Book Review: “Popping the Crypto Bubble”

Last year a friend sent me a copy of “Popping the Crypto Bubble.” I read the first few chapters before life got in the way and recently re-discovered it while unpacking and finally finished reading it.

This is a book I should have liked, after all, for years I have been labeled as a “crypto critic” or as a “no-coiner” terms that I thought were inaccurate or even slurs.1

In fact, for several years I wrote a private newsletter that was circulated among many now prominent anti-coiners. So if there is someone who should have wanted this book to be great, it is me. But it is not. It is actually a bad book.

I have formally written eight book reviews for “blockchain-related” books and I would rank this at the bottom. Part of it is the poor editing which has been highlighted by at least one other commentor. For example, the bibliography section is out of sync and is missing an entire chapter.2

But the bulk of the feedback is that the chapters are sloppily assembled with a hodgepodge of polemical rants. The substance comes across as a broken record of anger and angst.

In addition, the book is typically associated with a singular author, Stephen Diehl, but there is no unified voice throughout the book. Instead, many passages read as though they were carved out in a Google Doc by one of his two co-authors (co-workers actually).

As a result, a reader will find themselves ploughing through some semi-technical explanation of a financial product only to hear Diehl’s voice wedge itself at the very end, claiming it was all a scam or fraud or both. It is tiring because it happens so often.

Before diving into the book, worth mentioning that unlike virtually every other book on this topic, the authors do not provide their background or motivation in any section, although the tone is clear as early as page 1.

For readers unfamiliar, the three co-authors worked together at a US-based company called Adjoint, a tech firm I was introduced to in July 2017 when it was involved in doing something with smart contracts which Diehl has removed from his LinkedIn bio.3 Adjoint announced “Uplink” a couple months after that call.

WBB of Adjoint’s now deleted Press Release from October 2017 regarding Uplink.

Obviously it is okay for people to change their minds. Some people do not like the local sports team when they move to a different state or province. Some people fall out of love for avocado toast. Some people like working on “the next generation of distributed ledgers.”

So what changed Diehl’s mind between 2017 and 2022? According to Diehl’s presentation in December 2017 he was all-in on blockchains; then in a group presentation in April 2018, the co-founders were still on-board the blockchain train. It is not clear from the book (perhaps he has said somewhere else?) but he leaves no doubt that he is not a fan of cryptocurrencies or blockchains or smart contracts or web3.

Below is a breakdown of issues with each chapter. Note: all transcription errors are my own.

Chapter 1: Introduction

In the second paragraph on p.1 the authors write:

The overarching idea of cryptocurrency is based on a complex set of myth-making built on a simple unifying aim: to reinvent money from first principles independent of current power structures.

Where is the citation or source to back up that claim? Perhaps some Bitcoin maximalists hold that core view as their raison d’être to “reinvent money” but if we were to say, use the title of popular conference panels, it isn’t actually as common in 2023 or probably even June 2022 when the book was published. However the onus is on Diehl et al., to provide evidence for the claim and it is not presented.

Grammar: in the same paragraph there is a glaring grammatical issue on the first page of the book. It was also highlighted by one Amazon review:

Source: Amazon review

On the same page the authors write:

While a software is political, some software is more political than other.

Not only is there a missing “s” at the end, but it is not really clear what this means even with the following sentences related to the 2007-2009 Global Financial Crisis. Is Solitaire political? Is Excel political?

The concluding sentence of that same paragraph concludes:

The divisions over cryptocurrency are based on a philosophical question: Do you worry more about the abuse of centralized power, or about anarchy?

Again, no citation or anything to surmise why this is the philosophical question.

For instance, there seems to be a range of motivations for why a regulated financial institution operates a trading desk involved in the cryptocurrency world, or why that same organization might have a different business unit that builds a custodial product for their tokenization efforts. I have sat in meetings with these types of entities and I do not recall hearing anarchy mentioned, but maybe my sample size is too small or outdated.4

Chapter 2: The History of Crypto

On p. 3 the authors put in a pullquote:

Cryptocurrencies were intended as a peer-to-peer medium of payment but have since morphed into a product whose purpose is almost exclusively as a speculative investment.

Perhaps Bitcoin and some of its immediate clones were intended for payments (at least according to the original whitepaper) but again, no citation for the latter claim about speculative investment. Maybe that is true. Either way, later in the book the authors change their tune and say that cryptocurrencies are a reimaging of money. There is little consistency from beginning to end.

The first couple pages describing “the Cypherpunk Era” are okay but the authors slip up stating:

In the 21st century, most money is digital, represented as numerical values in databases holding balance sheets for bank deposits.

This may seem pedantic but the authors do not state what part of the world they are describing in the 21st century. If it is the U.S. then they probably mean to use “electronic” not “digital.” There are no digital dollars in circulation yet as the Federal Reserve has not issued a central bank digital currency (CBDC).

Instead, users are often left with siloed representations of non-fungible dollars “issued” by a menagerie of entities, typically intermediaries such as commercial banks. The e-Cash Act and STABLE Act were a couple of proposals to move in that direction, but as of this writing we do not currently have a “digital dollar” in the U.S.

On p. 5 the authors write:

To most consumers today, this is transparent, although it was first, in the early 2000s that, consumers became aware of the digitization of their money in the form of increasing online banking.

Who are these consumers, where are they based? If the authors are describing the U.S. a future edition of the book should be specific.

Continuing on p. 5 they write:

However, in the early days of e-commerce, there was still apprehension around receiving and making payments over the internet with credit cards. To fill this gap, PayPal emerged as a service to support online money transfers, which allowed consumers and businesses to transact with a single entity that would process and transmit payments between buyers and sellers without the need for direct-to-bank transfers.

On the one hand it is clear why PayPal was used as an illustration for this evolving time period, yet it should not be trotted out as a “success story.”

As highlighted by legal scholars such as Dan Awrey, PayPal has always operated as a “shadow bank” and “shadow payment” provider.5 Its management shoe horned the company into the bedrock of U.S. e-commerce all while dodging banking regulators calls for the erection of a state or national-chartered bank.

While some readers may be okay with that outcome, Diehl et. al., explicitly deride this specific type of behavior from pegged coin issuers (stablecoins). Incidentally, in the process of writing this review, PayPal announced the release of a pegged, centrally-issued stablecoin – PYUSD – on the Ethereum network. How does PayPal operate now? The same as it always has: which happens to be very similar to how centralized stablecoin issuers.

Source: Twitter

On p.7 they write:

The mechanism described in the bitcoin whitepaper proposed a novel solution for the double-spend problem, which did not require a central trust authority.

This part of the chapter is fairly straightforward and dry and lacks any of the hysterical commentary. Since there is no unified voice, perhaps it was written by one of the two fellow co-authors?

Either way, it is not explored or mentioned in this chapter (or anywhere else) but of the eight references in the Bitcoin whitepaper, three of them cite the works of Haber & Stornetta, whose digital signing concepts illustrate that there are indeed “useful” things that the blockchain world has contributed (see slides 22-24). Of course that would be contrary to the narrative this book is attempting to defend.

Worth mentioning that the writers typically use lower case b and e for both bitcoin and ethereum even when they are discussing the networks and protocols. This is a little confusing because conventionally, it is fairly common to use lowercase b to describe the unit-of-account, whereas uppercase B to describe the network or code.

For instance on p. 8 they write:

Moreover, the bitcoin algorithm took a particularly interesting approach to consensus by attempting to create a censorship-resistant network where no participants is privileged. The consensus process was eventually consistent and tied the addition of new transactions to the solution of a computational problem in which computers that participated in the consensus algorithm would need to spend a given amount of computational work to attempt to confirm the writes. This approach, known as proof of work created what is known as a random sortition operation in which a network participant would be selected randomly and probabilistically based on how much computational power (called hashrate) was performed to attempt consensus.

A couple of nitpicks:

(1) There is no singular “bitcoin algorithm.” Arguably the best explanation of the moving parts that Bitcoin uses is from Gwern Branwen: Bitcoin is Worse is Better. This is not the only time the authors incorrectly describe a bundle of technology.

(2) The authors should be clearer that “proof of work” itself is a concept that pre-dates Bitcoin by more than a decade (Dwork & Naor 1993). Over the past five years, more of the technical-inclined papers on this topic typically refer to the way proof-of-work is used in Bitcoin as Nakamoto Consensus. The authors mention Nakamoto Consensus a few chapters later however they are strangely very thrifty when it comes to footnotes or citations so a second edition should include this nuance.

On p. 8 they write:

Therefore the bitcoin architecture created a computational game mechanic in which the computers in this network (called miners) competed to perform consensus actions and successfully confirming a block of transactions gave a fixed reward to the first “player” to commit a set transactions.

This is not quite right. A phenomenon called “orphaning” (similar to uncles in Ethereum) occurs when more than one miner simultaneously solves (discovers) a block. At some point one of the branches is orphaned (pruned) when other miners build on one but not the other tree.

This is part of the reason why a hardcoded 100 blocks (roughly ~17 hours) is required before a miner can issue themselves a block reward (e.g., the coinbase transaction has a block maturity time box).

A typo occurs on the last sentence of that paragraph:

The critical ideas encoded in the protocol are the predetermined release schedule, fixed supply, and support for those protocol changes that have support off a majority of participants.

This has a typo: off –> of

On p. 8 the authors write:

One of the core algorithms used in most blockchains is a hash function.

While reading this it was:

(1) unclear why they used ‘algorithm’ and;

(2) which blockchain does not use a hash function?

On p. 9 they discuss difficulty adjustments:

This mechanism allows the difficulty of bitcoin mining to be artificially adjusted proportionally to the rewards.

It is not quite clear what “artificial” means here. In Bitcoin, the supply schedule for the issuance of new bitcoins halves roughly every four years (actually less than four years but we will discuss that later).

Those with commit access could theoretically modify the fixed rewards / supply schedule, and miners could update their node software to increase or decrease that amount. But none of this action is artificial, so why use that word?

We could argue that chronologically early miners received a disproportionally higher amount of rewards relative to the frequent empty blocks they built and processed for the first ~5 years. Is that fair? Probably not. Is it artificial? Probably not.

On p.9 they discuss censorship resistance:

The censorship resistance of this algorithm was the critical improvement over existing eCash systems which previously had a single legal point of failure, in that the central register or central node would have to be stored in a single server that could be targeted by governments and law enforcement. In this trustless peer-to-peer (P2P) model–the same mechanism that powered Napster and BitTorrent–all computers participated in the network, and removing any one node would not degrade the availability of the whole network. Just as previous P2P networks routed around intellectual property laws, bitcoin routed around money transmitter laws.

There are a few issues with this:

(1) Which algorithm are the authors referring to as an “algorithm,” the entire Bitcoin codebase circa 2009?

(2) Napster was quasi-centralized, it provided an index of files and that is why it was a relatively easy target for lawsuits by the music industry (RIAA) and law enforcement.

(3) The authors have a habit of wading into legal and regulatory territory without providing much in the way of definitions or what jurisdictions they are describing.

For instance, in the last sentence they are probably referring to the U.S. In the U.S., each individual state has laws and regulations around money service businesses (MSB), of which money transmission (MTL) is a subset of. Some states do not. At the federal level some entities are required to register with FinCEN which enforces the Bank Secrecy Act (BSA). A second edition should include specific jurisdictions to strengthen the authors arguments.

(4) This may be perceived as pedantic, in section 1 of the original Bitcoin whitepaper it describes the motivation of building a network for participants to engage in online commerce without having to rely on financial institutions. Conventionally this is more of a stab at know-your-customer (KYC) collection gathering requirements.6

On p.10 they write about how Bitcoin was first marketed, stating:

This new era marks a rapid expansion of a cottage industry of startups and early adopters who would build exchanges, mining equipment, and market network to proselytize the virtues of this new technology. The culture around the extreme volatility of the asset created a series of memes within the subculture of HODL (a portmanteau of the term “holding,” standing for “hold on for dear life”), which encourages investors to hold the asset regardless of price movement.

Couple of issues:

(1) It is clear later in the book that the authors have a gripe about how blockchains are proselytized. I deeply sympathize with their disdain towards shilling. I violently agree with them in some parts. But, like in the rest of the book, they miss the opportunity to provide the reader with specific examples.

(2) I have pointed this out in several other book reviews but the etymology, the genesis of “hodl” did not originate as an acronym or portmanteau. It came from a drunk poster on the BitcoinTalk forum, there are many articles discussing this. However, what the authors describe “hodl” to mean is correct.

On p.11 they start a new section on the “grifter era,” stating:

In addition to bitcoin, a series of similar technologies based on the same ideas emerged in the 2011-2013 era. The first movers were Litecoin, Namecoin, Peercoin, and a parody token known as Dogecoin based on an internet meme.

Several issues with this:

(1) Why did the authors use uppercase for four cryptocurrencies instead of lowercase?

(2) A second edition should probably arrange the first three by chronology or alphabetized. For instance, Namecoin was an evolution of BitDNS (a project that was spun up just as Satoshi stopped formally contributing to Bitcoin). It was launched in April 2011 and due to its utility usually is not placed in the same category as Litecoin or Dogecoin.

In the same paragraph they note that:

As of August 2018, the number of launched cryptocurrency projects exceeded 1600.

It is unclear why the authors chose that specific time frame. For instance, according to CoinGecko, they have identified 10,052 coins as of this writing. The infrequently updated “Deadcoins” database lists 1729 entries as of January 2023.

The next sentence is a little quizzical:

In 2015 a significant extension to the bitcoin model called the ethereum blockchain was launched with the aim to build a “world computer” in which programmable logic could be expressed on the blockchain instead of only simple asset transfers.

It is only eleven pages into the book but we still have not been provided a clear definition of an “algorithm” versus a “model” versus a “protocol.”

Ethereum (which the authors do not capitalize either) is significantly different than Bitcoin so to call it an extension is a bit of a stretch.

Also, Bitcoin uses a transaction model called unspent transaction outputs (UTXOs) whereas Ethereum uses a different model called Accounts. The former is unable to actually transfer assets per se, hence the creation of “colored coin” schemes starting in 2012 to enable other assets to be created (nearly all of the original “colored coin” efforts have disappeared and heterogenous assets that use the Bitcoin blockchain are currently conductible via the Ordinals protocol).7

Two sentences later the authors change the capitalization again:

In addition to fully visible transaction models of previous tokens, chains such as Monero and Zcash would incorporate privacy-enhancing features into the design, allowing participants to have blinded transactions that would obscure the endpoint details for illicit transactions with no public audit record.

A second edition needs to explain why the authors flip capitalization around. Is it only uppercased if the chain is mentioned just once?

Later in the book the authors do go on to describe some of the privacy and confidentiality approaches but only with the context of criminogenic behavior. It could be helpful for readers to have some citations of relevant papers or articles since the topic intersects with securing accounts, assets, and transfers in traditional finance.8

The next paragraph jarringly switches gears to proof-of-work mining (without mentioning PoW):

Early entrepreneurs realized that they could gain an advantage over traditional server farms if they built faster and more specialized hardware to compute these hashes. These entrepreneurs began to build ASICs (Application Specific Integrated Circuit), custom hardware circuits that could do the computations required for the bitcoin network more efficiently than traditional CPUs offered by companies like Intel and AMD.

For some reason this section omits two intermediate steps between CPU mining and ASIC mining. These would be GPU mining and FPGA mining. More importantly it misses the opportunity of pointing out that Satoshi herself was surprised and sullen when she learned that miners had figured out how to scale GPU mining the way ArtForz and Laszlo Hanyecz revealed.

A few sentences later they dive into mining pools:

These mining pools became a centralized and very lucrative business for early investors. An example is, the Chinese company BitMain, which began to centralize most of the computational resources, resulting in 70% of all bitcoin mining being concentrated in mainland China by 2019.

The authors skip a few years and neglect to mention key figures in the creation of commercialized ASICs such as Yifu Guo. Nor do they mention, in dollars or some other figure, how lucrative these pools were. Or which the first public ones were (Slush and Eligius were among the first).

This section also conflates mining hardware (used in farms) with pools which provide the block building itself for an aggregation of mining farms. Lastly, the capitalization of BitMain is incorrect (the company markets the hardware in either all caps – BITMAIN – or Bitmain).

On p. 12 they write:

The underutilization of coal-fired power production and Chinese capital restrictions on renminbi outflows offered a unique opportunity for enterprising Chinese citizens to move capital outside of the mainland beyond government controls. In 2018 the Chinese government officially declared cryptocurrency minig an undesirable activity. The same year, Bloomberg reported $50 billion of capital flight from the Chinese state using the Tether cryptocurrency.

This is not the correct chronology. Because the authors do not provide many citations it is unclear what they were referring to in 2018. A quick googling found a possible related article but the actual real big ban took place in two separate actions in May and September 2021. As their book was published in mid-2022, the authors could have used more recent figures here.

Note: later in Chapter 25 they do reference a more up-to-date story. They also not explain the specific legal and regulatory woes that miners faced in China which led them to move hardware overseas in the second half of 2021.

In addition, the authors only mention energy generation in passing but neglect to mention a key culprit for why Bitcoin (and other PoW-based coins) flocked to specific regions of China: subsidized electricity from hydroelectric dams due to overcapacity / overproduction of dams. This has been widely documented by others.9

Some of the miners literally packed up their machines onto trains after the rainy season was over and decamped for provinces in the north such as Xinjiang and Inner Mongolia, where coal-fired plants powered their wares for the remainder of the dry season. A crazy phenomenon and one the authors should consider adding in the next edition.

On p. 12 they write:

The Grifter Era period also saw the introduction of stablecoins such as Tether, aiming to be a stable cryptoasset with its price allegedly pegged to the US dollar and theoretically backed by a reserve of other assets. This is followed by a 2019 period of market volatility and market consolidation of cryptocurrencies, during which many unfounded ideas fell off and left a handful of 20 projects which would dominated trading volume and developer mindshare.

In this section the authors never really define what time the “Grifter Era” takes place. Based on the actual words they wrote up until this point we have years: 2011-2013, 2015, 2017, 2018, and 2019. Yet they specifically mention a “stable cryptoasset with its price allegedly pegged to the US dollar” which sounds like a “stablecoin” such as Tether (USDT). But Tether was actually launched as Realcoin in 2014.

Also, the authors do not mention any of the “20 projects” which dominated volume and mindshare. Seems like a curious omission. Does that include Binance and Cosmos then?

The chapter comes to an abrupt end, with the final paragraph:

In 2021 China outright banned all domestic banks and payment companies from touching cryptoassets and banned all mining pools in the country. At the same time, the United States continued to be hit by an onslaught of cyberterrorism and ransomware attacks that began to attack core national infrastructure and the country’s energy grids.

What is the reader supposed to take away from this chapters concluding remark? Later in the book the authors dive into ransomware but readers are not provided any citations or sources for where we can learn more about these specific cyberattacks.

For example, prior to being blocked by him on Twitter, I briefly corresponded with Diehl regarding ransomware. I even agreed (and still agree) with some of his points he has made on the specific topic. Yet here he misses the opportunity to connect liquidity (and banked-trading venues) with ransomware payouts. The next edition to clarify the current non sequitur.

Chapter 3 Historical Market Manias

This is one of their stronger chapters. It succinctly discusses the history of past manias and subsequent crashes including the South Sea Bubble, the Mississippi Bubble, the Railway Mania, Wildcat banking, the 1929 stock market collapse, Albanian pyramid schemes, Enron, and others.

While most of the prose is in a unified voice, at the tail end of the Wildcat section on p. 26 they write:

The wildcat banking era is an important lesson to learn from the past, given the recent fringe efforts to return to a digital variant of private money with stablecoins and cryptoassets.

It is followed by three citations all related to the topic at hand. Yet the authors fail to distinguish – as they fail to distinguish later in the section on stablecoins – that in the U.S. all commercial banks issue the equivalent of private money and credit.

In fact, it is the expansion of this credit (and leverage) by private banks and other lending institutions that often leads to booms and busts in the modern era. During this time frame both M1 and M2 aggregates – publicly money – basically grew linearly apart from the recent COVID-era emergency responses.

This distinction is important because to be consistent, the authors should recognize that in the U.S. credit expansion from non-banks and certain fintechs like PayPal, fall under the umbrella of “shadow banking” and “shadow payments” which predates the creation of Tether (USDT) and other centralized pegged coins by decades.

Source: Wikipedia

To be consistent, the authors need to update their priors and at a minimum reconcile for the audience what they prescribe all “shadow banking” and “shadow payments” should be required (or not) to do. Singling out “private money” without recognizing the very important nuance that most money and credit retail users interact with is private, is disingenuous.

While talking about the history of Beanie Babies, on p. 33 they write:

Buyers of Beanie Babies could never find the whole collection in one store, and the artificially limited supply meant it always appeared that the products were selling out. By limiting the distribution channels, creating the toys as part of a broader collection and simultaneously creating a variable artificial scarcity within the collection, the company bootstrapped a collectible item seemingly based on a small children’s toy which had very little intrinsic value unto itself–Not unlike the crypto market for non-fungible tokens (NFTs) today.

This is not necessarily a bad example but there are two more germane examples with respect to collectible NFTs:

(1) In the U.S., baseball card production is a licensed activity based on I.P. that Major League Baseball (MLB) has a monopoly on.10 The manufacturing arrangement effectively states who can and cannot produce the likeness of players, coaches, teams, logos, etc. on memorabilia.

Over the past several decades, collectible card manufacturers have remained relatively static yet these manufacturers (such as Topps and Fleer) created a glut of cards in the lates ’80s and early ’90s.11

Coincidentally, in the process of writing this review, MLB sued Upper Deck, “accusing it of trademark infringement for using its logos on trading cards without permission.”

(2) Getty Images. While they do have some non-commercial, royalty free stock galleries, Getty acquires the I.P. of images and uses an army of lawyers to sue anyone who violates or infringes on those rights. They attempt to artificially restrict the usage of easily reproducible imagery. 12

On p. 24 the discuss the Dot-com bubble of 1995-2001, stating:

The most recent bubble in living memory was is the dot-com bubble in the 1990s.

Two issues with this sentence:

(1) Grammar or typo with “was is”

(2) The very next page they discuss the subprime mortgage crisis which seems to be chronologically at ends with “most recent bubble” for the dot-com bubble. Which is the most recent?

On the final sentence of p. 24 they write:

Shortly after that, the use of the web for private commercial applications exploded. The era saw the rise of Google, eBay, PayPal, and Amazon coupled a vast Cambrian explosion of both technologies and new business models.

While all four of these technically co-existed during the time frame stated, only two of them went public before the end of 2001, the timeframe they gave.

Also, it is unclear why these Big Tech companies repeatedly receive a free pass throughout the section and the whole book. Apart from one subsection later on Occupy Wall Street and a small passage in the Conclusion, one consistency throughout the book is that the authors seem to be okay with the status quo and incumbency of both legacy financial institutions and Big Tech companies.

This seems at odds with the view of holding entities such as pegged-coin issuers accountable since cloud providers are largely unaccountable systemic utilities.

For instance, academics such as Lee Reiners have argued that cloud providers – such as AWS and Google Computer – should be regulated under Dodd-Frank Title VIII. Likewise another scholar, Vili Lehdonvirta, has argued that these cloud empires are as powerful as states yet unaccountable.

Both Reiners and Lehdonvirta are typically categorized (incorrectly?) as anti-coiners yet both of them provide a much more even handed treatment of systemic risks, such as large commercial banks, than the authors of Popping the Crypto Bubble.

Source: Twitter

On p. 37 they discuss the subprime mortgage crisis of 2003-2008, writing:

In the decade of real estate euphoria, the amount of mortgage-derived credit increased from $900 billion to $62 trillion.

That seems like a pretty big change over time, but there is no citation for readers to learn more. A second edition should provide one.

On p. 39 they describe the venture capital bubble of 2010-present, discussing WeWork and Uber blitzscaling, writing:

While these companies did achieve scale, they became mired in controversy and scandals as a direct results of their predatory and unsustainable business model. Although both WeWork and Uber went public, neither company was able to become profitable and is now trading at fractions of their inflated private valuations.

In mid-2022, when the book was published, part of that closing statement was untrue. WeWork pulled its IPO in 2019 and merged with a SPAC for a direct listing in October 2021.13

The authors missed the opportunity to dunk on SPACs which screwed over retail investors.14

Source: Bloomberg

On p. 41 the authors wrote about the Crypto Bubble 2016-present, a lot of which I agreed with. However one passage quickly falls into a rant, on p. 42 they write:

The simple undoing of this idea of a new financial system is that there is no economy in crypto; because it can never function as a currency. Nothing is priced in crypto. No commerce is done in crypto. No developed economy recognizes crypto as legal tender or collects taxes on it. The price of crypto simply oscillates randomly, subject to constant market manipulation and public sentiments of greed and fear, detached from any activity other than speculation. Crypto is a pure casino investment wrapped in grandiose delusions. As an investment, it is almost definitionally a bubble because crypto tokens have no fundamentals, no income, and correspond to no underlying economic activity.

A second edition could reword and cut out half of the rant and turn it into a much stronger statement all without using broad sweeping a priori cudgels.

For instance, saying “never” implies the authors know the future. But they, like the readers, cannot know the future of every cryptocurrency or blockchain to come. We need to use the facts-and-circumstances, an evidence-based approach, to determine which cryptocurrency (or token) currently has legs and which ones do not. Saying they all cannot is sloppy and lazy polemics. It is soothsaying.

Another area for improvement: in 2014 Yanis Varoufakis may have been the first economist to articulate – in long form – that a cryptocurrency like bitcoin (with an inelastic supply) will unlikely to be part of a circular flow of income. The authors could add that reference to make their argument stronger, after all, they are no stranger to Varoufakis who they cite in the next chapter.

They could also make the distinction between an anarchic cryptocurrency such as bitcoin or litecoin, which have inelastic supplies versus Dai or Rai, which are only minted when collateral is deposited into a contract. This would take an additional explanation of dynamic supply via collateralized debt positions (CDP) but would help inform the reader that there is another world beyond fixed supply coins such as bitcoin and its antecedents.

Another example they could use to buff up their argument is to provide references of jurisdictions that did attempt to accept cryptocurrencies as a form of payment for taxes, but then later stopped the effort. Ohio is one example of this occurrence.

Chapter 4 Economic Problems

The first few pages of this chapter start off strong. I even found myself nodding in agreement when the pointed out on p. 46 the euphemism some coin promoters use “cryptoassets” in lieu of “cryptocurrencies” to make the former more palatable. We highlighted that in the book review of an equally bad book, Cryptoassets by Burniske and Tatar.

But then it begins to go off the rails, again, starting on p. 52 they write:

In addition, without any nation-state recognizing cryptocurrencies as its sole legal tender, there is no demand for the currency to pay one’s taxes. The demand for cryptocurrency is only based on either criminality or speculation.

The book is full of these opinions stated as facts.

Again, if there is one person who wants to agree with Diehl et. al., it is me. I have written a slew of posts and papers, most of which are linked to on this site, which have attempted to dive into these very topics. But they are not doing themselves any favors by being so stingy on citations or explaining how they arrived at only two categories: criminality or speculation.

And this hurts their credibility because their claims could be stronger by simply googling or asking experts if they know of a citation they could add. Right now, their bold confidence comes across identically as coin promoters who claim – without evidence – the central banks are going to collapse in the face of Bitcoin’s choo-choo-train.

To both groups of people we can respond with Hitchen’s razor: what can be asserted without evidence can also be dismissed without evidence. And unfortunately for Diehl et. al., a large portion of the book could simply be dismissed due to a lack of evidence (or citations).

While discussing deflationary assets, they write on p. 52:

The US dollar has the deepest and most liquid debt markets mainly because the dollar has a relatively predictable inflation rate on a long time scale, and its monetary parameters remain predictable up to the scale of decades. Thus the risk of servicing loans is readily quantifiable, and banks can build entire portfolios of loans to their communities out of their reserves.

A future version should explain that specifically the authors (likely) mean the market for U.S. Treasury bonds, not dollars themselves.

On p. 53 they write:

Unlike in the fiat system, where the market conditions for debt products organically determine the supply of money in circulation relative to demand, a cryptocurrency must determine both supply and demand prescribed in unchangeable computer code. This would be like if the United States Federal Reserve decided what the monetary policy of the United States would be from their armchair in 1973 and into the future, regardless of any future market conditions, pandemics, or recessions.

This is a bit of a strawman and lacks needed nuance.

(1) In the U.S. the majority of money and credit expansion (and contraction) comes from private, commercial banks and other lending institutions, not just the Federal Reserve.

(2) The authors criticism is valid with respect to coins with fixed supplies that are purposefully attempting to replicate “money” but not every cryptocurrency or token is attempting to do that. In fact, as mentioned above, both Dai and Rai are dynamically issued based on collateral deposited, there is no fixed supply of either.

(3) There seems to always be debates around “unchangeable computer code” but most of this ideological debate has been sidestepped by issuing new smart contracts with upgrades (or downgrades or sidegrades).

Either way, the authors could strengthen at least one of their arguments by referencing David Andolfatto’s 2015 presentation (at the time, Andolfatto was a vice president at the St. Louis Federal Reserve).

On p. 55 they write:

A positive-sum game is a term that refers to situations in which the total of gains and losses across all participants is greater than zero. Conversely, a negative-sum game is a game where the gains and losses across all participants sum is less than zero, and played iteratively with increasing participants, the number of losers increases monotonically. Since investing in bitcoin is a closed system, the possible realized returns can only be paid out from funds paid in by other players buying in.

