[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? [↩]
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.
[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.
In other words, the ICO rackets have recreated many aspects of the financial services industry (underwriters, broker/dealers) but without any public disclosures, organizational transparency, investor protections, or financial controls. Much like boiler rooms of days past. It is no wonder that with all of this tomfoolery, according to Chainalysis, that at least $225 million worth of ETH has been stolen from ICO-related fundraising activity this past year.52
At its dizzying heights, in China, there were about sixty ICO crowdfunding platforms each launching (or trying to launch) new ICOs on a monthly basis.53 And many of these platforms also ran and operated their own exchanges where insiders were pumping (and dumping) and seeing returns of up to 100x on coins that represented “social experiments to test human stupidity” such as the performance art pictured below.
One recent estimate from Reuters was that in China, “[m]ore than 100,000 investors acquired new cryptocurrencies through 65 ICOs in January-June .”54 It’s still unclear what the final straw was, but the universal rule of don’t-pitch-high-risk-investment-schemes-to-grandmothers-on-fixed-incomes was definitely breached.
As a result, the PBOC and other government entities in China are now disgorging any funds (about $400 million) that ICOs had raised in China.55 This number could be higher or lower depending on how much rehypothecation has taken place (e.g., ICOs investing in ICOs). All crowdfunding platforms such as ICOAGE and ICO.info have suspended operations and many have shut down their websites. In addition, several executives from these exchanges have been given a travel ban.56
Cryptocurrency exchanges (the ones that predated the ICO platforms) have to delist ICOs and freeze plans from adding any more at this time. Multiple ICO promotional events, including those by the Fintech Blockchain Group (a domestic fund that organized, promoted, and invested in ICOs) have been canceled due to the new ban.57 Several well-known promoters have “gone fishing” overseas. This past week, Li Xiaolai, an early Bitcoin investor and active ICO promoter, has publicly admitted to having taken the ICO mania too far (using a car acceleration example), an admission many link to the timing of this crackdown and ban.58
A real ICO in China: “Performance Art Based on Block Chain Technology” (Source)
For journalists, keep in mind this is (mostly) just one country described above. It would be a mistake to pin all of the blame on just the ICO operators based in China as similar craziness is happening throughout the rest of the world (observe the self-serving celebrity endorsements). Be sure to look at not just the executives involved in an ICO but also the advisors, investors, figureheads, and anyone who is considered “serious” lending credibility to dodgy outfits and dragging the average Joe (and Zhou) and his fixed income or meager savings into the game.
There may be a legitimate, legal way of structuring an ICO without running afoul of helpful regulations, but so far those are few and far between. Similarly, not everyone involved in an ICO is a scammer but it’s more than a few bad apples, more like a bad orchard. And as shown above with the initial enforcement actions of just one country, short sighted hustling by unsavory get-rich-quick partisans unfortunately might deep-six the opportunities for non-scammy organizations and entrepreneurs to utilize a compliant ICO model in the future.59
(4) VC-backed entities
Theranos, Juicero, and Hampton Creek, meet Coinbase, 21.co, Blockstream, and several others.
Okay, so that may be a little exaggerated. But still the same, few high-profile Bitcoin companies are publishing daily active or monthly active user numbers for a variety of reasons.
Founded in May 2012, the only known unicorn to-date is Coinbase. Historically it has kept traction stats close to the chest but we got a small glimpse at what Coinbase’s user base was from an on-going lawsuit with the IRS. According to one filing, between 2013-2015 (the most recent publicly available data) Coinbase had around 500,000 users, of which approximately 14,355 accounts conducted at least $20,000 in business.60 This is a far cry from the millions of wallets we saw as a vanity statistic prominently displayed on its homepage during that same time period.61
What did most users typically do? They created an account, bought a little bitcoin, and then hoarded it – very few spent it as if it were actual money which is one of the reasons why they removed a publicly viewable transaction chart over a year ago.62
To be fair, the recent surge in market prices for cryptocurrencies has likely resulted in huge user growth. In fact, Coinbase’s CEO noted that 40,000 new users signed up on one day this past May. But some of this is probably attributed to new users using Coinbase as an on-and-off ramp: United States residents acquiring bitcoin and ether on Coinbase and then participating in ICOs elsewhere.63
After more than $120 million in funding, 21.co (formerly 21e6) has not only seen an entire executive team churn, but a huge pivot from building hardware (Bitcoin mining equipment) into software and now into a pay-as-you-go-LinkedIn-but-with-Bitcoin messaging service. Launched with much fanfare in November 2015, the $400 Amazon-exclusive 21.co Bitcoin Computer was supposed to “return economic power to the individual.”
In reality it was just a USB mining device (a Raspberry Pi cobbled together with an obsolete mining chip) and was about as costly and useful as the Juicero juicing machine. It was nicknamed the “PiTato” and unit sales were never publicly disclosed. Its story is not over: in the process of writing this article, 21.co announced it will be launching a “social token” (SOC) by the end of the year.64
Blockstream is the youngest of the trio. Yet, after three years of existence and having raised at least $76 million, as far as the public can tell, the company has yet to ship a commercial product beyond an off-the-shelf hardware product (Liquid) that generates a little over $1 million in revenue a year.65 It also recently launched a satellite Bitcoin node initiative it borrowed from Jeff Garzik, who conceived it on a budget of almost nothing about three years ago.66
To be fair though, perhaps it does not have KPIs like other tech companies. For instance, about two and half years ago, one of their 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.” So perhaps expectations of product roadmaps is not applicable.
On the flipside, some entrepreneurs have explained that their preference for total secrecy is not necessary because they are afraid of competition (that is a typical rationale of regular startups), but because they are afraid of regulators via banks.67 For example, a regulator sees a large revenue number, finds out which bank provides a correspondent service and if the startup is fully compliant with AML, CFT, and KYC processes, starts auditing that bank, and banks re-evaluates NPV of working with a startup and potentially drops it. Until that changes, we will not know volumes for Abra, Rebit, Luno, and others and that is why a year-old claim about 20% market share in the South Korea -> Philippines remittance corridor remains evidence-free.6869
While we would all love to see more data, this is a somewhat believable argument. A more insightful question might be if/when we get to a point where supporting Bitcoin players becomes enough of real revenue that banks would agree to higher investments and support. In the meantime, business journalists should drill down into the specifics about how raised money has been spent, is compliance being skirted, customer acquisition costs, customer retention rate, etc.70
(5) The decline of Maximalism
If you were to draw a Venn diagram, where one circle represented neo Luddism and another circle represented Goldbugism, the areas they overlap would be cryptocurrency Maximalism (geocentrism and all).71 This increasingly smaller sect, within the broader cryptocurrency community, believes in a couple of common tenets but most importantly: that only one chain or ledger or coin will rule them all. This includes the Ethereum Classic (ETC) and Bitcoin Core sects, among others.
They’re a bit like the fundamentalists in that classic Monty Python “splitters” sketch but not nearly as funny.
If you’re looking to dig into defining modern irony, these are definitely the groups to interview. For instance, on the one hand they want and believe their Chosen One (typically BTC or ETC) should and will consume the purchasing power of all fiat currencies, yet they dislike any competing cryptocurrency: it is us versus them, co-existence is not an option! The rules of free entry do not apply to their coin as somehow a government-free monopoly will form around their coin and only their coin. Also, you should buy a lot of their coin, like liquidate your life savings asap and buy it now.
Artist rendering of proto-Bitcoin Maximalism, circa 14th century
This rigidity has diminished over time.
Whereas, three years ago, most active venture capitalists and entrepreneurs involved in this space were antagonistic towards anything but bitcoin, more and more have become less hostile with respect to new and different platforms.
For instance, Brian Armstrong (above), the CEO of Coinbase, two and a half years ago, was publicly opposed to supporting development activities towards anything unrelated to Bitcoin.
But as the adoption winds shifted and Ethereum and other platforms began to see growth in their development communities (and coin values), Coinbase and other early bastions of maximalism began to support them as well.
There will likely be permanent ideological holdouts, but as of this writing I would guesstimate that less than 20% of the bitcoin holders I have interacted with over the past 6-9 months would label themselves maximalists (the remaining would likely self-identify with the “UASF” and “no2x” tags on Twitter).
So interview them and get their oral history before they go extinct!
There is very little publicly available analysis of what is happening with Bitcoin transactions (or nearly all cryptocurrencies for that matter): dormant vs. active, customers vs. accounts, transaction types (self-transfers vs. remittances vs. B2B, etc.).
On-chain transaction growth seems to be slowing down on the Bitcoin network and we don’t have good public insights on what is going on: are there are pockets of growth in real adoption or just more wallet shuffling?
In other words, someone should be independently updating “Slicing data” but instead all we pretty much see is memes of Jamie Dimon or animated gifs involving roller coaster prices.72
In the real world, “market cap” is based on a claim on a company’s assets and future cash flows. Bitcoin (and other cryptocurrencies) has neither — it doesn’t have a “market cap” any more than does the pile of old discarded toys in your garage.
“Market Cap” is a really dumb phrase when applied to the cryptocurrency world; it seems like one of those seemingly straightforward concepts ported to the cryptocurrency world directly from mainstream finance, yet in our context it turns into something misleading and overly simplistic, but many day traders in this space who religiously tweet about price action love to quote.
The cryptocurrency “market cap” metric is naively simplistic: take the total coin supply, and multiply it by the current market price, and voila! Suddenly Bitcoin is now approaching the market cap of Goldman Sachs!73
To begin with, probably around 25% or more of all private keys corresponding to bitcoins (and other cryptocurrencies too) have been permanently lost or destroyed.74 Most of these were from early on, when there was no market price and people deleted their hard drives with batches of 50 coins from early block rewards without backing them up or a second thought.
Extending this analogy, 25% of the shares in Goldman Sachs cannot suddenly become permanently ownerless. These shares are registered assets, not bearer assets. Someone identifiable owns them today and even if there is a system crash at the DTCC or some other CSD, shareholders have a system of recourse (i.e., the courts) to have these returned or reissued to them with our without a blockchain. Thus, anytime you hear about “the market price of Bitcoin has approached $XXX billion!” you should automatically discount it by at least 25%.
Also, while liquidity providers and market makers in Bitcoin have grown and matured (Circle’s OTC desk apparently trades $2 billion per month), this is still a relatively thinly traded market in aggregate. It is, therefore, unlikely that large trading positions could simultaneously move into and out of billion USD positions each day without significantly moving the market. A better metric to look at is one that involves real legwork to find: the average daily volume on fee-based, regulated spot exchanges combined with regulated OTC desks. That number probably exists, but no one quotes it. Barring this, an interim calculation could be based on “coins that are not lost or destroyed.”
(7) Buy-side analysts and coin media
We finally have some big-name media beginning to dig into the shenanigans in the space. But organizations like CoinDesk, Coin Telegraph, and others regularly practice a brand of biased reporting which primarily focus on the upside potential of coins and do not provide equal focus on the potential risks.75 In some cases, it could be argued that these organizations act as slightly more respectable conduits for misinformation churned out by interested companies.76
Common misconceptions include continually pushing out stories like the example above, on “market caps” or covering vanity metrics such as growth in wallet numbers (as opposed to daily active users). It is often the case that writers for these publications are heavily invested in and/or own cryptocurrencies or projects mentioned in their stories without public disclosure.
This is not to say that writers, journalists, and staff at these organizations should not own a cryptocurrency, but they should publicly disclose any trading positions (including ‘hodling’ long) as the sentiment and information within their articles can have a material influence on the market prices of these coins.
For instance, CoinDesk is owned by Digital Currency Group (DCG) who in turn has funded 80-odd companies over the last few years, including about 10 mentioned in this article (such as Coinbase and BTC China). DCG also is an owner of a broker/dealer called Genesis Trading, an OTC desk which trades multiple cryptocurrencies that DCG and its staff, have publicly acknowledged at having positions in such as ETC, BTC and LTC.77
What are the normal rules around a media company (and its staff) retweeting and promoting cryptocurrencies or ICOs the parent company or its principals has a stake in?
If coin media wants to be taken seriously it will have to take on the best practices and not appear to be a portfolio newsletter: divorce itself of conflicts of interest by removing cross ownership ties and prominently disclose all of the remaining potential conflicts of interest with respect to ownership stakes and coin holdings. Markets that transmit timely, accurate, and transparent information are better markets and are more likely to grow, see, and support longer-term capital inflows.78
For example, if Filecoin is a security in the US (which its creators have said it is), and DCG is an equity holder in Filecoin/Protocol Labs (which it is)… and DCG is an owner in CoinDesk, what are the rules for retweeting this ICO above? There are currently 16 stories in the CoinDesk archive which mention Filecoin, including three that specifically discuss its ICO. Is this soliciting to the public?79
Similarly, many of the buy-side analysts that were actively publishing analysis this past year didn’t disclose that they had active positions on the cryptocurrencies they covered. We recently found out that one lost $150,000 in bitcoins because someone hacked his phone.
At cryptocurrency events (and fintech events in general), we frequently hear buzz word bingo including: smart assets, tokens, resilience, pilots, immutability, even in-production developments, but there is often no clear articulation of what are the specific opportunities to save or make money for institutions if they acquire a cryptocurrency or uses its network to handle a large portion of their business.80
This was the core point of a popular SaveOnSendarticle on remittances from several years ago. I recommend revisiting that piece as a model for similar in-depth assessments done by people who understand B2B payments, correspondent banking and other part of global transfers. Obviously this trickles into the other half of this space, the enterprise world which is being designed around specific functional and non-functional requirements, the SLAs, compliance with data privacy laws, etc., but that is a topic for another day.
What about Coin Telegraph? It is only good for its cartoon images.81
There are some notable outliers that serve as good role models and exceptions to the existing pattern and who often write good copy. Examples of which can be found in long end note.82
Obviously the end note below is non-exhaustive nor an endorsement, but someone should try to invite some or all these people above to an event, emceed by Taariq Lewis. That could be a good one.
What about solutions to the problems and opaqueness described throughout this article?
