About a week ago I gave a guest presentation (webcast) with O’Reilly media regarding the “Continued Existence of Altcoins, Appcoins and Commodity coins.” For those interested, a short preview is found at, “Bitcoin and blockchain use cases won’t be sexy, but will be essential.”
Note: in order to listen to the webcast archive you have register for the event.
Send to KindleI was quoted a couple times in a new Reuters article, “All the rage a year ago, bitcoin sputters as adoption stalls.”
I think it is probably more accurate to say that according to the Bitcoin Distribution Chart, that there are roughly 250,000 to 500,000 ‘individuals’ controlling “wallets” (there really is no such thing as a wallet with respect to the Bitcoin protocol) with more than 1 bitcoin. The vast majority of the rest are probably categorizable as unclaimed tips, ‘dust’ (originally less than 5460 satoshi, now less than 546 satoshi), purposeful spam for research (taint analysis), etc.
Also (and I’m at fault for doing it too), we probably should stop using the word “liquidity” when more accurate words are probably velocity or movement. Liquidity has a different meaning in the financial markets.
A few other posts I wrote this past fall include:
[Note: I was also quoted earlier this month in Questions Linger as Daily Bitcoin Transactions Pass 100,000 Milestone from CoinDesk and Analysis: Around 70% of Bitcoins Unspent for Six Months or More also from CoinDesk]
Send to KindleEarlier today I gave the following presenation at the R3 Cryptocurrency Round Table in Palo Alto. It covers “Bitcoin 2.0” ideas including alternative consensus mechanisms, costs of operating decentralized ledgers, use-cases for these new ledgers within existing financial institutions and potential hurdles including disproportional rewards.
[Note: citations and references can be found in the notes of each slide]
Send to KindleLast Saturday I moderated a panel at PubNub for the 1 year ‘Dogeversary’ — the anniversary of Dogecoin. Panelists included Marshall Hayner, CMO of Block.io and David Dvorak, CTO of DogeTipBot.
Note: I don’t own any dogecoins and actually explained a hashrate vulnerability it had back in May (which they’ve at least temporarily rectified through ‘merged mining’ (AuxPOW) with Litecoin).
Panel starts at 1:33:32 but the sound quality doesn’t (marginally) improve until 1:36:42 (so start there) and ends at 2:17:00.
Send to KindleI have a couple new articles published over the past few days.
The first one, “The Rise and Rise of Lipservice: Viral Western Union Ad Debunked” is over at CoinTelegraph and deals with the remittance industry. Note: my original title included just the first 6 words, CT added the remainder including “debunked” which is probably apt.
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.
The second article is, “Too Many Bitcoins: Making Sense of Exaggerated Inventory Claims” at CoinDesk. Note: original working title was “Where is the inventory? Making sense of disaggregated inventory pools and financial controls” — I do have to say I like the CD editors choice, it’s much better!
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:
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:)
Send to KindleBased on comments from both reddit and Coindesk, the number one question today seems to be related to off-chain transactions. Why aren’t these being factored in to the equation? [Note: it bears mentioning that I did discuss this on p. 84, Chapter 4]
There are multiple problems with this perspective, however before delving into that I should point out that in the previous article, I did in fact link to Coinbase’s self-reported off-chain transaction numbers. They are relatively marginal, on most days comprising less than 5% of the total transactional numbers. But it is not clear from these numbers alone are or what they refer to: Coinbase user to user, user to merchant, and possible user wallet to user vault?
Below is their chart:
What impact does this have on the network?
It actually makes the network insecure in two ways:
1) Users become increasingly dependent on trusted third parties (TTP) on the edges, which defeats the purpose of having a blockchain in the first place (recall that “trusted” appears 11 times in the white paper). This also opens both consumers and entrepreneurs up to a host of vulnerabilities and abuses that the industry is continually plagued by.
2) As more users leave the actual blockchain and move off onto TTP, less funds (or “fees”) are going to pay miners for actual security, making the entire network more reliant on seigniorage (block rewards) which in the long-run has empirically been a losing battle.
Below is a chart from Blockchain.info that illustrates fees to miners:
Another chart illustrating this data was compiled from data by Jonathan Levin (formerly of Coinometrics) over the same time period:
Notice how fees have actually decreased and are now at a two year low. This is actually the opposite trend we would want to see and potentially troubling. In fact, contrary to prudence, instead of floating fees the core developers have “slashed” fees (more accurately called “donations“) by tenfold this past year. From an economic sustainability point-of-view, this is the diametrically opposite action that should be taking place. It will make the adjustment period at the next block halving much more painful to consumers as fees have to go up to incentivize miners to stay.
Earlier this summer, L.M. Goodman (creator of the Tezos protocol) noted a similar conundrum:
The race to build more hashing power (by developing ASICs for instance) means that the cost to pull off a 51% attack on the network increases. In this respect, the network is more secure. Note however that the amount of money spent on mining and mining equipment must be approximately equal, in the long run, to the amount of bitcoin paid in transaction fees or created through mining. Given off chain transactions, this could dwindle to very low levels in the future.
As Dave Hudson and others have pointed out (see Chapter 3), this fee has to increase because transactional volume simply is not increasing to the level it needs to in order to replace the block reward.
Meher Roy succinctly summed up this conundrum in a comment earlier today:
The question is how will the low-fee high volume work when off-chain is / will prove to be more convenient? Any on-chain fee will be out-competed by speed, lower fees and convenience of off-chain transactions. Why exactly are we sure on – chain transactions will rise 10000 fold that it needs to? How exactly does Bitcoin solve this collective action problem?
These are important questions that thus far, everyone seems to punt on.
What about off-chain data from exchanges? Surely they should be factored into this?
Unless exchanges are willing to publicly share that data, it is difficult to surmise what is taking place in their black boxes (we can have some idea based on public addresses).
But again, this is not a particularly good metric for those who believe lots of commercial trade is taking place. Off-chain transactions on an exchange are equivalent to forex. Value transfer, possibly. Retail commerce, no.
We do in fact know how much Bitpay and other payment processors do in business each day, we know this through the bitcoins they sell each day to liquidity providers. And altogether this amounts to around 5,000 – 6,000 bitcoins per day. Although there are some merchants that keep part or all of their bitcoins, the liquidity sales is the most accurate version of retail commerce we can estimate with today. And that has not changed much over the past six months.
[Special thanks to Dave Babbitt and Jonathan Levin for their constructive feedback]
Send to KindleBack in May I published a blockchain analysis piece on Coindesk that utilized graphs created by John Ratcliff. Ratcliff published several new charts yesterday that provide a fuller picture of this overall movement.
The chart above visualizes nearly 6 years of token movements.
Is there a way to isolate the past year and if so, what does the past year look like? That’s what the next chart illustrates:
What conclusions can be drawn from these charts?
1) that token movement (velocity) strongly correlates with a rapid increase in market prices (e.g., more velocity during the bull runs, less during price decreases); you can see that in the first chart with large bumps in April 2013 and then again in November 2013
2) because of the large dip in prices over the past year, most tokens are inactive in part because the owners are still “underwater”
3) that monthly liquidity is still only around 10% (more on consumption below)
4) the “tx volume” chart on Blockchain.info is no longer entirely valid due to a combination of the usual mixing and mining rewards but also because of increased advertisement spam (e.g., metadata within OP_RETURN), increase in P2SH and Counterparty tx’s. Only a full traffic analysis can provide a more accurate breakdown.
What is especially interesting is to see the “overhang” or rather the “underwater” coins that are moving from the 3 months to the 6-12 month band. What this effectively shows is that owners of those UTXOs purchased them during the bubble of November-December 2013 and are still willing to wait and hold onto these coins until the price rebounds. If there is no upward change in prices then some (or all) of these coins will eventually move into the next band sometime in the spring of 2015.
What other conclusions can be made?
This is a sobering chart for advocates or entrepreneurs within the merchant payment processing vertical. What this shows is that despite the near quadrupling of merchants that now accept bitcoin as payments (this past year increased from ~20k in January to ~76k through September), on-chain activity has not seen a corresponding increase by consumers. They are all effectively fighting for the same thin slice of liquid coins, a segment which empirically has not grown. This does not mean that there are no consumers, only that when paired with data from Bitcoin Day’s Destroyed, there probably hasn’t been any real on-chain growth beyond the exceptions in #4 above. Thus on any given day, payment processors (collectively) likely only process 5,000-6,000 bitcoins still. Other additional activity could be taking place off-chain in trusted third parties (like hosted wallets and exchanges such as Coinbase).
Too reuse an analogy from Chapter 14 (p. 224 and 230), that also means that since 3,600 bitcoins are created each day to pay for security, that with this ratio (3,600 : 6,000) every other mall patron is effectively being guarded by a mall cop which in laymens terms means there is massive security overkill still taking place. This is not a big deal today but when coupled with analysis from Dave Hudson, network transaction fees will have to increase by several orders of magnitude to replace the seigniorage that currently incentivizes miners. This is best illustrated in the cost per transaction metric on Blockchain.info.