Even though I largely agree with what they wrote here (and throughout much of the chapter), the authors introduce a new concept (a ‘closed system’) without defining what that is. And then they move on to the next thing to rail against.

It is frustrating because they could have explained to readers how, in proof-of-work networks such as Bitcoin, value leaks from the ecosystem: to state owned energy grids and semiconductor companies who typically do not reinvest the value (capital) back into the network.

Occasionally you will hear about a mining operator sponsoring a Bitcoin Core developer or helping with a lightning implementation, but by and large, the block rewards in Bitcoin are value that is extracted from the network by non-participants, or dead players.15 The authors do so somewhat later, but this would be a good place to drop a foreshadow towards that section, or at the very least define what a “closed system” is.

On p. 56 the authors inexplicably alternate between writing “a cryptoasset” and “crypto assets” within one paragraph.

Another example of a rant that takes away from the story they have built up through the chapter, on p.56 they write:

Crypto assets are completely non-productive assets; they have no source of income and cannot generate a yield from any underlying economic activity. The only money paid out to investors is from other investors; thus, investing in cryptoasssets is a zero-sum-game from first principles. If one investor bought low and sold high, another investor bought high and sold low, with the payouts across al market participants sum to zero. Crypto assets are a closed loop of real money, which can change hands, but no more money is available than was put in. Just as a game of libertarian musical chairs in which nothing of value is created, participants run around in a circle trying to screw each other before the music stops. This model goes by the name of a greater fool asset in which the only purpose of an investment is simply sell it off to a greater fool than one’s self at a price for more than one paid for it.

The voice of this author does not flow with the voices of the other authors. It sounds a lot like a long tweet and should be excised due to is repetitiveness. We get it, you hate cryptocurrencies / cryptoassets. It was clear the first dozen times you said it.

Another issue with this particular rant is that it inappropriately uses the term “first principles” when they probably should have used something like axiomatically. Or “by definition” which they have previously used. In addition, and more importantly, it is empirically incorrect.

There are blockchain projects, such as Onyx from JP Morgan that serve as a counterfactual to the a priori argument laid out above. A future edition either needs to reconcile with the fact that there are non-self-referential blockchain projects alive and in production, or excise the rants altogether.

On p. 58 they write:

Many economists and policymakers have likened cryptoassets to either Ponzi schemes or pyramid schemes, given the predatory nature of investing in cryptoassets. Crypto assets are not a Ponzi scheme in the traditional legal definition. Nevertheless, they bear all the same payout and economic structure of one except for the minor differentiation of a central operator to make explicit promises of returns. Some people have come up with all manner of other proposed terms of art for what negative-sum crypto investments might be called:

  • Decentralized Ponzi scheme
  • Headless Ponzi scheme
  • Open Ponzi scheme
  • Nakamoto scheme
  • Snowball scheme
  • Neo-Ponzi scheme

It would be nice if the authors came to consensus on whether it was spelled “crypto assets” or “cryptoassets.” Also, it is unclear who came up with the descriptive names above, however, it is likely that Preston Byrne should be credited with “Nakamoto Scheme.”

I currently think a decent description of Bitcoin itself is how J.P. Koning categorizes it as a game akin to a decentralized chain letter:16d

Source: J.P. Koning

Overall this chapter sounds a bit too much like a rehashed version of BitCon from Jeffrey Robinson. It could easily be improved by removing the repetitious everything-is-a-fraud refrain and adding relevant references.

Chapter 5 Technical Problems

This chapter is tied with Exchanges for probably being the weakest in the whole book. Part of the problem is the authors conflate scaling limitations that Bitcoin specifically has, with the rest of the blockchain world. There is no nuance, they make a number of inaccurate statements, and the chapter itself is assembled in a haphazard fashion.

For instance, on p. 59 they write:

The fundamental technical shortcomings of cryptocurrency stem from four major categories: scalability, privacy, security, recentralization, and incompatibility with existing infrastructure and legal structures.

That is at least five categories. Yet the book subsections include four: scalability, privacy, security, and compliance. There is no specific section on ‘recentralization’ as most of it is mentioned within scalability.

Continuing, on p. 59 they write:

In computer science scalability refers to a class of engineering problems regarding if a specific system can handles the load of users required of it when many users require it to function simultaneously. However regarding this problem, the technological program of bitcoin carries the specific seed of its own destruction by virtues of being tied to a political ideology. This ideology opposes any technical centralization, and this single fact limits the technical avenues the technology could pursue in scaling.

The entire chapter should be re-titled “Technical limitations of Bitcoin” because currently it is filled with strawmen. It appears that the authors have spent almost no time with blockchains beyond Bitcoin and Ethereum. Blockchain engineers and architects are well aware of these limitations and some have launched faster, more scalable “layer 1” blockchains in responses.

Note: these are not endorsements. Some examples include Algorand, Avalanche, Cosmos, Near, Polkadot, and Solana. All of these existed prior to the publication of their book.

Others have built “layer 2” rollups that sit-atop a layer 1 blockchain; these L2s are often significantly faster than the L1 they reside on top of. This includes Arbitrum, Base, Optimism, and zkSync. Even though both optimistic rollups and zk-rollups concepts existed prior to the publication of this book, yet they get barely a passing mention on page 63.

Continuing on p. 60 they write:

The bitcoin scalability problem arises from the consensus model it uses to confirm blocks of pending transactions. In the consensus model, the batches of committed transactions are limited in size and frequency, and tied to a proof of work model in which miners must perform bulk computations to confirm and commit the block to the global chain. The protocol constrains a bitcoin block to be no more than 1MB in size and a single block is committed only every 10 minutes. For comparison, the size of doing an average 3-minute song encoded in the MP3 format is roughly 3.5 MB. Doing the arithmetic on the throughput results in the shockingly low figure that the bitcoin network is only able to do 3-7 transactions per second. By comparison the Visa payment network can handles 65,000 transactions per second.

Working backwards, even though I agree with their point – and have even used Visa as an example – once again the authors do not provide any citations for anything above. There is no reason to be stingy across 247 pages.

But the bigger issue is that the authors fail to see how even forks and variants of Bitcoin itself – such as Bitcoin Cash – have successfully increased the block size to 32 MB, so it is possible to do it. With faster block times and a move over to proof-of-stake, block throughput on a future iteration of Bitcoin could be considerably faster than it is today.17

The problem that the authors almost identified is that between 2015-2017 prominent Bitcoin maximalists purged the Bitcoin Core community of “bigger block” views which then ossified Bitcoin development. Even so, the authors should have included the fact that SegWit and Taproot – both of which were locked in prior to the publication of this book – effectively allow for larger block sizes (to more than 2 MB).

On p. 61 they write:

An appropriate comparison would be the Visa credit card network, whose self-reported figures are 3,526 transactions per second. Most credit card transactions can be confirmed in less than a minute, and the network handles $11 trillion of exchange yearly. Credit cards and contactless payments are examples of a success story for digital finance that have become a transparent part of everyday life that most of us take for granted. The comparison between bitcoin and Visa is not perfect, as Visa can achieve this level of transaction throughput by centralizing transaction handling through its own servers that has taken thirty years of building services to handle this kind of load. The slow part of transaction handling is always compliance, ensuring parties are solvent, and detecting patterns of fraudulent activity. However, for the advocates proposing that bitcoin can handle retail transactions loads on a global scale, this is the definitive benchmark that must be reached for technical parity.

There a singular citation provided, but nothing from Visa itself. But the biggest problem with this passage is that it defends rent-seeking incumbents. In the U.S., Visa and Mastercard operate a duopoly that is good for their shareholders.

The next edition of this book needs to include an honest and frank conversation about the friction-filled payment infrastructure that allows private companies to extract rents on retail users in the U.S. For instance, two months ago a bi-partisan bill was introduced in both the House and Senate: “the Credit Card Competition Act, which would require large banks and other credit card issuers with over $100 billion in assets to offer at least two network choices to process and facilitate transactions, at least one of which must not be owned by Visa or Mastercard.”

Perhaps the bill goes nowhere, but the grievances it highlights are relevant for this book. For example, the E.U. capped interchange fees in 2015. Should Americans be granted lower fees as well?

Note: we are fortunate that public infrastructure upgrades, such as FedNow, will lower the costs to users across the country, however that is not intended as a point-of-sale or even retail-facing infrastructure (FedNow is an upgrade to the back-end). Plus its adoption may be slow.

This conversation could also discuss how commercial banks historically suffer from vendor lock-in from core banking software providers (such as FIS, Fiserv, Jack Henry), a cost that is eventually passed down to users as well.18

Also, it is worth pointing out that despite the authors celebratory mood towards Visa and Mastercard, according to the Bank of Canada many merchants do not actually like them:

Lastly, the only people who are still claiming that “bitcoin can handle retail transactions loads on a global scale” are Bitcoin maximalists. While very vocal on social media, fortunately they represent a small minority of the fintech world.

Yet the authors repeatedly build strawmen arguments to counter the maximalist viewpoint without (1) identifying an specific examples; (2) without acknowledging that there is more to the blockchain universe than an orange memecoin that is ossified.

On p. 61 they write:

The scalability issues of the bitcoin protocol are universally recognized, and there have been many proposed solutions that alter the protocol itself. Bitcoin development is a collaboration between three spheres of influence: the exchanges who onboard users and issue the bulk of transactions, the core developers who maintain the official clients and define the protocol in software, and the miners who purchase the physical hardware and mine blocks. The economic incentives of all of these groups are different, and a change to the protocol would shift the profit centers for each of the groups. For example, while the exchanges would be interested in larger block sizes (i.e., more transactions), the miners (who prioritize fee-per-byte) would have to purchase new hardware and receive less in mining rewards for more computational work and thus incur significant electricity cost. This stalemate of incentives has led to mass technical sclerosis of the base protocol and a situation in which core developers are afraid of major changes to the protocol for fear of upsetting the economic order they are profiting from.

There are plenty of good arguments to be made about challenges and issues surrounding Bitcoin, this is not one of them.

For starters, there is no citation for “bulk of transactions.” In the past, some centralized exchanges have attempted to bulk release transactions on-chain, however the authors do not give us any idea what percentage as of mid-2022.19

Chain analytics companies such as Elliptic and Chainalysis likely have some idea, it is unclear if anyone reached out to discuss it with them.20

Strangely the authors do not use a single chart or image throughout the book which is somewhat weird considering how many visuals could help their arguments.

For instance, above is a line chart from Bitinfo Charts showing the daily on-chain transaction usage of Bitcoin over the past three years. The black vertical line is the date the book was published. We can see that up until this past spring, on-chain transaction volume fluctuated roughly between 250,000 and 350,000 transactions per day.

The recent uptick in late April this year is due to the popularity of Ordinals, a new NFT-focused protocol that uses Taproot (an “upgrade” implemented about two years ago).

Furthermore, and most importantly: an increased block size does not force miners to purchase new hardware and receive less mining rewards and higher electricity costs. This is not even an argument that “small block” proponents such as Luke-Jr have made.21 It is just plain wrong.

Recall that “mining blocks” for proof-of-work networks has split the “mining” job into two separate organizational efforts: (1) mining farms, which operate hashing equipment; (2) mining pools, which aggregate the work generated by mining farms, into a block.

Larger block sizes do not create any new difficulty or work for mining farms, the entities who have to deal with changing electrical costs. Rather, block makers (mining pools) have to spend an extra few seconds validating and sorting transactions.

This is why the “small(er) block” argument was fundamentally wrong and why other blockchains, especially proof-of-stake based ones, have successfully increased block sizes and reduced block intervals. Mining farms typically only purchase new hardware when their current gear is no longer profitable to mine with, a larger block size is not one of those reasons.

Also, it is unclear which developers the authors spoke with but usually most developers that earn a salary or “profit” off of Bitcoin development are those that work at a company that operates mining equipment, such as Blockstream.

On p. 62 they discuss the overhyped lightning network, writing:

The lightning network itself introduces a whole new set of attack vectors for double spends and frauds as outlined in many cybersecurity papers such as the Flood and Loot attack. This attack effectively allows attackers to make specific bulk attacks on state channels to drain users’ funds. The lightning network is an experimental and untested approach to scaling, with progress on this scaling approach having stagnated since 2018. According to self-reported lightning network statistics, less than 0.001% of circulating bitcoin were being managed by the network, and transactions volume has remained relatively flat after 2019. No merchants operate with the lightning network for payments and as of today it is nothing more than a prototype.

I tend to agree with the authors views that lightning is mostly vaporware. Yet there are probably more accurate arguments than theirs. For starters, lightning is not “untested.” It is has been live and in the wild for years.

Second, according to Bitcoin Visuals, both nodes and channels were increasing during the first half of 2022 when this book was published. Specifically it is the network capacity and capacity per channel that have stagnated or declined (something the authors could mention). However, one counter-point that a lightning promoter could rightly make is that a small amount of bitcoin (sats) could in theory be used in a high velocity (high turnover) manner.

For instance, even though the velocity of M2 has declined over the past several decades yet we would not consider the U.S. economy as having declined over the same period of time. However we do not know what the velocity of sats is on lightning at this time. Perhaps it is negligible.

And lastly, I too am tired of the lightning promoters who used to say “it is only 18 month away.” Either way, the authors could use some other data and charts to back-up their thesis.

Source: The Block

For example, the line chart (above) is from The Block which shows the capacity of lightning measured in USD and BTC over the past three years. The vertical green line is approximately when the book was published. As we can see, while the amount of BTC has increased about 20% since the book was written, as measured in real money (USD), the value locked-up on lightning has not really changed much in the past couple of years.

Source: DeFi Llama

For comparison, above is a line chart from DeFi Llama. It shows the total value locked up (TVL) on Ethereum for the past five years measured in USD. The vertical dashed line is the date the book was published.

You can visibly see how the collapse of Terra (LUNA and UST) six weeks prior had immediate knock-on effects, sending the coin world into a bear market (as measured in USD).

On p. 63 they write:

Outside of the bitcoin network, there are similar problems in other cryptocurrencies. The bitcoin meme of technical indirection through Layer 2 solutions have been translated to other systems and their development philosophies. This perspective views the base protocol as being only a settlement layer for larger bulk transfers between parties, and those smaller individual payments should be handled by secondary systems with different transaction throughputs and consistency guarantees. The ethereum network has taken a different set of economic incentives in its initial design. At the time of writing, this network is still only capable of roughly 15 transactions per second. There is a proposed drastic protocol upgrade to this network known as ethereum 2.0 which includes a fundamental shift in the consensus algorithm. This project has been in development for five years and has consistently failed to meet all its launch deadlines, and it remains unclear when or if this new network will launch. Since this new network would alter the economics of mining the protocol, it is unclear if there will be community consensus between miners and developers that the protocol will go live or whether they will see the same economic stalemate and sclerosis that the bitcoin ecosystem observes. The ethereum 2.0 upgrade is unlikely to ever complete because of the broken incentives related to its development and roll-out.

Even in mid-2022 when this book was published, this fortune telling was a big L. Why? Because in December 2020 the proof-of-stake mechanism for Ethereum was successfully launched. It was called the Beacon Chain. Two months after the book was published, “The Merge” successfully occurred in which the proof-of-work function (and mining) were completely shut off.

Now you might be thinking that it is unfair to ding the authors and give them a loss on this prediction. But prior to The Merge, there were already about a half a dozen public Ethereum testnets that successfully transitioned from PoW to PoS. In either case, the authors should at the very least hedged their strong language.

It is worth pointing out that one of the anti-coiners that Stephen Diehl has endorsed (and cited) is Hilary Allen, who used the Financial Times to push a similar set of inaccurate predictions regarding Ethereum around the same time frame. This non-empirical, a priori approach does not help the credibility of their arguments. Reconsider citing them.22

For instance, on p. 63 they write:

The broader cryptocurrency community has seen a zoo of alternative proposed scaling solutions, these proposals going by the technical names such as sidechains, sharding, DAG networks, zero-knowledge rollups and a variety of proprietary solutions which make miraculous transaction throughput claims. However the tested Nakamoto consensus remains the dominant technology. At the time of writing, there is little empirical evidence for the viability of new scaling solutions as evidenced by live deployments with active users. Central to the cryptocurrency ideology is a belief that this technical problem must be tractable, and for many users, it is a matter of faith that a future decentralized network can scale to Visa levels while maintaining censorship resistance and avoiding centralization.

There are a few issues with this including the fact that the authors lump a bunch of technical names together without providing any context. This is a disservice to the reader who should google them to understand the nuances of say, sharding and zero-knowledge rollups.

Secondly, the authors introduce “Nakamoto consensus” for the first time without providing any context or definitions. Recall that pages ago this was noted as term that is conventionally used in long-form writing. It is good that they are aware of the term, but it is unfortunate that it came this far into the book and without any context.

Lastly, not every single cryptocurrency project or even blockchain effort is explicitly targeting “Visa levels.” Some blockchains that can process a few hundred transactions per second (TPS) are not trying to be a universal settlement layer. This is a strawman argument.

In addition, not that it should matter but Visa itself has both invested in blockchain-related companies for at least seven years and has partnered with other blockchain-related projects and even conjured up a way to pay for ETH gas fees with credit cards.23 Blockchains can be used for more than just money and payments, the authors should hedge their a priori mantra in the next edition.

For what it is worth, I am also skeptical that some of the L2s that have been announced for Ethereum will see a large amount of active users anytime soon. But it is disingenuous to throw the baby out with the bath water like the authors routinely do.

For instance, L2Beat is a frequently updated site that illustrates the total value locked (TVL) across more than two dozen L2s. It is worth keeping an eye on because TVL is one piece of evidence to back up a claim.

On p. 64 they write:

However, the inescapable technical reality is that every possible consensus algorithm used to synchronize the public ledger between participants are all deeply flawed on one of several dimensions: they are either centralized and plutocratic, wasteful, or an extraneous complexity added purely for regulatory avoidance.

This false dichotomy could easily be turned on the authors: guess who also operates centralized ledgers? Too big to fail banks. Are the participants also plutocratic and wasteful? This is not really the place to turn the tables on the authors but it is clear, one-third into the book, they have it out for public chains due to an ideology that regularly provides incumbents a free pass.

Why is that? It is possible to be both critical of cryptocurrency zealotry and also systemically important financial institutions (SIFIs). It is not one or the other. Why carry water for High Street banks? Let us not cherry pick favorites.

On p. 64 they write:

A consensus system that maps wasted computation energy to a financial return, both in electronic waste and through carbon emissions from burning fossil fuels to run mining data centers, is Proof of Work. Proof of work coins such as bitcoin is an environment disaster that burns entire states’ worth of energy and is already escalating climate change, vast amounts of e-waste, and disruption to silicon supply chains (see Environmental Problems). The economies of scale of running mining operations also inevitably result in centralized mining pools which results in a contradiction that leads to recentralization.

I agree with the authors, and have written so elsewhere.

However, a nitpick, the centralization of mining pools arose due to variance in mining rewards, and are not related to running mining farms. Pooling hashrate helps smooth out payouts much like pooling lottery tickets does in an office lottery pool.

On p. 64 they write:

The alternate consensus model proof of stake is less energy-intensive; however its staking model is necessarily deflationary; it is not decentralized, and thus results in inevitably plutocratic governance which makes the entire structure have a nearly identical payout structure to that of a pyramid scheme that enriches the already wealthy. This results in a contradiction that again leads to recentralization, which undermines the alleged aim of a decentralized project. The externalities of the proof of stake system at scale would exacerbate inequality and encourage extraction from and defrauding of small shareholders.

What is the source for everyone one of those claims? It is unclear.

The authors do provide a single reference from David Rosenthal attached to the final sentence of the paragraph. Rosenthal’s post primarily focuses on maximal extractable value (MEV) which is not a topic that comes up in this chapter or anywhere in the book.

It is possible that the authors were referring to Ethereum for some of their arguments.

For the sake of brevity, let us assume the authors are 100% correct about Ethereum having all of the failing listed above. But Ethereum was not the only public chain using proof-of-stake in mid-2022. Which of say, the top 20 PoS networks was decentralized? The authors do not even provide a metric for readers to measure or understand what is or is not decentralized.

For instance, the authors could have created a table that provides how many validators and/or validating pools per chain, or the distribution of tokens, of the percentage of token supply that is staked, and so forth.24

How are readers supposed to get on board and agree with the authors when the authors spend every other page ranting rather than providing coherent, evidence-based arguments?

On p. 64 they write:

Any Paxos derivative, PBFT, or proof of authority systems are based on a quorum of pre-chosen validators. In this setup, even if they are permissionless in accepting public transactions, the validation an ordering of these transactions is inherently centralized by a small pool of privileged actors and thus likewise involves recentralization. Any other theoretical proposed system that is not quorum-based and requires no consumption of time/space/hardware/stake resources would be vulnerable to Sybil attacks which would be unsuitable for the security model of a permissionless network.

The only reference the authors provide a single link regarding Sybil attacks to a presentation from David Rosenthal.

What is Paxos? What is PBFT? What is proof of authority? Once again the authors throw these acronyms and terms at the audience without even briefly describing them anywhere. What is proof of time or proof of space? Readers can clearly google after the fact, and find things on Chia or Bram Cohen, but why did the authors not feel compelled to provide any context?

The final sentence itself can be chucked out the window due to Hitchen’s razor: that which can be asserted without evidence, can be dismissed without evidence. This book has not created credibility for the authors, rather, just the opposite.

On p. 64 they conclude:

The fundamental reality is that cryptocurrency currently does not scale and cannot adapt itself to fit the existing realities of how the world transacts. The technology can never scale securely without becoming a centralized system that undermines its very existence.

One of the citations is to an article about how almost no one uses bitcoin for commerce – a comment I tend to agree with. The other reference is to another presentation from David Rosenthal. Even if Rosenthal endorsed their views it is still an a priori claim.

And more importantly: the onus is on the party making the positive claim. Their strident language “never scale securely” leaves no wiggle room and is tantamount to fortune telling.

On p. 66 they have dived into the privacy section, writing about Bitcoin:

This features means that while accounts are anonymous, the global transaction data can be used to infer specific properties about when, with whom, and in what amounts an address is transacting.

This is not quite true for other chains. A user (or organization) can run a node or a bunch of nodes scattered around the global and may be able to infer some information. But once the activity goes off-chain, into a custodian like a centralized exchange, then inferences become guesses without direct access.

On p. 66 they write:

The tracking and tracing of bitcoin involved in criminal activities has emerged as a standard practice in law enforcement and emerging companies such as ChainAnalysis have been able to deduce quite a bit of implied information simply from public information. Unlike with bank accounts, law enforcement does not require a subpoena of public information for an ongoing investigation. Notoriously many users of darknet services such as the Silk Road were caught because of a misunderstanding about the transparency of the bitcoin ledger used by these actors.

Couple of issues:

(1) Spelling: ChainAnalysis should be corrected to read Chainalysis

(2) While the authors are probably correct, the last sentence needs a citation or reference. For instance, a highly cited relevant paper is: A Fistful of Bitcoins: Characterizing Payments Among Men with No Names by Meiklejohn et al.

On p. 67 they discuss traditional banking, writing:

When a wire transfer is issued by a company whose corporate account is at HSBC in London to Morgan Stanley in New York City, the metadata contained within that transaction could contain commercially sensitive information. For example, if a British company is sending large amounts of funds to a newly created American division, it may indicate the intent for the company to expand into the American market. There are cases where the constellation of transactions between known entities could be used to deduce confidential information about the parties. However, this fact poses an existential question about the efficacy of cryptocurrency networks as an international payment system if pseudonymous accounts leak information.

Perhaps Flashboys is a little out-of-date but it could be worth mentioning the role high-frequency trading firms play(ed) in this scenario. This type of scenario exists in the cryptocurrency world too, as analytics firms provide granular on-chain data to trading firms (and sometimes the trading firms themselves build a boutique set of tools).25

On p. 69 they write about security:

In addition, these exchanges are some of the most targeted entities on the planet for hackers. In 2019, twelve major exchanges were hacked and the equivalent of $292 million was stolen in these attacks. Over time and in conjunction with bubble economics, these events have only increased in severity and frequency.

This could be true but where is the citation for the final sentence? Do the authors mean to also include decentralized exchanges (such as automated market makers) as well as bridges?

On p. 69 they write:

While some best practices can mitigate this risk, the fundamental design of bitcoin-style systems is that the end-user is responsible for their own keys and wallets by safeguarding their cryptographic secrets. This can be done through several strategies. So-called cold wallets are wallet key stored in physical objects such as paper and not connected to electronic devices.

Couple of questions:

(1) What is a “bitcoin-style system”? Do the authors mean blockchains in general or forks of Bitcoin or UTXO-based blockchains?

(2) Why do they say “so-called”? Private key management has been an ongoing area of trial-and-error since at least the invention of public key cryptography by Martin Hellman, Ralph Merkle, and Whitfield Diffie.

On p. 70 they write:

There are many news stories of ransom, kidnapping, and murder of crypto asset holders who attempted to safeguard their wallets personally.

Any chance they could refer to or cite one of them in a future edition?

On p. 70 they conclude with:

Of course, the natural solution to this would simply be that most users should not be their own bank; instead, they should use a “cryptobank” which holds their funds and provides them access. However, this is ultimately just recreating the same centralized authority system which cryptocurrency advocates attempted to replace. Providing cryptocurrency security for the masses either introduces more social problems that thee technology has no answer to or results in a recentralization that undermines its own idological goals. After all, we already have centralized banks and existing payment systems that work just fine.

While I agree with the first part of this passage, that a considerable amount of effort and resources has recreated the same sorts of centralized organizations but with less accountability and recourse, there are at least three problems with their patronizing tone:

(1) Typo “thee” should be “the”

(2) What jurisdictions are they writing about?

(3) Most importantly: the authors explicitly defend incumbents and legacy organization. They are defending a financial cartel without presenting any reasons to do so.

For example, because of implicit bail out expectations in the U.S., commercial banks are able to rent-seek off of society, as do private payment systems via usurious fees. While the authors pay some lip service in a section on “Occupy Wall Street” and in the “Conclusion” at the very end, it bears mentioning that executives and board directors at too big to fail (TBTF) institutions were not held directly accountable after massive bailouts in 2008-2009.

In point of fact, systemically important financial institutions (SIFIs) have become more concentrated since Dodd-Frank was passed in 2010. In the U.S., the deregulation of “midcap” regional banks in 2018, partially led to the subsequent collapse of several high profile commercial banks eight months ago, including Silicon Valley bank, Silvergate bank, and Signature bank. All of which required FDIC assistance to wind down.

Clearing houses (CCPs) are larger than ever and their systemic importance creates an implicit government bailout expectation which results in an ongoing moral hazard situation.26

In the U.S., not only are retail users stuck with a duopoly that extract rents but users are expected to regularly provide third parties with personally identifiable information (PII) to improve the user experience of sending funds in real time via fintech apps (like Venmo). This includes, normalizing man-in-the-middle (MITM) attacks through apps like Plaid, which integrate with retail banks.

I personally do not think most cryptocurrency projects or efforts solve any of these issues, but there is no reason to carry water for the status quo like the authors repeatedly do. Again, it is possible to critique both the world of blockchains as well as traditional finance. They are not mutually exclusive.

On p. 70 they start discussing compliance, writing:

The movement, storage, and handling of money are regulated, and most countries have laws on the international movement of funds. Showing up at an airport in Berlin with undeclared cash above €10,000 will and one in quite a bit of trouble.

What kind of trouble? Jailtime? No one knows because the authors drop that warning in the middle of a paragraph and go along.

On p. 72 they discuss cross-border payments and international money transfers, stating:

The inability to move money from a country is ultimately one of domestic internal infrastructure development and external international relations, rather than technical limitations Moreover, the proposed use case for cryptocurrency as a mode of international remittances is fundamentally limited because of a lack of a coherent compliance story. Even if we were to use cryptocurrency as a hypothetical international settlement medium, this system has not removed financial institutions from the equation. The system’s entry and exit points would have to perform the same checks of outgoing and incoming money flow required by many international agreements.

In general this is accurate and I even agree with the thrust of their argument. However it still lacks nuance because they do not specify which cryptocurrencies they are discussing.

For instance, SaveOnSend has chronicled the rise and fall of “rebittance” companies (Bitcoin-focused remittance providers) for years. And the graveyard for such startups is deep and wide.27

But the nuance the authors should make is that there is a clear distinction between Bitcoin (with a fixed supply) and a pegged stablecoin such as Dai or LUSD (from Liquity) which are dynamically minted, there is no fixed supply. Whether Dai or LUSD are used for international payments is something they could discuss, maybe neither are?

The passage also lacks any specifics or citations. A future edition could discuss the costs and frictions associated with correspondent banking and SWIFT’s decision to deploy gpi as a reaction to blockchain euphoria.28

Lastly, and perhaps importantly, it does not include discussions around real world asset-linked peggedcoins such as USDC and USDT.

Source: Twitter

Without detracting too much from the book itself, it is worth pointing out that the idea of commercial banks directly issuing “stablecoins” has been a topic of discussion since at least 2015.

At R3, some banks that participated in Project Argent later joined IBM’s now defunct endeavor called World Wire which used Stellar. One of the challenges that frequently surfaced during these experiments and deployments involved the legality of granting interest to token holders.

This is still a touch-and-go hot potato as we can see with the roll out of the European Union’s Markets in Crypto-Assets (MiCA).29 A second edition could also discuss this possibility in the CBDC section later on.

And since the authors seem very focused on the U.S., they might want to discuss the recent supervisory actions from the Federal Reserve regarding how domestic banks can transact with pegged stablecoins. But enough of doing their homework for them.

