcoin has walked away from a “peer-to-peer electronic cash” that initially pitched removing intermediaries. To even care about what ticker symbol ‘Bitcoin’ is on an exchange is to acknowledge the need for a centralized entity that establishes what the “price” is and by doing so takes away the bitcoin holder’s “self-sovereignty.”11
While the power struggles between various factions within the Bitcoin development community will likely rage on for years, by permissioning off the development process, Bitcoin Core (and any other identifiable development groups), have likely only begun to face the potential regulatory mine field they have foisted on themselves.12
Historically blockchain-based systems have and still are highly dependent on the input and decision-making by people: somebody has to be in charge or nothing gets done and upgrades are a mess. And the goal of appointing or choosing specific teams on anarchic chains seems to be based around resolving political divisions without disruptive network splits.13
The big questions now are: once these teams are in charge, what will governments expectations be? What legal responsibilities and regulatory oversight will the developers have? Can they be sued for anti-trust and/or RICO violations? With billions of dollars on the line, will they need to submit upgrade and road map proposals for approval?
Examples of developers who were removed: Alex Waters, Jeff Garzik, Gavin Andresen [↩]
Thanks to Ciaran Murray for identifying these exchanges. [↩]
Bitcoin mining is in fact based on an inhomogeneous Poisson process; a participant could theoretically find a block with relatively little hash rate. Although due to the probabilities involved, most miners pool their resources together to reduce the variance in payouts. [↩]
According to one alleged leak, Digital Garage is testing Confidential Assets, a product of Blockstream. [↩]
According to a paper from the Federal Reserve: payment, clearing, and settlement systems in the United States “process approximately 600 million transactions per day, valued at over $12.6 trillion.” [↩]
On AngelList, there are about 3,400 companies categorized as “payments” — most of these live on top of existing FMI, only a handful are trying to build new independent infrastructure. [↩]
A key difference between Bitcoin and say Ethereum is that with Ethereum there are multiple different usable implementations managed by independent teams and organizations; not so with how Bitcoin has evolved with just one (Bitcoin Core) used by miners. In addition, the Ethereum community early on formally laid out a reference specification of the EVM in its yellow paper; Bitcoin lacks a formal reference specification beyond the Core codebase itself. [↩]
Thanks to Stephen Palley for providing this observation. [↩]
It is unclear why the current Bitcoin Core team is put onto a pedestal. There are many other teams around the world building and shipping blockchain-related system code used by companies and organizations (it is not like there is only just one dev team that can build all databases or operating systems). At the time of this writing Core has not publish any papers in peer-reviewed journals and many of them do not have public resumes or LinkedIn profiles because they have burned business and professional relationships in the past. Irrespective of what their bonafides may or may not be, it is arguably a non sequitur that ‘permissionless’ coordination in open-source code development has to lead to a monopoly on said development. [↩]
Thanks to Colin Platt for this “appeal to authority” observation. [↩]
Bitcoin stopped being permissionless when developers, miners, and exchanges needed to obtain permission to make and use different code. And likely there are and will be more other cryptocurrency development teams that follow that same path. [↩]
[Note: below is a note from a friend, Bob, who is a former attorney turned tech entrepreneur who closely follows the cryptocurrency world. This was published with his permission.]
Hope all is well. I am writing to share some alarming signs of Bitcoin price manipulation.
Bitcoin price is about 10 times of what it was a year ago. The exchange that decisively sets Bitcoin price is Bitfinex, a secretive institution with unknown beneficiary structure and place of organization.
Bitfinex had its wire services suspended by Wells Fargo in April. To resume trading, Bitfinex enlisted the help of Tether, another company with unknown beneficiary structure and place of organization, but based on announcements is likely under common share holder control with Bitfinex. Tether sells crypto-tokens known as USD Tethers, or USDTs, that are purportedly backed by an equal number of US dollars. In other words, each USDT is a digital good priced at USD 1.00.
Despite the promise of “100% reserve” and the vague reference to “24×7 access to your funds” on Tether’s website, there is no contractual right, either tacit or express, for one USDT to be redeemed for one US dollar. It is probably through this legal construct that Tether hopes to characterize its USDTs as digital goods and not “convertible” virtual currency covered by FinCEN regulations.
The invention of USDTs led to the proliferation of numerous crypto-currency exchanges. Examples include Bitfinex, Binance, HitBTC, KKex, Poloniex, and YoBit. Instead of providing crypto-to-fiat trading pairs, these “coin-to-coin” exchanges offer crypto-to-tether trading exclusively. Therefore, USDTs not only help these exchanges remove the need for formal banking arrangement, but also enables these exchanges to organize in lesser known jurisdictions (e.g., the Republic of Seychelles) and operate outside of the regulation and supervision of major economies. Most of these exchanges claim to screen-off visitors from the United States and other countries with laws on coin-to-coin trading, but the screen-off is often perfunctory. In almost all cases, the screen can be defeated with a simple mouse click.1
It is doubtful that these exchanges perform meaningful due diligence beyond identity verification to combat money laundering, financing of terrorism, and corruption of politically exposed persons. Bitfinex, for example, requires no identity verification at all for most trading activities and imposes no trading amount limits on unverified accounts. The enablement of these exchanges where rampant money laundering is possible is outside of the scope of this note. Instead, I would like to bring to your attention the distinct possibility that Bitfinex, as the likely controller of Tether, is a bad actor.
Strong circumstantial evidence suggests that Bitfinex is creating USDTs out of thin air to prop up Bitcoin prices. Namely, Bitfinex is likely acting as a central bank that issues a fiat money called USDTs. The sole mandate of this central bank is to enrich itself through market manipulation.
The first image (above) attached to this email illustrates how mysterious amounts of USDTs were minted and injected into Bitfinex at precise moments when a crash seemed imminent.
The second image (above) illustrates a strong correlation (but admittedly not causation) between the total amount of USDTs in circulation and Bitcoin price.
Bitfinex released an internal memo in September to allay concerns that USDTs might have been created at will. The memo purportedly shows that Tether maintained sufficient US dollars to match all USDTs in circulation as of a day in September. The memo, however, is of no probative value. Among other strange things, the author of the memo didn’t verify with banks (names redacted) that account balances from Tethers were in fact correct, couldn’t promise that the balances weren’t overnight borrowings for purposes of producing the memo, and couldn’t promise that Tether indeed had access to those funds.
I therefore urge you to consider the possibility that the current price of Bitcoin is the result of Bitfinex’s manipulation and may collapse when regulators take action.
For example, Tether is almost certainly an administrator of virtual currency — it centrally puts into and withdraws from circulation USDTs, a virtual currency squarely intended as a substitute for real currency as admitted by Tether in the internal memo.
Tether has nominally registered as a money transmitter with FinCEN, but it is unclear if they fulfill any of the BSA filing requirements (e.g., filing SARs).2 As a company, Tether’s USDTs enables large crypto-currency exchanges (including US-based exchanges like Poloniex) to exist and powers trades thereon in the amount of millions every day. So it wouldn’t be surprising if FinCEN eventually decides to enforce its rules against Tether as it did against Liberty Reserve.
Further, CFTC approved recently various swap execution facilities, designated contract markets and derivative clearing organizations with Bitcoin flavor. And the Chicago Mercantile Exchange is expected to launch cash-settled futures on Bitcoin soon. Manipulation of Bitcoin prices referenced by these entities is prosecutable by the CFTC, an agency with broad statutory authority to prosecute manipulation of commodity prices under the Commodity Exchange Act (including Section 753 as amended by the Dodd-Frank Act.).