As I mentioned on a panel on Tuesday this collective “hodling” (hoarding) behavior is understandable given the future expectations of price appreciation. Yet it is probably not a good characteristic for a modern “currency,” for reasons discussed in Chapter 9 and also Why Market Prices Do Not Double With a Block Reward Halving.
Send to KindleOn Tuesday I was a panelist on a new segment from Follow The Coin, hosted by Tina Hui. The other panelist was the creator of Dogecoin (among other projects), Jackson Palmer.
Below are transcribed comments I made throughout the recorded portion with the approximate time they were said.
[2:46]
Ditto. When I first got involved with Bitcoin a few years ago, I was really excited, I did some mining. I built some machines in China and slowly but surely I kind of became more of a skeptic. I guess that’s what people know me for. I wouldn’t say I’m anti-Bitcoin, I think there is a lot of Koolaid that is continually circulated. I think Jonestown would be very jealous of the Koolaid in this space. Right now, the phrase I was talking to Jackson earlier was, you know how people are saying “Be your own bank”? I’m not saying you can’t be your own bank but what happens in reality is, like “Be your own textile factory” or “be your own data center” — for whatever reason that just doesn’t work out in reality. I’m not saying it can’t work out in this space but it looks like people prefer to be nannied, prefer to have costumer assurance. I probably just lost a few friends and followers but that’s how I kind of look at things. It’s become BINO: Bitcoin in name only. I have a whole talk on that otherwise.
[4:39]
I’d have to agree for the most part. For listeners, the use cases I think are interesting with the actual technology are pretty mundane. I was talking to Everett from Bloomberg, there is this thing called Consolidated Audit Trail. Back two years ago, the SEC put together something called Rule 613. The idea was to get all these institutions together in the financial industry to actually track every single transaction. That seems like a mundane, unsexy thing but at the same time this might be something that a blockchain may be able to do in some capacity because you have people who do not necessarily trust each another, you have a lot of them. Maybe you don’t need Bitcoin’s blockchain, maybe you can use some kind of other ledger, a proof-of-stake based ledger. I do think the technology does have some interesting potential but probably not for a lot of the things that are being funded.
[7:13]
Sure, so I’ll be mean, I’ll say something not nice. Tipping is a neat idea but in practice what ends up happening a lot and we see this on reddit and LTBCoin and stuff like that, is it incentivizes begging. So we end up having this magnet to rewarding behavior that you really don’t want to have. Obviously there are people who do take tipping seriously and put together some good comments and stuff like that. For example, with LTBCoin. If you are not familiar with it, Adam Levine had this really cool idea: “hey, how about we reward people who make comments.” That sounds great, you are part of the message, part of the community. What ended up happening is that attracted just tons of bots basically, people just spamming. We see this with reddit too with the different tippers. Some guy the other day, 2 or 3 days ago said, “hey, I literally made sock puppets to collect as many tips as I could.” And he collected something like 50,000 satoshi worth, which is not a whole lot but that’s a lot just spending time spamming around to try and get. It has some interesting ideas, the question is, how do you filter out the froth from legitimate players in this. And I’m not sure there is a real silver bullet to that. Maybe it just has to be part of the ecosystem, we’ve lived with it this far maybe it is something we have to soldier on with.
[9:24]
So I’ll be mean again. There really is no correlation between tipping and then encouraging that behavior in a restaurant. Most of the literature doesn’t point to the reason why China is stagnating for example isn’t because a lack of tipping in the country. It’s a cultural thing here in the US, I’m not anti-tipping. My wife and I tip, maybe on the lower side of scale of things. I think it is a funny activity that people do and I’m not against it, but I’m not sure it’s providing a good marketing signal to the participants or the people who receive it.
[10:11]
I don’t put tipping addresses for two reasons. The first one is, actually I talked with Victoria van Eyk at Changetip yesterday, and she said, “Tim, you shouldn’t use this reason.” But I’ll tell you the first reason why, I don’t want to accept candy from strangers. I’m not sure where that coin came from, maybe it is a Silk Road coin. Obviously that is something way down the line, I don’t think anyone is going to bust me for accepting some tip that way. But I do think we should be judicious against who we receive money from, especially in this era of Alex Green and just the amount of scammers and bad apples in this space you don’t know where that money comes from. The other, and this is nothing against Changetip, it’s just how it is efficient: it’s all off-blockchain. The whole purpose of this blockchain space is to provide decentralization, if we’re accepting tips from centralized silos it just reinforces that. So again, I’m not anti their service, but it kind of defeats the purpose if you have to rely on a centralized service to do all that.
[14:17]
Just like you said, it’s unsexy to build these vigilante services because they become centralized and who are you to decide who is the bad guy and stuff like that. So you end up recreating the system that we’re in right now, for better and for worse. There are some tools, if you guys are interested, there is a company called Bitreserve. They just released their transparency initiative called Reservechain and Reserveledger. The idea is you use the Merkle root to trace back to make sure all the tx’s are accounted for. Obviously multisig is one of the few areas I’m not bearish on, it’s legit. Whether or not you can build an entire company around just multisig, I don’t know, we’ll find out. Taking that internally for financial controls, segregating. Even hardware wallets, actually I just tweeted about that the other day. Hardware wallets seem like they have, I hate to say it, maybe they do have some potential — that’s not sexy again, who wants to carry around a wallet, a smartphone and then a hardware wallet with your private keys. Maybe that’s something that user behavior will end up changing or maybe it’s not.
[18:04]
So there is this thing called “affinity fraud.” And just like the name affinity, when you were in school you had affiliations, it’s kind of the same idea. It happens a lot in Bitcoin because there are so many self-identified libertarians essentially. So if you pretend to be a libertarian you can — no offense to anyone here — I’m about to lose some more friends here. They are identifiable targets, it happens in religions, it happens in just about any ‘affinity’ essentially. It’s not something that can be stopped immediately, there’s going to be bad actors that know they can take advantage of this. You have to be judicious. Again, I’m not sure if there is a way you can build a startup, fund it somehow and then go after these guys. It becomes this public goods issue. Again, I’m not saying the only solution is a government, but it seems like there is a perverse incentive to not get rid of these actors. Because what happens is, is especially with thefts and scams is these people need to launder the money and move their money – exit somehow. And to do so, they end up having to use — it creates demand for these other services. So in a way, there is a perverse incentive to not get rid of these actors because creates more demand for the underlying currency. Again, I’m not saying that it is going to stay the way it is, I’m sure I’m going to get a lot of emails saying, “no Tim you are wrong.” But so far no body has done much to get rid of these guys and maybe there is a reason why, maybe everyone is sort of benefiting from this underlying demand.
[22:29]
I will argue that Satoshi pre-mined. And I’m not saying that because I hate Satoshi. Is Satoshi here? Does anyone know Satoshi? You can prove it either way by signing. The reason I argue that is the biggest complaint with pre-mining is you have this allocation that took place before anyone else could particpate, that’s the bottom line. Satoshi only advertised Bitcoin on one obscure mailing list and then preceded to mine basically for an entire year without advertising it again and without doing any effort at all to do PR. He could have run a testnet. He could have done mulligan, “hey, we have these people, it’s been a year now, we’re going to reset it.” And if you add up all the coins that were basically coinbase free, that were just the coinbase transaction or plus one tx, that is about 4.8 million bitcoins (see p. 163) that were basically handed out for free. Without any merit. Again, I’m not saying that you need to confiscate those guys. But what we’re having today is capacity issues with blocks right now: about 30% to 40% of capacity on any given day. Dave Hudson has been doing a lot of good research on this. And so these miners are essentially doing more work today than they were at the beginning. And they’re not being rewarded any more than they were then. That’s an issue with the static rewards. So I would argue that it is essentially a pre-mine, he could have said testnet for the first year and didn’t.
[25:24]
Mine what, Bitcoin? So home mining, industrial mining? The only way most people are making money off of Bitcoin is price appreciation. You mine, you hope that it will increase in value. But you might as well just buy coins at this point. The only people who are really making money are Bitfury, a few places in China (see Chapter 5) and this is because they’re able to scale it and benefit off the energy. This is not to say you can’t possibly do it in maybe certain locations here in the US, like Washington I believe has 3 cents a kilowatt hour. And they were in the news for setting up some certain sites. But in general in this day in era, with ASICs it’s very difficult to actually have any margin. The argument is, ceteris paribus, it should take one bitcoin to actually make one bitcoin just because of the way the difficulty is auto-adjusted every two weeks. So on the margins there really is no profit except maybe a few different entities that can scale, like Bitfury.