On p. 73 they conclude, stating:

Of course, like all cryptocurrency arguments, the counterargument is ideological: compliance is a non-issue because nation-states should not exist and should not have capital controls. This ideological goal is inexorably embedded in the design of cryptocurrency, making it an unscalable and untenable technology for any real-world application where sanctions, laws, and compliance are an inescapable part of doing business in financial services.

The sole citation is to a decent paper from Brian Hanley, about Bitcoin and just Bitcoin. The authors once again created a strawman and used it to broadly smear all cryptocurrency-related projects, even those unrelated to Bitcoin. This is lazy.

While I agree with some of their conclusions, an empirical-based investigation for arguing their position would be to tediously dissect the issues and challenges of other blockchains too. Look at the facts-and-circumstances for each, just like public prosecutors do.

Chapter 6: Valuation Problems

On p. 76 they discuss asset classification, writing:

Transactions on speculative crypto tokens such as bitcoin and ethereum are considerably more expensive than credit card networks and wire services. More over, as we know they do not scale to national level transactions volumes, and lack the most basic consumer payments protections found in nearly every traditional payment system. No economy trades in crypto, no large-scale commerce is completed in the currency, and no goods or services are denominated in crypto because of its hyper volatility. Crypto payments are uniformly worse than any other payment mechanism except perhaps for illegal purchases. Let us therefore consider these aspect separately through a number of different theories.

There is a bit to digest here:

(1) Typo: “transactions” should be “transaction”

(2) It is a bit odd that for all the water they carry for traditional finance, Diehl et al. do not provide many citations that strengthen their argument.

For instance, in December 2016, the Federal Reserve published its widely cited “DLT” paper. On p. 3 the authors of Fed paper wrote about payment, clearing, and settlement (PCS) systems: “In the aggregate, U.S. PCS systems process approximately 600 million transactions per day, valued at over $12.6 trillion.”

The authors of the Fed paper also included a citation for that figure: Average daily volume and value were calculated using 2014 data on U.S. retail and wholesale PCS systems and were approximated based on the number of business days in the year. See Committee on Payment and Market Infrastructures (2015), Statistics on Payment, Clearing and Settlement Systems in the CPMI Countries.

Yet Diehl et al. do not mention real time gross settlement (RTGS) systems at all in the book. This would help strengthen their arguments and improve their credibility in certain sections.

(3) The authors do not provide specific dollar or euro amounts for how much more expensive it is to use bitcoin or ethereum versus credit card networks and wire services. They could be right but providing specifics would strengthen their argument.

(4) Overall the paragraph comes across as being highly opinionated – especially when using subjective words like “worse,” please provide evidence next time.

On p. 77 they discuss the theory of the greater fool, writing:

Crypto tokens have no such use or organic demand and exist purely to speculate on detached from any pretense of use-value. Cryptoassets are speculative financial assets with neither use-value nor any other fundamental value, while not being monetary; and can therefore not be commodities or currencies. The demand for a crypto asset is not generated by any use-value but rather from a narrative and the the greater fool theory. A financial asset that behaves like a commodity — by virtue of a lack of underlying cashflows – but whose demand is derived purely from its self-referential exchange value or sign value, rather than use-value, is sometimes in academic literature referred to as a pseudo-commodity.

There are at least six problems with this passage:

(1) The first two sentences are fairly repetitive, they could be condensed into one.

(2) The authors use “cryptoassets” but not “crypto assets” — there is no consistency.

(3) The authors could have done a literature review to see if anyone else previously had created an ontological analysis of cryptocurrencies. They would likely find a handy paper titled: “Bitcoin: a Money-like Informational Commodity” by Jan Bergstra and Peter Weijland.

Why? Because this particular book section feels like Diehl et al., are fumbling around in trying to create categories for something like Bitcoin, especially the last sentence regarding a “pseudo-commodity.”30

(4) I do not have any strong views as to what cryptocurrency (or cyptoasset) is or is not a commodity but specific regulators in specific jurisdiction do. Why did the authors fail to include any definitions or views from relevant bodies, like the Commodity Futures Trading Commission (CFTC)?

(5) Next, regarding “pseudo-commodity” the authors do not provide any references to any academic literature. A quick googling found this entry:

Source: Wikipedia

Were Diehl et al. referring to Karl Marx’s definition of “pseudo-commodities”?

(6) Lastly, later in the book they swap “greater fool theory” with Keynesian Beauty Contest. It is unclear why they use one versus the other. Either way, the authors claims still lack nuance due to the actual usage of real world assets (RWA) such as pegged stablecoins.

While I have been critical of some of these parasitic tokens, a few do in fact exist and do in fact represent legal claims to actual (off-chain) value. This is important because by failing to recognize the existence of RWA, the authors do a disservice to their stronger argument (self-referential value). A future edition should include a discussion on different types of RWAs separate from cryptoassets such as bitcoin.

On p. 80 they conclude, writing:

Crypto assets are quantitatively a completely irrational investment, and theoretically treating them as a sensible asset class necessitates irrational assupmtions of infinities or introductions of absurdities that contradict all of established economic thought. We are thus left with the most obvious conclusion: crypto is a bubble much like tulips, Beanie Babies, and other non-productive curio that humans have manically speculated on in the past. It is a financial product whose only defining property is random price oscillations along a path that inevitably leads to its ruin.

There are three issues with this:

(1) Once again the authors flip back to “crypto assets” instead of “cryptoasset.”

(2) In the second sentence they insert a word “curio” that doe not make sense. What is a curio?

(3) Lastly, they predict a future “ruin,” they are fortune tellers. That which is presented without evidence can be dismissed without evidence.

Chapter 7: Environmental Problems

For long-time readers of this website it is probably easy to guess that I am sympathetic towards arguments surrounding the negative environmental externalities created by proof-of-work cryptocurrencies. So I should be a fan of this chapter. And I mostly am.

But one of the quibbles upfront is that as this book progresses, the chapter lengths get shorter and shorter. For instance, this chapter is less than six pages long. An editor would likely have recommended combining similar themes together, and/or truncating longer chapters. The next edition could probably combine this with Ethical Problems since there is some overlap.

With that said, there are a few issues in this chapter. On p. 81 they write:

The technical inefficiencies of cryptocurrencies are the mark of a technology that is over-extended and not fit for purpose. However, what is even more concerning is the environmental footprint these technologies introduce into the world. Bitcoin and currencies that use proof of work consensus scheme require massive energy consumption to maintain their networks. This feature is central to their operation and is the mechanism that allegedly “builds trust” in the network. No network participant has any privileged status except in the amount of energy they expend to maintain the consistency of the network itself. The amount of energy spent in this global block lottery results in an expected direct return per watt, which is statistically predictable. In a nutshell, the premise of mining is to prove how much power one can waste, and the more power one can waste, the more resources one receives in return. The system is fundamentally inefficient in its design.

While I agree with the thrust of this paragraph, it still needs some nuance. In addition, an “s” should probably be added to the word “scheme.”

What nuance is needed?

For starters, a new and even old PoW network does not automatically require massive energy consumption. Rather, what happens in practice is that miners will deploy capital (hardware) up to the point where marginal costs equals the marginal value (MC=MV) of the block reward.

That is to say, when bitcoin was trading for $10 per coin, rational miners were spending no more than $10 to mine a coin.31 If bitcoin’s value measured in USD dipped below the marginal cost of mining, it would be more rational to turn off the machines and purchase the coins themselves. Were all miners rational during the time period of say, 2011 when the prices fluctuated around that level? This dovetails into conversations around edge cases for why a miner would unprofitably farm a PoW coin (such as for virgin coins).

At any rate, in 2011 when the price of bitcoin was around $10, a block reward (of 50 bitcoins) would be worth $500 (sans transaction fees). On average roughly 144 blocks are mined per day. Thus rational miners in aggregate would spend at most $72,000 per day, this includes both hardware and operational costs.

Annualized this would amount to roughly $26.2 million in capital. That is still a lot of money, but is significantly less than the costs to maintain and operate the Bitcoin network when the value of each bitcoin is $30,000 like today.

In other words, “massive energy consumption” is not an iron clad rule. It just happens that we know the resources deployed (consumed) to maintain a PoW network grow (or fall) in direct proportion to the coin value. This same phenomenon occurs in other industries, such as mining for physical commodities including petroleum or gold.

A quick googling shows there are a couple of papers on this topic of “siegniorage” that the book could possibly cite.

Lastly, while Bitcoin’s money supply schedule is fixed, there are two reasons why returns are not statistically predictable:

(1) According to Bowden et al., actual block propagation (arrivals) do not follow the (theoretical) homogenous Poisson process that was expected upon its release in 2009. This is one of the reasons that halvenings do not fall precisely every four years but have instead been “compressed” and are slightly accelerated.32 In theory the halvings should occur on odd years during January, but the next halving will actually occur about eight months ahead of schedule.

(2) No one can accurately predict or know the future price of bitcoin. And it is the future price that determines how much additional capital miners will deploy (in aggregate) which then shapes the difficulty level. This is one of the reasons why executives at Bitcoin mining companies have to publicly put on a “bullish” persona: future price is existential to their hashing operations.

One other paragraph that should be refined is on p. 85, where they discuss environmental horrors:

Whether bitcoin has a legitimate claim on any of society’s resources is a question that does not have a scientific answer, it is fundamentally an ethical question. There are many activities where humans burn massive amounts of fossil fuels for entertainment activities or activities that do not serve any productive purpose. For example, Americans burn 6.6 TWh annually for holiday lightning. The software industry must ask whether we should sustain a perpetually wasteful activity in perpetuity.

Starting in reverse, the authors actually did a self-whataboutism. Pretty rare. Recall that a whataboutism is a technique to deflect blame or responsibility by pointing out something unrelated that is also bad.

The authors do not need to compare Bitcoin’s resource usage with anything besides other public chains attempting to provide disintermediated payments (like a proof-of-stake chain). There are a lot of activities that humanity (purposefully) wastes resources on, such as nuclear weapons research and development. But nuclear weapons R&D has nothing to do with running a pseudonymous peer-to-peer payment network. That is an apples-to-oranges comparison.

Similarly, holiday lighting, like leaf blowing, wastes resources. But holiday lighting is not an apples-to-apples comparison with running a payments network. The authors have the upperhand in this chapter but sabotage themselves midway by incorporating the logic of Bitcoin maximalists like Nic Carter.33

The bulk of the chapter does cite and use references to peer-reviewed research, which is something that should be replicated across the whole book in a future edition.

Chapter 8: Cryptocurrency Culture

This chapter could have been a lot stronger than it was. It was an okay chapter but it missed the opportunity to really dive into the crazy cult of Bitcoin maximalism. At fifteen pages it felt short but still makes some decent observations, primarily with the history and background of cypherpunks.

With that said, there are still some issues that could be ironed out. For instance, on p. 87 they write:

The intellectual center of cryptocurrency culture is the premise to reinvent money from first principles independent of existing power structures. The cryptocurrency phenomenon can therefore be viewed as a political struggle over the fundamental question of “who should exercise power over money” in a world idealized by its acolytes. There is a great insight to learn about the movement from their manifestos: How a group describes their path to utopia gives a great deal of insight into their mind and values.

They then refer to a paper from Sandra Faustino. So what is the issue with this introductory paragraph?

They unintentionally use the revisionist history and language of Bitcoin maximalists.

Not every cryptocurrency project is attempting to reinvent money. Furthermore, with Bitcoin itself, the word payment (not money) is mentioned 15 times in the original whitepaper.

In fact, Samuel Patterson went through everything Satoshi ever wrote. Unsurprisingly Satoshi discussed payments significantly more than a “store of value.”

Source: Twitter

This distinction is important because it actually hurts Diehl et al. argument, that “cryptocurrency culture is the premise to reinvent money” because that empirically is not the case as we can see with many tokens unrelated to money.

On p. 93 they write about technoliberarianism, stating:

At the same time, questions concerning digital assets and what ownership meant in a world of bytes instead of atoms were being explored. The technology to copy and disseminate files freely became available was effectively a solved problem by 2010. These technologies marked the move toward censorship-resistant platforms, where information could be shared resiliently against removal by external actors.

The paragraph continues on but readers are never provided with a citation or reference for the year 2010. What exactly happened by that year?

Are the authors referring to streaming services? Perhaps they are thinking about digital rights management (DRM)? Or oppositely, are they casually suggesting anyone can share files via a protocol like BitTorrent? Who knows.

On p. 95 they write:

A malaise has descended over Silicon Valley as an unexpected dystopia has unfolded in the wake of the hopeful disruption. In the absence of advancement in the field, many developers have retreated into technolibertarin fantasies that center around pipe-dream decentralized technologies as a panacea to the world’s problems.

On the one hand I agree with the authors observation. I worked and lived in the Bay Area for five years, my wife even worked in the semiconductor industry in Santa Clara, right at the center of it. But for all of the talk about “Silicon Valley” being head over heals for cryptocurrencies, the reality was very different in 2014-2015.

For instance, during this time frame representatives from Pantera Capital, such as Johnny Dilley, were openly antagonistic towards anything that was not Bitcoin.34

Source: Twitter

In a now-deleted tweet, Brian Armstrong (co-founder and CEO of Coinbase) exuded what was the feeling du jour in the Bay Area.35

On p. 95 they ironically dive into Austrian Economics, stating:

Austrian economics had already gained some prominence in the late-19th and early-20th century from the studies of philosophers and economists Ludwig von Mises, Friederich von Hayek, and Murray Rothbard.

The authors should tweak the chronology here because two-out-of-three did not rise to any prominence in the English-speaking world until after World War II. Rothbard was not even born until 1926.

More to the point: why is it that these authors ironically dove into Austrian economics? Because some anti-coiners, such as the book authors, often use non-empirical means to arrive at a conclusion: a priorism is their cudgel.

For instance, they write on p. 96:

The school of Austrian economics differs from orthodox economics in its methodology. Instead of proceeding from an empirical framework of observations and measurements, Austrian economics is a presuppositional framework that attempts to create a model to describe all human economic activity by purely deductive reasoning.

This is a little too bit on the nose because that is precisely what the authors do in chapter after chapter, eschewing empiricism for a priorism.

As I have pointed out on this website and on social media: the Horseshoe Theory of non-empiricism between Bitcoin maximalism and anti-coiners, both regularly use a priori arguments rather than provide empirical evidence.

Diehl et al., like Michael Goldstein and Elaine Ou before them, cannot claim to be evidence-driven while simultaneously using deduction to arrive that “all cryptocurrencies are useless.”36

On p. 96 the authors twice mention this modus operandi:

The Austrians call this line of reasoning praxeology, a pure axiomatic-deductive system that its founder Mises claims can be knowable and derived independent of experience, in the same way that mathematics can be known.

And:

Mainstream economics arises out of the empiricism philosophy in which all knowledge is derived from experience, where true beliefs derive their justification from measurements, observations, and coherence to scientific models which make falsifiable claims.

This last quote is a doozy because Diehl et al., regularly make falsifiable claims because we know empirically there are non-self-referential blockchain projects and smart contracts that actually work.

It is incredulous to trot out a strawman and deductively claim that every cryptocurrency on the planet, even future iterations, cannot work. Lord give us the confidence of strident a priorism.

On p. 99 they write about fiat money, stating:

Just as the gold supply on Earth is limited, the number of bitcoins is similarly constrained by a fixed supply.

While a lot of Bitcoiners like to make this analogy, it is untrue. The supply of gold is somewhat elastic, limited by the cost of recovery (and mining). Whereas the supply of bitcoin is perfectly inelastic.

On p. 101 they mention in passing that:

Nevertheless, cryptocurrency advocates have repackaged the Austrian arguments and rebased them with bitcoin or other cryptocurrencies as their center. Trade books central to the bitcoin movement (such as The Bitcoin Standard) proceed from an exclusively Austrian perspective to posit the notion of bitcoin as a basis for a new global reserve currency to displace the US dollar and an alleged improvement on gold.

This would have been the perfect time to discuss the antics of specific Bitcoin maximalists, such as Saifedean Ammous.

Speaking of which, earlier in the book (p. 79) the authors mentioned a paper by Nassim Taleb. Yet what went unmentioned was that in 2018 Taleb wrote the foreword to Ammou’s book, The Bitcoin Standard. Two years ago Taleb would have a public change of heart.

To tie this back to the beginning of this book review, when did Diehl et al., have a change of heart following the launch of Uplink? Was there any “last straw” moment?

On p. 101 the authors discuss Financial Nihilism, writing:

While the ideologies and ideas around crypto vary, the most common worldview held by most crypto investors is simply a complete lack of any worldview. In normal philosophy, this perspective is called nihilism: the belief that all values are baseless and that nothing can be known or communicated.

Citation needed. How do the authors know what “the most common worldview held by most crypto investors”?

Did they conduct a survey at a conference? What can be asserted without evidence can be dismissed without evidence.

Chapter 9: Ethical Problems

This chapter could have been one of the stronger ones – after all, not a month goes by without some crazy high profile hack – but instead it felt a bit like a worn shoe due to repetitive polemics.

For example, on p. 103 they write:

Slot machines are a technology, yet it is a technology that is purpose-built for financial exploitation. In many ways, cryptocurrency carries the same moral character as slot machines. Cryptocurrencies are purpose-built for avoiding regulation and facilitating illicit financing, effectively enabling a dark network for payments in which illegal transactions external to the technology can be achieved within the system. There are several major categories into which the inescapable harm of cryptocurrencies falls.

Contra Diehl et al., not every cryptocurrency, or blockchain project is the same, nor are all purpose-built for avoiding regulation and facilitating illicit financing.

The clearest examples – although boring as they may be – are the permissioned blockchains used by enterprises. 37 A non-exhaustive list includes Project Ion from the DTCC, Onyx from JP Morgan, and BSTX (powered by tZERO).38 Maybe none of these projects grow beyond a small niche market, but they each serve as an empirical counter-example to the a priori argument made directly above. Readers are encouraged to follow Ledger Insights for more in this arena.

On p. 104 and again on p. 133 the authors mention a “FATF blocklist” but that does not exist. What they are probably referring to is the FATF “black list.”

On p. 105 they discuss selling snake oil, writing:

Day-trading cryptocurrencies can negatively affect the mental health of individuals involved in this activity. The stress and anxiety associated with attaching one’s life savings and well-being to an unnaturally volatile market can be both exhilarating and exhausting. The mental energy required to maintain a portfolio exposed to this level of risk requires a great deal of time, focus, and discipline that many retail investors lack and that in the long term may have a deleterious effect on mental well-being.

The authors provide a reference to a good article from Vice that interviews specific participants. A reader might ask, how is day-trading cryptocurrencies different than day-trading other assets? This is not answered because the authors immediately move on to the next topic, illicit activity.

On p. 107 they discuss illicit activity, stating:

Even more sophisticated launders use a technique known as chain hopping in which value in one cryptocurrency is swapped in a trade with the equivalent value in another cryptocurrency and then swapped back. This technique further obscures the origin of funds commonly using privacy coins such as Monero and ZCash.

A few issues with this statement:

(1) Misspelling, it should be “launderers” not “launders”

(2) The first sentence should state that the user switches value from one cryptocurrency to a different liquid cryptocurrency. It is unclear how often this type of swap happens and the authors do not provide any stats (likely because the precise figure is based on data from centralized exchanges). 39

(3) How “common” is the swap to Monero and ZCash? They reference a paper from 2018 and on p. 40 the author, Anton Moiseienko, describes the mechanics of “chain-hopping” but no stats are provided as to how frequently it occurs. So can it really be said this commonly occurs or not?

On p. 107 they write:

In addition, self-service laundromats such as tornado.cash provide automated money laundering services on the ethereum blockchain and require no technical expertise. These services are used to launder funds stolen from ransomware attacks using chain hopping techniques.

There are a couple of inaccuracies in this paragraph:

(1) For users of Ethereum, there is no native on-chain privacy or confidentially function, everything is public by default. It is not clear how many users used Tornado Cash to launder funds but anecdotally there appears to be many people who tested out the dapp without attempting to do anything nefarious.

How do we know? Because roughly two months after the book was published, OFAC, (a unit of the U.S. Treasury department) sanctioned Tornado and there were knock-on effects that impacted bystanders who received small amounts of ether (ETH) that had originated from Tornado. OFAC later revised the sanctions guidance to make a carve-out for the bystanders who received this ‘dust.’

(2) Tornado Cash did not have the ability to do anything with chain hopping, this is factually incorrect. Users of Tornado may have moved ETH to an exchange or a bridge and then swapped the ETH for a different asset, but Tornado did not have “chain hopping” capability. Note: over the years other developers deployed clones of Tornado on other chains, these were not linked or bridged to one another.

(3) It is worth skipping to p. 245 wherein the authors make some unfounded claims about privacy. Someone needs to ask the authors: are developers allowed to create confidentiality or privacy-enhancing tech on public chains? If not, why not?

On p. 107 the authors also write about Crypto Capital, regarding Bitfinex, and Yakuza crime syndicates in Japan. Both paragraphs are good concise explanations of what occurred but neither one included any citations or sources. A second edition should provide at least one.

On p. 108 they misspell “Stellar” as “Steller.”

On p. 109 they wrote:

In 2019 an early developer on the ethereum project was arrested by the FBI for allegedly providing technical instructions to the North Korean on the technical mechanisms to launder money through the ethereum network between North and South Korea.

There are a couple of issues with this:

(1) Grammar: rewrite “to the North Korean” instead it should probably read: “to the North Korean government”

(2) This is not a fair description of what Virgil Griffith was accused of doing. The transaction between North Korea and South Korea was intended to be a symbolic peace gesture and my understanding was that Griffith’s intent was for the South Korean government to approve it. This is a poor example by the authors because North Korea was going to violate sanctions in significantly worse ways. For instance, according to Chainalysis, North Korean hackers stole around $2.2 billion in cryptocurrency during 2022. Griffith’s demonstration did not bolster the hackers capabilities.

On pgs. 109-111 they discuss the unbanked, overall this was a decent section. However there are not many citations or references. Highly recommend citing a new paper from Olivier Jutel, “Blockchain financialization, neo-colonialism, and Binance.”

On pgs. 111-113 the authors discuss the MMM Ponzi, it was well-written. However, the second to last paragraph states:

Cryptocurrency is not standing on some moral pillar, nor is it acting as some technological Robin Hood. Instead it is simply removing all the processes protecting both sides of transactions and distributing those trust mechanisms to those parties. Bitcoin ATM operators are now forced to step in to prevent the vulnerable from scams where banks would have generally served as the safeguard. Instead of protecting the vulnerable against fraud, cryptocurrency now pushes this obligation on individuals themselves.

I tend to agree with most – if not all – of this passage. But it should be written to include a couple of nuances:

(1) Not all cryptocurrencies are the same and the authors should give specific examples. After all, there are at least 10,000 coins and tokens floating around, do the know for certain each is marketed or advertised as “some technological Robin Hood”? No, this is hyperbolic.

(2) Banks are probably not the best example to use here.

Why not? Because in the U.S., commercial banks are frequently fined and penalized over abusive conduct they have towards their customers. For instance, last month Bank of America agreed to pay $250 million in fines and compensation to cover “junk fees” it had levied on customers. Last December, the Consumer Financial Protection Bureau (CFPB) fined WellsFargo $3.7 billion for rampant mismanagement and abuse of customer accounts.

A future edition should just scrub reference of banks in this paragraph because it does not help their argument.

Chapter 10: The Cult of Crypto

This chapter is one I was looking forward to. I had hoped they would dive into the seedy world of coin lobbyists and maximalists. Instead readers are given a pretty vanilla description across six pages. A second edition should build on this foundations. For instance, they mention just one of Michael Saylor’s crazy quotes when we could probably fill an entire book with his loony toons.

For instance, on p. 115 they introduce the section thusly:

Cryptoassets are inherently negative-sum and, as such, consistently hemorrhage money.

This is factually untrue. Perhaps proof-of-work coins are negative sum (for reasons discussed a few times already) but real world assets (RWA), tokens representing off-chain claims on tangible goods, are not necessarily hemorrhaging money. Their histrionics are all so tiresome.

Squid Game, but on a blockchain!

On p. 116 they discuss the golden calf, writing:

They cryptocurrency movement shares many aspects of economically-based new religious movements such as Scientology. Crypto is fundamentally a belief system built around apocalypticism, the promise of utopia for the faithful, and a process for discrediting external critics and banishing heretical insiders.

The authors provide two citations. A paper about Bitcoin from Vidan and Lehdonvirta and then a very strange article from the Financial Times.

Why is the FT article strange? Because it frames Chris DeRose as a victim when in reality he is often the predator. For example, DeRose, and his podcasting co-host Joshua Unseth, are very public about their misogyny, they denigrate women and have attacked them online.

For instance:

Source: Twitter

DeRose and Unseth have subsequently deleted their twitter accounts and started new ones.

Prior to his outspoken mysoginy, DeRose – who just happens to be a vocal Bitcoin maximalist – frequently attacked me.

For example:

Source: reddit

Eight years ago, Chris DeRose (aka brighton36) attempted to smear me on reddit (see above). He purposefully used a screenshot of a presentation, without linking to the presentation. Fortunately sanity prevailed and the world eventually learned what the maximalists (and anti-coiners) both seem to try and coverup: there are other blockchains beyond Bitcoin.

But back to the specific paragraph on p. 116: parts of it are accurate. There are purity police that purge heathens who recommend larger block sizes and propagandists who fund bot armies to dog pile perceived adversaries. But it is not fair to say that “crypto is fundamentally a belief system built around apocalypiticsim.” There certainly does appear to be a great deal of overlap between some Bitcoiners and perma-doomer communities like Zero Hedge.

But anecdotally, looking through the various projects appearing on DeFi Llama, many do not appear to use “apocalyptical” oriented language on their landing pages. Again, the onus is on those making the positive claim: the authors need to backup this view in a future edition.

On p. 117 they write:

A key differentiating factor of the crypto ideology is that it lacks a central doctrine issued by a single charismatic leader; it is a self-organizing high control group built from individuals on the internet who feed a shared collective together. An organic movement it has arisen, evolved, and adapted to be a more viral doctrine of maintaining faith in a perceived future financial revolution in which the faithful view themselves as central. The inevitability of cryptocurrency’s future is dogma that is sacred and cannot be questioned.

This is a pretty good passage and anecdotally seems to jive with my own experiences. Worth pointing out that the authors crib a bit of that content from an article written by Joe Weisenthal.

Ironically the same toxic behavior occurs within the anti-coiner community too. Several of the prominent figureheads regularly block any criticism or feedback, this includes Diehl himself.40

From pgs. 117-121 they discuss trust believers. It is a pretty good section. They also note an interesting etymology. Writing on p. 118:

The communities and ideologies for the cryptocurrency subculture are fostered through mediums such as Twitter, Telegram groups, 4chan messages boards, Reddit, and Facebook groups. In cryptocurrency culture, promoting a specific investment is shilling for the coin. The term shilling comes from casino gambling, where shills are casino employees who play with house money to create the illusion of gambling activity in the casino and encourage other suckers to start or continue gambling with their own money.

The passage continues but it was very helpful context considering how frequently people are accused of shilling for this or that coin or token. They also reference an interesting article from Vice detailing how much coin shills are paid to shill.

Near the end of the chapter they write on p. 120:

The cryptocurrency ideology provides a psychological, philosophical, and mythmaking framework that, for many believers, provides sense-making in a world that seems hostile, rigged against them, and out of their control. They crypto movement fits all the textbook criteria of a high control group: it provides a mechanism for determining an in-crowd and an out-crowd (nocoiners vs. coiners).

The passage but this part is ironic for a couple of reasons. First there is some truth to it: in 2014 there were entire threads on reddit and Twitter discussing a “bear whale” that must be slain. Someone even drew a painting of it. Cultish behavior. The authors provided two citations, one to William Bernstein’s The Delusions of Crowds and the other a relevant paper from Faustino et al.

Yet something big and important is missing: the authors use the term “nocoiner” for the first and only time. They do so without providing any explanation or definition for what it is. And this is where their credibility suffers.

The etymology of “nocoiner” arose in late 2017, coined by a trio of Bitcoin maximalists who used it as a slur. I was on the receiving end of coinbros lobbing the unaffectionate smear for years. The fact that Diehl and other prominent “anti-coiners” use it as a way to identify themselves is baffling because it is the language of an oppressor. Do not take my word for it, read and listen to the presentations from those who concocted it.

If there is one take away from this book: do not willingly use the term “nocoiner” to describe yourself.

Overall this chapter was so-so but it also has the most future potential since the antics and drama-per-second are non-stop in the coin world.

Chapter 11: Casino Capitalism

This was another short chapter (just six pages) and the tone came across as if it was written by just one of the trio. It is dry and pretty straightforward. If we were to guess, it probably was not written by whomever uses “greater fool” like it is going out of fashion.

For example, on p. 125 there is a perfect time to use it:

However, many self-described “investors” are indistinguishable from gamblers. They may be driven by the same thrill-seeking and irrational behavior in picking stocks, just like they would pick numbers on a roulette wheel. One type of this investing is known as speculation which is investing in an asset for the sole reason that one believes that someone else will buy it for a higher price, regardless of the fundamentals.

The rest of the chapter is fairly vanilla. They introduce the term LIBOR but do not mention the infamous LIBOR scandal or how LIBOR was phased out in 2021-2022.

There are still a couple areas for improvement. For instance, on p. 128 they write:

Despite pathological examples of casino capitalism in the world, these types of behavior and products are overwhelming the exception and not the rule. When companies have positive quarterly earning statements, their stock prices rises, and in contrast their stock price falls when they have negative earning statements.