Although none of these CFTC-registered entities are currently including Bitfinex in the calculation of their Bitcoin reference rates (CME used to), it is well understood and could be easily established (partially because of the transparency of Bitcoin blockchain) that Bitfinex-initiated price movements ripple through all exchanges via manual and automated trading.3 CFTC could then have grounds to investigate Bitfinex’s possible manipulation of Bitcoin price via Tether.
If you are considering investing into Bitcoin at this time, please look closer at the exchanges involved in price discovery and give it a second thought.
For an example, see FinCEN ruling from August 15, 2015. [↩]
Tether Limited did do a basic registration which takes around 5 minutes and about 45 dollars. But they probably didn’t do what come after the registration, which includes many other filings to FinCEN such as submitting suspicious activity reports. [↩]
The initial reference rate announced by the CME included Bitfinex. Similarly, the Winklevoss Bitcoin ETF used a reference rate (called the “Winkdex”) whose comprising exchanges fluctuated over time. See Comments on the COIN ETF (SR-BatsBZX-2016-30). [↩]
[Note: I neither own nor have any trading position on any cryptocurrency. I was not compensated by any party to write this. The views expressed below are solely my own and do not necessarily represent the views of any organization I advise. See Post Oak Labs for more information.]
On All Hallows’ Eve in 2008, an anonymous person (or group of persons) posted a short technical whitepaper on an obscure mailing list about a new virtual coin-based online-only payment system they had been designing for the last eighteen months.1 Several months later, in January 2009, this same person posted the code that created the functionality described in the whitepaper and began minting this new virtual currency. Less than two years later, the creator walked away from the project and without ever revealing their real identity.
The creator likely stayed anonymous for a variety of reasons, including the fact that by creating and administering a new payment system they may have been violating money transmission laws in multiple countries.2 Despite multiple hoaxes, we still don’t know who this anonymous person was. But their system – like the Ship of Theseus – continues to exist in a form referred to as Bitcoin.
But before getting to that part of the saga, let’s look at May 2013. At the end of that month, US federal agents raided a Costa Rica-based company called Liberty Reserve due to money laundering violations (along with a list of other crimes). Liberty Reserve was a centralized payment platform that marketed to its users the ability to anonymously send funds to one another.
The US Justice Department said the scheme had been used to process 78 million transactions with a combined value of $8bn (£5.5bn) – many of which were related to hiding the proceeds of credit card theft, identity fraud, hack attacks and Ponzi scam investment schemes.
Last year the founder of Liberty Reserve, Arthur Budovsky, was convicted and sentenced to twenty years in prison. Several other insiders also received sentences. Liberty Reserve had more than 5 million users including more than 200,000 in the US — it is unclear at this time if any of the users are being prosecuted.
According to some cryptocurrency fans, Liberty Reserve’s big blunder was that they attached their legal names to the payment processing enterprise.
But this misses the point. If you play with a highly regulated industry such as financial services, be prepared for the existing stakeholders such as regulators and law enforcement to increasingly scrutinize your operations as they detect familiar activities, such as the marketing and sale of securities or operating a payment platform.
Cypherpunk cosplay uniform (mostly worn online)
If you spend your weekends cosplaying online as a cypherpunk and yet voluntarily sit on-stage wearing a name tag with your real name at public events and promote financial products and financial market infrastructure to the world at large, consider that there may be people who later watch these videos stored on Youtube. In its report on The DAO, the SEC cited two specific Youtube videos including one from Slock.it, the creators of The DAO. Recall that Slack stores everything, including your private pump and dump strategies. If you used cloud-based email, there is a non-zero chance that your successful solicitations and payola to coin media could be discovered after the cloud provider receives a subpoena.
What does this have to do with blockchains? Below we discuss a few ideas that tie in with money transmission and payment processing.
“Core” development teams
Let me state from the onset that I am unaware of any current or potential criminal or civil cases specifically against developers of cryptocurrency networks. Furthermore, regulators and law enforcement may not view development teams as administrators at all. I am not a lawyer and this is not legal advice.
What are administrators? At a very high level, in the United States, according to guidance published in March, 2013 by FinCEN:
An administrator is a person engaged as a business in issuing (putting into circulation) a virtual currency, and who has the authority to redeem (to withdraw from circulation) such virtual currency.
The rest of the March guidance goes into a little more detail of what administrators are with respect to money exchange itself.
For the purposes of this article, and without diving too much into the technical weeds, let’s consider this hypothetical:
Bob forks/clones Bitcoin in a new GitHub repo that he alone has commit access to. While other people can submit suggested changes, he alone has commit access to make any changes to the code. He likes his privacy so he doesn’t actively advertise or market the repo or coin or tell anyone who he is. And then sets up one mining node, initiates the genesis block, and begins Day 1 of Bobcoin.
Is Bob an administrator? If so, at what point does he stop being an administrator? When there are more than one mining nodes in operation? When more than one developer has commit access?
That’s a decision that regulators and law enforcement will need to make but from this cursory bit of detail, Bob clearly issued his own virtual currency. Can he redeem it?
Perhaps.3 Either way, he could unilaterally change the code and annul previous or future coins/transactions. He could change the money supply schedule, doubling or halving it if he so pleased. He could make a new rule that says block sizes should be arbitrarily larger or smaller. He could make a new version that separates the digital signatures from other data in the block. He could change the required transaction fee. He could add functionality such as P2SH. He could change how the difficulty setting adjusts. And so forth.
Even if other participants added computers and joined the Bobcoin network and diluted Bob’s mining hashrate, if the new participants solely rely on the code in his GitHub repo (e.g., are unaware of and/or do not use alternative implementations of Bobcoin code), then Bob remains very influential and could still directly make changes to the network.
Does being very influential — controlling the code repo to a financial network — constitute “administration”? Arguably yes, but there should be some objective measuring sticks as to what these attributes are (e.g., how many different people have commit access to a repo for financial market infrastructure).
In the proof-of-work-based cryptocurrency world today, we have observed a stark 180 logistical change from Bitcoin in 2009. Whereas originally all nodes were miners and vice versa, today you have a permanent bifurcation between: fully validating nodes and the mining process itself (hash generation process). Similarly, many participants in the market, including dozens of developers and miners, use their real legal identities through the use of verified social media accounts and the speaking circuit at fintech events. They are no longer pseudonymous.
In order for participants to coordinate and administer these types of networks, they did not necessarily need to reveal themselves. In fact, we still don’t know who many of the original creators of various cryptocurrency networks are that are still in operation (who is BCNext?). But because many have publicly identified themselves, they could be served with legal process and held responsible if legally liable: hiding behind pseudonymity or anonymity is no longer an option for them.
To borrow a phrase that has been recently used by several regulators, will it come down to the “facts and circumstances” to determine whether or not an entity such as a mining pool operator or core development team is a money service business or fiduciary? 4
Either way, popular euphemisms commonly used by cryptocurrency promoters and lobbyists include supposedly supporting “open” or “public” blockchains – several feelgood words – but as we empirically observe, in many cases these networks are not open to the general public: either as an actual validator or as a developer. Access can become gated by a clique who determines who can be involved.5
In December 2015, the individuals in the photo above allegedly represented about 90% of the Bitcoin network hashrate: Source
Command and control
According to some, the Bitcoin network is viewed as a “third party payment processor” and because no one single entity administers the network it meets FinCEN’s exemptions.6 Thus, the argument goes, cryptocurrency network creators do not need to obtain a money transmitter license in the US because each activity is separate and run by a different group of participants who meet some kind of legal or regulatory exemption.7
This may have been the case in 2009 and 2010 prior to mining pools and dedicated development teams but it may not stand up to closer scrutiny in 2017.