[27:22]
So many questions. So to give you an idea, the Gini coefficient in Bitcoin is 0.88 (see p. 129), perfect number 1.0 is unequal. I’m not some kind of egalitarian marching in the street. But a 0.00 is just the opposite, basically it’s perfectly even distribution. Bitcoin basically has a Gini coefficient higher than North Korea. I’m not saying that’s a good thing or bad thing, it kind of disincentivizes some people to join because they think they can no longer participate in the “get rich quick.” The whole asymptote itself was just one “get rich quick” idea. Again, I’m not saying it was a scam, I’m not saying that at all. As far as the hording versus the savings. So people get this often confused: the protocol itself does not have any mechanism to actually save. It is simply a lockbox. So it is essentially a digital mattress. There is nothing wrong with that. If you just want to hold onto it. But there is no mechanism to take that money within the protocol and lend it out. And what we’re seeing is we can build out lending platform, through like BTCJam. So as a result you have, if you actually look at liquidity, on any given month you have about 10% of all mined tokens ever are actually liquid (see Chapter 12). You have about 90% of tokens that haven’t moved for over a month and about 50% that haven’t moved in more than 6 months. And this is because there is nothing built into the protocol to actually put these into active, lending purposes or any of these other financial instruments. So that kind of creates a stagnant economy. Well you wouldn’t call it a currency. Like you’d call that some kind of commodity. There is no velocity of gold even though it’s legal. You just kind of bury it. Again, I’m not against if you guys want to hold coin. That’s the rational thing to do. The rational thing is, if you believe it is going to appreciate in value you hold onto it. Everyone thinks it’s going to go to the moon. Everyone is actually [acting] rational. So it’s not actually being used as a currency, it’s being used as a commodity and that makes sense because everyone thinks it’s going to raise and appreciate.
[29:52]
It’s hard to know how much money laundering has occurred. I mean unless you can identify ever single transaction and know what the intent was, you don’t know how much. Again, I’m not saying that this doesn’t take place with fiat. Everyone’s always saying fiat is number 1. We have the ability with a blockchain to actually monitor this stuff. And actually it defeats the whole purpose if you have to identify everybody along the way because then it adds all this costs and stuff like that. So it’s this weird paradox. [Question: So you’re actually pro-bitcoin?] I’m on the fence with the technology.
Send to KindleI was asked to provide some comments related to the SKBI conference last week in Singapore. Below are my full quotes that were lightly edited for two different publications.
Singapore Event Puts Bitcoin on Mainstream Finance Agenda from Coindesk:
“One of the discussions throughout the conference was related to bitcoin as a commodity, currency and potentially emerging asset class. While this is ultimately an empirical issue, the market so far — based on blockchain behavior — suggests that it could be some form of commodity. As to whether or not it can go the distance and become an entrenched asset class is another issue altogether largely due to the tendency for all proof-of-work based blockchains to ultimately “self–destruct” due to block rewards. Perhaps this will change and bitcoin will somehow be the exception to Ray Dillinger’s rules but it may be the case that its monetary policy cannot incentivize the labor force to stick around long enough to make bitcoin a viable asset class.”
Singapore Crypto Conference Brings Together Academia, Businesses and Regulators from CoinTelegraph:
“The Singapore conference was unique in that it provided a well-balanced cross-section of academics, business professionals, decision makers at governmental organizations and entrepreneurs within the industry. As a result, the sobering conversations that took place focused more around actual opportunities and challenges in the community today rather than the typical scifi cheerleading that is divorced from the reality that companies in this space face.”
Videos and other media should be up in the next week or so.
Bonus: some of my thoughts as to why transactional volume has increased despite a lack of corresponding increase in BDD and miner fee volume: Markets Weekly: Bitcoin Rises Amid Dark Markets Crackdown from Coindesk.
Send to KindleLast week I participated in a couple panels at the inaugural CAIA-SKBI Cryptocurrency Conference 2014 hosted at Singapore Management University.
Below are the slides of the presentation I did at a closed-door session on November 5th. Citations and references can be found in the notes of each slide.
Abstract:
With nearly six years of empirical data and use-cases behind the Nakamoto consensus method the community has observed that a cryptocurrency economy behaves differently than originally envisioned and intended. What has arisen from these half-a-decade of physical interactions is a nearly complete rollback of the primary attributes embodied within the first of these Nakamoto consensus protocols, Bitcoin – to the point where it may best to refer to it as Bitcoin-in-name-only (BINO). Consequently there are two other challenges within this existing BINO framework: (1) the diametrically opposed forces of speculative demand versus transactional demand; (2) decoupling coins from the ledger altogether. This presentation discusses several proposed solutions to the challenges currently being devised by a multitude of teams.
Send to Kindle[Last week CoinTelegraph sent me a couple questions for an article that has not appeared (I will link to it if it does). Below are the responses I provided.]
Q: “What can be inferred from the decline in Bitcoin price and market cap in the course of 2014? There are two downward trends, separated by a level period and slight uptick.”
A: I probably wouldn’t call it a “market cap” (due in part to Jonathan Levin’s cogent post) and in my view, an analysis of the self-reported bitcoin price is difficult because of the lack of transparency in the underlying trusted third parties. Perhaps something like a Consolidated Audit Trail or “proof of non-collusion” will become the norm as the industry professionalizes but until then this space will likely be vulnerable to a bevy of manipulations which may be causing these types of trends (e.g., purportedly like Willy Bot did last year). Furthermore, because bitcoin’s supply is based on a fixed, limited issuance the only way to reflect changes in demand is through it’s price. Thus, the fluctuations this past year are based on a myriad of factors some of which are difficult to measure like perceived regulatory/solvency risk and future law enforcement activity. And because it is still very illiquid, sudden shocks are absorbed / reflected through volatility. Consequently I do not think the market price is a reflection of the value of bitcoin as a transactional medium but almost entirely a function of speculative demand. This past May, Robert Sams spoke on this duality as did Yanis Varoufakis in a new book.
Q: “Bitcoin’s technical foundations have been stated as insufficient to support wide-scale adoption by Mike Hearn. Do you think price volatility could be directly influenced in future by improvements or failures in this area?”
A: Both Gavin Andresen and the Blockstream team have independently discussed some of the technical limitations this past week, reaffirming the challenges that Mike Hearn described on several occasions this past year. They have all also proposed potential solutions to these solutions, some involving soft forks, hard forks and even closer partnerships between mining farms, pools and developers. Fundamentally however I do not think that Bitcoin’s blockchain will be able to serve the vast majority of use cases that it’s proponents claim it will for a couple of intractable reasons. The first is because of the physics of decentralization; it is a matter of spatial topology (distance, length and redundancies) not materials science. Thus the more dense, the less lag which favors centralization. This past summer Murat Demirbas briefly wrote about this: Distributed is not necessarily more scalable than centralized. The other is costs to maintain (nominal) trustless decentralization though the proof-of-work mechanism. As I have written about several times, contrary to the traditional narrative, there are in fact no mandatory fees to utilize the blockchain and/or its Sybil-protection scheme. The direct fees users believe they are paying are better defined as donations, as fees are something that are mandatory. Consequently, the way to calculate how much proof-of-work costs is through a metric that Blockchain.info has visualized over the past years and which has hovered around $20-$30 per transaction. That is not a competitive price relative to other payment systems and will likely relegate Bitcoin to certain niches. I also think we will see other alternative consensus mechanisms come into production-level environments, creating a type of “consensus-as-a-service” (CaaS) of which a proof-of-work-based blockchain, such as Bitcoin, represents one part of that spectrum.
Send to KindleI was looking through my email archive today and came across an email related to Bitcoin startups that I sent to a friend back in July. Most of the points are still relevant today.
Bitcoin Startups! These Are The Trends We See by Adam Draper
A Few Reasons Your Bitcoin Startup Might Fail by Sean Percival
False Positives, False Negatives, and Reading Decks in Advance by Charles Hudson
Why did Investor X not look through the entire deck, the info is right there in font 8 on slide 27?!?!
Put simply due to time constraints this may not be possible. I don’t have the link, but I recall Jeremy Liew at Lightspeed Venture Partners says he looks through 150 presentations/decks (not including executive summaries) for each investment. In my own anecdotal experience, based on pitches I have seen over the past year I would probably say to keep it simple to get the point across in less than 15 slides because many investors do not have the time to look through every detail on the first round of a pitch (some, as Charles suggested above, may not even look at it at all).
Startups going through accelerators and incubators such as Plug and Play and 500 Startups may only have as little as 3 minutes to pitch during Demo Day. So unfortunately for geeks, you would likely need to remove all the techno mumbo jumbo even if your company is say, an analytics startup. Talk to your mentors to find out more on catering your marketing message.
Send to KindleA few links of interest this past week:
Send to KindleI just finished reading through the new sidechains paper (pdf). The team has clearly been thinking of clever solutions to a multitude of challenges.
Below are my first thoughts which could change as more information is released and/or code is implemented.