There are just a handful of startups that have been funded to create and use analytics to identify usage and user activity on cryptocurrency networks including: Chainalysis, Blockseer, Elliptic, WizSec, ScoreChain, Skry (acquired by Bloq) – but they are few and far between.83 Part of the reason is because the total addressable market is relatively small; the budgets from compliance departments and law enforcement is now growing but revenue opportunities were initially limited (same struggle that coin media has). Another is that the analytic entrepreneurs are routinely demonized by the same community that directly benefits from the optics they provide to exchanges in order to maintain their banking partnerships and account access.
Such startups are shunned today, unpopular and viewed as counter to the roots of (pseudo) anonymous cryptocurrencies, however, as regulation seeps into the industry an area that will gain greater attention is identification of usage and user activities.
For instance, four years ago, one article effectively killed a startup called Coin Validation because the community rallied (and still rallies) behind the white flag of anarchy, surrendering to a Luddite ideology instead of supporting commercial businesses that could help Bitcoin and related ideas and technologies comply with legal requirements and earn adoption by mainstream commercial businesses. For this reason, cryptocurrency fans should be very thankful these analytics companies exist.
Source: Twitter. Explanation: Wanna Cry ransomware money laundering with Bitcoins in action. Graph shows Bitcoin being converted to Monero (XMR) via ShapeShift.io
More of these analytics providers could provide even better optics into the flow of funds giving regulated institutions better handling of the risks such as the money laundering taking place throughout the entire chain of custody.
Without them, several large cryptocurrency exchanges would likely lose their banking partners entirely; this would reduce liquidity of many trading pairs around the world, leading to prices dropping substantially, and the community relying once again on fewer sources of liquidity run out of the brown bags on shady street corners.84
One key slide from Kim Nilsson’s eye-opening presentation: Cracking MtGox
And perhaps there is no better illustration of how these analytic tools can help us understand the fusion of improper (or non-existent) financial controls plus cryptocurrencies: Mt. Gox. Grab some warm buttery popcorn and be sure to watch Kim Nilsson’s new presentation covering all of the hacks that this infamous Tokyo-based exchange had over its existence.
Journalists, it can be hard to find but the full order book information for many exchanges can be found with enough leg work. If anyone had the inclination to really want to understand what was going on at the exchange, there are 3rd parties which have a complete record of the order book and trades executed.
Remember, as Kim Nilsson and others have independently discovered, WillyBot turned out to be true.
The empirical data and stories above do not mean that investors should stop trading all cryptocurrencies or pass on investing in blockchain-related products and services.
To the contrary, the goal of this article is to elevate awareness that this industry lacks even the most basic safeguards and independent voices that would typically act as a counterbalance against bad actors. In this FOMO atmosphere investors need to be on full alert of the inherent risks of a less than transparent market with less than accurate information from companies and even news specialists.
Cryptocurrencies aren’t inherently good or bad. In a single block, they can be used as a means to reward an entity for securing transactions and also a payment for holding data hostage.
One former insider at an exchange who reviewed this article summarized it as the following:
The cryptocurrency world is basically rediscovering a vast framework of securities and consumer protection laws that already exist; and now they know why they exist. The cryptocurrency community has created an environment where there are a lot of small users suffering diffuse negative outcomes (e.g., thefts, market losses, the eventual loss on ICO projects). And the enormous gains are extremely concentrated in the hands of a small group of often unaccountable insiders and “founders.” That type of environment, of fraudulent and deceptive outcomes, is exactly what consumer and investor protection laws were created for.
Generally speaking, most participants such as traders with an active heartbeat are making money as the cryptocurrency market goes through its current bull run, so no one has much motive to complain or dig deeper into usage and adoption statistics. Even those people who were hacked for over $100,000, or even $1 million USD aren’t too upset because they’re making even more than that on quick ICO returns.
We are still at the eff-you-money stage, in which everyone thinks they are Warren Buffett.85 The Madoffs will only be revealed during the next protracted downturn. So if you’re currently getting your cryptocurrency investment advice from permabull personalities on Youtube, LinkedIn, and Twitter with undisclosed positions and abnormally high like-to-comment ratios, you might eventually be a bag holder.86
Like any industry, there are good and bad people at all of these companies. I’ve met tons of them at the roughly 100+ events and meetups I have attended over the past 3-4 years and I’d say that many of the people at the organizations above are genuinely good people who tolerate way too much drivel. I’m not the first person to highlight these issues or potential solutions. But I’m not a reporter, so I leave you with these leads.
While everyone waits for Harry Markopolos to come in and uncover more details of the messes in the sections above, other ripe areas worth digging into are the dime-a-dozen cryptocurrency-focused funds.
Future posts may look at the uncritical hype in other segments, including the enterprise blockchain world. What happened after the Great Pivot?
[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: JL, DH, AL, LL, GW, CP, PD, JR, RB, ES, MW, JK, RS, ZK, DM, SP, YK, RD, CM, BC, DY, JF, CK, VK, CH, HZ, and PB.
One reviewer commented: “Another meta-topic is the notion of “community,” which is a myth if you ask me. Why hasn’t the “community” done “X”? Because the word is mostly a marketing fiction.” See also the discussion of the idea that “Code is not law” [↩]
One former regulator mentioned: “The cryptocurrency community needs to police itself better or it risks being policed more severely by unfriendly and unsympathetic regulators. Self-regulation is what certain hands-off banking supervisors attempted with US banks and other financial institutions 15 years ago and that ended poorly for many parties including those who were not directly responsible for making the poor decisions in the first place. Even in sports it is understood, with the exception of golf, it doesn’t work. In this Wild West atmosphere where are the sheriffs?” [↩]
Not unique to cryptocurrencies, but by enabling such bad actors, certain platform operators may even increase their short term profit. [↩]
For an in-depth look at these different costs, it is highly recommended to read this post from Save on Send. Some are convinced that this is the case because, on a small scale, the illiquidity of the end points serves to finance the operation, i.e. buying BTC with USD then selling BTC for MXN, may allow an apparent savings when compared with traditional remittance service providers. Also oft-forgotten is the cost of cash-out and distribution of cash at the end point; also KYC / AML / CFT functions are frequently left-off the calculation. [↩]
One reviewer stated that, “Any working groups advising the government on policy are certainly worthy of investigation. Who are these people and what are their potential conflicts of interest? For starters, in the US look at The Bitcoin Foundation and the Blockchain Alliance.” [↩]
It has a complex corporate structure and is nominally based in Hong Kong, operations and incorporation of subsidiaries are in other jurisdictions including BVI. [↩]
There were exceptions. Some users reported smaller haircuts as they were customers of SynapsePay. Another user claims to have retained a lawyer and he did not have any haircut. I independently verified this with an executive at SynapsePay. [↩]
Phil Potter, an executive at Bitfinex, has spoken about the hack on multiple different podcasts including once in detail, but this has since been deleted. [↩]
Bitfinex also recently announced that they will be doing an ICO (called NEC) to capitalize on the current token mania. [↩]
Bitfinex does do KYC and AML when a user withdraws USD and when they receive subpoenas. [↩]
One reviewer noted that: “Theoretically they could maintain a fractional reserve to service redemptions although this isn’t a problem per se, provided that it is disclosed. By saying you have “cash” backing, you could have some really bizarre stuff, like USD loans to unsavory entities. But maybe they do not do this either.” [↩]
One reviewer commented: “Tether offers users a way to move USD from one country to another, much like Western Union. So Tether should be obligated to run KYC/AML checks on not only those who are depositing US$ funds to get new Tethers (as it currently does), but also everyone who uses second-hand Tethers (it doesn’t). Now if Tether was like bitcoin, and had no physical address, it would be complicated for the authorities to enforce this requirement. But Tether is anchored to the brick & mortar banking system, so law enforcement should be easier, will it?” [↩]
One reviewer commented: “Let’s assume the worst for Tether, what does that mean? If it were to collapse would it harm the small investors or the whales? A few exchanges that allow Tether also allow you to hold your deposits in USD, aside from the ability to send USDT between exchanges, which arguably could actually be a net positive because it allows clients to net positions between exchanges potentially reducing the overall credit in the system. But this goes back to one of their continual issues: lack of communicating and transparency for how the whole money issuance and transmission process works.” [↩]
Note: they did have withdrawal fees which likely generated revenue from arbitrageurs. Several of the larger exchanges also raised venture capital and setup (and still run) order books outside of China with other business lines which may help offset some costs. [↩]
In addition to lying about being investigated, they were lying about the true volume on their exchanges. When the zero-fee domestic exchanges were required to add a minimum fee (to discourage wash trading), volume plummeted. [↩]
The 19th National Congress of the Communist Party of China starts on October 18th. All exchanges involving fiat-to-cryptocurrency trades will be closed. Both OKCoin and Huobi have overseas platforms (with independent order books and bank accounts independent of the domestic Chinese exchanges). These have cryptocurrency-to-cryptocurrency trading and will remain operating. Currently, users of the domestic fiat-to-currency platform can move their coins to the overseas platforms. [↩]
At one time or another, the spot price for each of the three large Chinese exchanges was a constituent part of several different pricing indices including the Winkdex, TradeBlock XBX index, and others such as OKEX (OKEX is an international subsidiary of OKCoin who replaced these exchanges on its own index). This is potentially problematic because, as I detailed in my COIN ETF report, these exchanges were prone to mismanagement, crashes, and ultimately quick closure. Going forward, what other sources of reliable pricing data can ETFs use that also accurately reflect market prices? [↩]
One insider in China noted that: “These exchanges had multiple chances to clean up their act and even self-regulate but because of the competitive pressures in China towards zero-fees, no one wanted to be left behind. It was a type of collective action failure, so the government finally had to come in and clean up the mess because no one else would.” [↩]
Note: volumes can and will be written on this section alone. If not on the legalities but on the ‘pump and dumps’ that have taken place. [↩]
One former regulator suggested: “Ignoring for the moment the overarching legal implications of what they did, because these activities took place on blockchains, future researchers should be able to eventually provide very accurate estimates the costs and losses to investors who put their trust and money into deceptive ICO organizers who were unscrupulous.” [↩]
Some argue this ban may just be temporary and cite a CCTV 13 interview with Hu Bing with the Institute of Finance and Banking who says the government will issue licenses in the future. [↩]
As of this writing there are many rumors circulating regarding how these new guidelines could impact cryptocurrency mining operators based in China. One recent story from the Wall Street Journal articulates a rumor that miners will need to also shut down operations because they are trading cryptocurrencies without a license. More existentially, if all fiat-to-cryptocurrency exchanges shut down domestically, miners would need a new method to liquidate their coins because they need to pay utilities in RMB (e.g., it doesn’t help to have a JPY or KRW-denominated bank account because Chinese utilities require being paid in RMB). [↩]
One insider noted that: “A New Zealand based person (and company) is one of the main men in all of this. I’ve encountered him on a number of occasions. He’s a complete fraudster. For example he told a group I am in that MGO would be listed on Poloniex within weeks of launch. Months later he hasn’t even got it on Bittrex. He’s now buying up lots of it wholesale from disenchanted investors who’ve taken a massive hit recently and will inevitably be sitting on a pile when the intentionally delayed launch and pump happens.” [↩]
Whalepool and The Coin Farm on Telegram are both examples of this type of coordination. [↩]
Based on translated stories from after the investigations as well as conversations with observers of these training sessions. [↩]
According to a source close to the investigations, law enforcement are using WeChat correspondence to chronicle the intentional cases of fraud and deceit. In some cases, ICO organizers would run a public WeChat group, providing investors with false information and then use a private WeChat group with a smaller circle of insiders to “laugh at the stupidity” of these investors and coordinate dumps. As a result, ICO organizers are leaving WeChat to use platforms like Telegram. See China’s WeChat crackdown drives bitcoin enthusiasts to Telegram from South China Morning Post [↩]
That is the best case scenario because it assumes that there were not additional losses to fraud and mismanagement, which we know there has been. [↩]
He had to refund the ICOs he promote (plus with an added premium). [↩]
One reviewer commented: “The inevitability of regulations coming down the pipeline is a certainty (not just “blanket bans”). Whether it’s 1 month or 1 year, regulations or enforcement of existing regulations will be coming in. A lot of these participants in the market seem to want to get in before regulations come into effect but in many jurisdictions they can still be liable for past actions (depending on the statute of limitations). That’s part of what I think is driving this tremendous amount of ICOs right now.” [↩]
At the time of this writing Coinbase has raised more than $225 million. By January 2015, Coinbase had in aggregate raised just north of $106 million. The ongoing lawsuit with the IRS states that there were 500,000 users by the end of the 2013 – 2015 period, of which 14,355 had done $20,000 or more of trading. Future research can look into Coinbase’s customer acquisition costs over time (e.g., switching costs) versus the same costs traditional banks have. Note: this also does not include the user numbers at GDAX, their platform marketed to professional traders. [↩]
According to an alleged insider (which may be untrue), some Coinbase users allegedly didn’t even know they may have been entitled to things like CLAM coins. Maybe they weren’t. Tangentially, the continual high percentage of hoarding done by cryptocurrency enthusiasts suggests that this still remains a virtual commodity and continues to fail the medium of exchange test needed to be defined as a transactional currency. [↩]