For instance, over the past couple of years there has been this phenomenon called the “block size” debate. Rather than go into the different camps and what they want or demand, let’s look at how various participants actually behave and act.
To begin with, let’s look at mining.
As mentioned above, mining in 2017 is different than it was in 2009. Whereas mining initially meant (1) validation back to the genesis block and (2) generating proofs-of-work (hashes), these two processes are fully separated today.8
Today mining pool operators pick and choose which transactions to include into blocks and validate the chain they are building their blocks, is the chain they intended to do so on. They can (and do) censor transactions. For a pre-arranged fee, some will include your transaction before including others, including transactions from the mining pool operator itself. Mining pools in turn pay miners (those with hash generating equipment) a share of the block reward for the work they do. Note: miners (hash generators) themselves do not validate blocks and in fact, the machines they use are comprised of ASIC chips, are incapable of doing anything other than some simple multiplication — they can’t even run the software needed to validate the chain, let alone software like Excel.
There is a third stake holder in the mining process; infrastructure managers, who own and operate (or lease) the physical infrastructure that houses the equipment for miners. Very little has been published on these participants (in English) because most of this infrastructure is managed in countries where English is not the mother tongue.9 These participants negotiate electrical rates and sometimes help install and operate the electrical equipment (transformers and wiring) at the various mining facilities (or outsource and manage that to someone else).
Now let’s look at the software implementation commonly used by many Bitcoin mining pools, called Bitcoin Core. Until very recently, most mining pools ran a reference implementation of what is called the Bitcoin Core implementation of Bitcoin. That is to say, the software running their node which builds and validates blocks, comes from a repository managed by a collective describing itself as Bitcoin Core. This software was originally called the “Satoshi client” (Bitcoin-Qt) and has been renamed a few times along the way to its current name of Bitcoin Core.
In October, 2017 one common refrain from the camp that collectively identifies itself as Bitcoin Core, is that miners do not ultimately operate Bitcoin. They argue that hashrate follows price and price follows the chain that is best maintained by the best developer team. This is empty rhetoric. We know that there are three entities involved in mining: mining pools, hash generators, infrastructure managers. We know their key importance because they have been lobbied non-stop by many different stakeholders (such as Bitcoin Core and Bitcoin Classic) over the past several years including both open and closed door events on multiple continents. They have been asked to sign agreements. And then have seen those same agreements broken. If miners are not important, they would not be lobbied or demonized at all: they would be ignored entirely.1011
Bitcoin Core is especially interesting because Bitcoin Core proponents claim it does and does not exist. It is a bit like Schrodinger’s cat: Core exists when it is convenient for its proponents (like rallying supporters to denounce an alternative implementation) but does not exist when it encounters accountability or responsibility for its collective decisions or the decisions made by its surrogates.
Bitcoin Core maintains a website, a verified Twitter profile, Slack and other media channels.12 It even has a public team page of some of the contributors. It is unclear how they precisely coordinate, but they work closely together with the owners and maintainers of Bitcoin.org and Bitcoin Core GitHub repo. Note: Bitcoin.org, Bitcoin Talk and /r/Bitcoin are all controlled by the same individual, “theymos.”13 The other channels are owned and controlled by a set of unknown participants. This collective does not have any known trademarks or copyrights at this time. While no one has yet identified the actual decision makers, Bitcoin Core has multiple surrogates who are publicly known and actively engaged in media.
When there are disputes over decisions, some individuals who have identified themselves on the Bitcoin Core contributor list, will come out defending Bitcoin Core. This includes asking for Bitcoin Core alleged lookalikes and doppelgangers to stop existing. Schrodinger’s cat strikes again: Bitcoin Core wants to own the term Bitcoin Core on social media so that others can’t use it, but do not want the accountability when the collective or someone from the collective makes a decision. Whose identification documents were used to create a verified Twitter (KYC’ed) account? What about the web domains? Those people are arguably actual representatives of the collective.
Bitcoin Core does not have a trademark on the Bitcoin logo, the Bitcoin ticker symbol, etc. The original code base was released under an MIT License and “Satoshi Nakomoto” is still the copyright owner.14 Tibanne KK (the parent company of Mt. Gox) actually has a trademark on “Bitcoin” in the UK; although since the logo was originally placed in the public domain it is unclear if Tibanne can enforce these claims. While the representatives and surrogates of Bitcoin Core argue over alternative implementations, if the entity called Bitcoin Core sued, this could open them up for a few things:
they might need to incorporate in order to have legal standing;15
they’d likely have to reveal their legal names (who is the verified Twitter entity?);
they could be liable for complying with state, federal and international laws around operating financial market infrastructure.
Some developers want the power to control a code repo but not the accountability that comes with it. Source: Spider-Man
Note: if you have a few moments, Angela Walch has a great paper on this topic worth reading. Recall one of the common refrains from multiple full-time cryptocurrency developers is that they must be conservative in how they upgrade the chain they are working on, “as billions of dollars are at risk.” These statements are arguably self-incrimination for being a fiduciary.16
It is unclear if Bitcoin Core itself will remain pseudonymous to avoid lawsuits and countersuits. But recall, no one currently owns “Bitcoin” — the network itself is a public good, a commons. However, Bitcoin Core does control the GitHub repo and tightly controls the commit access, occasionally removing those that do not align with their political views.17
What is the big deal? Isn’t this software similar to a browser?
No. The several thousand ISPs that are connected to each other forming “the Internet” are not dependent on the existence of Firefox or Internet Explorer or any browser. These ISPs use protocols which are developed and managed by various non-profit and for-profit entities, some with clearer governance than others (like ICANN and IETF). Network traffic will continue to flow irrespective of what browser is being used.
Bitcoin Core (the software) is not like a browser.18 If it was, the miners could simply switch out and use a different implementation and then start building blocks based on this new implementation. But as noted above, miners have been lobbied not to use anything but Bitcoin Core or face the consequences if they did. For instance, this past spring a group of Bitcoin Core affiliated developers threatened to change the proof-of-work mechanism. These same developers even created a Twitter account (hence deleted) and still maintain a website dedicated to promoting this change.
With threats like this, arguably miners aren’t really free to choose what implementation to run. To use Walch’s description, Bitcoin Core (and other identifiable developer teams) could arguably be a fiduciary if not an administrator.
George Kikvadze is an executive and vice chairman of BitFury, a large Bitcoin mining company based in the Republic of Georgia. Seven months ago he tweeted the statements above in reaction to a Bitcoin Core developer that threatened to change the proof-of-work algorithm used in Bitcoin in order to punish miners for using non-Bitcoin Core code.
Neither threat was carried out but this scenario raises interesting questions: if representatives of Bitcoin Core (or other development teams) who had commit access did change the proof-of-work mechanism to something the ASIC miners that BitFury designed was no longer capable of monetizing, is Bitcoin Core (or other developer teams) itself liable for the loss in revenue suffered by BitFury and other miners? Is it just the person who submitted the documents to get a verified Twitter account?