The biggest issue they did not address (so far) is how to incentivize mining after block reward halvings, though that probably was not their intent. Also, and again this is just day one, but it is also unclear if the IP will be released as open source and if someone could use that code to create Blockstream 2, 3, etc.?
My comments below each block quote:
Because the miners do not form an identifiable set, they cannot have discretion over the rules determining transaction validity. Therefore, Bitcoin’s rules must be determined at the start of its history, and new valid transaction forms cannot be added except with the agreement of every network participant.
Even with such an agreement, changes are difficult to deploy because they
require all participants to implement and execute the new rules in exactly the same way, including edge cases and unexpected interactions with other features.
How can this be done in a trustless manner? Mining was supposed to be anonymous. If they are identifiable by good actors, then they’re also identifiable by bad actors and not-so-good actors.
One problem is infrastructure fragmentation: because each altchain uses its own technology stack, effort is frequently duplicated and lost. Because of this, and because implementers of altchains may fail to clear the very high barrier of security-specific domain knowledge in Bitcoin[Poe14c], security problems are often duplicated across altchains while their fixes are not. Substantial resources must be spent finding or building the expertise to review novel distributed cryptosystems, but when they are not, security weaknesses are often invisible until they are exploited. As a result, we have seen a volatile, unnavigable environment develop, where the most visible projects may be the least technically sound. As an analogy, imagine an Internet where every website used its own TCP implementation, advertising its customised checksum and packet splicing algorithms to end users. This would not be a viable environment, and neither is the current environment of altchains.
Non sequitur. The same complaint could be leveled at German carmakers versus American carmakers with the fragmentation in something like unit of measurement (meters vs Imperial). The auto industry did not collapse because of fragmentation.
In addition, there is fragmentation within Bitcoin itself, with different pools relaying different types of transactions (or censoring others). A couple days ago Dominic Williams pointed this out (in a different email), that there are different payment processors and different wallets that are incompatible (you can send money between them, but you can’t open one wallet with another).
A second problem is that such altchains, like Bitcoin, typically have their own native cryptocurrency, or altcoin, with a floating price. To access the altchain, users must use a market to obtain this currency, exposing them to the high risk and volatility associated with new currencies. Further, the requirement to independently solve the problems of initial distribution and valuation, while at the same time contending with adverse network effects and a crowded market, discourages technical innovation while at the same time encouraging market games. This is dangerous not only
to those directly participating in these systems, but also to the cryptocurrency industry as a whole. If the field is seen as too risky by the public, adoption may be hampered, or cryptocurrencies might be deserted entirely (voluntarily or legislatively).
Why are floating prices considered a bad thing? Besides, the issues in this paragraph are exactly the same problem bitcoin faces each day and a solution to risks/volatility is not addressed in this white paper. See Ferdinando Ametrano’s paper as well as Robert Sams’ upcoming draft on Seigniorage Shares.
Our proposed solution is to transfer assets by providing proofs of possession in the transferring transactions themselves, avoiding the need for nodes to track the sending chain. On a high level, when moving assets from one blockchain to another, we create a transaction on the first blockchain locking the assets, then create a transaction on the second blockchain whose inputs contain a cryptographic proof that the lock was done correctly. These inputs are tagged with an asset type, e.g. the genesis hash of its originating blockchain.
This has me thinking about token history and fungibility. Perhaps it could be argued that moving these coins to a sidechain is an act of “mixing.” Are atomic swaps a form of mixing?
Also, if the proof-of-burn effectively means “deposits” (from one chain to another) and value transfer is taking place, is this impacted by regulations such as 12 U.S. Code § 1831t – Depository institutions lacking Federal deposit insurance
This is true for almost all aspects of Bitcoin: a user running a full node will never accept a transaction that is directly or indirectly the result of counterfeiting or spending without proving possession. However, trustless operation is not possible for preventing double spending, as there is no way to distinguish between two conflicting but otherwise valid transactions. Instead of relying on a centralised trusted party or parties to take on this arbitration function like Bitcoin’s predecessors, Bitcoin reduces the trust required — but does not remove it — by using a DMMS and economic incentives.
It is still unclear what the additional economic incentives will be in the Blockstream/sidechains model. Is it just the fees in section 6.1, such as the clever time-shifting mentioned later on?
This gives a boost in security, since now even a 51% attacker cannot falsely move coins from the parent chain to the sidechain. However, it comes at the expense of forcing sidechain validators to track the parent chain, and also implies that reorganisations on the parent chain may cause reorganisations on the sidechain. We do not explore this possibility in detail here, as issues surrounding reorganisations result in a significant expansion in complexity.
What are the costs of running and maintaining this validator?
No reaction. The result is that the sidechain is a “fractional reserve” of the assets it is storing from other chains. This may be acceptable for tiny amounts which are believed to be less than the number of lost sidechain coins, or if an insurer promises to make good on missing assets. However, beyond some threshold, a “bank run” of withdrawals from the sidechain is likely, which would leave somebody holding the bag in the end. Indirect damage could include widespread loss of faith in sidechains, and the expense to the parent chain to process a sudden rush of transactions.
Who determines insurance of a blockchain? Will FDIC or similar bodies have jurisdictional grounds as described in the above USC citation (not a joke, Blockstream founders are not anonymous nor most large farm & pool operators)?
As miners provide work for more blockchains, more resources are needed to track and validate them all. Miners that provide work for a subset of blockchains are compensated less than those which provide work for every possible blockchain. Smaller-scale miners may be unable to afford the full costs to mine every blockchain, and could thus be put at a disadvantage compared to larger, established miners who are able to claim greater compensation from a larger set of blockchains.
We note however that it is possible for miners to delegate validation and transaction selection of any subset of the blockchains that they provide work for. Choosing to delegate authority enables miners to avoid almost all of the additional resource requirements, or provide work for blockchains that they are still in the process of validating. However such delegation comes at the cost of centralising validation and transaction selection for the blockchain, even if the work generation itself remains distributed. Miners might also choose instead to not provide work for blockchains that they are still in the process of validating, thus voluntarily giving up some compensation in 360 exchange for increased validation decentralisation.
How can that be done trustlessly? How does that deal with the issues Dave Hudson talked about with respect to IHPP in general? Until IHPP is changed or modified, Hudson’s models will remain valid.
By using a sidechain which carries bitcoins rather than a completely new currency, one can avoid the thorny problems of initial distribution and market vulnerability, as well as barriers to adoption for new users, who no longer need to locate a trustworthy marketplace or invest in mining hardware to obtain altcoin assets.
This doesn’t seem to be addressing several other reasons for why alts exist: who will pay independent developers wanting to build on sidechains? What about non-SHA-based hardware (like scrypt or X11)? What is to prevent someone from forking “sidechains” code and creating a similar business?
An alternate mechanism for achieving block rewards on the sidechain is demurrage, an idea pioneered for digital currency by Freicoin (http://freico.in). In a demurring cryptocurrency, all unspent outputs lose value over time, with the lost value being recollected by miners. This keeps the currency supply stable while still rewarding miners. It may be better aligned with user interests than inflation because loss to demurrage is enacted uniformly everywhere and instantaneously, unlike inflation; it also mitigates the possibility of long-unspent “lost” coins being reanimated at their current valuation and shocking the economy, which is a perceived risk in Bitcoin. Demurrage creates incentives to increase monetary velocity and lower interest rates, which are considered (e.g. by Freicoin advocates and other supporters of Silvio Gesell’s theory of interest[Ges16]) to be socially beneficial. In pegged sidechains, demurrage allows miners to be paid in existing already valued currency.
I am not sure Freicoin is a particularly good example here because in practice few participants want an asset to always lose value (what investors actively demand demurrage?). Maybe this is reflected in its lack of adoption (thus far). Perhaps that will change, perhaps Freicoin will grow over the course of the next few years. But this also touches on the issue of whether or not these “coins” are commodities or a currency in the first place (I have argued they are informational commodities).
The point about reanimation is an interesting one (and good) because of the uncertainties of “zombie” coins (as John Ratcliff calls them) that jump back onto the market.
Also, while the experimentation use-cases in section 5.1.1 seem to have some active demand (as measured by crowdsales and hype this past year) they could also (IANAL) lead to legal issues that these 2.0 projects are having with respect to unregistered securities (see the SEC with its Howey test). This is a legally risky area as discussed by these lawyers. Also, if users can create digital tokens pegged to real world assets — if these are non-deliverable, does this turn that chain into a large “bucket shop“?
Co-signed SPV proofs. Introducing signers who must sign off on valid SPV proofs, watching for false proofs. This results in a direct tradeoff between centralisation and security against a high-hashpower attack. There is a wide spectrum of trade-offs available in this area: signers may be required only for high-value transfers; they may be required only when sidechain hashpower is too small a percentage of Bitcoin’s; etc. Further discussion about the usefulness of this kind of trade-off is covered in Appendix A.