At this time, it is unclear what the breakdown of these new (or old) users are acquiring cryptocurrencies on Coinbase and then participating in ICOs. As a company, Coinbase has been publicly supportive of the ICO zeitgeist and hosted multiple meetups where ICO creators presented. Earlier this year it co-sponsored a publication discussing the securities law framework of tokens. Based on several interviews for this article, users of both the Coinbase wallet and its subsidiary, GDAX, currently can send bitcoins and ether from their user accounts to participate in ICOs. It is unclear how often this is screened and/or prevented. For perspective, a former employee was allegedly fired for sending bitcoins from his Coinbase account to gamble on Chinese web casinos. Assuming this is true (and it may not be) then Coinbase could have the knowledge and/or ability to prevent users from participating in ICOs or other off-platform activity that violates its terms of service. [↩]
Another tech company that supposedly struggled raising funding and later issued its own coin (through an ICO) is Kik, through its Kin Foundation. [↩]
If this post is true (and it may not be), a dozen or so exchanges paying between $7,000 – $10,000 a month is roughly $1.4 million a year. The SaaS monthly estimate has been independently validated from conversations with a couple participating exchanges. [↩]
One reviewer recommended: “If I were a journalist, I would more closely scrutinize the social media habits of the executives (and their surrogates) on these teams so the ecosystem can ascertain the relationship between the amount of time senior employees spend opining on Twitter, Reddit, mailing lists, IRC, WhatsApp, Slack, WeChat, Telegram, BitcoinTalk, GitHub, Discord, etc., and the number of hours in a working day, or number of products shipped. Other social media analytics ideas for journalists: look at the Twitter tribes of Bitcoin (and other cryptocurrencies). Who is aligned with whom and pushing what agendas? Who are the trolls associated with those different tribes? How many suspect accounts are associated with each group? For example, how many accounts that were just created, or never tweeted before, or only have followers from within their own tribes?” [↩]
One reviewer argued that, “It could also because they want to protect their valuations and because they are privately held companies that may be legally forbidden to divulge this information.” [↩]
This article in Quartz did not provide actual data or evidence that these remittance numbers were real, no one fact-checked it and instead, reproduced similar headlines for several months. [↩]
According to a recent interview with Forbes, after nearly two years of operations Abra only has 73 users per day. They are currently raising another round at this time; it is believed that this will help fund their compliance team and for licenses which they currently lack. [↩]
One reviewer said, “A counterpoint could be: VC returns are even sharper than standard Pareto; 1:9 or even 1:99 as opposed to 2:8. Startups are hard – most fail – why should cryptocurrency world be any different?” [↩]
One reviewer suggested that: “In the future, you should explain why Maximalism is a type of Authoritarianism and is not to be conflated with cypherpunks.” [↩]
The theatrics around “BearWhale”-like events still persists. For example, one current conspiracy theory is that: “the Chinese government is shutting down Bitcoin miners to mine bitcoins themselves.” This is most likely false and the proposed solution is to “use satellites.” But in talking with professional miners in China, many of them have contracts directly with State Grid, so they could lose access to energy in a worst-case scenario and satellites would not be of any use (assuming any of those rumors are true). [↩]
To be fair, this is not unique to the cryptocurrency space. [↩]
Genesis Trading is also the marketing and distribution agent for Bitcoin Investment Trust and Ethereum Classic Investment Trust, two regulated financial products. DCG also is an owner in Grayscale Investments which is the legal sponsor both of these Trusts [↩]
Some employees in coin media have used social media channels to discuss various cryptocurrencies including ICOs over the past year. How many of these were sponsored or received a cut of the coins to do so? [↩]
Nearly all of the coin media site allow ICO advertisements as well. What are the terms and benefits that these media sites receive in exchange for displaying these advertisements and advertorials? [↩]
Note: this is not an exhaustive list and I’ll likely be flamed for not including X but including Y. Journalists who write good original stories include: Nathaniel Popper, Matt Levine, and Matt Leising. There have been several good op-eds written by lawyers which have appeared on CoinDesk, including Joshua Stark, Jared Marx, Brian Klein, Benjamin Sauter and David McGill. Some other original, constructive views that should be highlighted include Stephen Palley, Ryan Straus, George Fogg, Miles Cowan, Patrick Murck, Amor Sexton, Houman Shadab, Angela Walch, Scott Farrell, Claire Warren, Simon Gilchrist, and two perpetual curmudgeons: Izabella Kaminska and Preston Byrne (very prickly at times!). Non-lawyer thought-leaders, technical, and subject matter experts with bonafides worth interviewing include: Adam Krellenstein, Alex Batlin, Alex Waters, Andrew Miller, Andy Geyl, Antony Lewis, Ari Juels, Arvind Narayanan, Christian Decker, Christopher Allen, Ciaran Murray, Colin Platt, Danny Yang, Dave Hudson, David Andolfatto, David Schwartz, Dominic Williams, Duncan Wong, Elaine Shi, Emily Rutland, Emin Gun Sirer, Ernie Teo, Fabio Federici, Flavien Charlon, Gideon Greenspan, Ian Grigg, Ittay Eyal, Jackson Palmer, Jae Kwon, James Hazard, James Smith, Jana Moser, Jeff Garzik, JP Koning, John Whelan, Jonathan Levin, Jonathan Rouach, Jorge Stolfi, Juan Benet, Juan Llanos, Kieren James-Lubin, Lee Braine, Leemon Baird, Makoto Takemiya, Mark Williams, Matthew Green, Martin Walker, Massimo Morini, Michael Gronager, Mike Hearn, Muneeb Ali, Piotr Piasecki, Richard Brown, Robert Sams, Ron Hose, Sarah Meiklejohn, Stefan Thomas, Stephen Lane-Smith, Vitalik Buterin, Vlad Zamfir, Yakov Kofner, Zaki Manian, Zennon Kapron, and Zooko Wilcox-O’Hearn, as well as dozens of others from several different financial institutions and enterprises too long to list. I also think that Michael del Castillo, Ian Allison, Simon Taylor, Jon Southurst, and Arthur Falls try to do an honest job reporting too. Epicenter TV is arguably the best podcast in this space. [↩]
Chainalysis has a partnership with Circle which in turn enabled Circle to open up an account with Barclays. Two years ago, an alleged business plan for Chainalysis was leaked online and unsurprisingly, some in the community were up in arms that this small company provided these forensic services. [↩]
Presenting at Bitcoin / Ethereum Meetup in Hong Kong
I ended up traveling a lot more than I expected last year, including 9 times just to East Asia. The level of interest in that region will probably increase this year — especially as more projects and companies are funded — though I probably won’t do the Trans-Pacific shuffle nine times again this year.
As of right now there are probably just a small handful of startups in APAC that have the capital, connections, and capability to execute and build the commercial products and applications that are discussed at the plethora of fintech events. And almost none of them have anything to do with a cryptocurrency itself either… because cryptocurrencies weren’t designed to solve most problems financial service organizations have.
Below are the interviews, events, and presentations I participated in the last few months of 2016.
[Note: the views expressed below are solely my own and do not necessarily represent the views of my employer or any organization I advise.]
I have spent the past few weeks in East Asia, primarily in China visiting friends and relatives. Because the connection to the outside world was limited, the upside was that the cacophonous noise of perma cryptocurrency pumpers was relatively muted. I have had a chance to reflect on a number of ideas that are currently being discussed at conferences and on social media.
The first idea is not new or even unique to this blog as other companies, organizations and individuals have proposed a type of digital signature analytics + KYC tracking process for cryptocurrencies. A type of Kimberley Process but for cryptocurrencies.1
For instance, the short lived startup CoinValidation comes to mind as having the first-to-market product but was notably skewered in the media. Yet its modus operandi continues on in about 10 other companies.2
A Formal Kimberley Process
For those unfamiliar with the actual Kimberley Process, it is a scheme enacted in 2003 to certify where diamonds originated from in order to help prevent conflict diamonds from entering into the broader mainstream diamond market.
The general idea behind proving the provenance of diamonds is that by removing “blood diamonds” from the market, it can cut off a source of funding of insurgencies and warlord activity.3
What does this have to do with cryptocurrencies? Isn’t their core competency allowing non-KYC’ed, pseudonymous participants to send bearer assets to one another without having to provide documentation or proof of where those assets came from? Why would anyone be interested in enabling this?
Some may not like it, but a de facto Kimberley Process is already in place.
For instance, in many countries, most of the on-ramps and off-ramps of venture-backed cryptocurrency exchanges are actively monitored by law enforcement, compliance teams and data analytic providers who in turn look at the provenance of these assets as they move across the globe.4
On the fiat side, while many jurisdictions in North America and Western Europe currently require domiciled cryptocurrency exchanges and wallets to enforce KYC and AML compliance requirements, several areas of Asia are less strict because the local governments have not defined or decided what buckets cryptocurrencies fall into.5
There are some other noticeable gaps in this system involving crypto-to-crypto exchanges. Irrespective of regions: implementing harmonized KYC/AML standards on the non-fiat side of exchanges appears to be missing altogether. That is to say that very few, if any, exchange does any kind of KYC/AML on crypto-to-crypto.6
What are some examples of why a Kimberley Process would be helpful to both consumers and compliance teams?
Below are three examples:
(1) During my multi-country travel I learned that there are several regional companies that sell debit cards with pre-loaded amounts of cryptocurrency on them. Allegedly two of of the popular use-cases for these cards is: bribery and money laundering. The example I was provided was that it is logistically easier to move $1 million via a thin stack of debit cards than it is to carry and disperse bags of cash with.7
Attaching uniform KYC and legal identities to each asset would aid compliance teams in monitoring where the flow of funds originated and terminated with cryptocurrencies. And it would help consumers shy away from assets that could be encumbered or were proceeds of crime.
(2) Affinity fraud, specifically housewives (家庭主妇), are common targets of predators. This has been the case for long before the existence of computers let alone cryptocurrencies, but it came up several times in conversations with friends. According to my sources, their acquaintances are repeatedly approached and some actually took part in Ponzi schemes that were presented as wealth management products.
The new twist and fuel to these schemes was that there is some kind of altcoin or even Bitcoin itself were used as payout and/or as rails between parties. We have already seen this with MMM Global — which is still an active user of East Asia’s virtual currency exchanges — but two questionable projects that I was specifically shown were OctaCoin and ShellCoin.8
Note: in January 2016 multiple Chinese governmental bodies issued warnings about MMM Global and other Ponzi schemes.
[Video of MMM Global operations in The Philippines. Is that really Manny Pacqiauo?]
Victims who were not tech savvy and lied to, have no recourse because there is no universal KYC / KYCC / AML process to identify the culprits in these regions. Similarly, when these illicit virtual assets are re-sold to exchanges, customers of those exchanges such as Alice and Bob, may receive potentially encumbered assets that are then resold to others who are unaware of the assets lineage (much like a stolen motorcycle being resold multiple times). This creates a massive lien problem.
But property theft is not a new or unknown problem, why is it worth highlighting for cryptocurrencies?
Many of the original victims in East Asia are not affluent, so these scams have a material impact on their well being. The average working adult in many provinces is still less than $500 per month. Thus not only do they lack a cushion from scams but any price volatility — such as the kind we continue to see in cryptocurrencies as a whole, can wipe out their savings.
(3) Due to continual usage of botnets and stolen electricity — which is still a problem in places like China — the lack of identification from coin generation onward results in a environment in which ‘virgin coins’ sell at a premium because many exchanges don’t investigate where machines are located, who owns them, who paid for the opex and capex of those operations (e.g., documentation of electric bills).9
Unfortunately, the solutions proposed by many cryptocurrency enthusiasts isn’t to create more transparency and identification standards enabling better optics on coin provenance but rather to make it even harder to track assets via proposals like Confidential Transactions.10
Heists, thefts and encumbered coins
I am frequently asked how is it possible to know who received potentially encumbered cryptocurrencies? For amateur sleuths, there is a long forum thread which lists out some of the major heists and thefts that occurred early on in Bitcoinland.
Above is a video recording of a specific coin lineage: transactions that came from the Bitcoinica Theft that ended up in the hands of Michael Marquardt (“theymos”) who is a moderator of /r/bitcoin and owner of Bitcoin Talk.11
Recall that in July 2012, approximately 40,000 bitcoins were stolen from the Bitcoinica exchange.12 Where did those end up? Perhaps we will never know, but several users sued Bitcoinica in August 2012 for compensation from the thefts and hacks.
How are consumer protections handled on public blockchains?
In short, they do not exist by design. Public blockchains intentionally lack any kind of native consumer protections because an overarching goal was to delink off-chain legal identities from the pseudonymous interactions taking place on the network.
Thus, stolen cryptocurrencies often recirculate, even without being mixed and laundered.13
Consequently a fundamental problem for all current cryptocurrencies is that they aren’t exempt from nemo dat and have no real fungibility because they purposefully were not designed to integrate with the legal system (such as UCC 8 and 9).14 Using mixers like SharedCoin and features like Confidential Transactions does not fundamentally solve that legal problem of who actually has legal title to those assets.1516
Why should this matter to the average cryptocurrency enthusiast?
If market prices are being partially driven by predators and Ponzi schemes, wouldn’t it be in the best interest of the community to identity and remove those?17
Perversely the short answer to that is no. If Bob owns a bunch of the a cryptocurrency that is benefiting from this price appreciation, then he may be less than willing to remove the culprits involved of driving the prices upward.
For example, one purported reason Trendon Shavers (“pirateat40”) was not immediately rooted out and was able to last as long as he did — over a year — is that his Ponzi activity (“Bitcoin Savings & Trust”) coincided with an upswing in market prices of bitcoin.18 Recall over time, BS&T raised more than 700,000 bitcoins. Why remove someone whose activity created new demand for bitcoins? 19
But this incentive is short-sighted.
If the end goal of market participants and enthusiasts is to enable a market where the average, non-savvy user can use and trust, then giving them tools for provenance could be empowering. Ironically however, by integrating KYC and provenance into a public blockchain, it removes the core — and very costly — characteristic of pseudonymous, censorship-resistant interaction.
Thus there will likely be push back for implementing a Kimberley Process: doxxing every step of provenance back to genesis (coin generation) with real world identities removes pseudonmity and consequently public blockchains would no longer be censorship-resistant. And if you end up gating all of the on-ramps and off-ramps to a public chain, you end up just creating an overpriced permissioned-on-permissionless platform.
Despite this, Michael Gronager, CEO of Chainalysis, notes that:
Public ledgers are probably here to stay – difficult KYC/AML processes or not. I probably see this as a Nash equilibrium – like in the ideal world all trees would be low and of equal height but there is no path to that otherwise optimal equilibrium. We believe that fighting crime on Blockchains will both build trust and increase their use and value.