No terms of service
One of the fundamental challenges for any anarchic chain is coming to agreement on defining the chain in the first place.19 What is Bitcoin? Is it the chain with the most proof-of-work? The longest chain? The one that gets the most retweets? The one with the most starred repo on GitHub?
As I mentioned in a paper a couple years ago (Appendix A), because there is no de jure process to handle governance issues, the various communities and tribes rallying and fighting around their disparate visions must rely on ad hoc de facto processes, much of which spills over onto social media
Fundamentally there does not appear to be any contract rights involved in using or operating Bitcoin (the network). Who do users have contractual relationships with? If someone does, then you could theoretically sue them. But there is not even a click-through agreement or EULA when downloading Bitcoin Core (or any other alternative implementation).
This is relevant because earlier this month there were several Bitcoin Core contributors and surrogates, some of whom used their real names, claimed that alternative implementations such as Bitcoin Segwit2X (and its developers) could be violating the Computer Fraud and Abuse Act in the event that Segwit2X successfully creates a new fork next month.
If the CFA Act or money transmission laws are being broken post-Segwit2X then they are probably being broken now because of how various forks and updates are currently rolled out by developers and miners. While it is unclear if any regulators or law enforcement would see the interpretation of the CFA Act the same way as Bitcoin Core representatives do, this hypothetical legal threat raises a few interesting points:
What legal standing does anyone have in the event of a fork on an anarchic chain? Code is not law.
What country has jurisdiction and who has contractual relationships with one another?
Would such a lawsuit create precedence or chilling effect on anyone wanting to fork/clone code in the future? Who is liable for orphaned blocks?
What happens in the event of an accidental fork like the one in March 2013?
By pushing any interpretation of the CFA Act onto anarchic cryptocurrency networks, it could create interesting legal precedents for Bitcoin Core because once the government gets involved in deliberating which fork is and is not legitimate or which miners can or cannot participate, then you no longer have a pseudonymous anarchic network. Recall there was no EULA or Terms of Service on purpose when Bitcoin was launched years ago.
Another recent example, a Bitcoin Core surrogate who used his real name, publicly asked the New York State Department of Financial Services (DFS) to look into Coinbase’s support of Segwit2x. Does Coinbase violate the BitLicense for supporting one chain versus another? Last month a Bitcoin Core contributor who also used his real name, penned a letter to the SEC about why it should not approve an ETF because the company applying for it supported Segwit2X, an alternative Bitcoin implementation.20
A couple weeks later the same author of the SEC letter publicly said:
But, yea, lets be clear, I dont know a singla significant contributor to Core who will ever work on btc1/Segwit2XCoin. If all the miners switch over, most likely some folks will buy hashrate and there will be a Bitcoin chain again to work on. If, somehow inexplicably, the entire community gives up on Bitcoin and uses 2xCoin, then most likely the vast majority of Core contributors will just move on to something other than Bitcoin, though given how 2x has been going, I find that highly, highly unlikey.
The term “2XCoin” is intended to be an inside baseball pejorative towards the developers and supporters of Segwit2X. Other Core developers have publicly stated that other Core developers will walk away from (quit) the project if an alternative implementation successfully creates a fork.
Another common war cry during the summer was that Bitcoin Cash, a fork and airdrop of Bitcoin up to a certain block height, “was an attack on Bitcoin.” This statement raises a number of questions:
(1) there are multiple existing forks of Bitcoin that continue to exist (such as Bitcoin Dark), were these also attacks on Bitcoin? Where is the passionate uproar against the dozens of Bitcoin clones and forks including the ones that used line-for-line the same code but simply rebranded?
(2) Bitcoin needs to first be defined, since there is no 100% consensus or agreement on what it is (longest chain?) or even agreement on how to measure consensus, to prove that there is an attack you would need to at least agree on what Bitcoin is and what exactly was attacked. Since Bitcoin was designed from the outset to be forked and for those with the most hashrate to decide what is and is included in a block — and the rules therein — how is Bitcoin Cash any different in terms of legitimacy than Bitcoin?
If there is a regulatory arbitrator stating which fork is the legitimate legal one, you have a permissioned network. And I truly could talk all day about those because I popularized that term with this (now dated) paper more than two years ago and currently advise a couple companies involved in building those. Inquire within!
The tactics used by different cryptocurrency tribes versus others is not new. In fact, if you look as recent as the 1960s, during the Cultural Revolution in China there were struggle sessions in which the accused (class enemies) were captured and dragged out in front of the public and denounced for crimes that they didn’t commit.21
We see this type of behavior in the cryptocurrency world on a monthly basis, just look at the “Antbleed” hatchet job. This was a manufactured controversy and coordinated attempt to discredit a company (Bitmain) that had publicly spoken out against one specific Bitcoin implementation in favor of another.2223 Nearly six months later, the original accusations (of covert usage) are still unproven yet some of the promoters of this theory, several of which who are affiliated with Bitcoin Core, continue to attack anyone who stands in the way of their own vision. Many elements in the community thrive on both real and fake controversy in order to stay relevant: it is in a state of permanent lynching mode.
Other cryptocurrency chains
Lest I be accused of picking favorites, I should point out that future researchers could create an infographic depicting how all chains evolved over time.24
Below is a non-exhaustive list of other chains that have highly coordinated behavior between influential persons that look administrator-like:
Dash Core: run by a company (with a CEO no less); can identify the major participants involved and how they coordinate to make changes; they sponsor events and attempt to speak on behalf of the community while making any upgrades; they run various social media accounts
Ethereum Classic: this small community has held public events to discuss how they plan to change the money supply; they video taped this coordination and their real legal names are used; only one large company (DCG) is active in its leadership; they sponsor events; they run various social media accounts
Bitcoin Cash: an airdrop based on Bitcoin prior to a certain block height; can identify the major participants involved and how they coordinate to make changes; they run various social media accounts and events
Bitcoin Segwit2X: can identify the major participants involved and how they coordinate to make changes; they have met to formalize this process in multiple meetings including the New York Agreement (NYA); they run various social media accounts and claim to be the equivalent of Bitcoin Core
Bitcoin XT: defunct, in its terms they explicitly said one set of named individuals would be administrators
Litecoin: leaders are self-doxxed; have a formal Foundation as well; they run various social media accounts and events
Dogecoin: leaders are self-doxxed and publicly coordinated merged mining with Litecoin three years ago; there have a formal Foundation; they run various social media accounts
Ethereum: can identify and name specific people in the Ethereum Foundation and mining community who publicly coordinated several hard forks; these stakeholders sponsor public events and code changes; they run various social media accounts; the Ethereum Foundation has a registered trademark
Bitcoin Gold: an upcoming airdrop based on Bitcoin prior to a certain block height; can identify the major participants involved and how they coordinate to make changes; they run various social media accounts
Zcash: this was created by a company (Zerocoin Electric Coin Company); can identify and name specific people in the Zcash Foundation and mining community who publicly coordinate updates; these stakeholders sponsor public events, grants, and code changes; they run various social media accounts
Bitcoin: before Bitcoin Core consolidating itself, there was The Bitcoin Foundation which attempted to speak as the voice of Bitcoin… then it pretty much went morally and financially bankrupt
Dozens if not hundreds of others
Whereas the Bitcoin creator “walked away” (or is he lurking in the CoinDesk comment section?) most ICO issuers could have the same legal problems described above. Even ignoring the issuance of unregistered securities through ERC20 and ERC20-like standards, many of these these ICO coins and tokens were centrally issued and administered.