Who will maintain these? No Free Lunch.
Send to Kindle[Note: This was originally published on October 20, 2014 at Melotic.com]
Earlier this month CoinDesk published their quarterly State of Bitcoin report.
One stat (on slide 6) that was used to purportedly illustrate growth in user adoption was the increase in the amount of wallets created. According to their figures, there was a 21% increase from June to September this year (5.4 million to 6.5 million respectively).
The problem is however, opening up a wallet or creating a wallet does not constitute growth or adoption, it may simply show interest. Remember: in order to use the Bitcoin network users have to use bitcoins – or more technically speaking, unspent transaction outputs (UTXOs). Wallet creation is a zero-cost economic activity, it is negligible to do so and is not an accurate metric for actually measuring adoption (the use of UTXOs). For a lengthier answer, be sure to read Chapter 4.
On this point, two weeks ago Brian Armstrong, co-founder of Coinbase expressed similar skepticism towards wallet creation numbers, stating: “signups is a poor metric for market share” and had one specific alternative “KYC’ed accounts linked to bank+identity.”
Yet there is a problem with this as well. Both my wife and I have KYC’ed accounts on Coinbase, though neither of us have ever used it (yet). Similarly, I have probably created a handful of wallets over the past year over at Blockchain.info to test out sending several satoshi and never re-used the address. In fact, it is considered ‘best practices’ for end users to not re-use the same address, this is one of the reasons why Electrum and other clients provide multiple addresses to send UTXOs to and from. Another explanation is that some pools switch to dynamic payout addresses which also increases number of new addresses. Thus it should be expected that the amount of “addresses used” or in this case, “wallets created” has increased (recall, there is no such thing as an actual “wallet,” this is just nomenclature to help users better grasp the abstraction that are UTXOs).
Thus, actual bitcoin users (and holders) are probably not a significant fraction of the 6.5 million “wallets” opened through September. That is to say, if a bitcoin user is defined as someone who controls the privkey to a UTXO, it may be the case that bitcoin holders number somewhere between 250,000 to 500,000 globally and has remained in this range for the past six months (see also Android wallet plateau in Chapter 8).
How to measure actual users?
This is an ongoing question, one that has spurred numerous answers. I have written about it at least twice in both books. Some valid metrics include the change in Total Output Volume, Bitcoin Day’s Destroyed and fees to miners. In addition, the Top 500 Richlist is another way to measure on-chain users.
According to their continuously updated Distribution by Address, as of block 320,000 approximately 99.08% of all UTXOs reside on 329,451 addresses. The remaining 0.92% of all satoshis reside on more than 46 million addresses largely in the form of spam, mining rewards, unclaimed tips, etc.
What does this mean?
In April I published a draft of a working paper which used data from block 295,000. At that time, I looked at this slightly differently, noting that 99.08% of used addresses contained less than 1 bitcoin. Andrew Poelstra (andytoshi) corrected this statement, noting that:
“[T]he claim that 99.08% of all addresses contain less than one Bitcoin is an extreme understatement. In fact it is impossible for more than 21 million distinct addresses to correspond to UTXOs containing 1 bitcoin, but there are 1048 addresses. So it will always be the case that at least (100 ‐ 10^ ‐ 38)% of addresses contain less than one bitcoin.”
So what did the actual distribution look like? And what has changed since April? At that time 99.14% of all UTXOs resided on 301,901 addresses. So in the past 5 months there has been a diffusion of less than 1% of those UTXOs to other addresses.
This does not mean there is no activity, or no velocity. Without a full traffic analysis we cannot determine where these UTXOs end up flowing to. Yet it is clear that there has not been a 21% growth in user base during this time frame, otherwise the distribution would have likely changed dramatically (recall that on-chain users cannot participate on the network without at least 5460 satoshi, or the ‘dust limit’ so those marginal holders should not technically be viewed as users).
Again, it is known that certain entities like Bitstamp and Coinbase are large bitcoin holders and they may have on-boarded a number of new users internally. And that some of the addresses containing large amounts of UTXOs likely belong to these types of companies. Yet if there was a 21% growth in the user base over the past 3 months (let alone the 5 month window above), there would likely be other ways to measure and observe this activity as described below.
How to measure adoption?
Due to its pseudonymous nature, one way of measuring adoption is not wallets or price (this largely reflects changes in speculative demand) but in transactional demand. To gauge this metric there are several datum from the blockchain that could be correlated:
In contrast, not a single metric on slide 6 of the CoinDesk report actually measures user adoption. Rather, they all are indicators of interest.
Similarly, if a serious flaw and vulnerability was found in the core Bitcoin code base (bitcoind) which caused a cascade of hard forks that destroyed Bitcoin entirely, the github commit component would precisely measure the wrong thing, inputs, rather than an accurate attribute: healthy production code. In fact, that measure would spike, leading observers to believe that this collapse is good news for Bitcoin.
While future posts may look into these slides more it is necessary to point out that these interest metrics above could turn into user adoption (depends on what the “bitcoin sales cycle” turns out to be).
Readers are also encouraged to look through Sarah Meiklejohn’s research on this topic entitled, A Fistful of Bitcoins: Characterizing Payments Among. Men with No Names. Combing through and correlating this type of data may also be a good research project for students this fall and winter.
Send to KindleI am retiring the previous list name “Cryptocurrency in the news” because I think that fintech (financial technology) is a more accurate, all encompassing term for this space. There are other possible names like “dapps” (decentralized applications) however I prefer fintech because decentralization may not be what the market chooses as an end game.
Some links of interest:
Send to KindleSarah Meiklejohn is a researcher now at UCL. She is probably best known for her authorship of one of the best research papers in the digital currency space: A Fistful of Bitcoins: Characterizing Payments Among. Men with No Names.
She recently gave a presentation covering this paper (which admittedly has older data) and talks about some of the new privacy projects like CoinJoin which she says had a noticeable impact on a heuristic used in the study. The Q/A session at the end also has some good comments.
Send to Kindle[Note: This was originally published on October 15, 2014 at Melotic.com]
For a little background to this post, see my previous post on block reward halving and the scrypt alliance.
One of the common misconceptions within the virtual currency space stated by many advocates is that when a proof-of-work blockchain has a block halving, for some reason the market price is supposed to immediately double. Yet in practice, it rarely, if ever does on that date.
There are a couple reasons for why this is the case.
To be clear, when a block reward halving takes place, it is the future money supply – monetary stock creation rate – that divides in half. The current existing monetary supply does not divide by 50% (see Jonathan Levin’s explanation for defining bitcoin as narrow money stock).
Again, it is not as if the entire monetary stock divides in half overnight, it is just the block reward that does. If half of the money supply was destroyed or permanently lost, then ceteris paribus, it could have a non-negligible impact. For example, in late February and early March of this year, news related to Mt. Gox’s collapse suggested that up to 850,000 bitcoins may not exist.
That is to say that one potential outcome of Mt. Gox’s bankruptcy is that they were fraudulent operating, perhaps by running in an undeclared fractional reserve-like manner and some, many or all those coins simply did not exist. Consequently, market prices actually jumped for several days on this news, with speculators considering the possibility that the total money supply in circulation was smaller than what the market had previously factored in.
This is important, because if the demand of an asset remains the same while the supply is reduced, then ceteris paribus, the price of the asset could rise. The price may only change dramatically if previously unknown information becomes available but the halving does not fall into that category as it is known well in advance.
And as I briefly explored in my last post, perhaps altcoins and altchains are a type of substitute good. If this is the case, if the elasticity of demand for a good (a coin) changes due to the availability of a substitute good, then during this timeframe consumers (or speculators) may switch to other chains (technically this is called price elasticity of demand, or PED). There are several other determinants which readers may also be interested in.
If true, then perhaps during a block halving, what we may be observing is shifts of the demand curve as speculators move towards more profitable chains (since supply is fixed). And in the case of mining, the activity of mining itself is essentially taking out a “long” position on the coin itself. Or in other words, one distinct class of speculators in bitcoin, litecoin and dogecoin are the “long” positions of miners (e.g., to recoup the sunk costs and operating expenses, mining is essentially a market signal for “bullish” sentiment). Miners are a type of speculator and consequently this in turn intersects with the hash rate protection challenge discussed in an earlier post.
Theory and practice
In practice, no virtual asset – including bitcoin – has continually seen price doublings immediately after a block reward halving. In point of fact, in November 2012, bitcoin’s price did not double immediately after the halving (see Chapter 15 for more details).