This is not a natural law or something universal. In fact, forward guidance can often impact share prices too. As can euphoria that the authors described in Chapter 3.

A future edition should employ an editor to cut down on the repetition. This statement has already been made several time prior with the highlighted or italicized word being “greater fool.” Pages later, they will inexplicably use the term “Keynesian Beauty Contest.”

Chapter 12: Crypto Exchanges

Because of how many successful hacks and scams have occurred this chapter should have been a slam dunk. Instead this six page chapter was once again miserly on citations leaving the readers with little to trust besides the words of the authors.

On the first paragraph of p.131 they write:

The vast majority of investors in the crypto market go through a centralized business known as a cryptocurrency exchange.

How much is “vast majority”? We are not informed. In addition, the authors do not explain the difference between a banked exchange and a bankless exchange. Probably a more accurate intro sentence would be: Apart from miners and merchants, virtually all retail users on-board through a few dozen banked exchanges.

At the bottom of p. 131 they write:

Customers deposit funds with the exchange either through credit card payments, ACH, or international wire transfers to the exchange’s correspondent banking partners. Ostensibly crypto exchanges make money by charging transaction fees, offering margin trading accounts, and taking a percentage of withdrawals from their accounts. However, in practice, these exchanges engage in all manner of predatory behavior and market manipulation activities – a far more lucrative business.

How lucrative is market manipulation? They do not provide that answer.

And the one reference they provide is to a story by Matt Ranger that seem to use a number of spurious correlations. Putting that aside, the authors attempt to describe a banked centralized exchange (CEX). In perusing the current list of spot exchanges on CoinGecko, several dozen CEXs appear to be unbanked or bankless.

That is to say, users can move “crypto-in-and-out” but there is no way to convert or withdraw the asset balances into real money via a bank. It would be interesting to know what percentages of spot volume take place on banked versus bankless exchanges.

On p. 132 they write:

Cryptocurrency exchanges are extraordinarily profitable, as they serve as the primary gateway for most retail users to interact with the market.

Exactly how profitable they are? Who knows, we are not provided that detail.

For instance, what about the dozens of now defunct exchanges listed at Cryptowiser? Were they not profitable?

Continuing on p. 132:

The largest exchanges by volume have set up outside of jurisdictions where the bulk of their customers’ cash flow originates. There are a small number of regulated exchanges. Still, the major exchanges as a percentage of self-reported volume are unregulated and located in the Caribbean Islands and Southeast Asia.

How do they know where the bulk of an exchange cash flow originates? They do not provide a citation for that claim.

Perhaps it is true but what can be asserted without evidence can also be dismissed without evidence.

Also the authors provide a list of 9 specific jurisdictions: but only one is in Southeast Asia, four are in and around Europe, three are in the Caribbean, and one is in the Indian Ocean. So they should probably revise how state where the “major exchanges as percentage of self-reported volume” are located.

On p. 133 they write:

Many of the CEOs and founders of these exchanges are regularly seen in jurisdictions on the Financial Action Task Force (FATF) blocklist, interacting with sanctioned persons. Most personally avoid traveling to both the European Union and the United States for fear of prosecution.

How many is most? How many altogether? Any specific example of who that might be? Changpeng Zhao (CZ), founder of Binance? Kyle Davies, co-founder of Three Arrows Capital? Who knows.

As mentioned previously, they mistakenly state “FATF blocklist” when the actual term is “FATF black list.”

On p. 134, they write:

There is no regulation preventing any exchange employees from trading on non-public information or prioritizing their personal trades, manipulating the construction of the exchanges’ order book, or interfering with clients’ orders. Indeed, the ability to insider trade is seen by employees as one of the perks of working for a crypto exchange.

This chapter could have been a lot stronger if the authors simply provided specific names. It is pretty easy to do.

For instance, just before its direct listing in 2021, Coinbase paid $6.5 million to settle a suit with the CFTC over a Coinbase employee – Charlie Lee – who used his key position to wash trade. Two weeks before the book was published, the Department of Justice charged Nathaniel Chastain for insider trading while employed at OpenSea.

Enforcement may be uneven and perhaps lax, but it can and does occur depending on jurisdiction.

Also, how do the authors know that “the ability to insider trade is seen by employees as one of the perks of working for a crypto exchange”? Perhaps that is true, but where is the source?

On p. 135 they write:

However, many crypto exchanges over margin accounts allow up to 100 or 125 times, figures that are deeply predatory, and unseen in traditional markets.

There are at least two issues with this:

(1) Typo: “over” should be “offer”

(2) Perhaps in the equities market 100x or 125x leverage is uncommon but foreign exchange (FX) market trading venues frequently offer even higher rates. According to Benzinga, at least three FX platforms allow higher than 125x leverage. Is this good or bad? I do not have a strong view, and am using this as an counterexample that high leverage is unseen in traditional markets.

On p. 135 they write:

Many exchanges profit from liquidating some accounts as well as taking transaction fees on top of these insanely risky positions. Several class-action lawsuits filed in the United States allege exchange involvement. In a class-action lawsuit brought against several exchanges in the US, the plaintiffs allege:

[The defendant] acts like a casino with loaded dice, manipulating both its systems and the market its customers use for its own substantial financial gain.

Which lawsuits were these? What were the outcomes? Did the defendants (exchanges) lose and/or settle?

A quick googling discovers that the quote above came from a lawsuit naming BitMEX as the defendant. It is unclear what the status of that lawsuit but it was filed over three years ago.

Even though it is repetitive, I do agree with part of their concluding paragraph:

Crypto exchanges, just like casinos, entice customers with false promises of financial windfalls and get-rich-quick schemes. And they often omit the unspoken truth that the intermediary company sitting between investors and sellers is often a dodgy network of shell entities with predatory intentions and which could disappear with a moment’s notice – leaving customers with no legal recourse.

It is not accurate to say all crypto exchanges entice customers in that manner but putting that aside, it is unfortunate the authors previously used this same sort of verbiage many times before it finally lands.

In fact, eight years ago I gave a speech at a BNY Mellon event that highlighted some of the same issues mentioned in the chapter. Hopefully the authors publish a second edition because this chapter could be the bedrock of a good set of arguments.

Chapter 13: Digital Gold

Another short chapter (seven pages) that unfortunately only superficially looks at some important narratives.

Writing on p. 139 they state:

In the absence of cryptocurrency’s efficacy as a peer-to-peer electronic payment system, the narrative around the technology has shifted away from he use case outlined in the original paper and onto a new proposition: cryptocurrency is “digital gold” or a “store of value.”

This is revisionist history from a Bitcoin maximalist. As mentioned above, Samuel Patterson went through everything Satoshi ever wrote.

Source: Twitter

But this is besides the point: not every cryptocurrency or cryptoasset is attempting to be a new form of money or payment. CoinGecko tracks more than five dozen unique categories besides “money” or “payments.” Maybe all of the projects fail. Maybe none of them are interesting to the authors.

But the existence of these categories (and projects) serve as an empirical counterexample that nullifies the authors sweeping claims.

On p. 139 they write about fools gold:

The argument of crypto promoters is that cryptocurrency can be a store of value suitable for the world at large and form an economic basis for global economies on a long time scale.

Which promoters? Name names. Dan Held, Peter McCormack, and a slew of other maximalists might make that claim. Are their views representative of all “crypto promoters”? The second edition should be nuanced because this is tiring.

On p. 140 they write a very long paragraph, midway they state:

Cryptocurrencies are the purest exemplar of speculative investment and are one of the most volatile assets ever conceived. Cryptocurrencies have seen ludicrous price movements in response to global events such as the 2019 coronavirus outbreak, regulatory clampdowns, and exchange hacks. Drawdowns of 40-50% of value regularly occur with seemingly no underlying reason for the movements.

Is there a way to measure volatility? How about compared with say FX or a specific equity index? The authors could be right (and probably are here) but by not providing any reference or citation, readers are left in a lurch.

On p. 141 they write:

To all but the most faithful, the question “Do you see your grandchildren storing their savings in bitcoin?” is difficult to answer. A sensible answer would be probably not. To those who believe in the continuation of rapid technical progress, it is difficult to predict technology trends two to three years in advance, much less decades. As a thought experiment, if we believe in the bitcoin-maximalist (or any maximalist vision) rhetoric that “there can be only one global token,” that first-mover advantage dominates all other factors, this precludes any competitors from ever existing. In this model, the bitcoin ledger is the final authoritative store of value whose continuity is eternal.

This is the first and only time the authors mention “bitcoin maximalism.” Yet even here they do not succinctly define what it is.

Furthermore, the authors state that it is “difficult to predict technology trends two to three years in advance” yet they repeatedly not only make bold predictions in each chapter but they a priori claim that all cryptocurrencies inherently fail, are scams, cannot work, ad nauseam. This is a contradiction.

If the authors who wrote the paragraph above agree with their inability to predict the future then the next edition needs edits that reconcile with the multitude of contradictory claims.

On p. 141 they write:

Thus all subsequent technologies will either build on top of bitcoin sidechains or are fundamentally heretical in their vision.

What are sidechains? Who knows, the authors just lob it in there. For what it is worth, it is actually a topic we have discussed for nearly 9 years on this blog. Here is a slightly dated comparison.

On p. 141 they write:

The non-maximalist view argues against any single cryptocurrency universality. If we play devil’s advocate and assume cryptocurrency technology is not a technical dead end, then cryptocurrency markets can be seen as an economy of ideas in which the best and most technically efficient solutions attract the most investment. Rational investors will choose to store the most value in proportion to their merits. However, in this model, anyone’s current token can and will be replaced by a better one at some point, and this must repeat ad infinitum. Unless there is a continuity of account states between evolutions of the technologies, then the value held in deprecated chains will eventually be subject to flight to safer and more advanced chains. Under this set of assumptions, we again conclude that any one cryptocurrency cannot be a store of value. Their structure is identical to stock in companies that rise and fall tethered to humans activity and is inconsistent with the store of value model.

Working backwards, what is “the store of value model”? The authors do not say.

Furthermore, if we take a “screenshot” of any technology vertical decades apart there are shifts of who the industry leader is. From PCs, to printers, to scanners, to spreadsheet vendors. An entire category – smartphones – did not exist twenty years ago.41

Why is it so hard to fathom that there can be more than one blockchain in existence at one time? There are dozens of RTGSs deployed around the world, despite the existence of Visa and Mastercard… because they do different things.

The problem with this hypothetical illustrates how the Horseshoe Theory of non-empiricism that ties Bitcoin maximalism together with nascent anti-coin ideology. If you are a priori anti-cryptocurrency in any form, then by definition it does not matter what empirical evidence someone provides as a counterexample.

Thus the existence of more than one operational blockchain in the same time and space is futile to reconcile by definition.

On p. 142 they discuss bugs:

An advance in the mathematics of elliptic curves could theoretically yield a more efficient factoring technique that would render the specific choice of primitive used in historical wallets vulnerable to attack. While there is currently no known attack on the particular curved used in bitcoin, but however alternative technologies like IOTA have chosen combinations of specific, unverified primitives that have been proven unsound.

What unverified primitive were these? Who knows, the author does not provide a reference. A quick googling revealed that it may be a vulnerability with a hash function, Curl, that the IOTA developers created.

Speaking of bugs, if they write a second edition the authors could zero in on CVE-2018-17144, a bug that was first discovered by Bitcoin Cash developers in the summer of 2018. Bitcoin Core developers (who act as the de facto gatekeepers of Bitcoin) kept the severity of the bug under wraps until it was patched.

On p. 143 they write this whammy:

A standalone against cryptocurrency as a store of value is purely statistically. The exchange value of most cryptocurrency markets is highly correlated. As bitcoin moves, so does the whole crypto market. Both ethereum and bitcoin have a correlation coefficient of 0.9. Buying into any cryptocurrency besides bitcoin means one’s investment is overwhelming exposed to bitcoin’s extraordinary volatile price movements. Given bitcoin’s dominance and its distinction in driving the price of all other tokens, there is little reason to invest in anything but bitcoin.

Ta-da. Ladies and gentlemen, I present to you the anti-coiners who are actually Bitcoin maximalists. Re-read the paragraph above slowly.

Source: CoinMarketCap

The line chart (above) illustrates the market value of approximately 10 different cryptoassets starting in January 2016 to August 2023. While Bitcoin (BTC) typically does hover around 40-50% mark, there is no ironclad rule that says it always will. 42

Furthermore, this book review will not say what assets you should or should not buy. Will traders see higher returns over the long run by investing in a cryptocurrency that is not Bitcoin?

Unlike the authors of the book, we cannot predict the future. But you should definitely invest everything into PTK.

On p. 144 they discuss entities in control of >50% of voting/mining power:

Blockchains such as the ETC chain have recorded these events, and we have seen successful attacks frequently occur in the wild. This kind of attack would be expensive and energy-intensive. However, given the mining centralization it is already the case that four companies on the Chinese mainland control over 60% of the bitcoin hash power. This context represents a situation where four Chinese executives potentially are a social attack vector. The continuity of their interests is inexorably linked to bitcoin’s proposition as a store of value.

There a few issues with this passage:

(1) The authors do not say what ETC stands for, this is the first time it is presented to the reader. It is Ethereum Classic.

(2) How many times has ETC been successfully attacked? Who knows, the authors do not provide any details or references. A quick googling finds a news story stating that Ethereum Classic was hit by at least three successful 51% attacks in the month of August 2020. Yikes, that sounds like some evidence that could help bolster the authors claims, why did they not include it?

(3) Just above this paragraph the authors identify nine blockchains that have 1-4 entities in control of more than 50% of voting or mining power. They claim Dogeoin has 4 and Litecoin has 3.

But this hurts their credibility because Dogecoin has used “merge mining” with Litecoin since September 2014. I know this because I wrote an (accurate) prediction saying Dogecoin would eventually need to merge mine with Litecoin.

And guess what, Dogecoin’s existence is still driven by Litecoin’s existence. Dogecoin is fully dependent on Litecoin’s infrastructure. The article should be updated to include this type of information.

(4) Lastly, even when this book was published (June 2022) the aggregate hashrate coming from China-based mining farms had dropped well below 60%. The authors provide no citation so it is unclear when they were researching or writing this chapter.

For example, according to an article from May 2022, it was estimated that China-based mining farms generated ~21% of the network hashrate.

On p. 144 they write:

Additionally blockchains governed by standard consensus algorithms have regularly seen the emergence of so-called forks. A fork is when a subset of miners and participants diverge on their use of a single chain of blocks, resulting in two historical ledgers with different spending activities. Most major cryptocurrencies have seen forks, including bitcoin, which has bitcoin cash, bitcoin SV, bitcoin gold, while ethereum has ethereum classic. Economically this is an extraordinary event since the holders of wallets have active accounts on both chains, and their tokens now have two historical accounts of their provenance.

At least two issues with this:

(1) What are “standard consensus algorithms”?

Recall back in Chapter 2 they regularly swapped wordings between protocol and algorithm. And only described Nakamoto Consensus. What other consensus algorithms are there?

In Chapter 5 they casually mentioned Paxos and PBFT in passing but never conveyed any information to readers. So who knows what they are thinking here.

(2) Why do the authors have an issue with capitalizing the word bitcoin or ethereum? No one in any media writes “bitcoin SV” or “ethereum classic” because these are proper nouns. An editor would have helped them.

On p. 144 they write:

Physical commodities cannot “split” and have multiple version of themselves that pop into existence from nowhere.

This is a strawman because blockchains are not physical. Some lawyers have argued – and some regulators like the CFTC have made the case that certain (all?) cryptoassets might be “commodities.” This book review does not have the space to discuss the different external views from legal experts.

How do hardforks impact RWAs – such as pegged stablecoins – that reside on the chain?43 Are hard forks similar to “stock splits” in traditional finance?

Maybe this is something the authors could discuss in the next edition. Perhaps they can start by looking at how at least one student thinks hard forks should be taxed.

On p. 145 they discuss potential attack vectors:

State-level actors who thought bitcoin was a threat to sovereignty would be capable of causing mass disruptions or even destroying the network. If not fatal, such an attack would likely cause a massive movement in price that could effectively annihilate global liquidity. The most likely actor to engage in this kind of attack in terms of capacity and incentive is the People’s Republic of China.

Honestly, you have to use movie-voiceover-guy for that last sentence. And the authors do not provide any citation or reference to back up this cunning plan from the Chicoms!

On p. 146 they write:

Source: Breaking Bad

The question of bitcoin as a store of value in these catastrophic events is threefold: whether they are possible on short time scales, whether they are possible on long time scales, and on what time scales is the destruction of value possible. The externalities of nation-states failing or quantum computers are irrelevant to the continuity of physical commodities value. No process could cause all land, precious metals, or stones in all of the world to devalue simultaneously.

Gold’s historical claim as a store of value are a complex mix of factors: its industrial uses, decorative uses, long history of price stability, non-perishability, maintenance-free storage, and its millennia spanning narrative and collective fiction. Crypto advocates want to declare bitcoin as their new “digital gold” and yet all they bring is a weak fiction detached from the other necessary properties of a store of value.

Cryptocurrencies can never function as a store of value or digital gold. Instead, they are purely speculative volatile assets whose intrinsic value is built on nothing but faith in an expanding pool of greater fools that must expand infinitely and forever.

Is it appropriate to use the Breaking Bad diner scene template for the concluding paragraphs on chapter 13? Yes.

The authors cannot stop talking about bitcoin in a book called “Popping the Crypto Bubble.” It is not even clear who or what they are arguing with since they do not quote anyone or anything on this entire page.

Who is this rant directed at?

No other chain really exists apparently. No other use case exists beyond the one they build the strawman for (money/payments). It is all so tiring. But don’t worry, there is 100 pages more!

Chapter 14: Smart Contracts

The authors try out some “gotchas” but academic lawyers have beaten them to the punch by 5+ years.

For instance, at the beginning of p. 147 they write:

Smart contracts are a curiously named term that has sparked a great deal of interest due to the confusion of its namesake. Like many blockchain terms, a smart contract is a semantically meaningless term in the larger corpus of discussion, and its usage has been defined to mean great many different things to a great many people.

Strangely, the authors do not cite anyone or anything in the first few pages of this chapter. Yet there are “intro to smart contracts” at various law schools across the country, dozens of legal papers discussing ideas like “Code is not law” or what a “smart contract” might represent in a specific jurisdiction.44

Where is the cursory introduction to the history of “smart contracts”? The key figures or dates? Nada. Instead the authors take a deliberately dismissive tone. Because it is easier to dismiss out of hand a priori than do a literature review.

On p. 148 this is the pullquote:

Smart contracts have absolutely nothing to do with legal contracts.

Maybe that is true, where is the rigorous explanation or citation? Oh there is not any.45

On p. 150 after discussing Solidity and the EVM, they write:

Solidity was meant to appeal to the entry-level Javascript developer base, which uses coding practices such as copying and pasting from code aggregator sites like Stack Overflow. As a result, Solidity code generally has a very high defect count and has resulted in a constant stream of high-profile security incidents directly related to coding errors. Some studies have put the defect count at 100 per 1000 lines.

Which studies? Which high-profile security incidents? Who knows, there are no citations.

On p. 151 they write:

Moreover, smart contracts introduce a whole other dimension of complexity to the problem by forcing developers not only to verify the internal consistency and coherence of their software logic but also to model any and all exogenous financial events and market dynamics surrounding the price of the casino tokens used in the software. This hostile execution environment turns a pure computer science question into a composite question of both finance and software and expands the surface area of the problem drastically. At some point in the future, our theoretical models may be able to tackle such problems, but likely not for a long time as these problem are of a truly staggering complexity.

A couple of issues with this:

(1) Is there any number or percentage the author can give to illustrate how “truly staggering” the complexity is?

(2) Do some dapps have a large surface attack, yes. Do DeFi-related hacks still occur on a monthly basis, yes.

Imperfect as they may be, according to DeFi Llama there are a sundry of complex dapps that secure $24 billion of TVL on Ethereum right now, many of which were launched prior to the publication of the book. This include automated market makers such as Uniswap as well as lending protocols such as Aave and Compound.

These serve as illustrations, examples that the authors “long time” is already in the present. Their prediction was wrong.

Unsurprisingly, none of these dapps are mentioned in the book.

On p. 152 they write:

Meanwhile, the reality is that today smart contracts are an unimaginably horrible idea and it is a genuinely horrifying proposition to base a financial system on these structures. Smart contracts synthesize brittle, unverifiable, and corruptible software with irreversible transactions to achieve a result that fails in the most violent way possible when the wind blows even slightly the wrong way. They further lack a key component that most software engineering deployed in the wild requires, a human-in-the-loop to correct errors in the case of extreme unforeseen events such as fraud and software failure.

And what were the authors citations and references in the rant above?

Zilch. It is just their opinion.

I actually want to agree with them on a couple of points but each sentence has something fundamentally wrong with it, notwithstanding the hysterical language.46

The rant continues on the next paragraph:

Thus the very design of smart contracts and blockchain-based assets is entirely antithetical to good engineering practices. The idea of smart contracts is rooted in libertarian paranoia concerning censorship resisters and ignoring externalities instead of a concern for mitigating public harm.

And what are good engineering practices? The authors provide no citation or explanation, it is just their opinion.

Furthermore, recall that the authors worked on Uplink six years ago – which involved using smart contracts – was that idea ‘libertarian paranoia’?

On p. 152 they write:

The most catastrophic smart contract was undoubtedly the DAO hack. The DAO was an experimental, decentralized autonomous organization that loosely resembled a venture fund. Exampled simply, it is a program that would allow users to invest and vote on proposals for projects to which the autonomous logic of the contract would issue funds as a hypothetical “investment.” It was a loose attempt at building what would amount to an investment fund on the blockchain. The underlying contract itself was deployed and went live, consuming around $50 million at the then exchange rate with Ether cryptocurrency. The contract contained a fundamental software bug that allowed an individual hacker to drain DAO accounts into their accounts and acquire the entirety of the community’s marked investment. This hack represented a non-trivial amount of the total Ether in circulation across the network and was a major public relations disaster for the network. The community controversially decided to drastically roll back the entire network to a previous state to revert the hacker’s withdrawal of funds and restore the contract to regular operation.

In the last sentence they cited the 2017 The DAO report from the SEC.

There are at least four issues with it, working backwards:

(1) It is missing “the” between with and Ether in the 5th sentence.

(2) The community is not defined here, there were a number of key participants who were discussed in several books, including one I reviewed last year. This chapter is ten pages long, there is ample space to discuss the “most catastrophic smart contract” in more depth.

(3) How do they define “most catastrophic smart contract”? Do they mean by ETH or USD lost?

(4) Strangely, the authors do not mention that a hardfork took place and two separate networks emerged: Ethereum Classic (which was the original chain that the “DAO hack” still existed on) and Ethereum, where the hack was effectively smoothed over. Seems like a glaring omission.

On p. 153 they write:

The grandiose promise of smart contracts was for applications that build decentralized Internet applications called dApps. These dApps would behave like existing web and mobile applications but counter interface with the blockchain for persistence and consume or transmit cryptocurrency as part of their operations.

There is a big typo that make the 2nd sentence unintelligible: “but counter interface.” What does that mean? An errant “counter” in the middle?

Continuing in the same paragraph:

Much of the smart contract narrative is built around phony populism and the ill-defined idea that there is an upcoming third iteration of the internet (a Web 3.0) that will interact with smart contracts to provide a new generation of applications. In practice, none of that has manifested in any usable form, and the fundamental data throughput limitations of blockchain data read and write actions make that vision impossible.

You will never have guessed it but Stephen Diehl was a co-organizer for the anti-Web3 letter that circulated two weeks before his book was published. Imagine that, what an amazing marketing coup.

And guess what, he never defines what Web 3.0 is in that letter nor do the authors do so in this book. This despite the fact that Gavin Wood articulated one in 2014.

Sure they can disagree with Wood and other Web 3.0 promoters, but it is misleading to claim it is an “ill-defined idea.”

Furthermore, everything in their second sentence is falsifiable, they cannot make the claims a priori and just walk away.

For instance, there are a group of developers attempting to push a “Sign-in with Ethereum” (SIWE) movement, allowing users to authenticate with off-chain services by signing a message. This is one attempt to reduce the dependence on the oligopoly of single-sign-on from Big Tech firms. One live implementation comes from Auth0 and Spruce.

Don’t like SIWE? Fine, but it existed last year when the authors said nothing did any any usable form.

But how were the authors supposed to know? That is the whole point of market research and due diligence.

The authors continue on p. 153:

Most live smart contracts instead fall into a limited set of categories: gambling, tumblers, NFTs, decentralized exchanges, and crowd sales. The vast majority of code running on the public ethereum network falls into one of these categories, with a standard set of open-source scripts driving the bulk of the contract logic that is evaluated on the network. However, there is a wide variety of bespoke scripts associated with different ICO companies and high-risk gambling products that are bespoke logic and act independently of existing community standards and practices.

How many citations and references did the authors provide for each of the claims? Zero. That which is presented without evidence can be dismissed without evidence.

Maybe they are right on all accounts, but they need to bring evidence for each claim.

Furthermore, how do the authors reconcile the handful of categories they state as fact are where “the vast majority of code” can be bucketed as, versus the wider set of categories tracked by Coin Gecko and DeFi Llama?

On p. 153 they write:

The most common script is an ERC20 token, a contract that allows users to issue custom token crowd sales on top of the ethereum blockchain.

And exactly how common is it? What percentage were ERC20 token “scripts” (as they call them) in a specific year. Maybe they are right.

A quick google finds that according to Alex Vikati, in May 2018, that half of the top 100 contracts (by transaction count) were ERC20. The top non-ERC20 contract was Idex, a decentralized exchange.

Fast forward to 2022, according to Cryptoslate, Uniswap V3 was by a wide margin, the most widely used contract in terms of gas used. We should charge the authors for finding relevant citations.

On p. 154 they write about ERC20 tokens:

The total supply of these tokens in any one of these contracts was a custom fixed amount, and by interacting with the ERC20 contract, the buyers’ tokens were instantly liquid and could be exchanged with other users according to the rules of the contract. This is the standard mechanism that drove the ICO bubble and related speculation, and this token sale contract is overwhelmingly the most common use case for smart contracts.

They could be right but a citation needed for that last claim.

Later on the same page they write:

Another class of projects is the digital collectibles and digital pets genre. One of the most popular is CryptoKitties: a game in which users can buy, sell, and breed cartoon kittens.

The authors might want to rethink using CryptoKitties as an example because even in 2022 and definitely 2023 the project was a thing of the past.

Source: NFT Stats

It is too bad the authors eschewed any use of charts because they could have used public price charts such as the one above. As we can see, over the past three months trading activity CryptoKitties is pretty much for the birds, like the rest of the art and collectible NFT market.

On p. 154 they write:

Gambling products overwhelmingly dominate the remaining set of contracts.

What is their source? Citation needed.

On p. 155 they write:

The ICO bubble marked a significant increase in the interest in smart contracts arising from outlandish claims of how cryptocurrency ventures would disintermediate and decentralize everything from the legal profession and electricity grid to food supply chains. In reality, we have seen none of these visions manifest, and the technology is primitive, architecturally dubious, and lacking in any clear applications of benefit to the economy at large. The ecosystem of dApps is a veritable wasteland of dead projects, with none having more than a few hundred active users at best.

Oh?

The authors of the book on a road trip

I actually agree with at least half of what they said above but they do not provide any citations at all.

Where do they get the dapp users numbers? Maybe they are correct, but what is the source of information?

For example:

Source: DappRadar

A quick googling found an article from last year from DappRadar. The colored lines (above) shows the Number of Unique Active Wallets interacting with dapps. According to DappRadar, in Q1 2022, 2.38 million daily Unique Active Wallets connected to blockchain dapps on average.

You might disagree with DappRadar but the authors of the book did not present any source at all. Do better next time.

On p. 155 they write:

The very design of a smart contract is to run on an unregulated network which prevents it from interfacing with external systems in any meaningful fashion. This confusion around the namesake of smart contracts has been exploited by many parties to sell products and services.

Surely since it has been “exploited by many parties” the authors would be able to provide a citation or reference? Nope.

Maybe they are right but they also seem to be making up things as they go along. Don’t trust, verify is the motto, right?

Also, what exactly did Adjoint do with smart contracts in 2017-2018 time frame? Were they one of the entities trying to sell products and services around smart contracts via Uplink?

On p. 155 there is a pullquote:

Smart contracts claim to not trust external central authorities, but they cannot function without them. Thus the idea is doomed by its own philosophy.

I think there is some merit to the arguments they make around oracles in this chapter but the pullquote itself is just too sweeping and lacks nuance.

For instance, AMMs such as Uniswap use a TWAP oracle which is not an external oracle. The authors are wrong.

On p. 156 they write:

Within the domain of permissioned blockchains, the terminology has been co-opted to refer to an existing set of tools that would traditionally be called process automation. In 2018 so-called enterprise “smart contracts” were the buzzword du jour for consultants to sell enterprise projects.

Are Diehl et al., speaking from first hand experience? See also Evolving language: Decentralized Financial Market Infrastructure.

Continuing they write:

These so-called enterprise smart contracts had very little to do with their counterparts in public blockchains and were existing programming tools such as Javascript, Java, and Python rebranded or packaged in a way that would supposedly impart the “value of the blockchain” through undefined and indeterminate means. Indeed one of the popular enterprise blockchain platforms, IBM Hyperledger, provides a rather expansive definition of smart contracts.