One reviewer singled out Factom, Tierion, Ripple, and Stellar as well, but these communities have slightly different nuances worth looking into independent of this article. It bears mentioning that Ripple was penalized and settled with FinCEN in May 2015, but this was due to non-compliance with BSA requirements with respect to not filing suspicious activity reports (SAR) from a side fund it operated. 25 It was not about operating the nodes on the network.26 Furthermore, centralized issuance and operation of a network through watermarked tokens (e.g., Counterparty, Omni (Mastercoin), all colored coins) is still taking place today (see Tether).
This is not to say that you shouldn’t create a cryptocurrency nor a foundation. There are likely ways to create a new cryptocurrency and structure its governance in a legally compliant (or exempt) manner.
But some of those who issued a cryptocurrency which they centrally operate and mint could be on thin ice depending on how strict regulators and law enforcement are.27 Maybe they aren’t strict at all.
If it is centrally administered for 2 minutes versus 2 hours versus 2 years (like Satoshi did), at what point is that line crossed? What about a network like Stellar that was originally decentralized and then in an emergency, centralized (running off of one node) due to a break in its consensus mechanism? The Stellar organization itself operated the single validation node for months before re-decentralizing. That is clearly administering a network especially since they issued lumens to begin with (lumens are the native currency of the Stellar network).
Forks as securities
A friend of mine that is the CEO of a Bitcoin-focused company recently hired an attorney to look at the upcoming Bitcoin Segwit2X (S2X) fork proposal and thinks there could be an argument that the fork is a security based on the Howey test.
His rationale is the following, reused with his permission:28
S2X is a common enterprise based on the efforts of the signers of the NYA
Many of the signers of the NYA have long touted the benefits and profit expectations of increasing the block size
S2X was assembled by a promoter/ third party: the organizers of the NYA and its signers
Anyone who purchased bitcoin between May 2017 and the fork date is an investor, in particular if that person bought bitcoin in anticipation / expectation of the fork
If this is true, then you could likely insert and replace S2X and NYA with various cryptocurrency developer groups (including Litecoin, Ethereum, Ethereum Classic, Bitcoin Core, Bitcoin XT and others listed in the section above) and just modify the date to argue that each of these coordinated efforts is effectively a common enterprise seeking to profit from the expectations of X, Y, or Z features. It could be smaller or bigger blocks, sidechains, slower or faster block generation times, etc. In other words, if Segwit2X is a security, then arguably many coordinated “soft” and “hard” forks are.29
At this time, in the US, neither the SEC nor CFTC have publicly issued their position on how a fork falls within their scope and mandate.30
However, if any regulator or court does formally publish guidance or a ruling siding with a specific fork, the cryptocurrency community will have institutionalized permissioned-on-permissionless chains. An expensive contradiction.
Relevancy towards enterprise chains
Since you do not need proof-of-work to maintain all blockchains, enterprise focused blockchain and DLT-related companies (commonly referred to as private or permissioned chains) typically started off with the realization a couple years ago that:
In order for changes and upgrades to take place on a decentralized network, some clear governance needs to be created to manage that process;
Network validators, the nodes involved in validating transactions, would be run via known, identifiable (KYC’ed) operators who had specific contractual obligations that ultimately would rely on courts as arbiters (e.g., if there is a fork, only one chain would be deemed the legitimate de jure chain);
If an entity formally governs one of these networks it is likely that it would also be regulated under existing laws and regulations;
If an entity or group of entities has the power to coordinate and unilaterally make these changes at will without legal recourse, then this could be a single point of failure that could be abused. How to design a network that prevents this security hole from forming yet comply with existing laws and regulations all while providing recourse to the users in the event of disputes arising?
Note: all of the vendor platforms have their own differences and nuances; from an architectural standpoint they cannot all be lumped together as a monolithic entity.
But in this case, many of these companies took roughly the same tact: one which attempts to hold validating parties accountable ultimately through the existing legal system (via contracts and if need be courts). As a result, so far the vendors have generally gotten to bypass most of the drama around factional in-fighting described above. But each vendor still has their own challenges ahead. Once an enterprise chain’s mainnet is turned on in production and real value is being moved across their network, whoever administers and operates the network(s) could be legally liable for complying with a whole slew of regulations from multiple different jurisdictions.
That is why some operating models involve banks or other existing financial institution running the validating nodes — because they already have the necessary licenses and compliance structures put in place. That is also why some of the vendors created a consortium from the get-go because they foresaw the need to bring on different types of stakeholders early on. But ignoring the consortium approach for the moment, once real legal names are touching and managing real financial instruments, regulators and law enforcement begin to pay much closer attention.
In the US there is no private right of action under the FinCEN guidelines. Only FinCEN can initiate an enforcement proceeding, and based on conversations with legal experts who reviewed this article, these experts do not expect such actions right now given that FinCEN hasn’t thus far.
Can private parties initiate litigation? Based on one conversation with an interested party, it seems that there is arguably a private right of action under the CEA, under certain state money transmission business (MTB) laws and under securities laws. Will they? My guess is that as more real value (e.g., real money like USD) is associated with any of these anarchic blockchains, the odds of lawsuits due to any type of fork (intentional or not), trends closer to probably.
With that said, networks such as blockchains, do not maintain themselves. They do not upgrade themselves or automatically fix bugs that arise. They are not anti-fragile. They need people to do all of these pesky maintenance things. And with people comes politics and social engineering.31
Empirically if there isn’t disharmony in a blockchain community it is because most participants agrees who the administrator or administrators are.32
If there is a disagreement, as we have seen multiple times, a political struggle often takes place and a fork or two may happen: either a fork in the chain or a fork in the community. With hundreds of dead or zombie blockchains, it is clear that blockchains do not work without some kind of administrator and decision maker. Whether or not FinCEN or other money transmitter regulators come to the same conclusion is a different matter.
The takeaway from this piece isn’t that no one should be formally or informally engaged with anarchic chains such as cryptocurrencies. Or that passion and enthusiasm should be discouraged. Rather, it is about consistency and the rule of law. If you do not like the development or evolution in a community-without-formal-rules — such as the fractured tribes of Bitcoin — using the government as a club of convenience to get what you want and not expect consequences for their intervention on your behalf is shortsighted.
While a few dozen cryptocurrency startups have already begun using trade associations to lobby regulators on their behalf for a “hands-off” regulatory approach, at some stage the appearance of formalized governance of financial market infrastructure — even if it is marketed as self-sovereign, decentralized, open, and anarchic — could lead to increased regulatory oversight due to how the crypocurrency governance activity actually behaves in reality. This is definitely a topic worth revisiting in a year to see if any regulator publicly opines on the topic. 33
[Note: if you found this research note helpful, be sure to visit Post Oak Labs for more in the future.]
To protect the privacy of those who provided feedback, I have only included initials: RD, CP, SP, CM, VB, DG, CK, AW.