This again is a challenge and an existential problem for all coins, including bitcoin. As Ray Dillinger aptly noted earlier in May regarding the survivability of altcoins:
It doesn’t halve its remaining coin supply more often than it can double its value. That’s kind of hard to predict, but at this point I think the double-value time for cryptourrency is up to about a year, maybe two. It’ll get longer until it catches up to double-value period for the rest of the economy, which is 7 to 15 years depending on the industry. This is important because whenever the block reward goes down, the hash rate goes down in the same proportion; and when the hash rate gets too low, the blockchain becomes vulnerable to an attack which can destroy its value completely. Expect any coin that mines out its coin supply too fast, to collapse. I think even Bitcoin is going to be too fast in the long run; there’ll come a point when its double-value time is slower than its block-reward halving time and alts will start sucking up the hashing power making bitcoin vulnerable to attacks.
Will bitcoin’s price double again two years from now during its next block reward halving? It is unknowable what the price will be in the interim but historically it seems unlikely this would happen on that specific date.
What is another consequence of having a fixed, inelastic supply?
Again, when supply is fixed and its creation rate known, the only way to reflect changes in demand is through price. In bitcoin’s case, Robert Sams explained several months ago on a panel that this is a problem:
I think the issue [of] should you have more elastic supply or not…really comes down to the fact that if you have a fixed supply of something, the only way that changes in demand can be expressed is through the change in price. And people have expectations of increased demand so that means those expectations, expectations of future demand get translated into present day prices. And the inelastic supply creates volatility in the exchange rate which kind of undermines the long term objective of something like cryptocurrency ever becoming a unit of account. And forever it will be a medium of exchange that’s parasitic on the unit of account function of national currencies. So I do think the issue does need to be addressed.
This topic is continuously debated and is an issue highlighted by Yanis Varoufakis, a political economist at the University of Texas and the University of Athens. According to Jeffrey Robinson’s new book, Varoufakis says that speculative demand for bitcoin far outstrips transactional demand:
Bitcoin transactions don’t go beyond the first transaction. The people who have accepted bitcoins don’t use them to buy something else. It gets back to the circular flow of income. When Starbucks not only accepts bitcoins but pays their workers in bitcoins and pays their suppliers in bitcoins, when you go back four of five stages of productions using bitcoin, then bitcoin will have made it. But that isn’t happening now and I don’t think that will happen. [Because it isn’t happening now and because so many more people are speculating on bitcoin rather than transacting with it], volatility will remain huge and will deter those who might have wanted to enter the bitcoin economy as users, as opposed to speculators. Thus, just as bad money drives out good money, Gresham’s famous law, speculative demand for bitcoins drives out transactional demand for it.
While Varoufakis is discussing the circular flow of income, the last sentence in particular is germane to this conversation.
As described above, block rewards are fixed and known in advance. What is unknown in advance however is both the demand (from speculators) and in particular miners (the labor force). If these assets have a fixed supply rate, the only way to reflect changes in demand is through price signals.
Correspondingly, speculative demand is at odds with transactional demand. Expectations of future demand (or lack thereof) in turn creates shocks and volatility which in turn disincentivizes transactional demand on all chains. There are proposed solutions to this, but those are for later posts and will likely require a new ledger altogether.
For additional perspective I contacted Jonathan Levin, co-founder of Coinometrics, and according to him:
In economics we have a concept called rational expectations where agents use all the available information to decide their actions in equilibrium. In this framework the halving in the block rewards would have been anticipated and factored into the price. You are right to emphasize that when doing a demand and supply analysis, it is not the coins produced on a daily basis that matter but rather the entire stock of bitcoins in circulation. In that way the price of bitcoin should not double for a halve in the hashrate, in fact the effect should be negligible. This is considering just transactional demand and total supply. With goods/commodities this is likely to hold true but in currencies or cryptocurrencies this may be different. There are issues of security and speculation.
Now if we consider that the market price is actually the price that the users wish to sustain in order to have sufficient network security (tenuous). Then we may make an argument that the price of bitcoin should double. People who are speculating that this will have real effect may be buying up coins which moves the price closer to that equilibrium.
In my mind, economics would predict the hashrate to halve as the reward halves. Essentially the argument would go if the price has not doubled the hashrate must fall.
While variables such as compliance/regulatory changes and the transition along the hashrate S-curve (CPU -> GPU -> FPGA -> ASIC) create wrinkles in this dynamic, thus far the empirical data matches the theory. And collectively this is why prices do not double on halving day.
Send to KindleWhen 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:
Send to KindleLast week CoinDesk reached out and asked several questions related to Koinify and published a few of the comments in a story, “Crypto 2.0 Roundup: The Overstock Effect, Counterparty Debates and a Crypto iTunes.”
Readers may be interested in a few more of my thoughts below. [Disclosure: I am an advisor for Hyperledger and head of business development at Melotic.]
Send to Kindle[Note: This was originally published on October 7, 2014 at Melotic.com]
Contrary to conventional wisdom, usage fees for many cryptocurrencies including Bitcoin, Litecoin and Dogecoin is voluntary. In fact, when Bitcoin was first released, there were no direct usage fees. The fee that users visibly see included within wallet software (such as BitcoinQT, Electrum, and Hive) is in fact, arbitrarily set by the wallet code and can – in most cases – manually be reduced to zero. That is to say, users can broadcast transactions (UTXOs) to the network for “free” and eventually a mining pool (assuming it the transaction amount is higher than the dust limit) will pick them up and include them into a block. In the meantime these transactions will float around in the mempool, sometimes for several hours waiting to be picked up and confirmed. In theory, the higher the fee a user includes, the faster it will likely be included into a block because mining pools have an incentive to package it.
Why can’t all users permanently “free ride” off of what effectively is a tragedy of the commons (Sybil protection via hashrate and access to the mempool)? There is another variable: blocks have limited space (currently set at 1 MB), are a scarce resource and thus by definition are not a public good. Fees enable users to effectively bid on this private good rationed by the labor force of miners (I describe this at length in Chapter 2). In the future, miners may actually begin to set fees themselves, as the core protocol development team is planning to “float” the fees at some point.
In practice today, “voluntary” fees (donations) represent about 0.3% of the wages a miner earns each day. How do network operators (miners) get paid then? Through block reward subsidies (inflation) which are awarded throughout the day. Nearly all hash-based proof-of-work coins use a similar method of payment in which a coinbase transaction is paid out at intervals – for Bitcoin it is roughly every 10 minutes, Litecoin every 2.5 minutes and Dogecoin every minute. As a reward for services rendered, a fixed amount of payment is sent to the miner who broadcasts the “correct” block first which is then added on top of the previous block of the longest chain (those who broadcast a different block after the fact are said to have worked on “orphaned” blocks).
In theory, based on section 6 of the original 2008 whitepaper, transaction fees are supposed to eventually replace this subsidy:
The incentive can also be funded with transaction fees. If the output value of a transaction is less than its input value, the difference is a transaction fee that is added to the incentive value of the block containing the transaction. Once a predetermined number of coins have entered circulation, the incentive can transition entirely to transaction fees and be completely inflation free.
A June 2014 paper published by Kerem Kaskaloglu attempts to illustrate the “ideal scenario” (shown below) of the seamless switch from block rewards (seigniorage subsidy) to transaction fees (donations).
According to the current narrative, a combination of increased transactional volume and higher mandatory (or perhaps marketed-based) fees will purportedly pay for the labor force to stick around in the coming years. Why is this important? Because the network currently operates almost entirely on subsidies and thus with each block reward halving, the labor force is essentially given notice that their wages have decreased 50% and many could leave for more profitable ventures. While this is not an immediate concern in October 2014 for a network like Bitcoin – which does not have a closely competing SHA-based chain to worry about attack from (yet) – other altchain designers need to be cognizant of the economic incentive model they are building before they launch a new coin.
Again this is an empirical matter, so it cannot be known a priori whether or not the transition from a subsidy to a fee will happen for Bitcoin or other coins. However what we do know is that based on the history of altcoins up to the date of this writing, an increase in fees is the exception rather than the rule. Very few altcoins have seen a markedly significant increase in usage fees over the life of their chain.
The two charts below illustrate this:
The first chart shows the “voluntary” transaction fees from the previous 6 months for both Litecoin and Bitcoin. It is almost entirely flat which suggests a number of things including the fact that there probably has not been an increase in usage of either blockchain itself (other indices such as Bitcoin Days Destroyed and Total Volume Output would help narrow the amount of UTXOs on the move and to what extent). One exception is Counterparty, which on some days represents 3% of the Bitcoin network and whose assets may represent increasingly larger commercial transactions that are not fully measured yet.
The second chart shows the same time period but for Dogecoin. In this case, over the past 2 months there has been a steady increase in fees paid to the network, effectively doubling the spring and summer rates. At this time it is unclear why this is the case; almost all tipping is done off-chain in trusted third parties (so fees are usually not assessed) and the default fee for most Dogecoin clients are set at 1 dogecoin. We may learn later that it was due to the AuxPOW merge mine with Litecoin, asset issuance via Dogeparty, or perhaps this is a statistical outlier altogether.