One way some market participants are trying to help law enforcement fight crime is through self-regulating organizations (SRO).
For instance, because we have seen time and time again that the market is not removing these bad actors from the market, several companies have created SROs to help stem the tide. However, as of right now, efforts like the US-based “Blockchain Alliance” — a gimmicky name for a group of venture-backed Bitcoin companies — has limited capabilities.20 They have monthly calls to discuss education with one another in the West (e.g., what is coin mixing and how does it work?) but currently lack the teeth to plug the KYC/AML gaps in Asia. Perhaps that will change over time.
And as one source explained: consider this, has any Bitcoin thief been caught? Even when there is decent evidence, we are not aware of a Bitcoin thief that was actually found guilt of stealing bitcoin, yet.21 Thus an open to question to people who argue that cryptocurrencies are great because of transparency: a lot of bitcoin has been stolen, and no one has been found guilty for that crime. Why not?
Process of elimination
Over the past six weeks, there has been very little deep research on why market prices have risen and fallen. Usually it is the same unfounded narratives: emerging market adoption; hedge against inflation; hedge against collapse of country X, Y or Z; hedge against Brexit; etc. But no one provides any actual data, least of all the investors financing the startups that make the claims.
Perhaps the research that has been done on the matter was from Fran Strajnar’s team at BNC. For instance, on June 1st they noted that:
I reached out to Fran and according to him, in early June, “Somebody dropped many many millions ($) across 4 different Chinese Exchanges in a 2 hour period, without moving price – 4 days before the price rise started last week. Because it was over multiple exchanges and these trades were filled, we are digging into it further.”
If there was a standardized Kimberley Process used by all of these exchanges, it would be much easier to tell who is involved in this process and if those funds were based on proceeds of illicit activity.
Furthermore, barring such a Process, we can only speculate why journalists haven’t looked into this story:
(1) many of them do not have reliable contacts in East Asia
(2) those that do have contacts with exchange operators may not be getting the full story due to exchanges lacking KYC / KYCC / AML standards themselves
(3) some reporters and exchange operators own a bunch of cryptocurrencies and thus do not want to draw any negative attention that could diminish their net worth
Third parties such as Wedbush Securities and Needham have also published reports on price action, but these are relatively superficial in their analysis as they lack robust stats needed to fully quantify and explain the behavior we have seen.
Strangely enough, for all the pronouncements at conferences about how public blockchains can be useful for data analysis, very few organizations, trade media or analysts are publishing bonafide stats.
After all, who are the customers of these virtual currency exchanges? Because of reporting requirement we know who uses Nasdaq and ICE, why don’t we know who uses virtual currency exchanges still?
Two months ago I had a chance to speak with Marcus Swanepoel, CEO of BitX, about his experiences in Africa. BitX coordinates with a variety of compliance teams to help block transactions tied to scams and Ponzi schemes. In the past, BitX has managed to help kill off two ponzi schemes and has tried to block MMM Global which has spread to Africa.
Earlier this spring, some MMM users that were blocked by BitX just moved to another competing local exchange that didn’t block such transactions. As a result, over the course of 8 weeks this exchange did more than 3x volume than BitX during same time frame.22 BitX has subsequently regained part of this market share partly due to MMM fading in popularity.
Why is MMM so successful? Users are asked to upload videos onto Youtube of why MMM Global is great and why you should join and are then paid by MMM as a reward. This becomes self-reinforcing in large part because of the unsavvy victims who are targeted.
But MMM isn’t to blame for everything.
For instance, in China there have been a variety of get-rich-quick Ponzi schemes that rose and blew up, such as an ant farm scheme in 2007. And earlier this year, Ezubao, the largest P2P lending platform in China fell apart as a $7.6 billion Ponzi scam.23 No cryptocurrency was involved in either case.
Yet as Emin Gün Sirer pointed out, some of the activities such as The DAO, basically act as a naturally arising Ponzi.
In fact, one allegation over the past couple weeks is that The DAO attacker placed a short of 3,000 bitcoin on Bitfinex prior to attacking The DAO (which was denominated in ether).24 If there was a Kimberley Process in which all traders on all exchanges had to comply with a universal KYC / KYCC / AML standard, it would be much easier to identify the attackers as well as compensate the victims.
Similarly, because ransomware remains a “killer app” of cryptocurrencies such that companies, police stations, hospitals, elementary schools and even universities are now setting up Coinbase accounts and stockpiling cryptocurrencies to pay off hackers. What is the aggregate demand of all of this activity? If it is large, does it impact the market price? And how would a Kimberley Process help provide restitution to the victims of this ransom activity?
A strawman Kimberley Process
How can you or your organization get involved in creating a Kimberley Process for cryptocurrencies?
Right now there is no global, industry standard for “best practices” in mutualizing, implementing, or carrying out KYC / AML provisions for cryptocurrencies.25
In writing this post, several sources suggested the following process to kick-start an effort:
(1) organize an industry-level event(s) which brings together:
(a) AML analytics companies
(b) representatives from regulatory bodies and law enforcement (e.g., FATF, FinCEN)
(c) KYC/AML practitioners
(d) existing market structures and utilities such as SIFMA, ROC, Swift (e.g., KYC registry, LEI)
(e) compliance teams from cryptocurrency exchanges and wallets
(2) at the event(s) propose a list of baseline standards that exchanges and wallets can try to implement and harmonize:
(a) what documentation is required for KYC / KYCC / AML
(b) other financial controls and accountability standards that can assist exchange operators (e.g., remove the ability for an operator to naked short against its own customer base)
(3) tying these standards together with a uniform digital identity management system could be the next step in this process.
On that last point, Fabio Federici, CEO of Skry (formerly Coinalytics), explained:
In general I believe the biggest unsolved problem is still identity and information sharing. Obviously you don’t want all your PII and transaction meta data on a public blockchain, as this information could not only be leveraged by profit seeking organizations, but also malicious actors. So the question becomes what’s the right framework for sharing the right amount of information with only the people that need access to it (maybe even only temporarily).
PII stands for personal identifying information. In theory, Zcash (or something like it) has the potential to solve some of Fabio’s concerns: relevant info can be encoded in the transaction, and only the relevant parties can read it. But this delves into “regulated data” which is a topic for another post.26
Similarly, Ryan Straus, an attorney at Riddell Williams and adjunct professor at Seattle University School of Law explained that:
Identity is central to the legal concept of property. Property systems are information systems: they associate identified entities with identified rights. With the sole exception of real currency, possession or control is not conclusive indicia of ownership.
Factual fungibility simply makes it harder to prove that you have a better claim to a specific thing than the person who now possesses or controls it. The hard part about what you have written about is that it is difficult to avoid conflating KYC (which involves identity of people) and the Kimberley Process (which involves identifying things).
In order to enable participants to share information without being unduly hounded by social media, it was also suggested that the presence of: investors, cryptocurrency press and cryptocurrency lobbying groups should kept to a minimum for the initial phase.
In addition to implementing additional financial controls and external audits, cryptocurrency exchanges and wallets adopting a Kimberley Process would help provide transparency for all market participants.
While it is probably impossible to remove all the bad actors from any system, reducing the amount of shadows they have to hide could provide assurances and reduce risks to market participants of all shapes and sizes.
However, the trade-off of implementing such a Process is that it negates the core utility that public blockchains provide, turning them into expensive permissioned gateways. And if you are permissioning activity from the get-go, you might as well use a permissioned blockchain which are cheaper to manage and operate and also natively bake-in the KYC, KYCC and AML requirements. But that is a topic for another post as well.
One reviewer argued that analytics may be superior to KYC. In the event of a compromised account — so goes the argument — analytics can help provide linkage between the flow of funds whereas KYC of compromised accounts would be “illusory.” [↩]
This includes but is not limited to: Chainalysis, Blockseer, Skry, Elliptic, Netki and ScoreChain. [↩]
Incidentally there is a UK-based startup called Everledger which works with insurance companies and tracks a catalogue of diamonds vis-à-vis a blockchain. [↩]
See: Flow of Funds; KYSF; KYSF part 2; and bitcoin movements. To actively monitoring transactions at these entry and exit points, based on anecdotes, up to 20% of all nodes on the Bitcoin network may be managed and operated by these same set of participants as well. [↩]
Note: it bears mentioning that as of this writing, no country has recognized cryptocurrencies as actual legal tender and consequently cryptocurrencies are not exempt from nemo dat. This is important as it means the provenance of the cryptocurrencies actually does matter because those assets could be encumbered. [↩]
I asked around and my sources do not know of a single exchange that does KYC/AML on cryptocurrencies that are directly exchanged for other cryptocurrencies (e.g., Shapeshift). Furthermore, as highlighted in the past, there are gaps in compliance when it comes to certain fiat-to-cryptocurrency exchanges such as BTC-e and LocalBitcoins. [↩]
This is in USD equivalence, usually not in USD itself. [↩]
OctaCoin is interesting in that the operators behind it claim that it is financed from revenue streams of 3 online casinos who purportedly payout users on a regular basis. Note: gambling in China is a bit like golf in China: it’s illegal but everywhere. It is only legal in a few internal jurisdictions such as Hainan and Macau and elsewhere on the mainland only a couple of state-run lotteries are given legal status. [↩]
Note: stealing electricity to mine bitcoins has occurred in other areas of the world too, including in The Netherlands. [↩]
The official motivation for developing Confidential Transactions is to enable more user privacy which then leads to more fungibility. As one source pointed out: “At the end of the day it’s a balance between privacy and security. Basically the story goes ‘just because I don’t what anyone to know what I’m buying, doesn’t mean I’m a drug dealer.'” [↩]
Marquardt also allegedly co-owns both Bitcoin.org and Blockexplorer.com, and co-manages the Bitcoin Wiki. [↩]
The Craig Wright / Satoshi saga is interesting because in a recent interview Craig admittedly used Liberty Reserve which was an illicit exchange based in Costa Rica shut down by the US government. According to the interview he also had ties to Ross Ulbricht, the convicted operator of Silk Road. [↩]
See The Law of Bitcoin, Section 1.5 in the United States chapter from Ryan Straus. There are exceptions, see UCC Article 2 – sale of goods. [↩]
Interestingly, SharedCoin.com (sometimes referred to as Shared Send) used to be a mixer run by Blockchain.info, a venture-backed startup. It was recently shutdown without any notice and the domain now redirects to the CoinJoin wiki entry. They also pulled the SharedCoin github repo and any material that links it back to Blockchain.info. [↩]
One reviewer mentioned that: “Ponzi schemes will always exist and should probably be fought not just in the crypto space but where in other industries too; requiring continuous education. It would be way simpler and more effective to shut down domains owned by MMM than it would to be to do anything else, but here you actually meet the pseudonymity feature of the Internet. Try to do that internationally – it is not easy!” [↩]
Note: this is a similar argument that Rick Falkvinge made three years ago. [↩]
There are probably several dozen advocacy groups and non-profit working groups scattered across the world. Each has different goals. For instance, ACCESS in Singapore works with some regulators in SEA. While others are merely trying to create technical standards. [↩]
Most of the criminals that are convicted are found guilty of money laundering and interaction with illicit trade, not theft of bitcoins themselves. [↩]
Two months ago, the Financial Timesbriefly covered this story and Marcus wrote about some of it in March as well. [↩]
There were some early warning signs for that industry. For instance, according to a Bloomberg story in February 2015: “The value of China’s peer-to-peer lending transactions surged almost 13-fold since 2012 to $41 billion last year, according to Yingcan Group, which tracks the data,” notes Bloomberg. However, 275 of the more than 1,500 lending went bankrupt or had trouble repaying money in 2014, an increase from 76 just a year earlier, according to Yingcan. [↩]
There are currently two popular interrelated narratives on social media surrounding participation of the block making process on a public blockchain. The stories are most pronounced within the Bitcoin community but are also reused by Litecoin, Ethereum and other cryptocurrencies too.
This includes the unchallenged statements that:
(1) anyone can still participate in block making, it is ungated and “permissionless”
(2) following a reward halving (“halvening”), networks become more decentralized because large, centralized farms and actors split apart due to economic pressures
This post looks at both of these and show that in practice neither is really true as of April 2016.
Named block makers
A year ago I reflected on some of the debate surrounding permissioned and permissionless blockchains. Part of that post involved looking at how the mining market actually evolved in practice; not just based on the generalized claims made by enthusiasts at conferences.
For instance, based on block height below is a list of the first time a pool self-doxxed and signed a coinbase transaction, courtesy of Organ of Corti. Only the first 50 are chronologically included:
Recall that even though it didn’t initially sign coinbase transactions, Slush began publicly operating at the end of November 2010. Eligius was announced on April 27, 2011. DeepBit publicly launched on February 26, 2011 and at one point was the most popular pool, reaching for a short period in July 2011, more than 50% of the network hashrate.
While many enthusiasts claim that “anyone can mine,” in practice, very few choose to for a number of reasons that will be discussed below.
But more to the point, the reason cryptocurrencies allegedly have a “permissionless” characteristic in the first place has to do exclusively with the fact that there is no administrative gating or vetting process for allowing actors on the network to participate in the block making process. In 2009 there was no whitelist, blacklist, KYC or KYM (know your miner) process.
That is to say, those wanting to create a block did not need permission from a network administrator.1 That is the sole context of the term “permissionless.”
It is not related to developing other platforms that plug into the network. It is not related to whether the network codebase is open source or not. It is not related to being able to build software products that somehow utilize the network. It is not related to being able to view or not view transactions.
Yet due to how the market evolved, today in 2016 while everyone is still paying for the high marginal costs to maintain a network designed for pseudonymous and anonymous interaction, few participants, specifically block makers, are actually capitalizing off of that utility.