Both Ray Dillinger and Hal Finney have stated they analyzed and gave feedback to Satoshi on Bitcoin prior to its public announcement; perhaps there were others too. [↩]
It is possible to create a redeemable asset on Counterparty and several other platforms connected to Bitcoin. [↩]
One reviewer opined that: “I think it will be a technical legal definition that comes down to whether you can exert reasonable control before enforcing MSB rules. Whether you are an administrator or not will be a boring court decision: they could look at whether you were mining or developing with a high enough impact. [↩]
On the mining side, the capital costs of running a mining farm and pool that actually validates blocks on many of the larger cryptocurrency networks is relatively expensive and out of reach for most users; mining pools have been documented at attacking one another on the network itself (e.g., DDOSattacks). On the developer side, as discussed throughout this article, while it varies depending on the cryptocurrency, the control over the repo (specifically who has commit access) is often restricted to a few insiders who can permit and restrict who can be involved in the development process (e.g., they can remove a developer from mailing lists, forums, events, code repositories, etc.). [↩]
Cryptocurrency miners typically only have the ability to instruct payments of keys they control (although they can censor and/or fork as well). Thus, it is argued, the miners typically just perform IT services. [↩]
In the UK, there is some relevant guidance from HM Revenue and Customs with respect to money laundering and money service businesses [↩]
A year ago the narrative that miners were a key component of Bitcoin dramatically shifted in the minds of a group that lobbied for a change known as UASF: User Activated Soft Fork. The proposal – which thus far has not been activated – attempts to remove miners and replace their role with nodes controlled by UASF advocates, pretty much removing Sybil protection. Instead of buying hardware and pushing hashrate one way or the other, UASF advocates used social media to promote their views. Incidentally some of the same people promoting “no2x” (opposed to Segwit2x) were actively part of the “UASF” campaign. [↩]
One reviewer mentioned that: “It’s worth noting that in Ethereum, miners actually don’t have a large role in decision-making. Ironically enough, I think the reason for this is that Bitcoin prefers soft forks for governance, whereas Ethereum prefers hard forks, and soft forks naturally depend more heavily on miner support in order to succeed.” [↩]
Its Twitter account actively retweets and highlights specific content from a common group of promoters, advocating and endorsing their viewpoints. [↩]
“theymos” is his/her username; his real name is allegedly Michael Marquardt but little is publicly known about who he is beyond his control of the most highly trafficked Bitcoin-specific developer sites. Other pseudonyms that co-own some of these domains include “cobra.” [↩]
In the US, copyrights are unregistered. The copyright owner of the original source code still belongs to “Satoshi Nakomoto” however as of this writing, no one has stepped forward to claim this copyright ownership. [↩]
Alternatively they could be a “general partnership;” this was discussed in the SEC paper on The DAO (pgs 14-15). [↩]
One reviewer provided a counterpoint: “There’s a difference between voluntarily taking on responsibility and being legally assigned it. For example, if I suddenly decide that I feel morally obligated to make sure all children in some village in Africa are properly fed, I do not become their legal guardian.” [↩]
Alex Waters, Jeff Garzik, and Gavin Andresen (among others) have been removed in this fashion. [↩]
If we replaced “browser” with “TCP/IP” that would likely create massive economic disruption and finger pointing for blame. [↩]
One reviewer pointed out that: “If you’re looking for parallels with authoritarian regimes, there are many. Bitcoin Core’s arguments that there must be only one reference implementation to “preserve stability”; them playing linguistic games to deny the opposition legitimacy, high levels of censorship, etc. There are also parallels on the other side of this, where the “opposition parties,” despite having many legitimate grievances, are all good at protesting but focus on negativity and are not nearly technically competent enough to effectively form their own “government”. This happens in Russia, to some extent Singapore, China (think Hong Kong independence movement), etc. You can probably expand this out into an entire blog post.” [↩]
Bitmain is the largest manufacture of mining equipment, Antminer is the brand of one of its product lines. [↩]
One reviewer suggested that future researchers and analysts could also look at several other attributes: (1) Basing oneself in a country as an incorporated entity; (2) Having developers heavily concentrated in a country; (3) Heavily marketing in a country, especially if it’s the same country as above; (4) The operation of a chain being controlled by one implementation and one company (as opposed to Ethereum’s geth/Parity/now harmony split [↩]
One reviewer opined that: “Though it is worth noting that their ability to operate the network in a way that gives users permissionlessness was compromised as a result of these side activities. A useful cautionary tale.” [↩]
One reviewer commented that: “I think it’s worth making a distinction here between convertibility and central administration of tech. Bitcoin, Bitcoin Cash, Ethereum, Ethereum Classic, Dash, etc are all not immediately convertible; the portion of tokens that actually are convertible is relatively low and I think everyone already agrees that those are regulated.” [↩]
One reviewer mentioned that in the event a fork occurs, there could be legal repercussions pursuant to Commodities Exchange Act (namely, section 6(c), rule 180). [↩]
Even some of the proposed “self-governing” blockchains ultimately start out fairly centralized, arguably as administrators and MTBs. And due to the amount of coins that insiders and creators of these chains have, they could heavily influence the direction of votes (e.g., in a staking model, large coin holders are politically powerful entities who could coordinate and collude to fork in their own interest). Will they always remain as administrators? [↩]
Many thanks to Ciaran Murray for providing this observation. [↩]
One of the reviewers asked how several current and proposed proof-of-stake coin-based projects would fit in here as potential solutions. Since most of these are young and/or not even launched, see footnote 31 above. Some have governance challenges already, see Backroom battle imperils $230 million cryptocurrency venture from Reuters. Another reviewer opined that: “Systems like Bitshares, EOS, Tezos, et al will in practice be secure primarily precisely because there are large premines held by the foundations and developers themselves. It’s like a kind of ‘centralized administration without looking like centralized administration.'” [↩]
[Note: I neither own nor have any trading position on any cryptocurrency. I was not compensated by any party to write this. The views expressed below are solely my own and do not necessarily represent the views of my employer or any organization I advise. See Post Oak Labs for more information.]
Alternative title: who will be the Harry Markopolos of cryptocurrencies?
If you don’t know who Harry Markopolos is, quickly google his name and come back to this article. If you do, and you aren’t completely familiar with the relevance he has to the cryptocurrency world, let’s start with a little history.
Don’t drink the Koolaid
With its passion and perma-excitement, the cryptocurrency community sometimes deludes itself into thinking that it is a self-regulating market that doesn’t need (or isn’t subject to) government intervention to weed out bad actors.1 “Self-regulation,” usually refers to an abstract notion that bad actors will eventually be removed by the action of market forces, invisible hand, etc.
Yet by most measures, many bad actors have not left because there are no real consequences or repercussions for being a bad dude (or dudette).
Simultaneously, despite the hundreds of millions of dollars raised by VCs and over a couple billion dollars raised through ICOs in the past year or so, not one entity has been created by the community with the power or moral authority to rid the space of bad apples and criminals. Where is the regulatory equivalent of FINRA for cryptocurrencies?2
Part of this is because some elements in the community tacitly enable bad actors. This is done, in some cases, by providing the getaway cars (coin mixers) but also, in other cases, with a wink and a nod as much of the original Bitcoin infrastructure was set-up and co-opted by Bitcoiners themselves, some of whom were bad actors from day one.3
There are many examples, including The DAO.4 But the SEC already did a good dressing down of The DAO, so let’s look at BTC-e.
BTC-e is a major Europe-based exchange that has allegedly laundered billions of USD over the span of the past 6 years. Its alleged operator, Alexander Vinnik, stands accused of receiving and laundering some of the ill-gotten gains from one of the Mt. Gox hacks (it was hacked many many times) through BTC-e and even Mt. Gox itself.5 BTC-e would later go on to be a favorite place for ransomware authors to liquidate the ransoms of data kidnapping victims.