Nevertheless, while it cannot be said for certain, it is unlikely that the voluntary fee mechanism will fully provide the type of income to incentivize the Bitcoin labor force to continue providing its services (hashing) because it is a collective action problem (Note: Robert Sams recently touched on this issue in a new article). After all, why would most or all users one day in the future collectively start to pay (potentially) several orders of magnitude more to have the same exact service (recall that the total network reward to miners for their services today ranges from $20 to $40 per transaction)? In practice the fees alone may not be enough.
While the jury is still out on the longevity of all altcoins, one argument is that some are substitute goods. If this is the case, when conditions change (such as an increase in fees) users may move over to what they perceive as a similar, cheaper service. Or in this case, a similar chain. What does a substitute good mean? One definition explains that:
This means a good’s demand is increased when the price of another good is increased. Conversely, the demand for a good is decreased when the price of another good is decreased.
Or in other words, if the fee for using the Bitcoin network increases and a user perceives that Litecoin, Dogecoin or another network is a substitute good, then they may switch over and use the other, cheaper network for their transactional needs. The increased demand of that network token then may in turn lead to higher market prices of that token. In theory this could lead to some kind of market equilibrium among chains, though in practice there are and likely will be other factors at play.
In summation, there are no real “fees” in Bitcoin as they are entirely voluntary and should probably be called “donations” (until miners require that a fee be included). These donations are entirely arbitrary and are probably not comparable to fees on other payment networks (such as Visa) which are mandatory and holistic (the interchange fee pays for all of Visa’s expenditures, no donations required). This is further described in Chapter 3 and the full costs of today’s subsidies are visibly illustrated in the Cost Per Transaction chart. For more information on interchange fees, Richard Brown recently wrote a highly recommended piece for readers.
The next post will discuss why token prices do not double for a token after a block reward halving.
Send to KindleEven though this video is about 17 months old, the topics they cover — FinCEN, KYC, AML, MSB, MTL — are not only still relevant in the digital currency / payments space but their answers can be seen as foreshadowing the enforcement actions we see on a regular basis now.
Send to KindleTurns out about 15 months ago, someone had already figured out how the mining costs of hash-based proof of work moved relative to the market prices of tokens, see “Why Bitcoin will never be a good store of value” by Stefan Loesch. One common retort to Loesch’s argument is that at some point in the future, for some reason, users will one day start paying higher tx fees. This is unlikely because it is a collective action problem. Why would people pay several orders of magnitude more to have the same exact service?
A new feature/dashboard that I came across is CoinGecko — has some interesting metrics to look at.
Other links related to digital currencies and China (linking is not an endorsement of service, coin, chain, etc.):
Send to KindleCoinDesk recently reached out to me to ask and see if I had any views on the divergent Bitcoin trading volumes between China relative to the rest of the world. The piece they ran included a few of my comments as well as some from several other traders and exchange operators, “China’s Market Dominance Poses Questions About Global Bitcoin Trading Flows.”
Readers may also be interested in a few other comments I provided them, a few of which are slightly edited (removed some names and numbers):
Send to KindleJeffrey Robinson is the author of over 20 books This past week he published a new book that looks at the history and some characters of the Bitcoin ecosystem called “BitCon: The Naked Truth About Bitcoin.” Earlier this summer he contacted me and asked me several questions, the answers of which appear in several spots in the book.
If you are tired of the continuous pumping on reddit, Twitter and conferences you will likely enjoy his challenges to cliche arguments.
For instance he pointed out that all the wars in the 16th, 17th and 18th century were not funded by central banks therefore it is unlikely that in the event Bitcoin did somehow take over the world, it probably would not make war disappear. The term he uses to identify “true believers” that make such argument is Planet-Bitcoin — a place where this vocal group of people reside. Speaking of which, probably the best quip throughout the book was at the end when a “true believer” calls him a “currency denier.” Is that a thing now?
Two errors that stood out that I noticed: the Icelandic government actually ignored auroracoin entirely (it was just some random people that did the “airdrop”). The other part is he stated, “So much so that amateurs have been thrown overboard by mining pools who can afford the ever-increasingly gigantic […]” Technically these are farms not pools.
Two economic terms that are frequently glossed over by many digital currency advocates:
Recreating a circular flow of income when there are already dozens of competing currencies (e.g., USD, euro, yen) that currently fulfill this task will always be an ongoing hurdle for Bitcoin-like digital currencies.
Regarding my last quote in the book, I should point out that Ripple may not necessarily be a “better” protocol, it just solves different needs in different circumstances. Though for some of the purposes for which Bitcoin is being shoe horned for, Ripple may be a better solution of the two. However this is an empirical issue, we cannot know a priori and a TCO analysis should be undertaken by each enterprise. As far as the fate of Bitcoin — that it can survive because its big holders will subsidize it — perhaps this could be the case, but it is also hard to say how long “whales” or big holders will be willing to subsidize any chain. It is also unclear how many coins that purported whales actually control still (versus how much they have cashed out) — I have heard all sorts of ownership numbers and if you add them all up, they total more than 13.2 million coins that have been mined so someone at these conferences is embellishing.
A taste of quotes
While the user adoption, merchant adoption and transactional volume numbers will likely change in the coming weeks and months, it is a quick read and below are some choice quotes that stuck out to me.
On first-movers and fads:
The Dot-Com boom, and subsequent bust, of the 1990s rewrote that script. So did Betamax, mood rings, semi-automatic transmissions, floppy disks, 8-Track, Amphicars, Apple Lisa, WebTV, IBM PCjr, Zune, and the Segway.
On the externalizing the costs of mining:
Some miners even employ methods that are not exactly “cricket.” There was one in Holland who literally stole the electricity he needed to run 21 rigs. He eventually got caught. (source)
Regarding the continually misquoted numbers pulled from Coinometrics, Robinson asks co-founder Jonathan Levin for clarification:
“[…] It was right around the December price increase, so there was lots of stuff going on in the press about bitcoin, and all over social media, as well. Everyone was using social media to promote bitcoin Black Friday. It was a massive promotion and it paid off with big sales. But the numbers I’ve got for that period worked out at around 5%. So when you’re talking about comparing PayPal and Western Union with bitcoin the rest of the time, then only about 3% are for goods and services. That puts you at one-hundredth of any other network.” A good reason why, Levin says, might be because, “Bitcoin is terribly inefficient. It’s all about decentralized trust. But if you don’t need to have decentralized trust, updating a spreadsheet in a bank is far more efficient. The cost of updating the ledger is more expensive with bitcoin and takes much longer than any system in the world.” With bitcoin verifications taking up to 10 minutes, he asks, “What happens with Visa? How quickly do they reconcile their database? Instantaneously. Bitcoin introduces the ability to cut out the middleman. That’s fine. But the paradigm is that while the blockchain technology offers decentralization, it doesn’t give you a more efficient system.” That’s not bitcoin’s only “bragging rights” problem. According to Levin, “There is no correlation with the increase of merchants allowing customers to pay with bitcoin and the amount of bitcoins being used for transactions. It’s linear.”
On his use of imagery:
The New York Post’s Sunday business editor Jonathon Trugman wittily describes bitcoin as, “The Tinkertoy crypto-currency,” likening it to, “A modern-day game of three-card monte, with a little Sudoku thrown in, just to add a touch of mystique.”
On putting the theft at Mt. Gox into perspective:
If it turns out to be true that $ 400 million has been stolen, it’s more than the sum total of all the bank robberies in the US for the past seven years.
Regarding the hype of adoption and ATMs in Canada:
However, the Canadian Payments Association reported in April 2014 that while Canada is estimated to account for as much as 4% of bitcoin’s global transactions – ranking it number two in the world, behind the United States but ahead of China – the volume of bitcoin transactions represents a mere 0.01% of Canada’s total debit and credit-based transactions.
“[…] not just that his is the largest company to do that, but a fast check of Google reveals there are actually more piano tuners just in Canada than there are businesses anywhere in the world of any size, keeping bitcoins on their books.
On the continual problem surrounding the ‘circular flow of income‘:
Dr Yanis Varoufakis, a political economist at the University of Texas and the University of Athens, says speculative demand for bitcoin outstrips transactional demand, “By a long mile. Bitcoin transactions don’t go beyond the first transaction. The people who have accepted bitcoins don’t use them to buy something else. It gets back to the circular flow of income. When Starbucks not only accepts bitcoins but pays their workers in bitcoins and pays their suppliers in bitcoins, when you go back four of five stages of productions using bitcoin, then bitcoin will have made it. But that isn’t happening now and I don’t think that will happen.” Because it isn’t happening now, he continues, and because so many more people are speculating on bitcoin rather than transacting with it, “Volatility will remain huge and will deter those who might have wanted to enter the bitcoin economy as users, as opposed to speculators. Thus, just as bad money drives out good money, Gresham’s famous law, speculative demand for bitcoins drives out transactional demand for it.”