There are a couple issues with this:

(1) The authors are describing “chainwashing” a term I coined more than six years ago. Thanks for the credit guys!

(2) The authors lack attention to detail. There was no such thing as “IBM Hyperledger” and the sole citation they provide confirms that.47 In the end notes for Chapter 14 they cite Hyperledger Fabric Documentation.

IBM is not the same thing as Hyperledger.

The umbrella Hyperledger Project is a branch of the Linux Foundation. IBM is a contributor and sponsor of some of the projects. The fact that the authors conflate the two does not help their credibility.

In fact, there is more than one base-layer blockchain currently incubated within the Hyperledger umbrella including Iroha and Besu. Besu is an independent implementation of Ethereum based on code contributed from ConsenSys called Pantheon.

Continuing on p. 157 they write about Dfinity:

Both these meaningless paragraphs are the embodiment of the blockchain meme. It is an extension of the terminology to include “infinite use cases” through a meaningless slurry of buzzwords. Smart contracts simply are not useful for any real-world applications. To the extent they are used on blockchain networks, smart contracts strictly inferior services or are part of gambling or money laundering operations that are forced to use this flawed system because it is the only platform that allows for illicit financing, arbitrage securities regulation, or avoids law enforcement.

Oh?

Again, even though I may personally agree with some of their opinions, that is all they are, opinions. They need to provide citations otherwise their claims can be dismissed.

Surely the rants will stop now?

Continuing on p. 157 they write:

The insane software assumptions of smart contracts can only give rise to a digital wild west that effectively turns all possible decentralized applications into an all-ports-open honeypot for hackers to exploit and manifests the terrible idea that smart contracts are just a form of self-service bug bounty. These assumptions give rise to an absurd level of platform risk that could never provide financial services to the general public given the level of fraud and risk management required to interact with it.

Oh?

Getting a lot of mileage out of the meme template generator and we still have 90 pages to go. And yes, still no citations.

Their concluding paragraph to the chapter states:

Append-only public data structures, permissionless consensus algorithms, and smart contracts are all exciting ideas; however, combining all three is a nightmare that could never be a foundation for a financial system or for handling personal data. The technology is not fit for purpose and cannot be fixed. To put it simply, smart contracts are a profoundly dumb idea.

They did provide a citation – for ‘nightmare’ – to a paper by Ryan Clements. But it is about algorithmic stablecoins and not about smart contracts.

We have nine chapters left and at this pace, may run out of meme templates.

Also, what is an “append-only public data structure”? The authors throw in a new term without defining or describing it in the very last paragraph of the chapter.

As we all remember from writing class: thou shall not introduce new concepts in the conclusion.

Okay, so two can play that game!

In September 2016, Adjoint put out a press release discussing how it was great honor to be selected for EY’s blockchain challenge.

A quote from Diehl:

So at what point was working on smart contracts bad? Just not during the time Adjoint was involved?

Chapter 15: Blockchainism

This is another chapter I should have liked because it describes chainwashing. But it is five pages long and lacks many examples.

On p. 160 they write:

The alchemy of blockchainism is a concept rooted in the mystique and misunderstanding of the nature of bitcoin’s original approach to establishing trust between otherwise unrelated parties over an untrusted network. Bitcoin has a partial answer to this problem for a specific data structure of a particular application. The core fallacy of blockchainism is extrapolating that cryptocurrency has solved trust in generality rather than specificity. What “solving trust” means will depend on context, but this is central to many books, including Real Business of Blockchain, Blockchain Revolution, The Trust Machine, The Infinite Machine and dozens more books.

I agree. I wholeheartedly agree with this paragraph.

In fact, I wrote two lengthy book reviews of both Blockchain Revolution as well as The Trust Machine. Both were not good but for different reasons than why this book is not good. At least the other two books had an editor go through and sync up the bibliography with the book chapters.

For instance, at the bottom of p. 160 they write:

Professor at Stanford Roy Amara once said of the software field that “we overestimate the impact of technology in the short-term and underestimate the effect in the long run.”

I believe the authors need to add at least one comma before and/or after Roy Amara.

On p. 161 they write:

In this “game-changing” paradigm shift, any existing process that requires a single authoritative source of truth has now found the ultimate vehicle for storing that single source of truth without the authority component. The blockchain (often referred to in singular form) will decentralize power and disintermediate the global economy unlocking new opportunities and building international reciprocity and trust. The seductive marketing around this cliché is that without cryptocurrency, the blockchain itself could convey the same disruptive power as bitcoin for any domain.

The last sentence references an op-ed from Bruce Schneier.

I have re-read this paragraph multiple times. In the margins of the book I wrote “What does this mean?” Is the last sentence a compliment to blockchains? Or were they saying, you could make a blockchain without bitcoin?

Also, there was a “movement” in mid-2015, led by Bitcoin maximalists (and lobbyists and VCs who only invested in or lobbied for Bitcoin) to use a singular form of “blockchain” with the explicit connotation that they were referring to the Bitcoin blockchain, the only one that mattered (to them).

For example, here is one of my all time favorite (now deleted) tweets from a coin lobbyist:

Source: Twitter

They continue on about clichés but it is all too tiring to address so let us move on to the next page.

On p. 162 they write about the blockchain meme. The section overall is good but there is something problematic with the first sentence, writing:

The form of technology that many of these ventures may build is not novel at all; cryptographic ledgers and databases that maintain audit logs have been used since the early 1980s.

This is the type of cherry-picking that maximalists such as Chris DeRose frequently used in 2015-2017. And it was wrong then and it was wrong in 2022 and it is wrong now.

Why? Because “cryptographic ledgers and databases” have not stayed stagnate since the year the Sega Genesis hit toystore shoelves. It is like saying, what is the big deal about SpaceX, Wernher von Braun launched a V-2 into space in 1944.

This type of criticism is lazy cynicism because it assumes the readers are incapable of remembering anything after the Berlin Wall came down.

For example: not all blockchains are identical to Bitcoin and even Bitcoin has moving parts invented between the time David Hasselhoff serenaded East Berlin and Lehman Brothers collapsed.

On p. 163 they write:

Considering trade journalism and press releases from 2018, we see blockchain proposed by many seemingly sensible people as the solution to everything from human trafficking, refugee crises, blood diamonds, and famines to global climate change. This despite most technologists having minimal experience working with vulnerable groups or understanding the political complexities.

100% agree with this point. Unfortunately we still see marginalized groups used for “pulling on the heartstrings” marketing efforts today.

Continuing in the same paragraph they write:

This kind of thinking that blockchain somehow has the answers to our problems has infected consultants, executives, and now even politicians. The one group of people who are not asked about the efficacy of blockchain is programmers themselves, for whom the answer is simple: just use a normal database.

The authors cite a short related blog post from Leif Gensert.

But the authors do not any kind of survey of programmers. We see this same kind of claim in Chapter 25 at the end of the book too. The authors could be correct, but they do not provide any source, it is just their opinion.

The reoccurring problem is Diehl et al. forgot that there are empirical ways to test their thesis.

For example, the line chart (above) shows three types of developers tracked by Electric Capital based on commits to public repos for public chains. In their words: “Only original code authors count toward developer numbers. Developers who merge pull requests, developers from forked commits, and bots are not counted as active developers.”

When the book was published, roughly 8,000 full-time active developers were working on public chains. Is that a lot or a little?

Has anyone asked these developers about the efficacy of a blockchain? Do they have views about whether a project or organization should use “a normal database”? I do not know but it would be disingenuous for me to reject the developers Agency.

On p. 163-164 they write:

The charitable interpretation of this phenomenon is that this is simply an inefficiency in human language that results from civilization collectively defining new terminology and expanding its understanding of technology. However, the terminology itself lends credibility to a domain that primarily consists of gambling, illicit financing, and financial frauds.

This is a bad faith argument. And it is identical to the argument that a Financial Times reporter – the same one who frequently quotes Diehl – recently made regarding central bank digital currencies (CBDC).

We have not even gotten to the CBDC section yet, but the FT article brings an a priori argument to a empirical-based debate. How dare anyone provide nuance and evidence that contradicts your priors!

A disappointing chapter overall, and we still have 80 pages.

Chapter 16: Frauds & Scams

This chapter was eight pages long but could have been a few hundred considering just how many fraudulent projects and scammy endeavors have occurred over the past decade.

On p. 166 they write:

In advanced economies, fraud is always a possibility, but it is usually a tail risk that occurs with a low probability compared to the bulk of routine transactions. Fraud controls and rigorous due diligence are expensive relative to the likelihood of the fraud and, unless other required by law, are many times discard for the sake of saving cost.

Do the authors provide a citation about how common or uncommon fraud is?

Or how often due diligence is discarded or glossed over? Nope.

A typo on p. 166: “tech” should probably be fully written out to “technology.”

A missing letter on p. 167 “onsidering” should be “Considering”

On p. 168 they write the concluding paragraph to the fraud triangle subsection:

The opportunity for cryptocurrency fraud is pervasive simply because the lack of regulatory checks and controls on these ventures is relatively lax or non-existent. In an environment where a single user can abscond or run away with large amounts of investor money, seemingly with little risk to themselves, it will create an environment that will attract less scrupulous individuals. Cryptocurrency businesses are the perfect storm in the fraud triangle, and crypto fraud is today’s most straightforward and widespread form of securities fraud.

I think most of this paragraph is correct, though they cited a book from 1953 that appears to be more about social psychology than cryptocurrencies.

Either way, they showed their hand in the very last two words of the final sentence: everything is securities fraud to these authors, they say so at least a dozen times.

On p. 168 there is a spelling mistake: “swidler” should be “swindler”

On p. 170 they write:

Pump and dump schemes were rampant leading up to the Great Depression and became illegal in the United States in the 1930s after the passing of the Securities Act.

This may be true, but that is a lot of inside baseball for readers outside the U.S.

For instance, what is the Securities Act? What section of the (1933) Securities Act deals or discusses pump and dumps? Since pump and dumps were rampant prior to 1933, any rough figures on how common they were?

On p. 170 they write:

A study of pump and dump schemes has found that 30% of all cryptocurrencies are used in 80% of pump and dump schemes. Once used on a particular crypto successfully, it is very likely that another pump and dump will be done on that same coin again. More importantly, studies show that pump and dump crypto schemes occur with low volume coins with significant wealth transfers from outsiders to insiders, and resulting in detrimental effects on market integrity and price formation.

Good news and bad news. Good news is, they cite six relevant papers. The bad news, they barely paraphrased two of them.

For example, from a blog post from Kamps and Kleinberg:

We found that similarly to the traditional penny-stock market variant, the cryptocurrencies most vulnerable to this type of attack were the less popular ones with a low-market cap. This is due to their low liquidity making them easier to manipulate. We also found that around 30% of the cryptocurrency pairs we analyzed accounted for about 80% of the exhibited pump-and-dump activity.

From the abstract of Li et al.:

The evidence we document, including price run-ups before P&Ds start, implies that significant wealth transfers between insiders and outsiders occur.

The authors did not even paraphrase Kamps and Kleinberg correctly. Notice that K&K said that “around 30% of the cryptocurrency pairs we analyzed” whereas Diehl et al., write “30% of all cryptocurrencies.”

That is not a minor difference. Maybe next edition should just use the actual quotes?

At least the authors are finally citing, right?

On p. 173 they are concluding the chapter:

In many jurisdictions, directors of the company are explicitly banned from touting the expected returns of the investment. However, if one constructs an anonymous community in which others (outside the company) market the token’s investment opportunity, this can be sufficient to drum up market interest in the security. A digital pyramid scheme structure can be encoded indirectly into the computer pogram that dictates the network’s payouts, and this can create indirect kickbacks and incentives for early promoters. This decentralized and self-organizing fraud leaves the directors’ hand completely clean as low-level employees and outside actors purely perform the actions.

Possibly two issues with this paragraph:

(1) Did the authors mean to write “encoded directly” or “indirectly.” The context reads as if they meant to say “directly.”

(2) What they seem to describe here and on the previous page (regarding “distributed control”) might be pursuable via RICO statutes. Five years ago I mentioned that angle in an op-ed. To-date it does not appear that – at least in the U.S. – any RICO-related lawsuits or charges have been filed.

This chapter should have been an amazing slam dunk – it could have included a hundred different scams and/or fraudulent efforts but instead the authors could not even properly paraphrase from a couple papers they cited. A disappointment.

Chapter 17: Web3

I did not fully appreciate how good the authors – and Diehl in particular – were at marketing until I read this book.

I will mention more in the Final remarks later below, but recall that two weeks before this book was published, a gaggle of vocal anti-coiners got a variety of mainstream publications to cover their anti-web 3.0 letter?

Unsurprisingly, there is a lot of overlap between this chapter and the 741-word page letter. To their credit, the authors of the book at least spent 9 pages brewing the soup, let us see how it tastes.

On p. 175 they write:

In recent years, the cryptocurrency project experience something of a public relations problem; leading various actors to choose to refer to cryptocurrency under a different name, “web3”. The narrative of web3 is somewhat intentionally amorphous and open to a wide variety of interpretations. Therein lies the rhetorical power of ambiguous buzzwords in that it acts like an aspirational Rorschach test where everyone will see something different, but everyone assumes it means something positive.

So in 2014 I wrote how “Bitcoin’s PR challenges” and then a year later “The great pivot, or just this years froth?” In the latter I pointed out how VCs such as Adam Draper were telling their Bitcoin-related portfolio to rebrand as “blockchain” companies. This is chainwashing.

The same can definitely be said about the “web3” rebrand to some extent. But. And hear me out: Gavin Wood write up a definition and narrative for “Web 3.0” back in 2014.

You may think Wood was naïve but that specific point is one the authors are incorrect on.

Continuing on p. 175 they write:

While web3 may not be well-defined, five technology categories loosely correspond to some new crypto products that are being marketed under the web3 umbrella term: NFTs, DAOs, Play-To-Earn, DeFi, and the Metaverse.

In the margins of the book I wrote: “What is your definition of web3? And unsurprisingly the authors did not provide one.

They also did not provide a definition of “web3” in the anti-web3 letter last year. Surely it can be done in a nine page chapter?

On p. 176 they write about NFTs:

A significant pat of the web3 ecosystem is creating digital assets known as NFTs. Unlike cryptocurrencies, which are fungible, any individual assets are interchangeable with other digital assets. NFTs are a specific type of smart contract which lives on one of the ethereum or other blockchains that allow programmable blockchain logic.

You might not believe me but not once in this entire chapter or book do they ever write out what the full acronym stands for: non-fungible tokens.

And this omission is important because NFTs existed before CryptoKitties. They existed before the construction of Ethereum.

NFTs first existed as “colored coin” frameworks on Bitcoin but have evolved onto other blockchains, including permissioned chains. The conventional term for all of these efforts is “tokenization.”

The authors can throw shade all day long regarding tokenization efforts of real estate or precious medals, but these are technically “NFTs” — a world that is much broader than the strawman they concoct in this chapter.

This notable omission hurts their credibility, especially since they do not bother explaining the history of the concept.

Source: ChainLeftist

On p. 176 they write:

An NFT is a tradable cryptoasset that internally contains a URL, like those typed into a browser (e.g., https://www.google.com), which points to an external piece of data. This external piece of data could be a document, a file, or an image, but it is stored externally to the NFT itself. Since the image or data associated with an NFT is stored on a public server, any member of the public can “right-click” on the data to access the information independent of the blockchain.

The “right click and save” critique of art and collectible-related NFTs is partially valid.

For example, Cryptopunks and Bored Ape Yacht Club (BAYC) are examples of collections reliant on off-chain 3rd parties, for what the authors describe.

But the authors fail to recognize that there are exists art and collectible NFTs that are generated and live fully on-chain. A non-exhaustive list includes: ArtBlocks, Autoglyphs, Avastars, Chain Runners, Anonymice, and OnChainMonkey (see Slide 7).

On p. 176 they continue:

Some NFTs are even purely conceptual and do not link to any data. In these situations, abstract notions and contextual narratives about the NFT are the products being sold to investors. This setup may be done as a piece of performance art or as a thinly veiled way of raising money on an unregistered secruity investment as a proxy for illegal equity raise in a common enterprise by disguising it as an “NFT project.”

The authors cite the cringey Dan Olsen video published last year. Are the authors lawyers? Not sure. Are they specialists in securities laws? Not sure.

Did they quote or cite a lawyer specialized in securities laws? Nope.

Therefore, what is presented without evidence can be dismissed without evidence.

Peter van Valkenburg has something in common with Lionel Hutz

On p. 176 they write:

Buying an NFT is conceptually similar to Name-A-Star registries in which a person pays another person to record their name in a registry, allegedly associating their name to an unnamed star in the sky. The registry conveys no rights, obligations, or rewards, but it is an artificially scarce commodity based on a collective belief in the supposed value of the registry. It is like a tradable receipt with no physical good or rights attached, which only signifies a proof of purchase based on some bizarre and logically self-inconsistent redefinition of ownership or to signal sign value or class status as a form of conspicuous consumption within the crypto community. Many people who sell NFTs are willing to make the conceptual leap that this registry with a smart contract somehow conveys some abstract digital notion of “ownership.” However, this premise has several technical, legal, and philosophical problems.

The authors cite two papers, one from Joshua Fairfield and the other from Aksoy and Üner.

While they both highlight some of the same problems the authors do, neither paper comes to the same conclusions that the authors of the book do. These are real issues but not insurmountable problems.

In fact, companies such as Mintangible have been attempting to help NFT issuers utilize existing copyright licenses to protect their users.

Another edition should not leave the readers under the impression that actual I.P. lawyers are sitting on the sidelines, this is gaslighting.

Also, what does “logically self-inconsistent redefinition” mean? Did the authors add an errant “self” in there?

On p. 177 they write about the duplication problem:

NFTs have been criticized for having no way of guaranteeing the uniqueness of the datum or hyperlink. Since multiple NFTs can be created that reference the same artwork, there is no canonical guarantee of uniqueness that an NFT purchased is “authentic”. It remains unclear what “authentic” would mean regarding infinitely reproducible hyperlinks.

Apart from its polemical zealotry, one of the books core weaknesses is that the authors clearly did not conduct much market research, they certainly did not canvas outside experts to solicit answers some of their questions. It is often tedious to do, but even asking an open question about this on Twitter (now X) would probably have helped their misunderstandings.

For example, marketplaces like OpenSea and Magic Eden allow NFT issuers to become “verified” which help reduce some of the counterfeiting that takes place. Block explorers such as Etherscan allow the general public to inspect all transactions to determine the veracity of provenance; the public can look at the metadata and track the transaction history. You could even do a reverse-image lookup on Google.

On p. 178 they write about the multiple chain problem:

The NFT definition of “ownership” has been criticized as having no single source of trust since multiple blockchain networks can be created and operated in parallel, all of which can give rise to independent and potentially conflicting suppositions of ownership for the same piece of data. The same NFT can be minted on the Tezos blockchain and the Ethereum blockchain, with the same content but with two competition definitions of “ownership.” Give this contradiction in the design, there is no canonical way to say a priori which blockchain network represents the base concept of ownership. This premise presents an intractable logical contradiction a the heart of the definition of NFT redefinition of “ownership”. Having something multiply-owned in different contexts with different sources of truth introduces an irreconcilable multiplicity to the idea of ownership, which results in a philosophical contradiction.

The authors are either straight up lying – or more likely – have never interacted with counterfeit collectibles before.

For instance, my wife and I own a Frederic Remington “Mountain Man” bronze sculpture we got at a garage sale. On the bottom it says it is unique, one of 97 made. But we all know someone who owns one. Ebay is filled with replicas. And Remington himself clearly did not make a million busts during his lifetime.

Yet according to the hyperbolic authors of this book, this replica situation results in a ‘philosophical contradiction.’

The hypothetical scenario that the authors concoct is presents their superficial understanding of how provenance can be traced on a chain.

For instance, auction houses such as Sotheby’s and Christie’s are able to quickly determine which digital collectible is the “real” one simply by using a block explorer such as Etherscan.

Lastly, it is worth repeating that the authors use a strawman at the very beginning of this paragraph. They do not provide a single reference or citation for which definition. All around tomfoolery on their part.

On p. 179 they write about market manipulation:

Finally, NFTs have been criticized for excessive amounts of market manipulation and, in particular, significant cases of wash trading that are now expected and normalized in the market. These phenomena make it challenging to ascertain what (if any) of the price formation is organic versus the work of a coordinated cartel attempting to create asymmetric information.

I agree with most of this. I was even quoted saying it was hypothetically possible. But the authors mention that there are “significant cases of wash trading.” What is their reference?

On p. 179 they write about play to earn games:

Some video game company executives saw the popularity of play-to-earn game startups, and announced that they would be creating copycat games or incorporating NFTs into their titles. Major game publishers such as Ubisoft, EA, Square Enix, and others have expressed interest in including such NFT items in their games. The backlash has been tremendous, as serious gamers see it as a shameless unethical money grab. With graphics cards pricing spiking due to crypto miners’ demand, this only added fuel to the flames. The backlash from gamers has been swift with publicly announcing their contempt for NFT and NFT-based games, which led to many apologies and reversals from these gaming companies’ executives.

How many citations and references did the authors provide? Zero.

It is hard to know how much of the public feedback was real versus manufactured anger from anti-coiners who went out of their way to tell reporters the same sort of half-truths he does in this book.

I should know, because I was quoted in a few of the articles. Which articles? Oh now you want references. Too bad, you will need to comb through my archives and google my name and scroll through my tweets.

Note: two months after the book was published the Ethereum Name Service (ENS) was at one point the most popularly traded NFT, surpassing BAYC. A year later, ENS reached the official Google cloud blog:

Source: Google Cloud

On p. 181 they write “Democratic Republic of North Korea” but the formal name is “Democratic People’s Republic of Korea” — the government in North Korea does not use the word “North” just like the South Korean government does not use the word “South” to describe itself.

On p. 181 they write about DAOs:

DAOs are a form of regulatory avoidance which attempt to recreate the regulation of creating voting shares in corporations. DAOs place this practice outside the regulatory perimeter and have no recourse for shareholders in the case of embezzlement or fraud. They are best understood as shares in a common enterprise run by potentially anonymous entities and with no restrictions on the provenance of funds held by the “corporation.” However, they may be attached to an enterprise attempting to solve a complicated public goods problem such as fixing climate change or providing universal basic income.

This is one of the few times in the entire book when the authors write something with hedged language.

With that said, the very first sentence is confusingly written. What does “recreate the regulation of creating voting shares” mean?

Did the authors mean to say that DAOs recreate the trappings of a corporation, such as voting shares? Any other examples or references?

The authors write on p. 181:

The notion that we should create unregistered corporate structures whose assets can be transferred to anonymous entities with no corporate reporting obligations is somewhat challenging from a fraud mitigation perspective, especially in a post-Enron world. It remains unclear what the killer use case is for anonymously controlled governance structures around slush funds, other than crime or projects that need avoid regulation.

Couple of things:

(1) There is a missing word in the last sentence, likely needs to insert “to” between need and avoid. Also add an “s” at the end of need.

(2) A second edition should incorporate some of the criticisms of DAOs from legal practitioners such as Gabriel Shapiro. Shapiro has written extensively on this topic.

Note: the authors cite Angela Walch’s novel paper, Software Developers as Fiduciaries in Public Blockchains. I have previously cited Walch’s works, including this paper. But it does not really back-up what the authors are asserting here. They cited it after “fraud mitigation perspective” — what part of Walch’s paper do they think helps their argument?

On p. 182 they write about DeFi

Defi is a broad category of smart contracts that loosely correspond to digital investment schemes running on a blockchain that allows users to create loans out of stablecoin and have side payouts in so-called governance tokens.

A few issues:

(1) They need to capitalize the “f” of DeFi in the first sentence (the use ‘DeFi’ throughout the remainder of this section)

(2) While there may be various definitions for “DeFi” even back in mid-2022 the authors could have easily found several overlapping definitions, maybe in the next edition they can provide one as an example.

(3) The authors probably should add an “s” to the end of “stablecoin”

(4) Not every DeFi project uses “stablecoins” for collateral. In fact, it is possible to collateralize a project in a non-pegged coin.

Lending protocols such as Aave and Compound have white-listed collateral, most of which – even in mid-2022 – is not a pegged coin. 48

(5) What are governance tokens? Who knows. They only mention it here in passing and never return to it.

On p. 182 they write:

DeFi generally refers to a collection of services that offer lending products offered by non-banks and which exist outside the regulatory perimeter as a form of regulatory arbitrage and to fund margin trading activities to speculate on cryptoassets.

The authors cite a relevant paper from Barbereau et al. In a second edition the authors could build from this foundation, because one of the weakest areas is highlighted in this specific paper: failure to achieve political decentralization (e.g., end up with a plutocracy run by a handful of venture capitalists).

On p. 182 they discuss an interview with Sam Bankman-Fried on Odd Lots, but without mentioning his name.

One of the strangest phenomenon from anti-coiners this past year is the victory laps they take when some scam is revealed, as if they helped take down the fraudsters. “See I told you so!” they type out victoriously on Twitter.

Actually, no you did not. The authors of this book – like the rest of the industry – were completely oblivious to the actual crimes committed by SBF. If they make this claim, be sure to ask for receipts.

On p. 183 they dive into the Metaverse:

The metaverse is another intentionally ambiguous term for an alleged new technology. On October 21, 2011 Facebook after having been mired in whistleblower leaks, scandals, and a near-constant press cycle of relentless adverse reporting, decided to pivot away from its controversial social media business and build what they called The Metaverse.

A couple of issues with this passage:

(1) The authors got the year wrong, it was 2021 not 2011.

(2) While Facebook did rebrand to “Meta” and allegedly went all-in on “the metaverse” — they never actually did a full pivot: the did not close down their major products (such as Instagram and Facebook). That is not really a quibble with the authors, as Mark Zuckerberg himself has mentioned a pivot (which they did again). Rather, the audience should be informed of what a pivot typically is.

The next sentence is missing punctuation, as they write:

The metaverse itself is an idea first postulated in the science fiction novel Snow Crash by In the novel, the metaverse refers to a virtual world sperate from the physical one, which is accessible through virtual reality terminals. Stephenson describes a bleak cyberpunk…”

Grammar issue: the authors should add “Neal Stephenson” after “by” and then a period.49

In the concluding paragraph of this chapter, the authors write on p. 184:

The post hoc myth-making that has emerged around the metaverse and crypto synthesis is that somehow digital assets such as NFTs will become tradable assets in Facebook’s virtual worlds and that their alleged utility in virtual reality will become a way to generate income in the metaverse, which supposedly and necessarily, needs to be denominated in crypto. The myth of the metaverse has captivated the media, who have written no end of vapid think pieces feeding the vaguely colonialist rhetoric of a new virtual frontier for a new generation to colonize and capitalize. Many tech startups have since spun up companies based purely around virtual land grabs, in which plots of land in digital spaces are auctioned based on some narrative about their perceived utility in some distant future. The irony of this premise is that virtual worlds do not suffer from any concept of scarcity, except the ones their developers artificially introduce. Even if we accept the far-fetched premise of the existence of new virtual worlds, why should those worlds inherit the same hypercapitalist excesses as our present world?

Working backward, that is a fantastic question guys! Where were your hot takes during Second Life’s heyday? Or any MMO for that matter?

Are you aware that developers still create artificial scarcity in a host of games in order to sell power ups of all kinds?

Source: Newzoo

Are the authors against digital wares by video game developers? Or only against the sale of digital wares if the acronym NFT is involved? Their inconsistency is tiring.

I personally agree with some of their skepticism of user adoption of token-based economies in future games, but they do not give a lot of reasoning as to why readers should be up in arms about it.

The two references they provide – one by Paris Marx and the other from Alice Zhang – do not add much to the authors unwavering bravado.

For instance, six months before publishing this book, Paris Marx interviews Diehl in a podcast entitled: Web3 is a Scam, Not a Revolution. It all comes across as being strong opinions, yelled loudly.

Chapter 18: Stablecoins

This six page chapter was disappointing because apart from a blurb on CBDCs at the end, it only discussed Facebook’s Libra project. It did not explain the history of pegged stabelcoins and it did not mention who other centralized issuers were.

This is strange because Libra never launched. Yet today at the time of this writing both USDT and USDC – the largest issuers of USD-pegged stablecoins – account for around 90% of all USD-pegged stablecoin supply.

Source: The Block

You would think the authors might write about how Tether Ltd – and its parent company iFinex – had been sued and settled with both the CFTC and the New York Attorney General. And how during those investigations the prosecutors learned that Tether LTD – and iFinex – executives publicly lied about their reserves. Easy slam dunk, no?

Who knows why they focused on a project that never launched, perhaps it is because David Gerard – one of their fellow anti-coiners – wrote a book about Libra during this time frame too? 50 It is an enigma!

On p. 185, their introductory paragraph states:

In the digital age, whoever owns the world’s data owns the future. To that end, in 2018, American social media company Facebook announced it was launching a cryptocurrency project known as Libra, which would form the basis of the singularly most extensive surveillance system outside of government.

The paragraph continues but they even got the timeline wrong. While there had been rumors – for months – that Facebook was doing something with cryptocurrencies and blockchains – the formal announcement did not take place until June 18, 2019.

On p. 186 they discuss “the idea of stablecoins” without mentioning the elephant in the room (Tether / USDT). Instead they state:

Facebook is its core advertising company, and its advertising business is enormously lucrative. The microtargeting of ads to consumers generated $70.7 billion in 2019. However, as a public company there are only so many sectors that would satiate the company’s expected growth. The company’s expansion into the financial services sector was the natural choice given the relative stagnation of the social media market.