Who shut down BTC-e?
It wasn’t the enterprising efforts of the cryptocurrency community or its verbose opinion-makers on social media or the “new 1%.” It was several government law enforcement agencies that coordinated across multiple jurisdictions on limited budgets.6 Yet, like Silk Road, some people in the cryptocurrency community likely knew the operators of the BTC-e and willingly turned a blind eye to serious misconduct which, for so long as it continues, represents a black mark to the entire industry.
In other cases, some entrepreneurs and investors in this space make extraordinary claims without providing extraordinary evidence. Such as, using cryptocurrency networks are cheaper to send money overseas than Western Union. No, it probably is not, for reasons outlined by SaveOnSend.7
But those who make these unfounded, feel-good claims are not held accountable or fact-checked by the market because many market participants are solely interested in the value of coins appreciating. Anything is fair game so as long as prices go up-and-to-the-right, even if it means hiring a troll army or two to influence market sentiment.
And yet in other cases, the focus of several industry trade associations and lobbying groups is to squarely push back against additional regulations and/or enforcement of existing regulations or PR that contradicts their narrative.8
Below are eight suggested areas for further investigation within this active space (there could be more, but let’s start with this small handful):
Bitfinex is a Hong Kong-based cryptocurrency exchange that has been hacked multiple times.9 Most recently, about 400 days ago, $65 million dollars’ worth of bitcoins were stolen.
Bitfinex eventually painted over these large losses by stealing from its own users, by socializing the deficits that took place in some accounts across nearly all user accounts.10 Bitfinex has – despite promising public audits and explanations of what happened – provided no details about how it was hacked, who hacked it, or to where those funds were drained to.11 It has also self-issued at least two tokens (BFX and RRT) representing their debt and equity to users, listed these tokens on their own exchange and allowed their users to trade them.12
There have been suggestions of impropriety, with its CFO (or CSO?) Phil Potter publicly explaining how they handle being de-banked and re-banked:
“We’ve had banking hiccups in the past, we’ve just always been able to route around it or deal with it, open up new accounts, or what have you… shift to a new corporate entity, lots of cat and mouse tricks that everyone in Bitcoin industry has to avail themselves of.”
Yet there is little action by the cryptocurrency community to seek answers to the open questions surrounding Bitfinex. I wrote a detailed post several months ago on it and the only reporters who contacted me for follow-ups were from mainstream press.
There are a lot of reasons why, but one major reason could be that some customers have financially benefited from this lack of market surveillance because relatively little KYC (Know Your Customer) is collected or AML (Anti-Money Laundering) enforced, so some trades and/or taxes are probably unreported.13 This wouldn’t be an isolated incident as the IRS has said less than 1,000 United States persons have been filing taxes related to “virtual currencies” each year between 2013 – 2015.
But that’s not all.
The latest series of drama began earlier this spring: Bitfinex sued Wells Fargo who had been providing correspondent banking access to Bitfinex’s Taiwanese banking partners. Wells Fargo ended this relationship which consequently tied up tens of millions of USD that was being wired internationally on behalf of Bitfinex’s users. About a week later Bitfinex dropped the suit and at least one person involved on the compliance side of a large Taiwanese bank was terminated due to the misrepresentation of the Bitfinex account relationship.
This also impacted the price of Tether.
Tether, as its name suggests, is a proprietary cryptocurrency (USDT) that is “always backed by traditional currency held in our reserves.” It initially used a cryptocurrency platform called Mastercoin (rebranded to Omni) and recently announced an ERC20 token on top of Ethereum.1415
As a corporate entity, Tether’s governance, management, and business are fairly opaque. No faces or names of employees or personnel can be found on its site.16 Bitfinex was not only one of its first partners but is also a shareholder. Bitfinex has also created a new ICO trading platform called Ethfinex and just announced that Tether will be partnering with it in some manner.17
Tether as an organization creates coins. These coins are known as Tethers that trade under the ticker $USDT each of which, as is claimed on their webpage, is directly linked, 1-for-1, with USD and yen equivalents deposited in commercial banks. But after the Wells Fargo suit was announced, USDT “broke the buck” and traded at $0.92 on the dollar.18 It has fluctuated a great deal during the summer currently trades at $1.00 flat.
Which leads to the question: are the seven banks listed by the recent CPA disclosure aware of what Tether publicly advertises its USDT product as?19
Who is responsible for issuance, and how if at all can they be redeemed? Are they truly backed 1:1 or is there some accounting sleight-of-hand taking place behind the scenes?20 Where are those reserves going to be exactly? Who will have access to them? Will either Tether (the company) or Bitfinex going to use them to trade?21 These are the types of questions that should be asked and publicly answered.
The only reason anyone is learning anything about the project is because of an anonymous Tweeter, going by the handle @Bitfinexed, who seemingly has nothing better to do than listen to hundreds of hours of audio archives of Bitcoiners openly bragging about their day trading schemes and financial markets acumen (in that order).
Despite myself and others having urged coin media to do so, to my knowledge there have been no serious investigations or transparency as to who owns or runs this organization. Privately, some reporters have blamed a lack of resources for why they don’t pursue these leads; this is odd given the deluge of articles posted every month on the perpetual block size debate that will likely resolve itself in the passage of time.
The only (superficial) things we know about Tether (formerly Realcoin) is from the few bits of press releases over time.22 Perhaps this is all just a misunderstanding due to miscommunication.23 Who wants to fly to Hong Kong and/or Taiwan to find out more?
(2) Ransomware, Ponzi’s, Zero-fee and AML-less exchanges
China’s two biggest bitcoin exchanges, Huobi and OKCoin, collectively invested around 1 billion yuan ($150 million) of idle client funds into “wealth-management products.”
In other words, the reason these exchanges were able to operate and survive while charging zero-fees is partially offset by these exchanges using customer deposits to invest in other financial products, without disclosing this to customers.24
Based on conversations with investigative reporters and former insiders, it appears that many, if not most, mid-to-large exchanges in China used customer deposits (without disclosing this fact) to purchase other financial products. It was not just OKCoin and Huobi but also BTCC (formerly BTC China) and others. This is not a new story (Arthur Hayes first wrote about it in November 2015), but the absence of transparency in how these exchanges and intermediaries are run ties in with what we have seen at BTC-e. While there were likely a number of legitimate, non-illicit users of BTC-e (like this one Australian guy), the old running joke within the community is that hackers do not attack BTC-e because it was the best place to launder their proceeds.
Many exchanges, especially those in developing countries lacking KYC and AML processes, directly benefited from thefts and scams. Yet we’ve seen very little condemnation from the main cheerleaders in the community.25
For example, two years ago in South Africa, MMM’s local chapter routed around the regulated exchange, patronizing a new exchange that wouldn’t block their transactions.26 MMM is a Ponzi scheme that has operated off-and-on for more than twenty years in dozens of countries. In its most current incarnation it has raised and liquidated its earnings via bitcoin. As a result, the volume on the new exchange in South Africa outpaced the others that remained compliant with AML procedures. Through coordination with law enforcement it was driven out for some time, but in January of this year, MMM rebooted and it is now reportedly back in South Africa and Nigeria. The same phenomenon has occurred in multiple other countries including China, wherein, according to inside sources, at least one of the Big 3 exchanges gave MMM representatives the VIP treatment because it boosted their volume.