(1) Acquiring the necessary hardware to become a profitable miner invariably leaves a paper trail. If instead you acquire the hardware on the second-hand market — in order to remain anonymous — you will still likely leave a paper trail with your legal identity in order to pay for the large energy bill and property taxes. This is one of the reasons why miners in locations such as China do not publicize their fundraising activities or annual revenue: they don’t want to leave a paper trail to pay any extra taxes.2
(2) The other main mechanism for vetting miners now is through the use of data science itself. Roughly 10 companies globally provide law enforcement, compliance teams and regulators access to relatively robust analytics tools to track provenance of bitcoins (or other cryptocurrencies) back to coin generation itself. And in order to sell these mined bitcoins (e.g., to pay for the electricity and the mining hardware), nearly every bitcoin conversion to fiat marketplace now requires some compliance of local KYC and AML regulations.
While there are workarounds such as LocalBitcoins and SharedCoin, generally speaking the pseudonymous network itself in 2016 has largely become doxxed. Yet the high costs of maintaining pseudonymity, via proof-of-work, still remain.
Above is a pie chart that estimates the hashrate distribution among mining pools over the past 4 days (as of late April 2016). The 10 largest pools collectively made 97% of the blocks during that time period.3
Above is the pool distribution of the past year based on coinbase data aggregated by Blocktrail.
The 10 largest pools collectively account for roughly 91.6% of all block making activity. There is also a relatively long tail that includes roughly another 60 entities (some of whom do sign coinbase transactions) that represent the remaining 8.4% of all block making the past year.
Why do any actors sign transactions at all, after all, isn’t a core characteristic of a public blockchain pseudonymous consensus? To my knowledge, no one has formally published a thorough explanation for the reasons why. But one repeated rationale is that pools do so in order to prove to the miners (hashers) connected to the pool what the provenance of the block reward income is.
What does that mean?
For those who have never partaken in the mining process before, a quick history lesson: within the first two years of Bitcoin’s existence a division of labor arose in which block making became separated from hashing itself (e.g., generating proofs-of-work).
That is to say, the security of network security was outsourced to entities who create proofs-of-work and who are colloquially referred to as miners.4 Miners, in return for steady payouts of income, send their work to a pool operator who subsequently batches transactions together into blocks and pays workers based on a pre-arranged agreement (usually proportional, share-based).5
Today, if average Joe buys ASIC mining equipment, he typically does not connect them to his own pool but instead connects them to a pool run by Bob the devops professional.6 And how can Joe trust Bob not to shave off pennies from each share of work that Joe submits?
Block signing in theory provides some semblance of transparency: letting the hashers know if pool operators are skimming off the proceeds by not accurately reporting blocks found (e.g., income).
For instance, if a pool operator makes a block based off of the proof-of-work submitted by one of the hashers connected to a pool, such as Joe, but does not sign the coinbase, the pool operator can try to pretend that it didn’t win the block reward in the first place and therefore would not have to pay the workers (hashers). This was allegedly more commonplace prior to 2013, before the advent of VC financed farms and pools.7 Now many of the medium and large hashing farm operators want to know the exact revenue number and hear good reasons for why some is missing or if the pool was just “unlucky.”8
Why doesn’t everyone become a block maker, after all, the process is billed as being “open” to all?
There are multiple reasons why, but the most important reason boils down to economics. Dave Hudson has written about 10 different articles on the baked-in variance (inhomogenous Poisson process) that motivates individuals to continually pool their mining effort versus solo mine.9 Spoiler alert: you are likely to be struck by lightning before you will ever create a block and reap a block reward by solo mining off of your laptop at home.
Other reasons for why few decide to become block-makers include: the added costs of providing DOS protection to your pool and the need to hire competent staff that can prevent and be on the lookout for problems like BGP hijacking which results in lost revenue.
This has not changed for multiple years and will likely not change for reasons discussed below.
With the upcoming Bitcoin block reward halving that is expected to take place in mid-July, there is a growing chorus of ‘hope’ that it will somehow lead to fewer large mining farms and pools.
This probably won’t occur for several simple reasons, namely due to economic incentives.
Recall that the major reasons why mining activity itself has gravitated to locations such as China isn’t due to conspiracy theories involving lizards but instead ancillary costs.
Specifically the following factors:
relatively low labor costs (e.g., professional hashing facilities need to be maintained by a workforce 24 x 7 and wages in China are lower than Russia and the US for this activity)
relatively low property costs (e.g., if you have good guanxi, you can utilize and own land at rates below those found in parts of Russia and the US)
first-to-market with hardware; because a lot of the final assembly of hashing equipment takes place in southern China, in terms of logistics and transportation end-users have a lead-time advantage over other geographical regions
close personal connections with hardware manufacturers and fabrication plants in China and Taiwan; acquiring hardware for mining cryptocurrencies is just as relationship driven as other specialized non-commoditized industries. Because medium and large miners know who the chip design teams are and what the ASIC roadmaps will be, they can stand in line at the front and acquire hardware before others.
What will happen after a block reward halving?
Just as oil producers with the highest marginal costs have been forced to exit the fracking market over the past couple of years, Bitcoin miners with the thinnest margins will likely exit the market immediately.
What this actually results in, at least the short run, is a more concentrated group of larger hashing farms and pools.
Because miners as a whole are effectively being given a 50% pay cut to provide the same utility as before. And ceteris paribus, if Alice doesn’t currently have thick 50% margins, then she will likely exit the market.
In contrast, some of the most profitable miners in China and Republic of Georgia are now operating — even with the large difficulty rise over the past 6 months — with 50+% margins. They may be squeezed, but they do not have to exit the market.
Basically, the less efficient players will be squeezed out and the more efficient players will remain. Who is likely be be more efficient? Larger farms in cheaper locations, or smaller pools made up of less sophisticated players with less capital?
But if the price of cryptocurrencies rise — in this case bitcoins — then won’t former miners come back into the market?
Maybe, but recall, we have seen this song and dance before and it is likely that the block reward halving is already factored into both the current market price and the hardware replacement cycle and as a result there probably will not be a doubling of the market price of bitcoins. However, that is a topic for a different post.
Other public blockchains
What do mining pool distributions look like for other cryptocurrencies?
Above is the distribution of mining pools for Litecoin over the past day. Interestingly, Coinotron — a pool I used when mining 3 years ago — currently represents 2.8% of the block making during that time frame. Two years ago, in May 2014, it represented about 50%.
In August 2015, Litecoin underwent its first block reward halving. Contrary to popular belief, its market price did not double. In fact, nine months later the price of a litecoin measured in USD is just fifty cents higher than what it was pre-halving.11
Above is the distribution of mining pools for Ethereum over the past day.
Interestingly Ethereum formally launched in August 2015 and has seen the same consistent pattern of 3-4 pools representing the majority of block making activity as other cryptocurrencies have witnessed.
In fact, Dwarfpool, despite its name, has flirted with the 50% threshold several times, most notably in March. The Ethereum development team plans to transition the network from proof-of-work to proof-of-stake (Casper) later this year; it is unclear if the “staking” process will result in similar centralization.
Other cryptocurrencies continue to face similar pool centralization. This includes Namecoin which last year saw one pool, F2Pool provide more than 50% of the network hashrate for multiple months. While it does not appear that F2Pool behaved maliciously, the fact that one block maker could potentially rewrite history by doing block reorgs motivated Onename to migrateaway from Namecoin.
It is surprising that with the 60%+ hashrate located in China that there is scant detail in English about how that ecosystem works. But there are reasons for this.
Recall that based on the current 25 BTC block reward, roughly $450 million in mining rewards has been divvied out over the past year to miners. On paper that would mean that China-based miners received more than $270 million in revenue, which cements this industry as one of two that continually see large annual revenue flows (the second being exchanges themselves).
I contacted a mining operator in China that currently operates about 40 petahashes per second in equipment. Note: miners use the abbreviated term ‘P’ and ‘PH’ to denote petahashes per second.
According to him:
“Our public hashing number is based on all our own hardware. This includes two facilities in western Sichuan plus a new Xinjiang site. All of these machines were originally S3’s from Bitmain but we have replaced them with S7’s. We want to build larger operations than what we have today, but our goal is to maintain a specific percentage of the entire network.”
“Remember our electric rates changes from season to season: different time of year and that hydro power has problems in the winter because of less melt water which results in an energy price that is twice as the rate in the summer.”
“The land is basically free because it is in the mountains and no one is interested in buying property there. So all it takes is construction materials and labor. We hired 10 people last year. We intentionally hired more than we needed so we can build a team and send them places. Our front end operation probably only needs 4-5 people and we pay them $1,000 a month which is actually very competitive for that region.”
“We know a Chinese guy, Mr. LY. He lives in Sichuan and was originally a hydroelectric operator but now owns his own hydro power station. He learned he could make more money mining than just running the station.”
“Why are people like us able to be competitive? In Yunnan, Guizhou and Sichuan there was an overinvestment in hydropower last decade and now there is a surplus of electricity.12 Dam operators couldn’t sell the electricity generated so that’s where Bitcoin miners moved to. Also, in Liaoning, some people can free electricity because of the proximity to oil fields – they are given cheap electricity to local residents as compensation for confiscated land/polluting the environment — it is subsidized electricity.”
“No one really pays taxes because miners don’t generate something considered valuable. That’s to say from the perspective of taxpayer, miners don’t generate something of value, because the government doesn’t really recognize bitcoin. Bitcoin mining isn’t illegal, we still pay a small amount of taxes but it’s like running a company that doesn’t make money. Instead a miner just pays a small amount of taxes and all the profit is invisible to the law as it stands today.”
I also reached out to another mining operator based in southern China who explained that in practice, mining farms that produce 1 PH or more are usually not based in cities:
“Most of the time they are not in cities, more like in the middle of nowhere and it would be inaccurate to name towns.”
Instead he listed provinces where they are spread out including: Heilongjiang,Liaoning, Hebei, Sichuan, Tianjin, Anhui, Jiangsu, Ghuizhou, Inner Mongolia, Shanxi, Guangdong. “Shenzhen for sure, there are testing facilities that are easily over 1P.”
What about ‘subprovincial’ locations?
“It is inaccurate to present information that way. A lot of the time, the sites are between borders because it’s in the middle of nowhere. And it normally spreads over lots of sites. One place has nearly 200 sites crossing two provinces; a lot of small ones representing about 100KW of power each. They are spread over several hundred kilometers; no economy of scale after a certain point.”
No service-level agreements
This type of self-doxxing, quasi-dynamic environment has led to another interesting phenomenon: ad hoc customer service via social media.
For example, two days ago, a user sent approximately 291.2409 bitcoins as a mining “fee.”13 A small pool called BitClub Network built the block that included this fee. This fee is equivalent to about $136,000.
The community as a whole then began a crowdsourced investigation into who may have sent this fee and the motivations for doing so, with many believing it to be a mistake. After all they reasoned, a typical “fee” that most mining pools require in order to be included in the next block is usually less than 25 cents on most days.
A user affiliated with BitClub has since publicly stated it would like to return the fee to the original entity that sent it, though it is unclear if he is speaking with any authority or if the whole thing was a ruse to begin with.
But, as I have argued before, this not only sets a bad precedent for miners as a whole due to a loss of revenue from the forthcoming ‘halvening,’ but the ability to contact a block maker sets a dangerous precedent for the core utility of the network: the disappearance of pseudonymous consensus.
Or in other words, if block making was actually pseudoymous and decentralized, with 100+ unidentified pools creating blocks each day, it would be difficult if not impossible to locate and provide timely customer service to a user who made a mistake.
For instance, the most well-known block reorg occurred in March 2013 and it was only resolved when miners, including Slush and BTCGuild, contacted and coordinated with one another via IRC. If the network was more decentralized and pseudonymous, this coordination would have been very difficult to do, and this was by design.
I pointed out this irony on Twitter earlier this week as well: that there are trade-offs with this approach and the downside of using a bearer asset-based system that had no service level agreement, no EULA, no terms of service results in a world in which users who make mistakes have to complain on social media and hope someone is charitable.
And this happens on a regular basis: earlier this month a user accidentally sent 13.65 bitcoins to the BTCC pool and used reddit as his customer service forum.
That type of friction is not what most consumers want.14 It is a poor user experience which has gradually led to the creation of ‘trusted’ intermediaries in this ecosystem which as described in previousposts, recreates the existing financial system but without the same level of oversight and financial controls.
The cryptocurrency community is learning the hard way why intermediaries exist, why SLAs exist, why legal identities are required for financial transactions, why consumer protection laws arose and so forth. Pointing out these patterns is not malice or due to a lack of understanding of how cryptocurrencies work, but rather it serves as illustrations for why it has been hard to find real sustainable traction in the space.
Thus, for all the hype around “trust anchors” tied into public blockchains such as Bitcoin, claims of decentralization and “trust-lessness” are empirically untrue.
In practice, due to centralization and identity leakage, the cost to successfully reorganize a block isn’t through a Maginot Line attack (e.g., via hashrate), but through cheaper out-of-band attacks, such as hosting events in which self-doxxed miners participate. But that is also a topic for a different post.
16 months ago, Vitalik Buterin and others jokingly quipped that the trends towards centralization in Bitcoin mining (and other cryptocurrencies) resulted in a world where each coinbase transaction effectively arose from a multisig process.
To quote Buterin: “with Bitcoin, we’re paying $600 million a year on a 5-of-10 multisig.”
10 is roughly the amount of quasi-permanent block makers in a given day. And $600 million was the amount of revenue that miners received at that time due to the higher market value of bitcoin.
In theory, anyone can turn on their computer and hope to become a block maker on a public blockchain — no one has to register with a “Blockchain Admin” because there is no admin. However, in practice it requires a certain amount of technical knowledge and more importantly, capital, to profitably and sustainably operate a mining farm and pool.
And in order to scale this profitably, in practice, most miners at some point reveal their legal identities thereby negating the core characteristic of a public blockchain: pseudonymity. How? Miners, after having erected purpose-built facilities or to liquidate their holdings, may be required by external authorities to go through a gating / vetting process (such as KYC).
Ironically, a substantial increase in cryptocurrency prices may inevitably result in self-doxxing of all major farms. How? As market prices increase, miners in turn expend more capital to increase their own hashrate to chase the seigniorage rents.