There are a few errors:

(1) The authors need to include “at” between is and its in the first sentence.

(2) How do we know it was the “natural choice”? Is this speculation on the part of the authors? Are financial services the terminus for all technology companies?

(3) The authors should be clearer that Facebook generated $69.6 billion of revenue from ads in 2019. The current wording is only correct insomuch as they are detailing total revenue.

On p. 187 they write:

The degree of public scrutiny came in full force after the company announced its intentions with Libra. The project was widely criticized for its overreach, lack of compliance with existing regulations, and threads to the sovereignty of existing nations to control their currencies. European representatives nearly universally denounced the project, and several United States senators issued veiled threats to the Libra consortium members to withdraw from the project. The consortium members caved to these demands, and the more respectable companies such as PayPal, Visa, and Mastercard all withdrew from the project.

Most of the information is true but the authors do not provide any citations. In fact, David Marcus – then head of the Libra team – testified in front of a Senate committee a month after Libra was announced. And Mark Zuckerberg – the CEO and co-founder of Facebook – appeared before a congressional hearing four months after Libra was announced.

Both Marcus and Zuckerberg were publicly questioned about Libra and that is not mentioned in the book.

While that omission is strange, unsurprisingly the authors call “PayPal, Visa, and Mastercard” more respectable companies. That seems consistent with their earlier views.

As we have pointed out in this review: PayPal has operated like a centralized stablecoin issuer since it was created. And both Visa and Mastercard operate a rent-seeking duopoly in the U.S.

Speaking of which, Raj Dhamodharan EVP of Blockchain at Mastercard recently did a podcast explaining how Mastercard regarding stablecoins, bank deposits and CBDCs. Is this a scam – because it involves cryptocurrencies – or is it okay since Mastercard is working on it?

On p. 188 they write:

The mechanism proposed for maintaining consensus of the Libra ledger state was significantly revising the models found in public cryptocurrency projects. Bitcoin allows any user running the protocol to connect and participate in the consensus state and submit transactions. However, Libra being run as a business created a context in which only large corporations would be invited to maintain the consensus state and run the servers to maintain the network. These corporations would all maintain legal contracts with the Libra entity and theoretically run individual nodes of software that Facebook provided them. The governance model of the Libra consortium was a performative farce, and the engineering behind the protocol reflected the same level of theatricality.

This is incorrect in a few areas:

(1) There comment regarding Bitcoin needs clarification; in practice “participate in the consensus state” is distinct from “submit transactions.”

For example, while anyone can run a Bitcoin “mining client” on their computer at home, they will likely not generate the correct value to build a block (e.g., ‘solo’ mining is not typically profitable). While a user can run a full node at home – and certainly submit transactions – it is not really the same thing as building a block which “pools” do today.

(2) It is unclear how the authors evaluated the engineering talent and protocol itself since they do not provide any citations. Labeling everything a scam or fraud is not an argument, it is an opinion.

On p. 188 they write:

Instead of a consensus model like proof-of-work, which would have been unsuited and inefficient for the Libra case, Facebook invested in a not-invented-here form of a classical consensus algorithm known as Paxos; and named their derived implementation HotStuff. The goal of this setup served no purpose other than giving the appearance of decentralization. A closed network in which a fixed set of corporate validators maintained a faux-decentralized state was, for all intents and purposes, equivalent to a centralized setup of replicated servers. This performative decentralization permeates all levels of the Libra codebase and the project. In all aspects, the codebase is trying very hard to convince you it is like other public blockchain projects when it bears little similarity in practice.

Oh?

The authors ranted about HotStuff and were wrong.

HotStuff was created by engineers at VMware in March 2018. See the paper from Yin et al.

HotStuff is not based on Paxos but instead is based on PBFT. Some of the VMware team were hired by Facebook and others hired away by other blockchain teams, such as ChainLink and Ava Labs (the group behind Avalanche).

The authors also fail to produce a single reference for what part of the codebase was trying hard to convince you it was not a public blockchain. Perhaps the github repository was acting weird, but readers are left in the dark about what it was.

Also worth pointing out that the Sui and Aptos public blockchain projects absorbed some of the talent from the Libra / Diem team that disbanded after it was shutdown in January 2022. And Silicon Valley Bank purchased some of Diem’s (Libra) I.P. assets. All of this was concluded before the publication of the book.

Lastly, the authors still do not explain what Paxos is or what “not-invented-here” means. A second edition needs to explain what these “classical” consensus mechanisms are, at least at a high level.

On p. 189 they write:

Facebook Libra was a project of paradoxes, contradictions, and gross mismanagement, which ultimately led to its failure. However, if the project had launched, it would have enabled Facebook to engage in predatory pricing, self-dealing, and the capacity to annex adjacent markets, all while not subject to Bank Holding and Secrecy acts that protect consumers deposits by virtue of being a technology company dealing in its own allegedly “sovereign” currency. Nevertheless, Facebook remains a deeply unethical company that attracts the most deranged and opportunistic employees with no regard for the integrity of democracy or public well-being. Facebook is a company that is the very embodiment of corporate irresponsibility and depravity at every level.

I am sure there are many readers who would like to dance on Facebook (Meta’s) grave too, but at least get the facts straight.

For instance, what ultimately led to Libra (Diem’s) failure was that its banking partners (specifically the custody banks) were pressured to not support its launch.

For example, Diem had deployed a public testnet during its lifetime and the throughput numbers were considerably higher than other public blockchains, yet politically in the U.S. it was unpalatable. Which is part of the reason why some of those engineers went on to build Sui and Aptos, which are high-throughput chains.

Moving along, what is the “Bank Holding and Secrecy acts”? Do the authors mean the Bank Holding Company Act of 1956 and the Bank Secrecy Act of 1970? Which parts of the act(s) was Libra (Diem) subject to?

Lastly, the authors should probably add an “s” to the end of Facebook in the first sentence. And a second edition should briefly explain the name changes (Facebook -> Meta and Libra -> Diem) all of which occurred prior to the publication of the first edition.

Over a mere three paragraphs the authors write about Central Bank Digital Currencies, starting on p. 190:

The Facebook project and its implication as a threat to countries’ national sovereignty has given rise to a recent digital transformation trend for central banks to explore similar ideas. These projects are known as central bank digital currencies. The proposition is simple and based on the fact that central banks typically have enormous balance sheets of their lending activities and hold the accounts for many entities that interact with the Federal Reserve or the European Central Bank. Several central banks, including the People’s Bank of China and the Boston Federal Reserve, are exploring projects to this end.

There are multiple problems with this:

(1) The history is completely incorrect. Experiments and pilots with CBDCs occurred long before Libra existed.

For example, Project Jasper was a project involving the Bank of Canada and R3; phase 1 was accidentally leaked to the public in 2016. As I mentioned previously, Project Argent (another R3-led effort) partially spun-off into World Wire.

The Utility Settlement Coin consortium was launched by UBS and Clearmatics in 2015; it grew to over a dozen commercial banks and multiple central bank participants before spinning off into Fnality International in May 2019 (formalized just before the Libra announcement).

There were other separate, independent efforts taking place simultaneously around the globe. In fact, the term “Fedcoin” (created by J.P. Koning) pre-dates all of these ideas by multiple years.

A second edition should pay closer attention to these examples.

(2) The authors do not mention that there are multiple different CBDC models, some focused specifically on “retail” uses and some on “wholesale” uses.

Source: CBDC Tracker

For instance, the map (above) comes from CBDC Tracker. Each dot represents a pilot, trial, or even production implementation of a CBDC. In some cases they use a blockchain, in others, they do not.

The authors could peruse the literature from the Bank for International Settlement (BIS) as well as the Bank of England, both of which have produced research on this topic prior to the advent of Libra.

For instance, the “Money Flower Diagram” was published in a BIS publication in 2017:

Note: CADcoin was the name given to the digital asset used in Project Jasper; this was about three years before Libra was announced.

On p. 190 they write:

Advocates have generally embraced Libra and CBDCs as an “on-ramp to cryptocurrency” and praised the project for its illusory legitimacy to unrelated projects like bitcoin. However, Facebook and central banks are not building cryptocurrencies, and at best, digitizing existing accounting and payments systems. These proposed solutions bear no resemblance to bitcoin or any cryptocurrencies although and use this confusion is used as part of the blockchain meme to confuse the public.

There are at least five problems in this passage:

(1) Can the authors give us an example of an advocate who embraced both Libra and CBDCs who did not also work for Libra?

(2) Facebook’s Libra (Diem) project had closed its doors about five months before this book was published, so they should have at least put the second sentence it in past tense.

(3) Since the authors do not define or provide any model for what a CBDC is, it is clear in their 2nd sentence they are making it all up. Claiming that “at best” it is “digitizing existing accounting and payments systems” is wrong. They should consult an actual expert next edition.

(4) The last sentence is wrong because there are dozens of CBDCs proposals and implementations, some of which do share and use Ethereum-related infrastructure. The only people confused are the authors, and the Financial Times who for some reason quotes them.

(5) Lastly, there is some grammatical issues with the final sentence. Do they mean to use “although” or “use”?

On p. 190 they continue in their concluding paragraph:

Digital currencies are not synonymous with cryptocurrency, especially when a central issuer offers it. Digital currencies and payment rails are an essential part of public infrastructure that – especially in the United States – needs to transition from slow legacy batch systems that operate 3-4 times a week to real-time payment systems that other developed economies regularly use. These efforts are separate and entirely unrelated to cryptocurrency. Distributed ledger technology has nothing to offer central bank digital currencies as a central bank by definition, centralizes the architecture.

Every single sentence in this paragraph has an issue:

(1) Why is it “especially” when a central issuer offers it? The authors had the chance to explore centralized pegged-coins in this chapter but only focused on a project that never launched, Libra.

Are USDC and USDT not considered part of the “cryptocurrency” world because they are centrally issued? Maybe that is the case, but they did not bother to spell it out.

(2) FedNow was publicly announced August 5, 2019. Six weeks later there were congressional hearings about real-time payments on September 25-26 2019. That is nearly three years before the publication of this book. The authors did not fully describe how often “batch systems” operated in the U.S. during that time or why that aspect was important.

(3) Some of the efforts, such as FedNow, are indeed unrelated to CBDCs, but not every RTP and CBDC project around the world are mutually exclusive.51

(4) This is the first time the authors mentioned “distributed ledger technology” and they do not define it for the audience. And just two paragraphs above they mention the Boston Federal Reserve is exploring projects (Project Hamilton) and guess what the Boston Fed is using? A derivative of Bitcoin.

Overall everything in this subsection is wrong. Yet, strangely enough the authors (twice!) cite a solid paper from Kiff et al. That paper mentions “blockchain” 22 times and “smart contracts” 25 times. Did the authors even read it?

Lastly, the authors had a big miss, not predicting at least one of the problems facing centralized pegged-coin reliant on commercial banks as custodians: a credit event for the custody bank.

For example, two years ago I explained potential credit events with Signature Bank and Silvergate Bank (which Circle used as custodians to hold reserves backing USDC):

Where is Diehl et al. prediction? Nothing specific was mentioned in this chapter or book. They also missed the opportunity to discuss collateral-backed assets such as Dai and Rai.

If you are still reading this review it is worth taking a break because we still have more than fifty pages to go and the errors continue.

Chapter 19: Crypto Journalism

This chapter could have easily been filled with public antics from coin reporters who have gone out of their way to promote specific cryptocurrencies or even acted as sycophants to coin personalities, like SBF.

Instead readers are provided less than five pages of content, and only one that mentions disclosures.

On p. 192 they write:

The confusion about trade journalism as a reliable source is unfortunately common in the absence of authoritative mainstream reporting on cryptocurrency. Government bodies and financial institutions such as the International Monetary Fund, United States Securities and Exchange Commission, and FinCEN regularly cite cryptocurrency trade journalism as the basis for public policy.

If by “regularly cite” the authors mean, the IMF, SEC, and FinCEN will refer to a coin zine in the footnotes, then yes they do. Is that good or bad? It depends on the facts-and-circumstances.

Unfortunately the authors do not provide a single example so we have no idea what they think.

Continuing on the next page they write about the ICO bubble:

This process of credibility purchasing, exploitation of transitive trust, and stoking a “fear of missing out” was a core part of the engine that drove the ICO bubble and was a lucrative enterprise for those participating in it. Several unethical publications silently pulled their articles touting tokens that were later the subject of lawsuits or criminal investigations.

Which publications? Which tokens? What lawsuits and criminal investigations? We have no idea because there is no citation.

On p. 193 they write:

The articles pushed by these outlets vary from the mundane to the bizarre, but several trends are apparent headline trends across most outlets. The first narrative is an almost pending corporate adoption of bitcoin or blockchain technology.

Can we get an example? A reference?

In the same paragraph they write:

The content of the articles will cherry-pick quotes from seemingly mundane internal report on emerging trends in financial services to support whatever position the outlet is looking to promote. The contents of these reports rarely ever support any research and hesitation.

Can we get an example? A reference?

The only citation for the whole paragraph (which is even longer than what was quoted above) is to a very short Financial Times blog post about Terra.

At the bottom of p. 193 they discuss news about Venezuela and Zimbabwe, stating:

The narrative pushed by cryptocurrency outlets is that the citizens of these nations are fleeing their domestic currencies in favor of digital currencies as a flight to safety. While it is true that there are some users of cryptocurrencies in these nations, as there are in most internet-connected countries, there is absolutely no macro trend of citizens towards bitcoin as a means of exchange.

They cite a relevant article from Reuters regarding Venezuela. But it is worth highlighting that once again, in the last part of the final sentence, the authors cannot stop talking about bitcoin. It lives rent-free in their minds.

Yet the world of cryptocurrencies and blockchains is much larger than the orange memecoin.

On p. 194 they write:

During the height of the ICO bubble, investigative journalists looked into the price for journalists to promote a given ICO project at various cryptocurrency outlets. Shockingly the investigation found the prices of an article from a low of $240 to a high of $4500.

Hurray, they finally provided a relevant citation! This is what the chapter should have included, similar stories.

Throughout this chapter – and in particular this section – I kept wondering what were you guys doing in 2017-2018?

Did you warn the public about what you perceived as scammy ICOs? This would have been a good spot for the authors to provide some bonafides.

Chapter 20: Initial Coin Offerings

This chapter has one of their strongest sections and also has some of their worst prose and arguments. at 16 pages it could definitely serve as the foundation for a new edition.

On p. 197 they write:

During 2017-2019 there was a massive secondary bubble on top of the cryptocurrency bubble in which fledgling blockchain companies used the ethereum blockchain as part of crowd sale activities to sell custom tokens representing alleged ownership in new enterprises.

This is not 100% accurate. Not every ICO during that time frame only used Ethereum.

For instance, in July 2017, Binance conducted its ICO that raised $15 million, split between BTC and ETH. That same month Tezos raised around $232 million from approximately 66,000 BTC and 361,000 ETH. The authors do not provide any examples. Also, not every ICO claimed the tokens represented ownership in new enterprises. That is something the authors made up.

On p. 197 they write:

The simple fact remains that no company that raised funds under an ICO model has taken any profitable product to market.

That is probably true, but they do not provide a reference. An outlier for sure, but an example of one company that did was Binance, which operates the largest centralized exchange by spot volume. 52

On p. 197 they write:

The first ICO was in 2013 for a small project called Mastercoin. The project raised $2.3 million by selling a custom digital token for a specific exchange amount of bitcoin and ethereum per new token issued.

While Mastercoin (later rebranded as Omni) is widely considered to have conducted the “first” public ICO, the authors are incorrect on at least one detail: Ethereum did not even exist at this time.53

Nor did anyone participating in the Mastercoin ICO ever exchange ETH for the new token because Mastercoin lived on top of Bitcoin (it was similar to other “colored coin” projects at the time). I wrote a paper on this topic nearly eight years ago, feel free to use the works cited.

On p. 198 they write:

For ICO exit scams, the strategy is straightforward. You construct a fantastical prospectus that makes wild claims about a product or business imply or outright state that investment will increase in value over time and incur massive returns for early investors. Then you raise the money and then hop on a plane to a country without an extradition treaty and launder the money into the local currency. This is known as a exit scam or rug pull.

This was an enjoyable paragraph to read. To their credit they did cite a New York Times article that provides some examples. Yet a second edition should clarify that it is “an extradition treaty with the U.S.” (or a relevant jurisdiction) Also, probably need to use “an” instead of “a” in front of exit scam.

On p. 198 they write:

This is the simplest and most common form of ICO business model. The best example of this is the April 2018 Vietnamese scam for two companies named Ifan and Pincoin. The two firms are alleged to have misled approximately 32,000 investors and stolen upwards of $660 million.

I recall that sad story, even mentioned it in the private newsletter (mentioned earlier):

Source: Post Oak Labs newsletter

The authors say it is the most common form of ICO business model. Do the authors have a percentage or other figure to determine how common it is?

On p. 199 they discuss the Telegram ICO involving the The Open Network (TON) token. The authors use the date of 2020 but the references they cited actually refer to the year 2019. The authors should revise the language because the lawsuit was in October 2019.

On p. 199 they write:

The secondary economic question pertains to the fact that the overwhelming majority of these companies have produced nothing of value. The lack of any marketable blockchain artifacts raises some existential questions about the utility of this sector.

That may be the case but the authors are trying to have it both ways. On the one hand they demand evidence, on the other hand they a priori dismiss all blockchains and cryptocurrencies as utility-free. They need to be consistent.

On p. 200 they write:

The question remains where did all this money go? Not all of it was spent on Lamborghinis, parties, and cocaine (although a fair amount was).

There is no citation, so how do the authors know “a fair amount was”?

Continuing in the same paragraph:

While it is true that these companies have created jobs, however, this kind of job creations is the equivalent to paying employees to dig ditches and then fill it back up again. The parable of the broken window is an economic thought experiment regarding whether a child breaking a window is a net win for the economy simply due to the window having to be replaced. The activity of replacing the window has unseen costs that, when netted over all of the participants, are in aggregate negative over the opportunity costs of other productive activities. ICOs, simply put, are a society-level misallocation of capital that incurs a massive opportunity cost in the number of productive things and companies that could be built with said capital.

That is probably true – in fact I agree with the thrust of this passage – but they do not provide any example to strengthen their position. Frédéric Bastiat’s parable that they dutifully summarize can be explored in a second edition; the authors could explain what the ICO funds could have been spent on instead. Although this is tangential to the broader issues around consumer (and investor) protections.

On p. 200 they write:

For coins that are neither exit scams nor thinly-veiled pump and dump schemes, there is another class of projects with slow-burn failures. This class of ventures stems from the inability to deliver on unrealistic business defined by the whitepaper. These whitepapers typically involved appeals to vague buzzword and aspirations to build software built around “decentralization” memes and vague terms such as: Immutable, Decentralized, Trustless, Secure, Tamper-proof, Disintermediated, Open/Transparent, Neutral, Direct transfer of value.

I agree with the authors because what they are basically describing is chainwashing. But the problem is they are throwing rocks at glass houses because Adjacent did something similar back in 2016-2018. Just look through the direct quotes from Diehl and his colleagues during that time frame.

For what it is worth, I think it would have been consistent for them to criticize using these phrases all while explaining they have first hand experience in the industry (which Diehl has removed from his online biography).

On p. 200 they write:

Several jurisdictions became ICO-friendly to encourage innovation and job growth, to collect taxes, and to expand the possibilities of having homegrown domestic startup success stories. The most popular choices for jurisdictions were the Swiss canton of Zug and the island of Malta. The Swiss banking culture of client confidentiality encouraged many ICO companies to incorporate in the Zug region and then use the Swiss or Lichtenstein banking system to convert their bitcoin and ethereum into Francs and enter the traditional financial system. These funds could then be distributed to British offshore trusts, often set up in Gibraltar, to hide the funds from taxation and lawsuits.

The authors provide a reference to a note by Julianna Debler. While it discusses jurisdictional issues, it does not mention anything about Switzerland, Malta, or Lichtenstein.

How do we know these were the most popular jurisdictions? How do we know the funds were setup in Gibraltar? The authors may know something but did not provide a citation for it.

On p. 202 they write:

The average Series A for an American startup is around $13 million. However, these ICO funds raised capital 10-100 times that of a typical Series A round.

There is definitely a lot of blame to go around, but there is no reason to make up anything when publicly known facts seem incriminating.

For instance, what source do the authors derive the average Series A figure? When I lived in the Bay area the average Series A was typically between $2m – $5 million. According to Carta, in Q1 2023 the median cash raised for a Series A was $6.4 million.

But let us assume that the authors are correct, that the figure is closer to $13 million. They are also saying that “these ICO funds” raised $130m – $1.3 billion. Which funds were they referring to? Only a couple dozen ICOs raised more than $100m. A few outliers, like EOS, raised more than $1 billion.

On p. 202 they write:

There was an unusual pattern of ICO-backed tech ventures founded entirely by lawyers and social media influencers with no technical leadership. From a technical perspective, many of these slow-burn companies attempted to build the software proposed in their initial whitepaper only to find that the underlying technology stack they initially proposed was simply too slow, immature, or impossible to support their product pitched. Many companies overpromised the capacity of so-called smart contracts to build arbitrarily complex financial products and were quickly hit by the hard limitations shortly after investigating the technology. In the absence of experienced technical leadership, many of these companies attempted to remedy the immaturity of the software themselves and hired repeated iterations of teams unsuccessfully to build what they had initially promised.

Anecdotally I have heard similar stories but the authors should provide examples or a reference.

On p. 203 they write about Crazy Coins. This is one of the most interesting sections in the book. However it is worth pointing out that very few of them were actual ICOs.

On p. 207 they discuss celebrity endorsements, writing:

On the back of the speculative bubble of coin offerings, many entrepreneurs recruited a variety of people to promote these investments. These included many celebrities such as rappers and Hollywood actors who used their influence and social media presence to tout unregistered securities.

The authors do not mention if they are licensed lawyers or consulted lawyers yet many chapters are littered with accusations such as “tout unregistered securities.”

That may true but the accusation has to be proven in a court. So a future edition should add hedging words like “alleged” or “possible.” Or they could quote a securities attorney.

On p. 208 they discuss court cases, starting with the SEC lawsuit with Telegram. While the authors seem to do a good job summarizing the case, they miss one minor detail: The Open Network eventually launched. Telegram users can transfer Toncoin (the token) to other users on the app itself.

On p. 210 they write:

This model appeals to entrepreneurs as it increase the addressable investor pool to include international and unaccredited individuals who may not otherwise be able to participate.

This may or may not be true. Either way, the authors never explain what an accredited versus unaccredited individual is or what jurisdiction they are referring to (likely the U.S.).

On p. 210 they write:

Companies that engage in this sale often create a Theranos-style long firm whose premise is based on increasingly large token sales on top of a company that is either empty or fraudulent. For these companies, statement is simple: the token is the product.

There are a couple of grammatical issues. What is a “Theranos-style long firm”? What does “statement is simple” mean?

The authors reference an interesting and relevant paper from Paul Momtaz. However the Momtaz paper does not mention Theranos at all.

At the top of p. 211 they write:

Regulars are given many additional political tools to enforce rulings, however, the primary mechanism of action is to bring suits against the worst violations after the fact. Under-resourced regulators will simply often go after the top 20% of worst cases that will result in clear legal precedence and prevent future violations, but on the whole, the system lacks the resources to pursue every case.

There are a couple of issues:

(1) They misspell “regulators” in the first sentence (“Regulars” -> “Regulators”)

(2) Where do they refer the “top 20%” of worst cases? Where does that figure come from?

On p. 211 they write about tokens as illegal securities, writing:

The economic crises of the 1920s and 1930s led to a new variety of laws to curb the excesses of wild speculation that had created the crises.

Which crises were the authors referring to in the 1920s? The Great Depression? Was the Great Depression caused by speculative excesses or were there other contributors?

The authors should probably refine their statement to say something like, “In the U.S., the fallout from speculative excesses and mania that came to a head in late 1929 paved way for the passage of laws such as the Securities Act of 1933.”

On p. 212 they write about the Howey test:

A product is considered a security under US law when it shares the following three characteristics.

Yet later on p. 234 they mention Howey test has four characteristics. They should probably talk to a licensed lawyer to reconcile the wording. For instance, the authors should chat with Todd Phillips, who recently wrote a relevant op-ed in their favorite periodical, the Financial Times.

On p. 212 they say “During the 2016-2018 ICO bubble…” yet in the ICO section on p. 203 they mention “the 2017-2020 bubble.” Are these dates referring to different bubbles?

On p. 213 they write:

The other method around the securities laws is the use of dual-purpose tokens, which can be redeemed for services within a network and traded speculatively. In many of these dual-use token cases, the smoking gun is the presence of prominent venture capital investors where the expressed purpose of their investment vehicle is to return on the investment on their fund. If a messaging app offered a token that granted the alleged “utility” of being able to purchase in-app stickers, it is implausible that a fund of this size’s intent is to buy hundreds of millions of dollars of stickers for its own use. Instead, they intend to use their capital and information asymmetry to gain an advantage in trading the tokens for a return after the presale. The alleged utility is simply a very thin legal cover to hide their real intent.

A couple of issues with this statement:

(1) Which jurisdiction are the authors referring to? The U.S.? Which specific securities laws are they referring to?

(2) That could all be true – and I a sympathetic to their general argument during the ICO bubble years – but the authors do not provide any examples of a specific fund that did this. They basically sound like self-deputized prosecutors.

Overall this chapter has a number of areas the authors can build a strong foundation from, specifically the areas of “crazy coins.”

But even the title of that subsection makes you wonder: how do the authors determine what are crazy and non-crazy coins? They definitely should include direct quotes from actual licensed attorneys because some of their arguments probably have merit but right now it comes across as opinions of news clippings.

Chapter 21: Ransomware

This is a four page chapter that abruptly ends. It could have been much stronger if it included the history of “data kidnapping” in the 1990s. With that said, the authors do provide several specific examples and even a timeline, so that is a good start.

On p. 215 they write:

Most bitcoin use outside of speculation is not in payments but in financial black market activities and malware.

Source? Citation?

Surely just a little googling can help back-up the argument. For instance, according to Chainalysis, illicit use of cryptocurrencies hit a record $20.1 billion during 2022. Yet earlier this month an expert with CipherTrace says: Chainalysis data contributed to ‘wrongful arrest’ of alleged Bitcoin Fog founder. That seems like something readers might like to learn about.

On p. 217 they write:

In late 2019 there was an attack on the University of California San Francisco research department performing COVID-19 vaccine development, which locked servers by epidemiology and biostatistics departments.

The authors do not provide a reference to that UCSF story and a quick googling shows the date is incorrect. The hacking event – and subsequent ransomware demand – was in June 2020.

On p. 217 they write:

With cryptocurrency enabling ransomers, it allows these criminals to proliferate behind the scenes with very little chance of getting caught.

I sympathize and mostly agree with this statement. However it is missing a very important word – liquid cryptocurrency.

Why? Illiquid cryptocurrencies can be difficult and expensive to quickly move in and out of.

For instance, if Diehl issued his own token – Diehlcoin – its mere existence does not a priori enable ransomers. Rather, a deep and liquid cryptocurrency is necessary to expedite the process at scale. That is one of the reason that J.P. Koning recommended focusing on the payments leg of ransomware.

On p. 218 they provide eight dates that are not ordered chronologically, a new edition should order them by-date or at least explain that the ordering is done by ransomware amount.

Lastly, the very final sentence includes “a $5.2B/year industry” — the authors should spell out “billion” instead of abbreviating it.

Chapter 22: Financial Populism

This six page chapter should have been longer or at least spent longer discussing the fall-out of the 2007-2009 financial crisis.

It only plays lip services to the frustrations and concerns highlighted by protestors within the Occupy Wall Street movement.

For instance on p. 220 they write:

However, the genuine grievances percolating about the American zeitgeist were not bracketed purely to leftists groups; the events of the global financial crisis were indiscriminate and universal in the damage they caused the public, regardless of political affiliation. Movements on the right, such as the Tea Party, also adopted financial populist language as a reaction against the perceived injustice of the Obama administration’s bailout package and recovery plans. It was a rare moment in America where both the left and the right were, for equally legitimate reasons, furious at the fact that the public had been swindled by reckless Wall Street speculation – much of which was entirely based on crimes that would be later uncovered by post-crisis financial journalism.

Any specifics about the bailout packages and recovery plans? Wasn’t TARP legislation passed in the final months of the previous (Bush) administration?

Either way, the authors moved on without mentioning anything about the existence of systemically important financial institutions (SIFIs) during that time period which is a big omission; nor do they mention important legislation like Dodd-Frank.

Instead, they say these folks were naïve simpletons, writing on p. 221:

A valid criticism of the Occupy movement was that, in hindsight, the campaign had no clear goals or vision of what success or positive change would entail. Occupy was primarily a youth movement made up of individuals who overwhelmingly did not understand the complexity of the global financial system, regulation, or the principal causes of the financial crisis but were personally impacted by all these factors. The campaign was a reactionary movement against a not-well-understood injustice that had been exacted against them but which almost none of them could articulate the actual problem or proposed solution. The exposition of the movement’s ideas led to many misconceptions and debatably amounted to little tangible change in regulation or policy.

Perhaps this is all true but up until this point, apart from two pages in chapter 3, the authors do not spend any time discussing the GFC; nor the tangible changes in regulation and policy (such as Dodd-Frank).

Later in the chapter they mentioned TARP but do not mention how – in the U.S. – are still left with a highly concentrated financial system that privatizes profits and socializes losses.