On the odds that Bitcoin will supplant the state:
Professor Stephen Mihm, who teaches economic, cultural and intellectual history of 18th and 19th century America at the University of Georgia, is convinced that bitcoin will not survive, because it cannot survive. He’s written, “Anyone who thinks that bitcoin will triumph, has to believe that it will succeed where earlier generations of private currencies failed, that bitcoin will, improbably, manage to overthrow more than centuries’ worth of accumulated state power, jealously guarded and ruthlessly enforced. That’s a preposterous fantasy, and a dangerous one if you’re an investor. Indeed, people who believe that governments of the world will let a stateless crypto-currency usurp their hard-won monetary prerogatives aren’t forecasting the future. They’re living in the past.”
More on whether or not it will supplant the state:
He says, another reason why bitcoin won’t be the one is because, “The misguided notion that you can free government from currency. Governments regulate money. They put certain constraints on it that you have to follow. So the technology that evolves must be ready to accommodate that. Most commerce will still be done in dollars. Currency is backed by the full faith and credit of a government. Bitcoin is backed by the full faith and credit of wasted computer time.” Seeing The Faithful, “Like a tribe,” he likes to think that their enthusiasm will, somehow, someday, “Help make progress towards a more rational digital currency. But, ultimately the providers of those currencies are probably going to be governments.” At this point, Borenstein argues, “No one should see blockchain technology as an end to a means. No one should look on it as a single achievement. Instead, it should be seen as a point on a spectrum. We may be long gone when bitcoin finally dies, but that doesn’t mean it’s been a success.”
On volatility:
David Yermack, a professor at New York University’s Stern School of Business, and director of the Pollack Center for Law and Business, believes that bitcoin resembles a speculative investment similar to the Internet stocks of the late 1990s. Writing in the MIT Technology Review, he summed up bitcoin’s problems this way: “During 2013 its volatility was three to four times higher than that of a typical stock, and its exchange rate with the dollar was about 10 times more volatile than those of the euro, yen, and other major currencies. Bitcoin’s dollar price exhibits no correlation with the dollar’s exchange rates against other currencies. Nor does it correlate with the value of gold. With a currency whose value is so untethered, it is nearly impossible to hedge against risk.”
Even if volatility subsided and bitcoin somehow found a place as a global payment system, because there can only ever be 21 million bitcoins, Yermack pointed out, it is inherently deflationary. “A fixed money supply is incompatible with a growing economy. Workers would have to accept pay cuts every year, and prices for goods would gradually fall. Such conditions might lead to public unrest reminiscent of the late 19th century’s free-silver and populist movements — an ironic consequence of a currency known for its futuristic cachet.
On the talk of losing purchasing power over the past century:
Levine shrugs that off. “Talk of 1913 dollars is completely meaningless. You need a small amount of consistent inflation because the effects of deflation are so awful. Why is everyone holding onto their bitcoins instead of spending them or lending them? Because they think it will be worth more. Back in the 1800s, people put cash in the mattress because nobody was managing the currency and there were no credible markets, except in Britain. These days, only a nitwit puts cash in the mattress.” He throws back at them the classic dilemma that the Founding Father’s faced in the 18th century – the bankers versus the farmers. “Historically, the bankers wanted hard money, which meant gold, so that their dollar denominated assets would become ever more valuable. The farmers, who were always in debt, wanted cheap money, which in the 1800s meant silver, because they wanted some inflation so they could pay off all their loans. This argument starts with Hamilton and basically doesn’t end until we get off the gold standard. Bitcoin is a world where everybody wants to be a banker and nobody admits he’s a farmer.”
Is it similar to how the internet evolved?
I then asked Borenstein what he thought about The Faithful’s often quoted comparison – that the birth and development of bitcoin mirrors the birth and development of the Internet. He wasn’t having any of it. “The Internet was designed by the most open process known to man, there’s not even an organization behind it. Thousands of people are responsible for making the Internet work through endless sessions of technical minutiae where everybody agrees to do something the same way. That does not sound like bitcoin. There may be all sorts of similarities that don’t matter. The same language, the same open source modules, but I don’t see it as being anything at all like the same.” While he remains hopeful that, one day, we will see widespread use of digital currencies, he confidently predicts, “Bitcoin won’t be it. The technology must be configured in such a way as to meet the national, political and social goals of the people who are going to run that currency. You could lay that universal framework at the software level, the systems that will inevitably be out there, to make them interchangeable. If that happens, I doubt that bitcoin’s code will be very useful.”
On hype and irrational exuberance:
Tech guru John Dvorak described it perfectly in one of his columns: “The amount of money squandered during the Dot-Com era because of ‘paradigm shifts’ and ‘new economies’ is staggering. People actually believed that all retailing would be online and that all groceries would be delivered to the home as they were in the 1920s, despite changes that make delivery impractical. Who cares about reality?”
On the wisdom of trying to short exuberance:
Referring to bubbles as “spontaneous optimism,” John Maynard Keynes pointed out, “The market can stay irrational longer than you can stay solvent.”
On the difficulty of creating other derivative products:
His answer to the first question is no. His answer to the second is yes. Bitcoin mining is very expensive, he explains, and most miners barely break even. Then, because the technology is designed to produce fewer and fewer bitcoins, he is concerned with who’s going to pay for verifying each transaction? “Eventually, as the supply of bitcoin diminishes, those fees will increase to cover the cost of authenticating the transactions, and will become competitively close to the fees for international bank wires. The arithmetic is really simple. I don’t see any way around it.” Levine shares Krugman’s doubts about bitcoin as a currency – “For a while I thought it was like Pet Rocks without the rocks” – but now he wonders, “Would you be willing to take out a mortgage written in bitcoin? The volatility suggests no one would. And, what does it say about bitcoin as a currency when nobody is willing to do anything with it besides a spot transaction?”
On MintChip and building things before there is enough demand for it:
The idea of electronic payment systems has been around for a while, but it wasn’t until 1990 that it actually got off the ground. That’s when Dr. David Everett in the UK invented the first “electronic purse.” His system was called Mondex. Developed with National Westminster Bank, it was a revolutionary idea for its day. The cash was your smart card and you spent it at point of sale terminals. For a while it got a lot of attention, then eventually, fizzled out. Everett was severely disappointed.
“I’m afraid it was way before it’s time. Just too early. In hindsight, there was nothing really broken about payment systems at the time. The Internet didn’t really exist yet. Mobile phones didn’t really exist yet. The focus we had was paying at point of sale. It was very good for the merchant, but in the end it was not so for the consumer who argued, why would I bother?” A world expert on payment systems, coding theory and cryptography for the protection of data, Everett is CEO of the Smart Card Group, technical director of Smart Card News and a man who says that his mission in life is still electronic cash. “I am an enormous believer in electronic cash.” When the Canadians asked him to help them design MintChip, he jumped at the opportunity. “MintChip was almost ten years after Mondex and I was convinced about that one too.” The idea that a Mint would produce electronic cash, “Just seemed so logical,” he says. “That’s what mints do. They mint cash.” As technical architect for the project, Everett was looking to reproduce the ease would want to do, so now you’re into merchants. Maybe a big retail chain. Say Walmart. The cost of managing cash for them is quite high, and credit and debit cards carry with them transaction fees. For big merchants, electronic cash is ideal. Here’s a way of handling payments at a fractional cost of handling cash. Walmart Dollars would work very well and if they did it, everyone would follow.” Ideally, he says, whatever the next stage is, it would not be linked to a bank account or a debit card. “We need to be unconnected. In that sense it is like bitcoin because bitcoin is unconnected. But what I want to see is a real electronic object representing cash. That’s very different from bitcoin.” For him, bitcoin is, “A new form of gold. It is electronic gold. Whereas Mondex and MintChip is equivalent to real currency, a real pound or a real dollar. I think there are a lot of nice things in the bitcoin technology, but I don’t think it’s very good for cash. It doesn’t really lend itself to immediate payments. I’m surprised bitcoin has gone as far as it has.”
On the faux news that Mastercard would be adding support for bitcoin as well as a recent patent filing:
[…] assured me Mastercard wasn’t doing anything of the kind. He explained, the application was filed to protect Mastercard’s intellectual property and did not indicate any commitment to bitcoin. “There is no obligation to ever build anything that a patent application covers.” JP Morgan had done a similar thing with a payments’ patent, putting bitcoin in there, and The Faithful reacted in kind. A spokesperson for Morgan gave me much the same answer as Mastercard. Now I brought it up with Borenstein. A man who still spends a large part of every day working on patents, he says that neither company has any intention of ever accepting bitcoins. Instead, he suggests, they harbor more sinister intentions. “Every patent has to describe all the different storage technologies it might reside on. Which really means, they’re arming themselves for a possible war. Just in case bitcoin ever poses a real threat. They’ll do what they can to wipe them out.”
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