Because of the KYC requirements of utilizing resources like electricity at a hydroelectric dam and the subsequent identity leakage, this turns the block making process itself into a mostly known, permissioned activity. Consequently, based on this past history, the term DMMS should probably be qualified with a “quasi” modifier in the front: QDMMS.
Similarly, while many enthusiasts have been led to believe a block reward halving will somehow re-decentralize the mining ecosystem, the fact of the matter is chip performance (as measured in hashrate efficiency) is only one factor in the total calculation that professional miners must account for.15
Furthermore, semiconductor engineering itself is effectively on a known, mature trajectory and which appears to be lacking any significant leaps in technological improvement. The largest entities, such as Intel, see this relatively static path which is one of the reasons why they have formally abandoned their tick-tock roadmap and now plan to lay off 12,000 people.
In contrast, energy prices, land prices, labor costs and taxes are among other major components that professional mining operators look at as a whole and decide whether to stay in a market or not. Even if there is some price increase after the halvening, home mining by amateurs outside of China will likely continue to remain unprofitable after July.
Thus a year from now the mining ecosystem will probably look a lot like it does today, with most farms and pools being self-doxxed and relatively centralized.16
[Special thanks to Antony Lewis for his constructive feedback]
There are other reasons too including not wanting to divulge any comparative advantage they might have that would incentivize new entrants to come into the market. [↩]
Note: it is believed that some large mining operators, such as Bitfury, may actually spread some of their hashers (workers) across multiple pools, in order to reduce their own pool percentage and thereby reduce the concerns over centralization. This can only be proven with an on-site physical audit. [↩]
Note: a fee implies something that is mandatory. The discussion surrounding what is and is not a fee or how it should be calculated and applied is a contentious topic in the cryptocurrency community. [↩]
Cryptocurrencies are effectively designed ‘for cypherpunks by cypherpunks.’ While caveat emptor may be desirable to certain demographics, others prefer consumer protection which bearer-based systems do not have. [↩]
Note: in terms of efficiency, 28nm chips are usually in the range of 0.25-0.35 watts/(gh/s), while the newer 14nm or 16nm ones are more likely 0.12 watts/(gh/s) or less. [↩]
[Note: the following overview on known Bitcoin mining farms was originally included in a new paper but needed to be removed for space and flow considerations]
Several validators on the Bitcoin network, as well as many watermarked token issuers, are identifiable and known.1 What does this mean? Many Bitcoin validators are drifting usage outside the pseudonymous context of the original network due to their use of specialty equipment that creates a paper trail. In other words, pseudonymity has given way to real world identity. Soon issuers of color will likely follow because they too have strong ties to the physical, off-chain world.
For instance, on August 4, 2015, block 368396 was mined by P2Pool. This is notable for two reasons.
The first is that the block included a transaction sent from Symbiont.io, a NYC-based startup building “middleware” that enables organizations and financial institutions to create and use ‘smart securities’ off-chain between multiple parties and have the resulting transaction hashed onto a blockchain, in this case, the Bitcoin blockchain.2
Several weeks later, Symbiont announced that it would begin using their “stack” to provide similar functionality on a permissioned ledger.3 This follows a similar move by T0.com – a wholly owned subsidiary of Overstock.com – which initially used Open Assets to issue a $5 million “cryptobond” onto the Bitcoin blockchain, but have subsequently switched to using a “blockchain-inspired” system designed by Peernova.456
The second reason this was notable is that the block above, 368396, included at least one transaction from Symbiont which was mined by a small pool called P2Pool.7Unlike other pools discussed in this paper, P2Pool is not continually operated in a specific region or city.
It is decentralized in that all participants (hashers) must run their own full Bitcoin nodes which stand in contrast with pools such as F2Pool, KnC mining pool and BTCC (formerly called BTC China), where the pool operator alone runs the validating node and the labor force (hashers) simply search for a mid-state that fulfills the target difficulty.8
Due to this resource intensive requirement (running a full node requires more bandwidth and disk space than merely hashing itself), P2Pool is infrequently used and consequently comprises less than 1% of the current network hashrate.
P2Pool’s users are effectively pseudonymous. Due to the intended pseudonymity it is also unclear where the transaction fees and proceeds of hashing go. For instance, do the hashers comprising this pool benefit from the proceeds of illicit trade or reside in sanctioned countries or who to contact in the event there is a problem? And unlike in other pools, there is no customer service to call and find out.
Bitcoin’s – and P2Pool’s – lack of terms of service was intentionally done by design (i.e., caveat emptor). And in the event of a block reversal, censored transaction or a mere mistake by end-users, as noted above there is no contract, standard operating procedure or EULA that mining pools (validators) must adhere to. This is discussed in section 3.
This pseudonymous arrangement was the default method of mining in 2009 but has evolved over the years. For example, there are at least two known incidents in which a miner was contacted and returned fees upon request.
Launched in late summer of 2012 and during the era of transition from GPUs and FPGA mining, ASICMiner was one of the first publicly known companies to create its own independent ASIC mining hardware. Its team was led by “FriedCat,” a Chinese businessman, who custom designed and integrated ASIC chips called Block Eruptors, ASICMiner operated their own liquid immersion facility in Hong Kong.9
At its height, ASICMiner (which solo-mined similar to KnC and BitFury do today) reached over 10% of the network hashrate and its “shareholders” listed its stock on GLBSE (Global Bitcoin Stock Exchange), GLBSE is a now defunct virtual “stock market” that enabled bitcoin users to purchase, trade and acquire “shares” in a variety of listed companies.10 GLBSE is notable for having listed, among other projects, SatoshiDice which was later charged by the Securities and Exchange Commission (SEC) for offering unregistered securities to the public.1112
While unregistered stock exchanges catering to cryptocurrency users and China-based mining pools may be common sights today, on August 28, 2013, a bitcoin user sent a 200 bitcoin fee that was processed by ASICMiner.13 Based on then-market rates, this was approximately worth $23,518.14 The next day, for reasons that are unknown, ASICMiner allegedly sent the errant fee back to the original user.15At the time, one theory proposed by Greg Maxwell (a Bitcoin Core developer) was that this fee was accidentally sent due to a bug with CoinJoin, a coin-mixing service.16
Liquid cooled hashing equipment at ASICMiner in 2013. Source: Xiaogang Cao
The second notable incident involved BitGo, a multisig-as-a-service startup based in Palo Alto and AntPool, a large China-based pool (which currently represents about 15% of the network hashrate) operated by Bitmain which also manufacturers Antminer hardware that can be acquired directly from the company (in contrast to many manufacturers which no longer sell to the public-at-large). On April 25, 2015 a BitGo user, due to a software glitch, accidentally sent 85 bitcoins as a mining fee to AntPool. Based on then-market rates, this was worth approximately $19,197.17
The glitch occurred in BitGo’s legacy recovery tool which used an older version of a library that causes a 32-bit truncation of values and results in a truncation of outputs on the recovery transaction.18 To resolve this problem, the user “rtsn” spent several days publicly conversing with tech support (and the community) on Reddit.19
Eventually the glitch was fixed and Bitmain – to be viewed as a “good member of the community” yet defeating the purpose of a one-way-only, pseudonymous blockchain – sent the user back 85 bitcoins.
Fee to Bitmain (Antpool) highlighted in red on Total Transaction Fee chart. Source: Blockchain.info
On September 11, 2015 another user accidentally sent 4.6 bitcoins (worth $1,113) as a fee to a mining pool, which in this instance was AntPool.20 Bitmain, the parent company, once again returned the fee to the user.
HaoBTC is a newly constructed medium-sized hashing farm located in Kangding, western Sichuan, near the Eastern border with Tibet.22 It currently costs around 1.5 million RMB per petahash (PH) – or $242,000 – to operate per year. This includes the infrastructure and miner equipment costs. It does not include the operating costs which consists of: electricity, labor, rent and taxes (the latter two are relatively negligible).
The facility itself cost between $600,000 – $700,000 to build (slightly less than the $1 million facility BitFury built in 2014 in the Republic of Georgia) and its electrical rate of 0.2 RMB per kWh comes from a nearby hydroelectric dam which has a 25,000 kW output (and cost around $10 million to construct).23
In dollar terms this is equivalent to around $0.03 / kWh (during the “wet” or “summer” season). For perspective, their electric bill in August 2015 came in at 1.4 million RMB (roughly $219,000); thus electricity is by far the largest operating cost component.
When all the other costs are accounted for, the average rises to approximately $0.045 per kWh. The electricity rate is slightly more expensive (0.4 RMB or $0.06) during winter due to less water from the mountains. The summer rate is roughly the same price as the Washington State-based hashing facilities which is the cheapest in the US (note: it bears mentioning that Washington State partly subsidizes hydroelectricity).
HaoBTC staff installing hashing equipment. Source: Eric Mu
At this price per joule it would cost around $105 million to reproduce “work” generated by the 450 petahash Bitcoin blockchain. Due to a recent purchase of second-hand ASICMiner Tubes, HaoBTC currently generates just over 10 PH and they are looking to expand to 12 PH by the end of the year.24The key figure that most miners are interested in is that at the current difficulty level it costs around $161 for HaoBTC’s farm to create a bitcoin, giving them a nearly 100% margin relative to the current market price.
The ASIC machines they – and the rest of the industry uses – are single use; this hashing equipment cannot run Excel or Google services, or even bitcoind. Thus common comparisons with university supercomputers is not an apples-to-apples comparison as ASIC hashing cannot do general purpose computing; ASIC hashing equipment can perform just one function.25
There is also a second-hand market for it. For instance, hashing facilities such as HaoBTC actively look to capitalize off their unique geographical advantages by using older, used hardware. And there is a niche group of individuals, wanting to remain anonymous, that will also purchase older equipment.26
Although individual buyers of new hashing equipment such as Bob, do typically have to identify themselves to some level, both Bob can also resell the hardware on the second-hand market without any documentation. Thus, some buyers wanting to buy hashing equipment anonymously can do so for a relative premium and typically through middlemen.2728
While Bitbank’s BW mining farm and pool have been in the news recently29, perhaps the most well-known live visual of mining facilities is the Motherboard story on a large Bitcoin mining farm in Dalian, Liaoning:30
Incidentally, while Motherboard actually looked at just one farm, the foreigner helping to translate for the film crew independently visited another farm in Inner Mongolia which during the past year Bitbank apparently acquired.31
Are there any other known facilities outside of China?32
Genesis Mining is a cloudhashing service provider that purportedly has several facilities in Iceland.33According to a recent news story the company is one of the largest users of energy on the island and ignoring all the other costs of production (aside from electricity), it costs about $60 to produce a bitcoin.34 However, when other costs are included (such as hardware and staffing) the margin declines to — according to the company — about 20% relative to the current bitcoin price. At the time of the story, the market price of a bitcoin was around $231.
The four illustrations above are among a couple dozen farms that generate the majority of the remaining hashrate.
What does this have to do with colored coins?
The network was originally designed in such a way that validators (block makers) were pseudonymous and identification by outside participants was unintended and difficult to do. If users can now contact validators, known actors in scenic Sichuan, frigid Iceland or rustic Georgia, why not just use a distributed ledger system that already identifies validators from the get go? What use is proof-of-work at all? Why bother with the rhetoric and marginal costs of pseudonymity?
The social pressure type of altruism noted above (e.g,. Bitmain and BitGo returning fees) actually could set a nebulous precedent: once block rewards are reduced and fees begin to represent a larger percentage of miner revenue, it will no longer be an “easy” decision to refund the user in the event there is a mistake.35 If Bitmain did not send a refund, this backup wallet error would serve as a powerful warning to future users to try and not make mistakes.
While there have been proposals to re-decentralize the hashing process, such as a consumer-device effort led by 21inc which amounts to creating a large corporate operated botnet, one trend that has remained constant is the continued centralization of mining (block making) itself.3637 The motivation for centralizing block making has and continues to be about one factor: variance in payouts.38 Investors in hashing prefer stable payouts over less stable payouts and the best way to do that with the current Poisson process is to pool capital (much like pooling capital in capital markets to reduce risk).
Whether or not these trends stay the same in the future are unknown, however it is likely that the ability to contact (or not contact) certain pools and farms will be an area of continued research.
Similarly one other potential drawback of piggy backing on top of a public blockchain that could be modeled in the future is the introduction of a fat tail risk due to the boundlessness of the price of the native token.39 In the case of price spikes even if for short time can create price distortions or liquidity problem on the off-chain asset introducing a correlation between the token and the asset that theoretically was not supposed to be there.