Perhaps the youthful participants in the Occupy movement were ignorant, but the patronizing tone of this paragraph and the book seems like projection.

A reader could substitute “Occupy” with “anti-coiners” and arrive at the same conclusion as the authors did about the veracity of anti-coiners inability to articulate the actual problems facing the financial system. For example, in this book the authors show they do not understand how PayPal actually operates (e.g., as a shadow bank).

On p. 221 they discuss WallStreetBets and Bitcoin

The political imagination of Satoshi – and many crypto apostles who followed his vision – was that the financial system could not be reformed. Nothing less than the wholesale destruction of corrupt financial institutions would achieve their goals.

That may or may not be true, is there a citation or source for that?

The sole reference is to a paper from Carola Binder. The paper does not mention anything about cryptocurrencies, including bitcoin. Is this another strawman by the authors?

On p. 222 they write:

The American public’s rage toward Wall Street and the elected officials are, in many ways, highly justified. In response to the financial crisis, the American government created the Trouble Asset Relief Program (TARP) in the form of a $7000 billion government bailout to purchase toxic assets from financial institutions to stabilize the economy. While, in hindsight, the package may have been necessary, it only reaffirmed the notion that the financial sector plays by a different set of rules than the public; rules that encourage risk-taking because public taxpayer money is always available whenever the situation becomes too dire. Economists use the term moral hazard to describe conditions where a party will take risks because the cost incurred will not be felt by the party taking the risk. The clearest example of these excesses was when in 2009, a year after the bank rescue program, Goldman Sachs paid out $16.7 billion in bonuses to bank employees, seemingly as compensation for their extreme risk-taking leading up to the crisis. These bonuses paid out, seemingly on the back of the taxpayer, enraged the public. Despite all the public anger, the Obama administration did not prosecute any of the high-level executives involved in the events leading up to 2008. Instead the courts prosecuted a single executive, Kareem Serageldin, who was sentenced to 30 months in prison for conspiracy to falsify books and records at Credit Suisse. In what many perceive to be an affront to justice, the rest of the sector was graciously given a bailout and a slap on the write despite the public outcry for the Obama administration to collect banker scalps.

While the authors pay some lipservice to injustice that carries on to today, their 270 word exposition contains no mention of market structure, specifically how single points of failure (SPOF), single points of trust (SPOT), and systemically important financial infrastructures are still hanging over our heads.

Will blockchains or cryptocurrencies “solve” SIFIs? Maybe, maybe not. But the authors do not even attempt to discuss a scenario of decentralized financial market infrastructures (dFMI). Yup, I co-authored a paper on that topic too.

A couple of other quibbles about that passage:

(1) They do not explain why TARP was necessary. At the time, others argued for alternatives and even no bailouts at all. A second edition should explain the pro-TARP position.

(2) Courts are venues where litigation occurs and as such do not ‘prosecute,’ it is prosecutors who prosecute entities. Worth revising the wording the sentence about Kareem Serageldin.

On p. 223 they discuss the Reddit forum WallStreetBets, writing:

Despite the narrative of a populist uprising, the so-called Gamestop Revolution had little effect on the broader market. Instead, the vast majority of retail investors who chose to participate in the Gamestop bubble ended up losing money, as is characteristic of other historical bubbles. In the aftermath of the bubble popping, the Wall Street Journal report that many of the brokers and market makers made outsized profits off the increased volume in trades; the Journal wrote that “Citadel Securities executed 7.4 billion shares of trades for retail investors. That was more than the average daily volume of the entire U.S. stock market in 2019”. It also reported that Wall Street investment bank Morgan Stanley “doubled its net profit in the first quarter of 2021 to $41. billion” At the end of the day, the real winners of the GameStop bubble were the same entrenched institutions as before, and the public learned the hard lesson that day trading is not an effective means of protest against the financial establishment.

Several issues with this:

(1) This is the first – and only – time that the authors acknowledge “entrenched institutions.” Up until this point we have highlighted how the authors implicitly carry water for incumbents and legacy institutions. A second edition should build beyond the single reference they provide, to a paper from Jonchul Kim.

(2) A second edition could also discuss the role Robinhood played in this faux populism. And specifically, the constraints in the financial plumbing.

For instance, Robinhood had to raise $1 billion and throttle trades at one point due to clearing and settlement bottlenecks with the DTCC.54

(3) The authors should be consistent with how they write “Gamestop” or “GameStop” because they use both.

On p. 224 they write:

Financial populism is a reaction to this fundamental economic shift that can be framed in terms of six key components of the ideology.

The authors only list five components, where is the sixth?

Chapter 23: Financial nihilism

What expectations do you have for five pages in a chapter called financial nihilism?

On p. 227 they write:

Crypto is a symptom of the problems of our era, of a post-truth world awash in crackpottery, and a breakdown of trust in our institutions. For the first time in a generation, Americans feel the economic crunch like never before. Now well into their thirties, the millennial generation has been hammered by both the 2008 financial crisis and the coronavirus pandemic. Study after study confirms that Americans are more atomized, lonely, depressed, and desperate. At a certain level, the psychological state of market participants also begins to alter the markets and the fabric of the financial landscape itself.

Which studies? Any example? And what is threshold for “a certain level”?

On p. 228 they write about alienation:

Nihilism is an anti-philosophy, an intellectual dead-end from which no other observations can be derived. The financial form of nihilism takes these ideas and applies them to the concept of value and markets.

Hey, I think I know where their story might be headed…

Source: Twitter

Thanks for the credit guys! Don’t forget to cite Colin Platt too.

On p. 229 they write about the subjective theory of value:

A radical reading of the subjective theory of value asserts that any objective measure of value cannot exist, and the subjective preferences of the buyer entirely determine that market value and the seller, revealed through the autonomous operation of the free market. Dogecoin, diamonds, and dollars all have the same intrinsic value of zero because everything has zero intrinsic value. Markets simply trade in memes, some more popular than others, but none having any objective status or corresponding to any truth. Any investment scheme is thus assumed to be a grift a priori. After all, it is an attempt to get others to believe in some collective delusion which is assumed to be a Ponzi structure because everything is a Ponzi. The entire economy is thus nothing more than a Keynesian beauty contest for collective delusions. The role of the individual in late capitalism is to be nothing more than a maggot eating the corpse of civilizations while the world boils itself to death in an orgy of greed and corruption.

Oh?

In re-reading the passage above, while the authors were purposefully exaggerating the bleak worldview of the “nihilist” it is clear that the two camps share at least one common cudgel: the grift of a priorism.

We have documented around two dozen examples – so far – of the authors eschewing empiricism for an a priori approach.

Their argument immediately falls apart because prosecutors (which the authors have deputized themselves as) must use facts-and-circumstances, evidence, to prosecute a case. Not oration.

On p. 229 they mention there “in a world of zero interest rates” but the world of ZIRP – at least in the U.S. – ended several months before this book was published. The Fed began hiking rates in March 2022.

On p. 230 they write about how everything is a Ponzi:

Instead of a 401k, a diversified portfolio of mutual funds, and a mortgage, for a nihilist it is an entirely natural alternative to constructing a portfolio of CumRocket, Shibu Inu, SafeMoon, and a hundred other blatant scams in the hope that one of the scams works out.

Let us be pedantic: while some readers may know what a 401k is, not everyone might, so a future edition should probably explain what a 401k is or what a diversified portfolio of mutual funds are.

The authors should probably also explain why an investor pays management fees that mutual funds charges (versus an index fund that might not). Also, the authors might want to explain what type of mortgage they are thinking of too (they are not all the same in every country).

Also, since they do not provide any evidence for why CumRocket, Shibu Inu, or Safemoon are scams, then we can dismiss their claim without any evidence.

In the concluding paragraph of this chapter they write:

The world has a structure to it, and through the capacities of reason and science, we can understand both the world and the human condition, and through reason, we can improve our condition to build a better future. While democracy is not perfect, it is perfectible. Even if none of this were true, it is still better to labor under a delusion of misplaced hope and optimism than to wallow in aimless despair. Financial nihilism is a worldview that, although understandable, can be outright rejected.

Like most concluding paragraphs in the book, this is just rhetoric and polemics. The chapter does not actually cite anything about despair, is there a study on the level of despair of degen coin nihilists?

Chapter 24: Regulation

We have mentioned this before but it bears repeating: an editor would have helped consolidate similar topics together. This nine page chapter has some new ideas and concepts but it also regurgitates a number of topics that have already been semi-addressed elsewhere. It is also filled with more rants which are tiring to hear over and over again.

On p. 233 they write:

We live in a new golden age of fraud. Never since the 1920s has financial fraud and grifting been so ingrained in public as today. Yet, the cryptocurrency bubble is entirely built on a single foundation: securities fraud. The investment narrative of cryptoassets derives from an uncomfortable truth; selling unregulated financial assets to unsophisticated investors is a great way to raise large amounts of money quickly and with little overhead and oversight. In the 1920s, people raised money from the public on the back of promises of “easy money” from non-existent oil wells, distant gold mines in foreign countries, and snake oil cure-alls. And yet nothing has changed. Today, we have promises of investments to build financial perpetual motion machines created on the back of promises of decentralized networks, a new digital economy, and blockchain snake oil cures for whatever problem one sees in the world.

The authors cite a relevant paper from Boreiko and Ferrarini and a book from Michèle Finck. Both primarily focus on blockchain-related regulations in Europe.

But as they have in previous chapters: the authors also keep interchangeably using “securities fraud” with the sale of “unregulated financial assets.”

I am not a lawyer, are the authors? Who is being defrauded in their mind? Are they sure they do not mean “financial assets that should be regulated” or “financial assets that have been regulated in different ways depending on the jurisdiction”?

A second edition should clarify what exactly they mean when they use these words and more importantly what jurisdiction(s) they had in mind.

On p. 233 they write:

The Securities Framework put in place by our grandparents following the Market Crash of 1929 is based on universal truths about the nature of capitalism.

Look we all probably agree with the thrust of this particular page but it comes across heavy-handed in places. And more importantly, the argument presents “The Securities Framework” as if it was handed down by Moses and cannot be changed.

Apart from having semi-endorsed the STABLE Act and e-Cash Act, I do not currently have a strong view about any of the proposed legislation on the docket in the U.S. at the state or federal level. But that is not why you came to read this book review either.

On p. 234 they mention “the initial coin offering bubble of 2018” which is yet another date format. Previously they have said 2016-2018 and 2017-2020. A second edition should reconcile and harmonize these.

This full paragraph is enjoyable:

The initial coin offering bubble of 2018 gave us the most unambiguous evidence of how crypto creates a criminogenic environment for fraud. By allowing potentially anonymous entrepreneurs to raise crypto-denominated capital, from all manner of international investors, with no due diligence, reporting obligations, registration requirements, or fiduciary obligations to their investors, we saw exactly what one might expect: a giant bubble of outright scams. Some studies put the number of outright ICO scams at 80%. These companies had no pretense of any economic activity, and the founders simply wanted to abscond with investor money. The rest of the 20% merely fall under the category of illegal securities offerings, companies that sold digital shares as a proxy for equity in a common venture to American investors.

I actually agree with some of what they wrote, but it is how they wrote it – hyperbolic! – that is problematic. With the amount of alleged fraud and scams that took place in that era, there is no reason to exaggerate or get sloppy or lazy about references.

Where do the get the 80% and 20%? There are no citations.

Did they make it up? A quick googling found a 2018 report from Satis Group which claims that: Over 70% of ICO funding (by $ volume) to-date went to higher quality projects, although over 80% of projects (by # share) were identified as scams.

Is this what the authors had in mind? Do the authors agree with Satis’s methodology? If so, add it to the bibliography in the next edition.

How do we know the remaining 20% are “illegal securities offerings”? The authors do not explain why there are only two categories. What about ICOs that did not solicit Americans?

The remaining portion of this subsection is hard to take seriously since, as mentioned previously, they do not have a consistent view on how many prongs the Howey test is.

On p. 235 they write about shadow equity and securities fraud, specifically around venture capital firms. They do not provide any citations yet state that: “The venture investing model is an integral part of the United States tech economy and an engine for enormous prosperity and growth.”

Maybe it is, what is the reference?

Continuing on the same page:

However, in the post-2018 era, the outsized venture returns seen in the previous era have largely fallen by the wayside. The unicorns-companies valued at over $1 billion – that were once darlings of Silicon Valley, Peleton, WeWork, Uber, and Lyft have not performed like the giants of the dot-com era when IPOing; the unicorn stampede has become a bloodbath in the public markets.

A few issues with this:

(1) They probably should add a colon after “Silicon Valley”

(2) They misspelled Peloton (not Peleton)

(3) While we all probably understand the gist of what the authors are trying to say – that recently listed unicorns have underperformed since they IPO’ed – the comparison with “dot-com era giants” is not the best one.

In fact, in Chapter 3 they specifically highlighted the “The Dot-Com Bubble”. What are we supposed to do with this conflicting information?

For example, the authors do not mention specific “dot-com era giants” but we can probably assume they would include Amazon since it was mentioned in Chapter 3. Its first five years after listing were pretty dicey.

(AMZN) Source: Yahoo Finance

A future edition could simply say something like, some high-profile unicorns have underperformed since being publicly listed.

Continuing in the same paragraph they write:

Venture capitalists chasing the double-digit yields of the past have turned into increasingly more bizarre, risky, and unsustainable business models as part of their portfolio building. For venture capitalists dipping their toes into crypto investing, this has increasingly meant not investing in equity in their portfolio companies but instead investing in crypto tokens as a proxy for equity, a controversial mechanism known as shadow equity.

What is shadow equity? The authors do not provide a formal definition. What does Google say?

So the authors create a new term – shadow equity – do not provide a definition for the readers and it turns out there is already another working definition that is not the same thing as what the authors were describing.

A second edition should either drop the term “shadow equity” or find another term industry participants use to describe whatever it is the authors had in mind.

Continuing on p. 236 they write:

However, with shadow equity companies are not effectively issuing shares represented by cryptoassets or smart contracts, which are securities yet receive none of the investor protections of regular equity. Instead of a traditional equity raise, venture capital firms approach founders of crypto companies and do backroom deals that exchange capital for a percentage of the tokens that the company will issue in a sale known as a pre-mine. For instance, if a company issues 30 million shadow equity “share” tokens, it might allocate 20% or more of these tokens to its investors before selling them directly to the public.

There are several issues with this, including:

(1) Despite how common this allegedly is, the authors provide no specific examples or citations.

(2) It technically is only a “pre-mine” if there is actual mining taking place (such as a proof-of-work coin). There are other industry terms for non-proof-of-work coins but why should we do all the homework for the authors?

(3) Anecdotally I have heard of different types of retention and compensation models, but the one they describe for “shadow equity share tokens” is new. Where did they hear that?

On p. 237 they use the word “tieing” but the correct spelling is “tying”

On p. 237 they write:

Since the rise of the “web3” marketing campaign, many high-profile venture capital firms, although not all, have engaged in mass securities fraud to juice the returns on their portfolio.

Did the authors provide a single example? Nope. Perhaps they are correct but that which is presented without evidence can be dismissed without evidence.

Continuing in the same paragraph:

Investors’ returns on shadow equity are directly offering these investments to the public far faster than any other traditional form of venture investment. A typical web3 company can have a pre-mine sale, raise $50 million, offer the token to the public in a giant marketing push, and watch the price temporarily soar 10-20x in value in a massive pump while insiders take their profits, and before it all collapses down to peenies on the share; and all this before any pretense of a product is event built.

Did the authors provide a single example? Nope. Perhaps they are correct but that which is presented without evidence can be dismissed without evidence.

On p. 238 they write about industry lobbying efforts. But they do not mention a single lobbying organization which is a real disappointment because lobbying organizations like Coin Center white wash the negative externalities of proof-of-work mining.

For instance, they write:

All the while, the cryptocurrency industry has been lobbying lawmakers left and right, attempting to pass beneficial laws which all them to circumvent securities laws and create loopholes for them to continue the gravy train perpetuated by open and ubiquitous fraud. The revolving door between government agencies and crypto companies has been prolific in the last few years. Currently, the government risks falling into an irreparable state of regulatory capture where agencies are run by the entities they allegedly regulate.

I agree with the general thrust of this but you know what the authors are missing? Specific examples and evidence.

For instance, five years ago Lee Reiners wrote the first long-form article diving into the “revolving door.” A second edition must include that. In addition, Nathaniel Popper was the first mainstream reporter who covered how specific venture firms were actively lobbying specific regulatory agencies in the U.S., asking for “carve outs.”

It is worth pointing out to readers that a number of anti-coiners have shown open disdain with Popper despite the fact that he was covering this space long before the anti-coiners decided to care about it. The fact that Popper’s coverage is not cited reduces the credibility of these authors who have not done diligence.

For instance, where were the authors when Popper was reporting on the misdeeds of Centra?

On p. 239 the authors present a framework for discussion (with regulators) and propose five questions. These are good questions.

On p. 240 they present a “path forward” which includes:

Cryptoassets are clearly securities contracts. They meet both the legal and practical qualifications for being regulated, just like any other investment contract. To investors, they present with much the same presentation of opportunity: to generate a return based on the efforts of others, but with far more extreme risk. The existing securities framework would vastly mitigate these risks and protect the public from harms that have been well-understood by economists and lawyers for 100 years now.

All cryptoassets are “clearly securities”? What supporting evidence to the authors provide to back up this claim? Nothing. That which is presented without evidence can be dismissed without evidence.

Continuing on p. 240 they write:

The amount of pump and dumps and market manipulation present in crypto markets is unprecedented and is primarily created and done by exchange operators themselves. Massive amounts of non-public asymmetric information, economic cartels, and manipulation are not conducive to either capital formation or financial stability.

How unprecedented are the pump and dumps? How do they know these are primarily created by exchange operators?

What supporting evidence to the authors provide to back up this claim? Nothing.

That which is presented without evidence can be dismissed without evidence.

Also, this is the first and only time the authors complain about cartels. They missed the opportunity to discuss them in Chapter 3 regarding the financial industry during and after the 2007-2009 crisis.

On p. 241 they propose to “ban surrogate money schemes derived from sovereign currencies.” This is not a bad idea per se, Rohan Grey has kind of discussed something similar. But this would impact PayPal, is that something the authors are aware of?

Continuing, they write:

As found in many stablecoin projects, surrogate money schemes attempt to create dollar-like products that mimic public money. However, the products are not backed by the full faith and credit of the United States Government, and in many cases not even back by any hard assets. Stablecoins are subject to extreme risk of runs, much like we saw in bank runs in the Great Depression, an event not seen in the United States in 90 years.

It is too bad the authors did not take the opportunity to flesh out their arguments – in full – in the chapter 18. Such as, what is the definition of a “stablecoin”?

In this chapter they still do not provide specific examples of stablecoins that they perceive to be bad actors.

Furthermore, what do the authors mean by “bank runs”? Does this mean customers of banks standing outside the physical branch while the bank goes under?

Source: FDIC

As mentioned in the review of Chapter 18, the authors only discuss Libra (Diem). They do not mention specific banks, which is a big miss because others – including myself – specifically predicted the commercial banks that could collapse.

They need to do better with providing evidence, they had ample space in 247 pages to do so.

Continuing they write about money market mutual funds (MMMF):

The creation of stablecoins in almost precisely the same system, but instead backed by even riskier assets like Chinese commercial paper and other cryptoassets, which take the run risk of MMF and expand it exponentially.

The authors do not provide any evidence or references regarding Chinese commercial paper.

They could strengthen their argument if they – for example – explained how the New York Attorney General sued and settled with Tether Ltd (USDT). And during this investigation the NYAG discovered that Tether Ltd had at one point held securities issued by a couple of Chinese banks including ICBDC and CCB. Why not include these helpful details?

Also, why is it riskier to own these Chinese assets and what makes the run risk exponential? Perhaps both are true, but that which is presented without evidence can be dismissed without evidence.

Continuing in the same paragraph:

On top of this, the proliferation of private money simply weakens the dollar’s strength both domestically and abroad. Stablecoins are the financial product for which the upside is entirely illusory, and the downsides are catastrophic. The proliferation or integration of stablecoins is not in the interest of the United States from both a financial stability and foreign policy perspective.

This is a weird argument. In some ways, it is very similar to pro-pegged stablecoin legislators make:

Source: Twitter

Also, if the authors are actually against the “proliferation of private money” then they should be shaking their fists at the entities responsible for the creation of the vast majority of “private money” in the U.S., commercial banks.

Their next recommendation is to “firewall cryptoassets away from the banking sector and the broader market”

Writing on p. 241:

The Glass-Steagal Act, put in place after the Great Depression, set “firewalls” between different divisions of the banks.

They misspelled Steagal (should be Steagall). While I agree with parts of their proposal they could have mentioned that Glass-Steagall was eventually repealed in 1999. Is that good or bad? Seems like a good future discussion to have in a book.

Their final recommendation is a “complete ban.” Writing on p. 242:

Alternatively, the United States could consider a path similar to what China recently enacted or to the historical American Executive Order 6102, which forbade ownership of gold. Despite the rhetorical claims to “not throw the baby out with the bathwater,” there is, after 13 years of crypto, very little evidence that there is any baby at all.

The authors do cite a relevant article from the WEF regarding the 2021 bans in China. Why they waited until the very end of the book to cite this is unclear. Why not reference it in earlier chapters regarding China? What parts of the bans do the authors agree with? All of them?

Also, it is clear that throughout the book, the authors did not put much effort into finding evidence to even support their own claims, let alone conduct market research that provides evidence that contradicts their a priori cudgel.

It is worth pointing out that the copy/paste Twitter account – Web3 Is Going Great – conducts similar behavior as the authors: they both cherry-pick news that is favorable to their narratives. It is disingenuous and dishonest.

Continuing in the same paragraph:

Introducing completely non-economic digital speculative “playthings” introduces nothing to an economy other than slightly more exotic gambling games. In fact, there is a strong argument that such activities may come at an enormous opportunity cost, in the capital and talent that get diverted to ever-more extravagant ways to financialize digital nothingness. We can create an entire industry speculating on the volatility of nothingness and turn every fictional thing into a tradable token, but should we?

That is a good question! What evidence did the authors provide or refer to to reinforce their strong argument? Nothing.

I actually agree with one of their points here (regarding opportunity costs) but without evidence it is just another random opinion. A future edition could also cite the musings of John Bogle, the founder of Vanguard and creator of the index fund. He often characterized the excessive speculation that benefited financial intermediaries as the “croupier’s take.”

The final paragraph of the chapter reads:

The only overall outcome of this program is the equivalent of digging digital ditches and filling them up again. Perhaps our society has better things to do than digging deeper and deeper ditches and filling them up again. And quite possibly, the Americans should simply ban crypto and play intellectual catchup with what seems like the rather sensible policy the Chinese have concluded on for the same universal common-sense financial and public harm mitigation reasons.

What would a ban entail? That no Americans in America can have a digital wallet on their phone? That no Americans in America can install software that runs a blockchain validator? What is the plan?

Also, the authors do not actually explain what China banned. For instance, private individuals can still own cryptocurrencies in China. Do the authors want to replicate that too?

All-in-all this chapter is a disappointment because it should have come earlier in the book, it should have been more comprehensive, it should have had more citations and references, and most importantly: it should have been vetted by experts in their fields including at least one licensed lawyer.

Chapter 25: Conclusion

The final four pages are basically a long rant, so let us dive in.

On p. 243 they write:

Crypto is a gripping story full of sound and fury, hope and fear, hype and noise, greed and idealism, yet despite all that, it is a tale signifying nothing in the end. Crypto is not just an experiment in anarcho-capitalism that did not work; it is an experiment that can never work and will never work. Crypto was promised as the technology of the future, yet it is a technology that can never escape its negative externalities or its entanglement with the terrible ideas of the past. Crypto is not the future of finance: it is the past of finance synthesized with the age-old cry of the populist strongman, To Make Money Again.

There are a few issues with this:

(1) The authors erect a strawman but empirically we know not all “crypto” projects are attempting to ‘make money again.’ Nor do all blockchains use proof-of-work. In fact, in looking at the current list of Layer 1s on CoinGecko, the majority are based on proof-of-stake. What are the negative environmental externalities of proof-of-stake?

(2) Yet again, the authors use an a priori argument to predict the future: “an experiment that can never work and will never work.” How can they know the future with such certainty? This is soothsaying.

Continuing on p. 243 they write:

While our existing financial system is undeniably profoundly flawed, not optimally inclusive, and sometimes highly rigged in favor of the already wealthy; crypto offers no solution to its problems other than to create an even worse system subject to unquantifiable software risk, profound conflicts of interest, and an incentives structure that would exasperate wealthy inequality to levels not seen since the Dark Ages. Put simply, Wall Street is bad, but crypto is far worse.

When I tried to explain to friends that this book unnecessarily carries water for incumbents, this is the reoccurring meme that came to mind.

There is no reason the authors have to defend incumbents or the a cartel that regularly is fined for the very activities that the authors abhor. Guess who invented all of these criminogenic concepts in the first place?

Rather, it is possible to critique both the coin world and the traditional financial world. You do not have to join one camp or the other.

In fact, real researchers should attempt to be neutral, or at the very least, provide some kind of nuance. There is no nuance in this book. To their credit, they did cite a Bitcoin-specific article from 2013 in referring to the Dark Ages. Too bad for them, the coin world in June 2022 was more than just the orange memecoin.

On p. 244 they write:

At all levels of sophistication and from all walks of life, every type of investor needs to be given truthful, fair, and full information about their investments and protected against fraud and unnecessary risk by our public institutions. Crypto’s very design is entirely antithetical to building or improving any of our existing markets and only serves to add more opaqueness, systemic risk, and fraud.

Oh, now they authors finally care about systemic risk. It only took 244 pages.

To their credit, they do cite a few external sources. The first is Hanley’s paper on Bitcoin (and only Bitcoin). The second reference is to a three-person interview that meanders around, why did the authors add it? The third is a reference to a blog post from Ed Zitron’s whose hyperbolic rant sounds nearly identical to the authors. Opinions are not evidence, they are opinions. Maybe there is some evidence but… what can be presented without evidence can be dismissed without evidence.

On p. 244 they continue:

All scientists and engineers are duty-bound to our profession and our communities that the public good is the central concern during all professional computing work. As a technologist, cryptoassets present our industry with an immense challenge and fundamental questions about the nature of responsible innovation.

Did Diehl – or one of the other authors – just break the fourth wall? Do the authors have a monopoly on who gets to represent “the technologist”? I have worked for tech-related companies for years, are my opinions weighted any differently than theirs?

They do cite two references, one is the same presentation from David Rosenthal and the other is a hyperbolic presentation from Nicholas Weaver. Are these challenges insurmountable? According to the authors and Weaver, that would be an a priori no.

On p. 245 they write:

Despite thirteen years of development, there is widespread debate over the proposed upside of cryptoassets from technical and financial considerations. While the aspirations of technologies may be genuine, the reality of the technology and its applications are vastly overstated and not in line with what is possible. Blockchain-based technologies have severe limitations and design flaws that preclude almost all applications that deal with customer data and regulated financial transactions. Real-worlds applications of blockchain technology within financial services are sparse and ambiguous as to whether they are an improvement on existing non-blockchain solutions. Most senior software engineers now strongly reject the entire premise of a blockchain-based financial system because the idea rests on both economic and technical absurdities.

Let’s walk backwards for a moment. Recall from Chapter 14 that we are all taught in writing class not to introduce new concepts or ideas in the conclusion of a story. The authors not only do it again, but they do not provide any citation.

For example, did the authors conduct a survey to determine that “most senior software engineers now strongly reject.”

Guess what? We all know what the proper response is to this.

The authors also showed their direct contributions as at least one of the co-authors of the anti-Web3 letter that was published two weeks before this book. How do we know?

The letter has a passage that sounds identical to the remark above:

After more than thirteen years of development, it has severe limitations and design flaws that preclude almost all applications that deal with public customer data and regulated financial transactions and are not an improvement on existing non-blockchain solutions.

Coincidence. Not at all.

At the time, I pointed out that the first web browser (appropriately called the “WorldWideWeb“) was launched in 1990. It was not until 2004 that Google revealed Ajax-based Gmail followed by Google Maps.

If the authors are trying to make the claim that anything (everything?) useful should have been invented in 13 years then they should hold other tech initiatives to the same standard. Besides, most blockchains themselves are much younger than 13 years too.

For instance, Ethereum’s mainnet launched 8 years ago and has undergone extensive changes over the past several years.

Lastly, what are “existing non-blockchain solutions”? This is the type of argument that Bitcoin maximalists such as Chris DeRose frequently used: just use a database. Okay, which one? Are you a database expert now too? Can other experts have a difference of opinion or is your view the final word?

Continuing on p. 245 they write:

The catastrophes and externalities related to crypto are neither isolated nor are they growing pains of a nascent technology; instead, these are the violent throws of a technology that is not built for its purpose and is forever unsuitable as a foundation for large-scale economic activity.

There is something wrong with the grammar in the middle of this rant: “these are the violent throws of a technology that is not built for its purpose”. What does that mean? On the margin of the book I wrote, “Did the authors meant to say ‘not fit for purpose’?” but even that does not make sense there.

Either way, by claiming “is forever unsuitable” the authors are once again trying to predict the future a prori.

Continuing on p. 245 they write:

Technologies that serve the public must always have mechanisms for fraud mitigation and allow a human-in-the-loop to reverse transactions. Blockchain technology, the foundation of all cryptoassets, cannot, and will not, have transaction reversal or data privacy mechanisms because they are antithetical to its bae design. The software behind crypto is architecturally unsound, and the economics are incoherent.