It was a lack of this market surveillance and customer protections and outright fraud that eventually led to many of the Chinese exchanges being investigated and others raided by local and national regulators in a coordinated effort during early January and February 2017.27
Initially several executives at the non-compliant exchanges told coin media that nothing was happening, that all the rumors of investigation was “FUD” (fear, uncertainty, doubt). But they were lying.28
Regulators had really sent on-site staff to “spot check” and clean up the domestic KYC issues at exchanges. They combed through the accounting books, bank accounts, and trading databases, logging the areas of non-compliance and fraud. This included problems such as allowing wash-trading to occur and unclear margin trading terms and practices.29 Law enforcement showed these problems (in writing) to exchange operators who had to sign and acknowledge guilt: that these issues were their responsibility and that there could be future penalties.
Following the recent government ban on ICO fundraising (described in the next section), all exchanges in China involved in fiat-to-cryptocurrency trades have announced they will close in the coming weeks, including Yunbi, an exchange that was popular with ICO issuers.30 On September 14th, the largest exchange in Shanghai, BTCC (formerly BTC China), announced it would be closing its domestic exchange by the end of the month.31 It is widely believed it was required to do so for a number of compliance violations and for having issued and listed an ICO called ICOCoin.32
The two other large exchanges, OKCoin and Huobi, both announced on September 15th that they will be winding down their domestic exchange by October 31st.33 Although according to sources, some exchange operators hope this enforcement decision (to close down) made by regulators will quietly be forgotten after the Party Congress ends next month.34
One Plan B is a type of Shanzhai (山寨) hawala which has already sprung up on Alibaba whereby users purchase discrete units of funds as a voucher from foreign exchanges (e.g., $1,000 worth of BTC at a US-based exchange).35 Many exchanges are trying to setup offices and bank accounts nearby in Hong Kong, South Korea, and Japan, however this will not solve their ability to fund RMB-denominated trades.36
It is still unclear at this time what the exact breakdown in areas of non-compliance were largest (or smallest).37 For instance, how common was it to use a Chinese exchange for liquidating ransomware payments?
As mentioned in an earlier post, cryptocurrencies are the preferred payment method for ransomware today because of their inherent characteristics and difficulty to reclaim or extract recourse. One recent estimate from Cybersecurity Ventures is that “[r]ansomware damage costs will exceed $5 billion in 2017, up more than 15X from 2015.” The victims span all walks of life, including the most at-risk and those providing essential services to the public (like hospitals).
But if you bring up this direct risk to the community, be prepared to be shunned or given the “whataboutism” excuse: sure bitcoin-denominated payments are popular with ransomware, but whatabout dirty filthy statist fiat and the nuclear wars it funds!
Through the use of data matching and analytics, there are potential solutions to these chain of custody problems outlined later in section 8.
(3) Initial coin offerings (ICOs)
Obligatory South Park reference (Credit: Jake Smith)
Irrespective of where your company is based, the fundraising system in developed – let alone developing countries – is often is a time consuming pain in the rear. The opportunity costs foregone by the executive team that has to road show is often called a necessary evil.
There has to be a more accessible way, right? Wouldn’t it just be easier to crowdfund from (retail) investors around the world by selling or exchanging cryptocurrencies directly to them and use this pool of capital to fund future development?
Enter the ICO.
In order to participate in a typical ICO, a user (and/or investor) typically needs to acquire some bitcoin (BTC) or ether (ETH) from a cryptocurrency exchange. These coins are then sent to a wallet address controlled by the ICO organizer who sometimes converts them into fiat currencies (often without any AML controls in place), and sends the user/investor the ICO coin.38
Often times, ICO organizers will have a private sale prior to the public ICO, this is called a pre-sale or pre-ICO sale. And investors in these pre-sales often get to acquire tokens at substantial discounts (10 – 60%) than the rate public investors are offered.39. ICO organizers typically do not disclose what these discounts are and often have no vesting cliffs attached to them either.
The surge in popularity of ICOs as a way to quickly exploit and raise funds (coins) and liquidate them on secondary markets has transitively led to a rise in demand of bitcoin, ether, and several other cryptocurrencies. Because the supply of most of the cryptocurrencies is perfectly inelastic, any significant increase (or decrease) in demand can only be reflected via volatility in prices.
Hence, ICOs are one of the major contributing factors as to why we have seen record high prices of many different cryptocurrencies that are used as gateway coins into ICOs themselves.
According to one estimate from Coin Schedule, about $2.1 billion has been raised around the world for 140 different ICOs this year.40 My personal view is that based on the research I have done, most ICO projects have intentionally or unintentionally created a security and are trying to sell it to the public without complying with securities laws.41 Depending on the jurisdiction, there may be a small handful of others that possibly-kinda-sorta have created a new coin that complies with existing regs.42 Maybe.
Ignoring the legal implications and where each fits on that spectrum for the moment, many ICOs to-date have pandered to and exploited terms like “financial inclusion” when it best suits them.43 Others pursue the well-worn path of virtue signaling: Bitcoiners condemning the Ethereum community (which itself was crowdfunded as an ICO), because of the popularity in using the Ethereum network for many ICOs… yet not equally condemning illicit fundraising that involves bitcoin or the Bitcoin network or setting up bucket shops such as Sand Hill Exchange (strangely one of its founders who was sued by the SEC now writes at Bloomberg).
The cryptocurrency community as a whole condemned the “Chinese government” for its recent blanket ban on fundraising and secondary market listing of ICOs.44 The People’s Bank of China (PBOC) is one of seven regulators to enforce these regulations yet most of the public antagonism has been channeled at just the PBOC.45
Irrespective of whether you think it was the right or wrong thing to do because you heart blockchains, the PBOC and other regulators had quite valid reasons to do so: some ICO creators and trading platforms were taking funds they received from their ICO and then re-investing those into other ICOs, who in turn invested in other ICOs, and so forth; creating a fund of fund of funds all without disclosing it to the public or original investors.46 ICO Inception (don’t tell Christopher Nolan).
In China and in South Korea, and several other countries including the US, there is a new cottage industry made of up entities called “community managers” (CM) wherein an ICO project hires an external company (a CM) who provides a number of services:
for X amount of BTC the CM will actively solicit and get your coin listed on various exchanges;
the CM takes a sales commission while marketing the coin to the public such that after the ICO occurred, they would take a juicy cut of the proceeds; and several other promotional services.47
The ICO issuers and fundraising/marketing teams usually organize a bunch of ICOs weekly and typically employ a market maker (known as an “MM” in the groups) whose role is to literally pump and dump the coin. They engage in ‘test pumps’ and ‘shakeouts’ to get rid of the larger ICO investors so they can push the price up on a thin order book by 10x, 20x, or 30x before distributing and pulling support. You can hire the services of one of these traders in many of the cryptocurrency trading chat groups.48
There were even ICO boot camps (训练营) in China (and elsewhere) usually setup with shady figures with prior experience in pyramid schemes.49 Here they coached the average person to launch an ICO on the fly based on the ideas of this leader to people of all demographics including the vulnerable and at-risk.50 Based on investigations which are still ongoing, the fraud and deceit involved was not just one or two isolated incidents, it was rampant.51 Obtaining the training literature that was given to them (e.g., the script with the promises made) would make for a good documentary and/or movie.