For instance, the staff of Let’s Talk Bitcoin issues LTBCoin on a regular basis to listeners, content creators and commenters. [↩]
One reviewer likened the Overstock “cryptobond” proof of concept as a large wash trade: ”Basically it’s a cashless swap of paper and thus no currency settlement. And the paper has no covenants and thus very easy to digitally code. Basically Overstock is paying FNY a spread of 4% for doing this deal. And if the bond and loan are called simultaneously, say in the next month, that means that Overstock paid FNY about $16,667.00 to do this trade. And since there was no cash exchanged, I am presuming, then this is smoke and mirrors. But they actually did it. However, I don’t see much of a business model where the issuer of a bond has to simultaneously fund the investor with a loan to buy the bond and pay him 33 basis points to boot!” [↩]
In (Rosenfeld 2012) the author noted that one of the risks for running an “alternative to traditional markets” – such as GLBSE – were the regulatory compliance hurdles. Overview of Colored Coins by Meni Rosenfeld, p. 4. [↩]
Personal correspondence with Eric Mu, August 10, 2015 [↩]
One common talking point by some Bitcoin enthusiasts including venture capitalists is that Google’s computers, if repurposed for mining Bitcoin, would generate only 1-2% of the network hashrate – that the Bitcoin network is “faster” than all of Google’s data centers combined. This is misleading because these Bitcoin hashing machines cannot provide the same general purpose utility that Google’s systems can. In point of fact, the sole task that ASIC hashing equipment itself does is compute two SHA256 multiplications repeatedly. [↩]
Some academic literature refers to miners on the Bitcoin network as “anonymous participants.” In theory, Bitcoin mining can be anonymous however by default mining was originally a pseudonymous activity. Participants can attempt to remain relatively anonymous by using a variety of operational security methods or they can choose to identify (“doxx”) themselves as well. See The Bitcoin Backbone Protocol: Analysis and Applications by Garay et al. [↩]
This is similar to the “second-hand” market for bitcoins too: bitcoins originally acquired via KYC’ed gateways sometimes end up on sites like LocalBitcoins.com (akin to “Uber for bitcoins”) – where the virtual currency is sold at a premium to those wanting to buy anonymously. [↩]
While it is beyond the scope of this paper, there are a couple of general reasons why medium-sized farms such as HaoBTC have been erected in China. Based upon conversations with professional miners in China one primary reason is that both the labor and land near energy generating facilities is relatively cheap compared with other parts of the world. Furthermore, energy itself is not necessarily cheaper, unless farms managers and operators have guanxi with local officials and power plant owners. And even though it is common to assume that due to the capital controls imposed at a national level – citizens are limited to the equivalent of $50,000 in foreign exchange per year – there have been no public studies as to how much capital is converted for these specific purposes. There are other ways to avoid capital controls in China including art auctions and pawn shops on the border with Macau and Hong Kong. See also How China’s official bank card is used to smuggle money from Reuters and What Drives the Chinese Art Market? The Case of Elegant Bribery by Jia Guo See On Getting Paid From China. Is There Really A $50,000 Yearly Limit? from China Law Blog and Bitcoins: Made in China [↩]
It is unclear how much hashrate they actually operate or control, a challenge that plagues the entire cloudhashing industry leading to accusations of fraud. [↩]
And this is also a fundamental problem with public goods, there are few mechanisms besides social pressure and arbitrary decision making to ration resources. As described in (Evans 2014), since miners are the sole labor force, they create the economic outputs (bitcoins) and security, it is unclear why they are under any expectation to return fees in a network purposefully designed to reduce direct interactions between participants. See Economic Aspects of Bitcoin and Other Decentralized Public-Ledger Currency Platforms by David Evans [↩]
In 2014 the state of New Jersey sued a MIT student, Jeremy Rubin, for creating a web-based project that effectively does the same thing as the silicon-based version proposed by 21inc. See Case Against Controversial Student Bitcoin Project Comes to Close from CoinDesk. In addition, the FTC, in its case against Butterfly Labs also looked at BFL not informing customers properly regarding difficulty rating changes. According to the FTC’s new release on this case: “A company representative [BFL] said that the passage of time rendered some of their machines as effective as a “room heater.” The FTC charged that this cost the consumers potentially large sums of money, on top of the amount they had paid to purchase the computers, due to the nature of how Bitcoins are made available to the public.” [↩]
This issue was cited in the CryptoNote whitepaper as one motivation for creating a new network. On p. 2: “This permits us to conjecture the properties that must be satisfied by the proof-of-work pricing function. Such function must not enable a network participant to have a significant advantage over another participant; it requires a parity between common hardware and high cost of custom devices. From recent examples , we can see that the SHA-256 function used in the Bitcoin architecture does not possess this property as mining becomes more efficient on GPUs and ASIC devices when compared to high-end CPUs. Therefore, Bitcoin creates favourable conditions for a large gap between the voting power of participants as it violates the “one-CPU-one-vote” principle since GPU and ASIC owners possess a much larger voting power when compared with CPU owners. It is a classical example of the Pareto principle where 20% of a system’s participants control more than 80% of the votes.” [↩]
I would like to thank Ayoub Naciri for providing this example. [↩]
A couple days ago, on Monday, I was on a panel hosted at Stanford University as part of the “Blockchain Global Impact” conference. The panel covered remittances, unbanked residents and financial inclusion.
Below is a presentation I put together based on research for Melotic, for SKBI in Singapore and in preparation for the panel.
About two weeks ago an in-depth investigative report covering the impact of pollution on the environment in China was uploaded and published on a number of Chinese video streaming sites. It is called “Under the Dome” (based on the TV show). It was an instant hit and reached over 200 million views within its first week — thereupon it was removed, scrubbed from the Chinese internet by censors.
I lived in three different cities during my five-year stay in China and the pollution varied from location to location. Fortunately I spent the vast majority of the time in the south — which has its own issues — but the air was almost always better than the type found in the north and specifically in the Beijing metro.
This is not to say there were not very bad air pollution days too. I recall my last week in Shanghai, in December 2013 (prior to moving to California), that in the twilight hours the smog was so thick that I couldn’t see the flashing red lights atop of the apartment I lived in.
It was bad enough that it earned its own Wikipedia entry and a number of news outlets wrote a few stories on it:
Why spend time writing about this? Because it is increasingly clear that keynote speakers in this industry are factually wrong about many things, including the various margins that money service organizations (MSO) like WU have. For instance, yesterday there was a really good thread on reddit that broke down the erroneous claims from Andreas Antonopoulos regarding the margins that WU and others have, it is wrong by an entire order of magnitude.
Over the past year as I conducted interviews for my research I would often hear stories of how such and such owned X amount of bitcoins. In just a six month period it became pretty clear that someone somewhere was embellishing because there just aren’t that many bitcoins around. This was especially true once you start hearing rumors of the amount of bitcoins that large holders in China claim to have. Which side of the Pacific is exaggerating more?
A few things were cut in the 2nd article to slim it down a bit and also because it meandered a little. Here are a few of the items:
While an imperfect facsimile a UTXO (unspent transaction output) or bitcoin, is not equivalent to equity.
Remember, pre-Artforz, miners and hashers were one and the same, so a DMMS was not a farm or pool back then as it is today.
Some of these exchanges started within a niche such as futures speculation. For example, Bitfinex originally shared (mirrored) the Bitstamp order book and later, after growth, established their own thereby allowing their customers to partake in price discovery through the spot market (e.g., providing bids and asks). Others such as Coinbase effectively operate what Coindesk calls “a Universal” — that is as a hosted wallet, merchant processor and exchange — albeit without a users ability to speculate on the bid/ask of a token (in most cases Bitstamp acts as their liquidity provider who in turn receives coins from miners and so on).
This year alone, several exchanges have been hacked and/or customer funds were stolen by insiders, including Mintpal, BTER, CoinEx, Coinmarket.io, Neo & Bee (it wasn’t an exchange per se, it collapsed too soon to figure out what they meant, if at all, to do) and most prominently, Mt. Gox. Despite a spectrum of counterparty risks and the advent of decentralized and multisig trading (eg the Counterparty DEx and Coinffeine), traders, on the whole, still prefer to use centralized exchanges due to their trading speeds (milliseconds instead of 10+ minutes).
Lastly, a friend of mine, Anton Bolotinsky sent me some additional feedback that may be of interest to some readers:
The statement: “Also, withdrawal time from an exchange is not necessarily related to the price of bitcoin.” Seem to be out of context.
I’d assume it’s about market phenomena – which will move price if people withdraw both btc and fiat positions from exchange. They would either have some very fast cash deposit/withdrawal mechanism to be able to do it daily. Alternatively, at the end of the day, they would convert fiat to btc, and withdraw btc. This would move the price.
If fiat positions are not liquidated, withdrawing only btc, will reduce risk exposure to 50% on average. And will create evening & morning blockchain transactions spike – btc from exchange to wallet, and back. I can’t see anything like this happening.
Another thing that somebody will probably comment: btc exchanges, unlike NYSE, work 24/7, nothing besides trading volumes (maybe) changes. So notion of doing something for night might be archaic:)
When digital archeologists peruse Reddit in 20 years, to look at what happened to the Bitcoin community, it is posts like this pumper that will serve as a case study — an exhibit of how false information was used to promote adoption. As shown in the comments, the Klarna Group is not in fact adopting Bitcoin. It is unclear who is behind these type of posts, but it is unfortunately very common.
Below are some other interesting stories related to digital currencies and China. Link is not an endorsement to services:
Readers may also be interested in a few other comments I provided them, a few of which are slightly edited (removed some names and numbers):
I should preface this by saying that the OTC/off-chain liquidity/inventory is something that is not being factored into most of the overall discussion on trade volume. I know that all the mining farms in China have liquidity partners (usually with the big three exchanges) and I could introduce you to one in particular who might be willing to talk on the record, or at least give you color. The reason I mention this is because if you can some how dig up the OTC/dark inventory numbers, the aggregate volume might actually be larger in USD than RMB (at least, that would be my guess).
To answer your first two questions I think it bears mentioning that there really hasn’t been any new VC-backed exchange that has setup in the US in the past 6 months or so (itBit moved its SG operations to NYC). Perhaps once the legal issues are more defined this can change.
In addition to having no fees on trades, I think this short comment on reddit describes some of the internal structural differences at the Chinese exchanges for question #3.
They’re busily trying to answer question #4 with a variety of value-added services like margin trading and issuing of derivative products as well as integrating with API services and even building out support for mining contracts (BTCChina apparently just acquired a mining pool/farm to do just that).
As far as your last question, I think it would be fair to say that public/open consumer-based exchanges are centered in China, but based on the OTC numbers that I hear throughout each month, USD is still probably bigger. For instance, BitPay sells around XXXX BTC a day to its liquidity partners. That’s usually more than ______ does (at least this past summer). Their daily sales are chopped/sliced up and sold to liquidity partners. Charlie Shrem briefly touched on this a week or so ago.
Writing at Forbes, Eric Mu interviewed Jake Smith, better known as “The Coinsman.” Jake was responding to a comment I wrote last month:
Tim Swanson, the author of The Anatomy of a Money-like Informational Commodity, recently said that you missed the “unseen calculation, the economics of extracting and securing rents on this ledger unit, which consume scarce resources from the real economy.” – Do you think he is wrong?
I think attacking mining from an environmental point of view is quite silly, because pretty much everything in the modern era relies on resource consumption, and for the vast majority of those things society has decided that the trade-off is worth it. I think Bitcoin is one of the most valuable and revolutionary inventions the world has ever seen, so even if it is using a lot of electricity I don’t think that’s a valid criticism against it. The internet uses vastly more electricity than Bitcoin, no one is bashing the internet for using resources.
Swanson’s quote would also imply that Bitcoin is not part of “the real economy”. I would say that by virtue of its existence, it is.
Further, Bitcoin’s value is derived in part from the fact that it is difficult to create.
The biggest problem with the analogy above, which is commonly used by Bitcoin advocates, is that it is not an apple’s to apple’s comparison. In this instance, Bitcoin acts as a distributed Excel workbook, a spreadsheet application that uses the internet to distribute itself. Thus it is incorrect to equate it with the much broader umbrella that is the entirety of the internet.
This same problem happens when people claim that Bitcoin can and/or will replace the banking system. For instance, last month Jake interviewed Nan Xiaoning, CEO of Bitocean:
I think Satoshi had a lot of foresight in this regard. He wasn’t a dummy, I’m sure he considered different ways of distributing coins.
Some people say that bitcoin wastes a lot of electricity. But the banking industry surely uses more resources than bitcoin does. But bitcoin is a peer-to-peer system. I think using resources to guarantee its security and stability is the way it should be.
Another inaccurate analogue/comparison. Bitcoin’s protocol does not provide any of the functionality of the banking system beyond a security lock box (that should not be confused with a distinctly different term, a savings account) and a corresponding ledger of access and usage (the debate over whether or not someone “owns” a privkey corresponding to a UTXO it is still being argued over by lawyers globally). The current protocol does not natively allow for lending, saving, notary, underwriting debt and equity or setting of interest rates (among many other services real banks actually provide).
In both cases above the examples above miss the forest from the trees. As Robert Sams pointed out a few days ago, the proof of work mechanism used in Bitcoin was designed to make Sybil attacks expensive. The verification process is a marginally trivial task and can be handled (and in practice actually is handled) by mining pools via small computers such as a Pi-based box.
How specialized is the hashing (not verification) process? A good comment on reddit yesterday noted that:
Rather than taking the whole header, they mine using something called a midstate. Due to the nonce being at the end of the header, the software hashes up to just before the nonce, and then sends that (called a “midstate”) to the mining chip. The mining chip then only needs to add a nonce, do the end of a SHA256 round, and then one more, and then check if the result is good enough. Rather than returning data, they just return nonces which look to be valid.
Instead, a more accurate way to look at this issue is from the spectrum of centralized to decentralized (which was also discussed by the Hyperledger team in an interview a couple days ago).
Centralized tools and services have certain vulnerabilities (e.g., single point of failure and potential abuse) but its cost basis is different than say, a decentralized entity. The economics of both need to be accounted for (and are) when rolling out a new system internally (this is called the Total Cost of Ownership).
On the other end, decentralized systems are less vulnerable to some of the same issues that centralized systems are, yet to make them less vulnerable in fact requires consuming scarce resources that centralized solution do not have to (because they are trusted networks). In the case of Bitcoin, bitcoin miners (or technically hashers) effectively destroy (or “burn”) a corresponding amount of energy (technically exergy) to protect the network from Sybil attacks on an untrusted network. This is a real cost that cannot be ignored yet as shown above, is often handwaved away.
[Note: as an aside, most miners, mining farms and mining manufactures do not pay for their capex or opex in bitcoins, nor is this likely going to change anytime soon. Instead they must rely on and permaborrow the unit of account of fiat (typically a USD or RMB) to effectively measure and allocate resources. This unit of account issue — wherein economic activity within the Bitcoin world is measured with the unit of account that is fiat to create this network — was also broached by Robert Sams several months ago.]
Furthermore, as I mentioned in chapter 8, if the TCP/IP analogy was correct then the marginal revenue for ISPs would split in half every 4 years. And that through competition the marginal cost of protecting and sending packets would equal the marginal value of those packets. This would not be an effective way to run a business let alone design a network topology.
In the real world, the marginal costs of running an ISP, which is centralized, have to be less than the marginal revenue otherwise they go bankrupt as they could not pay for overhead. So yes, in fact, ISPs do try to actually mitigate the leakage, wastes and otherwise inefficiencies in its own internal network and they do this through a myriad of ways.
Bitcoin’s existence is on the other side of the spectrum. Bitcoin was purposefully designed to make it cost prohibitive to spam ownership change on a public, untrusted network — the complete opposite in organization that an ISP is designed to operate as. The average person would likely see this as inefficient, but that is because up until the past decade — with the advent of Bittorrent and other distributed systems — the public at large was unfamiliar with how these systems are designed. And as Sams pointed out, using the word “efficient” versus “inefficient” may not be the most accurate terminology, because each model has different attack vectors they have to account for.
Thus again, it is not about being pro or anti proof-of-work. Rather it is acknowledging that proof of work requires a certain economic model that have real costs that scale with token value and in the case of Bitcoin, is not environmentally “greener” than some centralized solutions (e.g., ApplePay).
Not only does this show that several vocal Bitcoiners are unfamiliar with how real IPOs work (underwriters typically represent the lion’s share of additional equity ownership and the date is fixed weeks and months ahead of time) but that it illustrates how some Bitcoiners like to blame people and go on a witch hunt when prices decline but then reassure themselves that they are investment geniuses when prices trend northerly.
In point of fact, the Alibaba IPO was not a surprise to anyone, the investors are all large financial institutions and not hoi polloi. The IPO was oversubscribed and not even well heeled, well connected HNWIs could get into an allotment — only banking institutions were able to because of the enormous demand. And none of those institutions are: 1) large bitcoin holders and 2) needed to sell bitcoins to raise funds to buy Alibaba shares.
Perhaps this will change in the future, but that is not the case in this instance (be sure to also check out Izabella Kaminska’s lively twitter feed).
Closing tabs. Some China related news scattered below as well.
The Bank of England published a couple of papers that have been making the rounds. One area of contention, by some, is a section in the 2nd paperThe sustainability of digital currencies’ low transaction fees which discusses some of the issues brought up in Chapter 3.
Mobile Money Accounts are Outnumbering Bank Accounts in Africa from Let’s Talk Payments (“there are 242 mobile money service providers operating in 89 countries holding a total of 203 million mobile money accounts. Although Kenyans have been using such service for more number of years as compared to others, but they are not the leader anymore. In Tanzania, in 2013, 44% of adults used some form of mobile money as compared to 38% of Kenyans. Tanzanians conducted 99.9 million mobile money transactions worth $1.8 billion.”)
The article states that this operation’s output is roughly 5% of the entire network hashrate and the electrical costs for it are about $1 million per month.
A couple guys on reddit did the math and came up with these other two numbers:
$1 million electric bill per month = $33000 per day/$500(price of btc) so they need to mine 66 btc/perday just to cover electricity.
If they have 5% of the network, then it’s 3600*0.05 = 180 bitcoin per day, or about $90k.
So they are generating $90,000 in revenue per day yet fully 1/3 of the costs are soaked up by electricity. Note: Last month, the bottom line price at a farm like this, to “create” a bitcoin was 2700 RMB ($444).
What this means is that if this is the most efficient set up possible (economies of scale via low labor costs, quick installation from manufacturer, relatively cheap land prices, relatively competitive electrical rates) then to power the rest of the Bitcoin network with similar data warehouses, the global cost for electricity alone would be around $240 million a year. Obviously this may not be the case as each geographic region and jurisdiction have several variables that could impact and move this final amount up or down, yet that is probably a relevant range.
Similarly, the hardware costs would likely double, triple or perhaps quadruple the costs as well. Add on costs of maintenance (things break), rent, etc. and this pushes the world wide costs of bitcoin mining upwards into the $1 – $2 billion per year range, which as copiously detailed in Chapter 3, is what theory predicts (MV=MC). This does not also take into account all the various exceptions to the rule of miners mining at losses to get “virgin” coins, or researchers externalizing costs onto government run computers, etc.
This dynamic could change as market prices for bitcoins fluctuate, see further discussion from Dave Hudson on this.
Lot of interesting stories the past couple of weeks but I need to close some tabs. One older post of interest — for you statistics buffs — comes from Distributome Data & Activity: Horse Kicks which describes the use of a Poisson distribution to model how Prussian Calvary officers were kicked and killed by horses between the years 1875 and 1894.
Other notable links related to China as well cryptocurrencies (and sometimes both):
What gives a dollar bill its value? by Doug Levinson (from the feedback I’ve gotten from the last few weeks it seems as if a lot of the Bitcoin community is not really familiar with how money and credit work or exist)
Foreign Currency Translation from Cengage (“Develop the necessary understanding and skills to translate the financial statements of a foreign entity into U.S. dollars using the all-current and the monetary-nonmonetary translation methods.”)
51% Of The Network? by Dave Hudson (looks like you actually need to have closer to have 60% of the hashrate to really have 51%)
I received some feedback from a veteran of the mining subindustry in China regarding my previous research on this space.
According to him there are a number of other moving pieces at play that are fluid will not necessarily last.
For instance, providers such as HashRatio have succeeded, not by designing their own chip but by figuring out the best combination of system and power configurations. Going from chip to working system is non-trivial. The end result are systems which are not necessarily pretty to look at, but they work.
One of the issues this new source had with my report was that because of guanxi is relatively hard to quantify, knowing whether or not you have the best price of a particular resource (like energy) is always a lingering question. That is to say, even if Alice knows the boss of a coal mine, another competitor, Bob, may know his bosses boss which gives Bob even cheaper rates than what you thought you were receiving. Improving guanxi is a millennia old Herculean task.
Some other highlights according to the source:
If Alice’s metric is purely dollars per ghash, the analysis was correct. This is because there are two important figures: Alice’s new ASIC kWh/hash multiplied by her electricity cost / kWh.
While Moses Lake is quoted in many news reports at being 1.7 cents per kWh, there are many other parts of the state which are very low, some averaging 2.3 cents per kWh. And Washington has a much better infrastructure (both for electricity and internet) than China which makes it a very competitive geographic region.
Similarly, Russia is 1 to 1.2 cents per kWh, though, you would be in Russia.
China is cheap relative to a lot of countries, but relative to Washington and Russia the community capacity is still limited by State Grid, a large state owned enterprise (SOE) with a flat rate of 0.3 RMB kWh buying in any power station linked to it. Miners will likely be unable to go under that.
While Alice can do some meter fiddling or go off grid power, those options are hard to find and probably will not last long.
State Grid has likely heard of bitcoin mining, but the wattage usage is not big enough to pique their interest or oversight.
Inner Mongolia, as part of China, has overinvested in wind farms. Yet there are large areas that are not linked to the grid yet. And due to the unstable nature of wind, as well as poor internet infrastructure, none of the mining pools has gone there yet. And it is sparsely populated which leads to potential difficulties in sourcing human capital and talent to run a pool.
Mongolia, the country, imports roughly 10-20% of its electricity from Russia, so Bob might as well go to Russia if he is willing to set up a facility in Mongolia.
There are several people to keep your eye on for analysis in this space (such as those in the acknowledgements portion of the piece). Dave Babbitt is working on his master’s thesis on this specific issue (hence his up-to-date numbers), Jonathan Levin is about to defend his thesis (which goes into several mining models), Robert Sams is brilliant with both econometrics and with understanding incentives and Cal Abel speaks in a whole new different league. I also had some illuminating exchanges with John Ratcliff (he posted some subsequent comments over here). Andrew Poelstra has a very critical eye and sharp mind for any logical errors and Bryan Vu is both articulate and provided some good counter-points to the hypothetical trend lines. Dan Forster and Karl Holmqvist helped spark the initial barage of questions, Joseph Chow helped tweak the responses and Petri Kajander made sure my writing was coherent. Also, thanks to Ruben Alexander, editor at Bitcoin Magazine for his encouraging words.
Lastly, my sources in China including Weiwu are without a doubt, resourceful and survivors. That region of the world is a very tough market and unfortunately doesn’t receive the respect it deserves.
For instance, below is a Figure 4 from the new U.S.-China Economic and Security Review Commission (pdf) by Lauren Gloudeman.
Thus the next time you hear someone on reddit complain about China in relation to Bitcoin or tell you how Chinese demand did not impact prices, show them this diagram. Who will replace the Chinese whale? Maybe Wall Street.
While I am not endorsing bitcoin as an investment (I don’t actually), a vocal minority of English-speaking Bitcoin adopters on reddit and Bitcoin Talk are proverbial bandwagon fans.
In November, when Chinese consumers exploded onto the Bitcoin scene, many commentators cheered them on, welcoming them into the big leagues.
Ever since bitcoin prices peaked in early December (corresponding with the December 5th notice (Chinese) from the PBOC), many of these same armchair commanders / evangelical adopters have thrown all of China under the bus.
For instance, on Friday CoinDeskpublished a story about FXBTC (a Chinese bitcoin exchange) closing down next week. The very first comment was the following:
The rest of the world would be better to ignore these PBOC reports. Bitcoin will go stronger once that happens.
Throughout each week similar such comments are posted on reddit (here) and Bitcoin Talk (here). The truth is, Chinese consumers created enormous demand that drove up the prices in late November and early December. And the price has fallen measurably since the peak five months ago a peak which corresponded with the first “crack down.”
This may not be something you want to hear as an investor, but it is the truth of the matter. While some claim that Chinese exchanges were fudging their volume and liquidity, extraordinary claims require extraordinary evidence. I wrote an article 4 months ago (that was republished by Business Insider) that discussed several ways to purportedly fake the volume, yet even I do not have a smoking gun (yet). In fact, post-December 5th I think most of the big exchanges (like Huobi and OKCoin) were probably posting real numbers. And in all likelihood, correlation is causation: the PBOC is a force to be reckoned with, they enacted (caused) new regulations and guidance which scared both smart money and Chinese day traders away which correlates with the continual drop in prices.
To compound this issue are enthusiastic Bitcoin advocates in China, especially exchange and merchant developers who spread their own counter-propaganda that is wholly without evidence. The fact of the matter is, there has been a cat and mouse game going on for months now and while exchange operators have found temporary workarounds, the writing is on the wall: Bitcoin exchanges are for the time being persona non grata on the mainland. There may be a few other loopholes and workarounds (which are quickly removed), but to believe otherwise is wishful thinking. No amount of marketing spins or gimmicks like ATMs will likely change that in the short-run.1
Perhaps these types of inflammatory we-love-you-now-we-hate-you comments only represent a vocal minority, but it is pretty clear that most tokenholics do not care about utilizing a trustless consensus mechanism to empower the underbanked in developing countries such as China.2
Instead of loathing China, the community as a whole should sympathize with the loss of a comrade. I do not expect this to happen though. I briefly mentioned this in my Q/A at Stanford on Monday. The Chinese government is opaque but the worst thing they could do is go all draconian (like blocking websites or arresting entrepreneurs) which they haven’t and egging them on, as endless threads on reddit do, is only hurting the very people Bitcoin was purportedly designed to help.
Will Hong Kong be the saving grace?
Most Chinese operations now have accounts in Hong Kong but they cannot operate as bitcoin businesses; the Hong Kong Monetary Authority (HKMA) has asked Hong Kong banks to report any account related to cryptocurrencies so most of the accounts are usually not open about the true nature of the operations. Some are still openly related to bitcoin but for mining investments (hardware purchases) or merchant investments and there is still pressure on those.
If you only care about the value of the token, the ledger entry, the UTXO, etc. then you are going to need a bigger whale. China was a huge whale. Perhaps in a bit of irony, this summer funds from Wall Street (from bitlicensed firms) could end up driving up the price once again, effectively bailing out some of the reddit bitcoin holders who are now underwater. Cui bono.
[Note: Weiwu Zhang has been posting some interesting analysis over the past few months at a German Bitcoin site. His prediction are not always correct, but it is a fresh perspective that seems more grounded than the typical “invest on hope” mantra.]
Update: Just found out that all of the Bitcoin exchanges in China have pulled out of the upcoming Global Conference in Beijing on May 10th. They are taking the PBOC notification / guidance very seriously and do not want to irk policy makers. So they will not give presentations or show up in any official capacity (their sponsorship continues though — money has already been paid). This is sad news.
Update 2: I have had three different independent confirmations to the first update. The Global Conference website is slow to update the changes to the schedule. This article (Chinese) is apparently the one that asymmetrically influenced the entire segment a week ago. Its message of “don’t irritate the PBOC” went viral with about 30,000 hits (which is probably a decent estimate of how many people actually use bitcoin on-chain in China). The exchanges met later and then decided not to attend in official capacity. The article mentions that the PBOC does not want China to be the largest market (as it has been) and actually mentions an upperbound target of 3000-8000 BTC daily volume for the entire country. The actual number is unimportant, the attitude is. The PBOC (and China) does not want to be a leader but rather as a follower based on the regulations and outcomes from the US and other jurisdictions (like Germany and Canada).
Update 3: the big exchanges just issued a joint statement (Chinese) saying they will adhere to the new PBOC guidance. They did not clearly say what that exactly means and will continue to operate (function as an exchange).
Update 4:CoinDesk just published a new story on the exchanges that pulled out of the conference.
Bitcoin ATMs are likely underutilized globally, many are probably unprofitable too, hence the lack of public boasting by ATM operators. [↩]
The title of the white paper and the first section of the white paper are specifically identify peer-to-peer payments as a way to reduce friction and trust of the traditional banking system. [↩]
A rail cargo line has been “relaunched” between Europe and China that is one month faster than traveling by sea and costs 20% the price of air cargo.
What is the motivation for restarting this potential time + cost savings? Because:
In a month, the export value of one consignment of electronic products might devalue by about two percent, about several tens of thousands of dollars.
This actually relates to Bitcoin/Litecoin mining as well. Most ASICs today have less than a 6 month profitably window before they need to be dumped or pointed to another profitable altcoin. The sooner you ship a batch, the quicker the receivers can recoup the costs.