This is factually untrue. An RTGS such as Fedwire has irreversible transactions. There are no “human-in-the-loop” on purpose. In order to negate one transaction a subsequent transaction must be sent. This is true for cases such as bankruptcy too.

Do not take my word for it, here is what the Federal Reserve actually says:

We see this in other systemically important financial infrastructure too, such as CLS. CLS was setup after the collapse of a German bank giving rise to what we now know as Settlement risk or Herstatt risk.

I have patiently tried explaining these ideas – around SIFIs – to various anticoiners and Bitcoin maximalists and they frequently just pretend that “irreversibility” is a characteristic of blockchains and nothing in traditional finance. 55

Lastly, when the authors say that cryptoassets cannot and will not have “data privacy mechanisms” is there any existing confidentiality or privacy-related effort that they are okay with? They dunked on Tornado Cash earlier in the book, and they singled out both Monero and Zcash as well.

Are the authors okay with developers attempting to create new confidentiality or privacy-related technology or is it just not allowed in the universe the authors live in?

Continuing they write:

The theoretical upsides of every crypto project are entirely illusory. It is a solution in search of a problem. Its very foundations are predicated on logical contradictions and architectural flaws that more technology cannot fix and will never be resolved.

The authors are once again predicting the future with a lot of certainty: Will never be resolved. This is an a priori argument and once again, can be rejected because it does not have any evidence. The only thing they cite is another op-ed by Ed Zitron. A scientist should sit down and explain to the authors – and many of the people they cite – and explain the difference between a priori arguments and a posteriori arguments.

Continuing they write:

The impact of crypto’s externalities is massive and becomes more more pronounced every day it is allowed to continue to exist. Crypto is a project that will always create more net suffering by its very design because its design is antithetical to both the rule of law and the foundations of liberal democracy. Technologies working on cryptoassets and web3 are not building a brighter and more egalitarian future; they are only creating a path back to serfdom, where the landed elite are now tech platforms that control the means of communication, the money supply, and the levers of the state itself.

It took 246 pages but now the authors are finally critics of “tech platforms that control the means of communication.”

Are the authors critical of Big Tech for this type of centralized ownership and control or because “crypto” might be involved in some way? Who knows.

What we do know is that the authors believe that crypto “will always create more net suffering by its very design”.

Lacking any citations this can be classified as an opinion.

The final paragraph of the chapter, states:

A tech-led plutocracy is not a future we want to build, and despite the inevitability rhetoric of its supporters, crypto does not have to be part of our future. Crypto has no physical existence; it is a meme, an idea-and an incoherent one at that-which is no more eternal or permanent than the notion of the divine right of kings to rule once was. Crypto is an idea that is as senseless and ephemeral as every other collective delusion throughout history that has since passed into the intellectual dustbin of history, and this time is not different.

Can we talk about “inevitability rhetoric” for just a moment? The authors use this exact rhetoric over and over in each chapter. It is tiring. And it is not an adequate substitute for an evidence.

Obviously coin promoters should also be held to the same standard and if you read my other book reviews, I point out the same sorts of issues.

That is their conclusion, were we expecting something less polemical and more substantive?

Chapter 26: Acknowledgements

This is not an actual chapter but it now helps sync up the out-of-sync bibliography. It is worth looking at really quickly:

Many thanks to all those who helped with editing, citations, and research. Adam Wespeiser, Brian Goetz, Ravi Mohan, Neil Turkewitz, James King, Alan Graham, Geoffrey Huntley, Rufus Pollock, Paul Hattori, Grady Booch, and Dave Troy. And to the many other crypto critics who laid the intellectual foundation myself and others to follow.

Did Diehl – or one of his co-authors – break the fourth wall again? Who is “myself”? The same person who was referring to themselves in the Conclusion as “a technologist”?

It is not a huge coincidence that many of the people the authors acknowledge also happen to be co-signers of the anti-web3 letter that was published two weeks prior to the books publication.

Overlapping names include: Adam Wespeiser, Alan Graham, Geoffrey Huntley, Rufus Pollock, Grady Booch, and Dave Troy. Two of the co-authors of the book – Darren Tseng and Stephen Diehl – also sign the letter.

Nearly all of the works cited overlap as well. Guess who probably had a heavy hand in drafting that totally-organic-anti-web3 letter?

Book review final remarks

This is probably the worst book I have reviewedBlockchain Revolution and both of Michael Casey’s books are pretty close to the bottom of the barrel however Popping the Crypto Bubble is basically a long winded blog post filled with evidence-free assertions.  The authors fail at providing a modicum of supporting references beyond endless rants.

What makes this particular book extra cringy is how much playtime the Financial Times has given it.56 Not only do some of its reporters seem to have a direct line to Stephen Diehl, they even did a softball interview with him without having read the book.

Where did it go wrong?

The best illustration: Chapter 18 is entitled “Stablecoins.”  It is six pages long.  Five pages discuss Libra – a project that was never launched – and the final page briefly covers CBDCs without diving into specific CBDC models.  One of the authors – Diehl – spends a great deal of energy on social media regarding “stablecoins” but could not spend a minute discussing the history of pegged stablecoins or what stablecoins exist today.  The authors could not even bother quoting arguments that strengthened their views – such as lawsuits from the CFTC and NYAG.  While they said the word “Tether,” they did not mention USDT or USDC at all. Why the omission? 

What is another example of weaknesses?  In Chapter 24 they have a subsection on “coin lobbying.”  But they do not mention any specific lobbying organizations or shills in congress.  How hard is it to provide supporting details?

Tim, you are just angry they did not cite you!

Undefinied acronyms and undeserved victory laps

The authors do not define NFTs or explain their history.  They repeatedly use a metonym – Sand Hill road – yet the casual reader may not understand it refers to Silicon Valley.

The authors could have but did not interview anyone inside or outside the industry. They could have done some original first-hand reporting. Instead we are served with a compilation of a stories from third parties. This is the same laziness that the copy/paste Twitter account – Web3 Is Going Great – suffers from; a lack of authentic research.

Anti-coiners should hold themselves to the same standard they frequently criticize the coin industry with, and that includes providing evidence and citations. For all of their claims around “fraud” and “scams,” the authors only made generalized forecasts and did not make any specific predictions around say, FTX or Terra. They missed out on describing the implosion of centralized lenders altogether. 

After all the pump and rah-rah books, the world needs a solid detox. The market needs a book about blockchains and cryptocurrencies with a critical, yet nuanced, eye. This is not that book.  

Endnotes

  1. As described in The Tribes of maximalism, the etymology of “no-coiner” comes from three vocal Bitcoin maximalists, Michael Goldstein, Elaine Ou, and Pierre Rochard who used it as a smear. []
  2. For instance, Chapter 9 covers “Ethical Problems” but in the Bibliography “Ethical Problems” is Chapter 10. The root problem is the authors skip Chapter 1 altogether in the Bibliography: in the book, Chapter 1 is a two page introduction and Chapter 2 is a ten page History of Crypto. The bibliography mislabels Chapter 1 as Chapter 2 and it has a knock-on effect for the remainder of the bibliography. []
  3. While at R3 I was introduced to Diehl via Simon Taylor, one of their advisors. []
  4. At the time of its publication, one of my popular (older) posts was: Archy and Anarchic Chains. I attended and participated in dozens of formal meetings with regulated financial institutions between 2015-2019, the word “anarchy” may have been mentioned in jest a couple of times. []
  5. PayPal is mentioned 67 times in Dan Awrey’s law review paper: “Bad Money.” []
  6. This dovetails into the motivations behind why Bitcoin was created, with some arguing it was built following the challenges facing the online gambling industry which had difficulties maintaining persistent banking access; Caribbean-based ones were frequently debanked. []
  7. There have been a wide-range and wide-variety of tokenization efforts unrelated to the euphoria around digital art collectibles. Coincidentally I wrote a paper on this topic in 2015: Watermarked tokens and pseudonymity on public blockchains. []
  8. In 2017, while at R3 I helped co-edit a relevant paper with experts from Blockseer and the Zero Electric Coin company (creators of Zcash): Survey of Confidentiality and Privacy Preserving Technologies for Blockchains (pdf). []
  9. I wrote about Bitcoin mining in China in May 2014. []
  10. Decades ago, the Supreme Court exempted Major League Baseball from antitrust laws. []
  11. This is a topic I wrote about at length in a newsletter several years ago; it discussed the sub-industry of collectible trading conventions and even price guides (such as Beckett). []
  12. Contra anti-coiner insistence: it is not a scalable business model for a one-person studio, expecting an artist – that wants to use NFTs as a distribution and royalty collection mechanism – to start suing perceived violators en masse. []
  13. While writing this review, WeWork warned it had “substantial doubt” that it could continue as a business. []
  14. After a decade, Uber finally did finally post a profitable quarter, but that was a year after the book was published. []
  15. I have previously argued that proof-of-work-based networks actually can be negative sum since the mining activity introduces negative environmental externalities. []
  16. One reviewer of this review commented: I don’t agree that JP is calling crypto an early bird game. It doesn’t have to generate returns for the earlier entrants. What is wrong with viewing it as a superficial commodity like gold or diamonds? []
  17. This is unlikely to occur due in part to the implicit control that Bitcoin miners and their maximalist enablers have on the BTC ticker symbol. Previously, several prominent maximalists such as Samson Mow and Adam Back have used their sway via Blockstream, to push miners in specific directions. []
  18. Perhaps the hooks will be underutilized but several of the vendors for core banking software – including Fiserv and Jack Henry – have production-ready hooks with blockchain-related integrations for clients. []
  19. Early efforts towards creating “clearing” or “settling” networks between exchanges eventually led to now defunct SEN and Signet (Silvergate Exchange Network and Signature Network). This relatively centralized infrastructure allowed participants (such as exchanges) to settle trades around the clock irrespective of weekends or holidays. And they could do so without trades having to be transferred on-chain, forgoing the fees and time delays. Note: according to Fortune, Signet was a white-label version of TassatPay, a private, blockchain-based solution currently operational at five other banks. []
  20. I was a formal advisor to Blockseer which provided similar on-chain analytics services before its acquisition by DMG Blockchain. Both Elliptic and Chainalysis typically post quarterly and annual reports that includes this type of information for public consumption. []
  21. Luke-Jr is a prominent Bitcoin Core developer who was a central propagandist for smaller blocks during the “block size civil war” primarily between 2015-2017. One of the hurdles he personally faced was that his internet connection in Florida was relatively slow and he used it as a barometer for how home validators should be able to upload and download a block. In the past he has voiced disdain for developers attempting to use OP_Return and recently threatened to spam the network to ban Ordinals. []
  22. Also, there is no reason to carry water for any of these chains but if you are going to critique them at least use consistent verbiage. []
  23. Visa was an investor in Chain.com back in September 2015 when the startup pivoted from Bitcoin API services to enterprise blockchain infrastructure. []
  24. A quick googling revealed a couple of papers published before the book was made public: DQ: Two approaches to measure the degree of decentralization of blockchain by Lee et al., and The Importance of Decentralization by Muzzy and Anderson. []
  25. Several of the large data and analytics providers have service contracts with trading entities that can flag events, e.g., when specific addresses become active. A recent example is when Arkham, an analytics firm, mistakenly reported that bitcoins connected to Mt. Gox and the U.S. government were on the move, the errant news temporarily resulted in a large selloff. []
  26. I have pointed this out to maximalists and anti-coiners over the years and the response is deafening. For example, nearly two years ago I did an interview with Aviv Milner who is podcaster. For some reason he would twist any criticism of the traditional financial industry – specifically concentration risk – as… not a valid criticism. Anti-coiners such as the authors of this book and several podcast series seem uninterested in holding traditional financial organizations to the same standard as the coin world they attempt to investigate. It is okay to find warts in both of them! []
  27. I have written about them several times, primarily in the 2014-2016 era. []
  28. The germination of ISO 20022 arose from some of those early blockchain-related conversations as well. Worth pointing out that in this case, it was specifically unrelated to cryptocurrencies; although a number of cryptocurrency efforts currently market themselves as “ISO 20022 compliant.” []
  29. The banking lobby in Europe is opposed to interest-bearing stablecoins in part because in theory it could dent their deposit base, just as narrow banks could. []
  30. In fact, I liked the Bergstra and Weijland paper so much that in 2014 I used the title for a short book I wrote on the same topic. []
  31. Put it another way, how many bitcoins does it cost to create a bitcoin? For miners to be profitable, the aspiration is less than 1 bitcoin. []
  32. Credit to Kevin Zhou who first pointed this out in 2014 while at Buttercoin. Yes, the same Kevin Zhou who accurately predicted the demise of Terra. []
  33. While Carter tries to place himself front-and-center of this specific topic, it was Andreas Antonopoulos who first prominently used the holiday lighting example. []
  34. It was not a coincidence that Dilley would later join Blockstream as their first chief strategy officer. []
  35. In fact, Coinbase would not list any other asset besides Bitcoin until 2016 because the executive team and early investors were prominent Bitcoin bulls. Listing Ethereum Classic (ETC) was a “newsworthy” event in 2018. []
  36. Michael Goldstein, Elaine Ou, and Pierre Rochard – are prominent Bitcoin maximalists and were co-creators of the term “no-coiner” and “pre-coiner” in late 2017-early 2018. The term “no-coiner” was intended to be an insult, a slur. []
  37. I have some bona fides in this as I authored the most widely cited paper on the topic back in 2015: Consensus-as-a-service: a brief report on the emergence of permissioned, distributed ledger systems []
  38. I have mentioned these specific examples to both Bitcoin maximalists and anti-coiners alike, and again, the goal posts shift. For instance, Jorge Stolfi, a computer science professor and Aviv Milner, the podcaster mentioned above, both ignored the existence of such projects or dismissed them out of hand. I even tried to help introduce Stolfi to a director at the DTCC so he could ask specific questions, which he did not. []
  39. Eight years ago I corresponded with a reporter at Fusion regarding the possibility of litecoin (LTC) being used for illicit activity (regarding chain hopping). []
  40. There is a clear insular clique that only engages with one another, much like certain coin tribes do (such as IOTA). []
  41. Early touchscreen-based personal data assistants (PDAs) included Palm Pilot, Apple Newton, and Blackberry from RIM. []
  42. Maybe as RWAs are deployed to Ethereum less attention will be paid to an ossified chain like Bitcoin, lowering Bitcoin’s marketcap below 30%. Who knows, maybe the opposite occurs. Being a cheerleader on specific price points based on ideology seems foolish. []
  43. This question initially stumped Libra / Diem managers. Anecdotally, one of the managers I spoke to early on in that project assumed that the custody bank would decide which fork to recognize. []
  44. A simple googling resulted in numerous papers including: Smart Contracts and the Cost of Inflexibility by Sklaroff, Towards user-centered and legally relevant smart-contract development: A systematic literature review by Dixit et al., and Smart Contracts, Blockchain, and the Next Frontier of Transactional Law by McKinney et al. Were those authors wrong? Sounds like the job for Diehl et al. to read and determine. []
  45. If you scroll back to the top of this book review and click on Diehl’s presentation and talks in 2017 and 2018, his thinking does not seem to incorporate or recognize what has gone on. []
  46. For instance, a variety of enterprises including regulated financial institutions have built and deployed smart contracts for a bevy of experiments, some that are still in pilot mode. Maybe these enterprises should be laughed out of the room but this is an empirical, evidence-based activity, the conclusions are not predetermined beforehand. []
  47. There is a lot of confusion over the origins of “Hyperledger,” here is a brief backstory. []
  48. This was a weakness in Hilary Allen’s own writings, specifically the DeFi Shadow Banking paper they cite in Chapter 12. Allen’s paper incorrectly states that lending protocols will accept any collateral, it was one of many technical inaccuracies in that paper. []
  49. Coincidentally, in the process of writing this review Lamina1 – a new layer-1 blockchain advised by Neal Stephenson – launched a beta of the metaverse-focused network. []
  50. The cited Gerarad’s book – Libra Shrugged – as reference number 2 in the bibliography for that chapter. []
  51. As part of a literature review the authors could look at the Bank of England’s new RTGS. Section 6 of the roadmap specifically mentions DLT and Section 3 of their Consultation paper discusses CBDCs. []
  52. At the time of this writing the management team is under investigation by the U.S. Department of Justice. []
  53. While not usually categorized as “ICOs,” there were some Bitcoin-related projects that did crowdsale / crowdfunding raises in 2012-2013 coordinated on the BitcoinTalk forum. []
  54. Coincidentally, Nathaniel Popper, a former reporter with The New York Times left the newpaper to write a book on the topic of financial populism. He had a good command of how cryptocurrencies and blockchains worked, yet anti-coiners attacked him for the cardinal sin of recommending nuance. []
  55. The authors also cite Hilary Allen who is not a credible authority on this particular topic. Rosen uses identical techniques and opinion-filled arguments in her writings, and frequently cites Diehl. Demand evidence from them. []
  56. It is not fair to blame the entire team at the Financial Times, some of their reporters did a stellar job chronicling the FTX collapse. []

Presentation: 8 areas for PMF and IMF with blockchains*

This past week I gave a new presentation at the 2nd annual Soranomics event (last year I presented on a related topic: pegged coins aka “stablecoins”). It includes a number of illustrations to discuss product market fit and infrastructure market fit.

Below is a copy of the deck as well as the A/V. Note: there are citations and references in the speaker notes. Note: I am to publish a long-form version based on this content.

Not all algorithmic stabilization mechanisms are the same

We (the ‘royal we’) have previously discussed various flavors of pegged coins, “stablecoins,” as well as CBDC proposals. This short, non-comprehensive post will look into the rise and rapid fall of the Luna and UST, two cryptocurrencies native to the Terra blockchain.1

What are the separate categories that the “stablecoin” idea can be bucketed into?

Figure 1 Source: Robert Sams based on the model by Klages-Mundt et al.

Above is a helpful taxonomy created by Klages-Mundt et al. and adapted by Robert Sams.2 One of the commonalities among all of these efforts above is that they are intended to administer an elastic money supply (as opposed to fixed, deterministic, or inelastic supplies used in many cryptocurrencies such as bitcoin).

Most analysis on this topic lacks the important nuances separating custodial and non-custodial “stablecoins” as well as those that depend on exogenous collateral versus endogenous collateral.

We are not going to dive into each one of the projects above. Furthermore, the usage of a name or logo is not an endorsement of a particular company or project.

So what happened to Luna and the UST this past week?

To answer that we need to quickly explain what the Terra blockchain is and how and why there are more than one layer 1 token such as Luna, UST, KRT (Korean Won) and SDT (an SDR token). 3

Brief history

Launched just over two years ago – in April 2019 – the Terra blockchain incorporated elements of the “Seigniorage Shares” idea with a couple of twists. Whereas several other projects attempted to collateralize (back stop) a single stabilized asset through a mint/burn mechanism, Terra enabled arbitrageurs to burn Luna (the volatile, staking token) and mint one of several different pegged coins, the most prominent of which is UST. UST was marketed as being stable relative to the USD. That is to say, through an automated on-chain program, a trader could burn $1 worth of Luna (at Luna’s prevailing market price) and receive 1 unit of UST (irrespective of the prevailing market price of UST), and vice versa: a trader could exchange 1 unit of UST and receive $1 worth of Luna.4 In theory.

You might be asking yourself, what guarantees that traders will be able to redeem $1 of either at any point in time? Terraform Labs (TFL) is the main developer behind the the Terra blockchain. One of the ways TFL attempted to architect guaranteed redemption and simultaneously mitigate a “death spiral” (an existential crisis that multiple “algo stablecoins” have crashed into), was by capping the daily minting of UST.5 The exact amount has changed over time but the goal was to help throttle the unbounded risk of an oversupply of UST (or some other pegged coin).

Why is this important?

Because as mentioned above: UST (and the other pegged coins that can be minted) were explicitly uncollateralized — although there has been an implicit acknowledgement that the aggregate UST (and other minted currencies) needs to remain below the marketcap of Luna which is the key conduit for redemptions. An imbalance, or “flippening,” could (and did) result in a crisis of confidence and collapse.

Figure 2 Source: Coinmarketcap

The chart (above) shows the aggregate market caps of both UST and Luna over the past 12 months. At their height last month, they together represented almost $60 billion in (paper) value. Today that has dropped to just over $1 billion.6

Why did things go wrong?

Before we answer that, let us look at when “the flippening” occurred.

The chart (above) shows the aggregate UST marketcap relative to Luna’s marketcap over the course of a single day. At around 1am SGT on May 10th, UST’s marketcap overtook Luna for good.

What is another way to visualize this?

The chart (above) shows the same aggregates but over the course of the past 6 weeks.

What does this mean? Due to the “macro” bear market in cryptocurrencies (the aggregate coin market is more than 50% off its all-time high from last year), Luna’s market cap saw a rapid decline that quickly became a vicious cycle due to the Why.

While there are a bunch of mostly cliché conspiracy theories as to which traders took advantage of the knowledge and conditions to short Luna (and UST), the conditions that led to UST’s rapid ascent (relative to Luna) seen in Figure 2, are pretty pedestrian.

What was the key reason for this ascent starting in November? The popular Anchor dapp on the Terra blockchain. What is Anchor?

Launched in March 2021, Anchor is an all-in-one asset management dapp that allowed traders to deposit their Luna as collateral and borrow UST against it. Often traders would go to an exchange and convert the UST into Luna, depositing the Luna into Anchor and lever up several more times. Its ease of use led to rapid growth, with total-value-locked (TVL) growing from zero to $6 billion within six months. The loan-to-value (LTV) ratio shifted over time but was northward of 70% when UST overtook Luna this past week.

Why did TVL grow so fast on Anchor?

The main reason was the dapp subsidized both lenders and borrowers through the emission of a governance token called ANC. For over 6 months, Anchor marketed itself as being able to provide 19.5% APY on all UST deposits via a blended combination of Luna staking emission and reoccurring ANC airdrops.7 Both sophisticated and unsophisticated investors, believing that $1 UST was redeemable at par with $1 USD, deposited large quantities of $UST (which others could then borrow as well). Anecdotally we have heard of startups at incubators and seasoned fintechs in emerging markets offering retail users access to this high yield product. The yield was unsustainable and developers knew it so various interest groups (including several high profile investors) proposed ways to reduce the ANC yield each month depending on economic indicators.

But by the time the downward adjustment was implemented it was too late. This relatively high yield had turned UST into a “hodl asset,” a “store of value” — something that the uncollateralized system was not properly designed to absorb.8

Prior to the collapse of Luna and UST, the development teams behind Terra and Anchor recognized this shortcoming and this past February announced the Luna Foundation Guard (LFG) and organization that would accumulate exogenous collateral to defend the $1 USD peg.

Recall that at the very top in Figure 1, Terra was categorized as using endogenous collateral, that is capital native to the protocol itself (e.g., Luna, UST). As part of the initial LFG announcement, the organization aspired to accumulate large quantities of exogenous coins starting with bitcoin and later others (such as AVAX, and even both USDC and USDT). At its height, LFG’s reserves tallied over $3.5 billion and as of this writing it has shrunk to around $80 million (sans some squirrelly BTC).

Anchor aweigh

Even without Anchor the fundamental problem is that the underlying collateral is volatile, so what is over-collateralized can become under-collateralized very quickly (whether it is endogenous or exogenous).9

Those who argue that the solution for decentralized stablecoins is to be “fully backed” are still kind of missing the point. If these protocols are all using the same 3-5 major coins as collateral, you can get the same ‘death spiral’ scenario materializing if the stablecoin supply grows large vis-à-vis the collateral marketcap. After all, even LFG’s liquidation of $1.6 billion BTC moved the largest coin cap.

So who is the buyer-of-last resort? If it is actually decentralized, it can only be the parties who can liquidate or redeem the collateral. CDP systems like Maker have the incentives for this behavior, but suffer from the coin supply side being driven by lending and no mechanism to equilibrate that supply to the demand side (the mechanism is the stability fee and savings rate, but that is set by governance, not the market)

The root problem for UST and Luna, (as Kevin Zhou, Matt Levine, and others have mentioned), was that neither had any source of value independent of the other. If the market decided to sell both, there was nothing to give you confidence that they would recover. UST was built on Luna and for the past 6 months Luna was built on essentially Anchor yield savings. Even a large “stabilization fund” – with a transparent and automated mechanism for how it would be deployed – would not prevent the Luna/UST market cap from growing to dwarf the LFG backstop, thus a sequence like this past week was always a risk.

We could spend pages describing alternate plans and paths the development teams, users, traders, and other interest groups could have taken to stymie the collapse. Instead we wanted to highlight one final chart that we found interesting.

Divergence

The chart (above) shows the intraday prices each day over the course of a week between Luna (in dark pink) and bLuna (in blue).

What is bLuna? bLuna is a liquid staking mechanism managed by Lido in a partnership with Anchor.10 Liquid staking is actually an interesting concept. Most readers are probably vaguely familiar with staking on a proof-of-stake network: users deposit their coins to an address on-chain and receive some form of remuneration (emission) for helping to secure the network (and process transactions, if they are a validator).

But the coins used in staking are effectively frozen and cannot be easily used elsewhere as collateral. Enter liquid staking. As the name suggests, liquid staking is a concept that has been implemented in two different ways: at the dapp layer (via Lido, Marinade, and a few others) or at the native L1 layer (Osmosis in the Cosmos ecosystem is about to be the first to do so).

Liquid staking is neat because it allows all of the locked up (“frozen”) capital to be used as collateral for lending. An imperfect example: Bob purchases $200,000 of Apple stock. He wants to buy a new home and instead of selling the stock he finds a bank willing to use his Apple stock as collateral for the down payment on the house. Similarly, liquid staking is not rehypothecation as no new asset is created.11

The reason a lot of brain cycles have been spent on creating liquid staking dapps (like Lido) is that the vast majority (>95%) of all staked assets on proof-of-stake networks is illiquid. If they can become liquid that would enable more capital to be used for endogenous lending — instead of having to rely on exogenous capital like wrapped assets (WETH, WBTC) or real world assets (USDC, USDT).

In theory, when an asset transforms from a staked asset into a liquid staked asset, the market prices of the two should be very similar. In some cases, such as stETH (ether deposited in Lido on Ethereum) or mSOL (sol deposited in Marinade on Solana), the liquid asset accrues the emission reward therefore becoming slightly more valuable over time (in proportion to the emission rate).

In the case above, bLuna and Luna were tightly coupled but clearly broke down between May 9th-11th due to the massive selling pressure and unstaking that took place (more than 95% of all Luna has been unstaked down considerably over the past month). This brings us to the final section.

Proposed category

Surprise! I have a couple ideas on how to evolve the “algo stabilization” world, including adding a (possible) new category to the four incumbents above: a demurrage-based settlement asset.

But first, let’s take a step back and ask the question what amount of UST could Luna have absorbed?

Even the most hardened maximalist or anti-coiner would concede that a single solitary 1 UST could probably be absorbed by Luna’s market cap.

So where is the limit? Where do the wheels fall off? When do things become unwieldy?

It was not the UST borrow side that was a priori the fundamental culprit. Amplifying the problem was goosing the UST demand side with 19.5% “risk free” returns on Anchor. For instance, if the arbitrage mechanism only allowed the creation of UST (or other pegged assets) based on a small single digit percentage of Luna’s marketcap, it is likely this collapse might not have happened in such a dramatic fashion.

Yet as mentioned above, this approach alone still would not have staved off simultaneous sell-offs of both UST and Luna and/or hyperlunaflation.

Future developers looking to enter this arena could construct an asset with a stabilized unit-of-account that maintains a diminutive aggregate relative to the staked asset being burned. E.g., depending on the use case, an aggregate the size of $100,000 could conceivably power a small on-chain economy much like in traditional markets rely on a high velocity of money to grease the economy (where money is circulates among participants like a hot potato).12

That is to say, a high velocity stabilized unit-of-account, one that is used as a medium-of-exchange and not as a store-of-value or hodl asset, probably has a lot more longevity so as long as its creation (or borrowing) is not heavily subsidized. Sprinkle in some demurrage – or negative interest rates – to further disincentivize hodling and focus on a handful of uses (n.b. “hodling” is not using).1314

Final remarks

It is pretty easy to dance on the grave of another dead / dying cryptocurrency, there have been a few dozen marathon’s worth of victory laps on social media this past week. Despite autopsies and red flags, it is likely that some folks will attempt to emulate the heavily subsidized borrowing model too.

Apart from designing a purposefully limited high velocity, stabilized unit-of-account, what can non-developers do?

Arguably, the most accurate commentator on this topic is a friend, Kevin Zhou (founder of Galois Capital), who publicly predicted what would occur months ago. But unlike the maximalists and anti-coiners who stridently label everything a scam and a fraud, Zhou actually modeled out several scenarios in detail. Give him a follow.

Future analysis could look into the on-chain contagion such as dapps that were impacted including Mirror protocol (did the yield at Anchor cannibalize the other use cases by acting as a liquidity gravity well?). As of this writing it is unclear what direction a “LunaV2” will take but worth pointing out that key stake holders in the ecosystem agreed to shut down the network twice and switched to PoA.

Endnotes

  1. There are oodles of news articles exploring how the “death spiral” took place, this is not really one of them. []
  2. In 2015 Sams created the USC consortium (which has evolved into Fnality) as well as proposed the original “Seiniorage Shares” concept in 2014. []
  3. Note: according to the Terra Token Cash Flow chart, Terra was actually generating more in KRW fees (primarily via Chai) than it was earning in UST fees. The KRT ecosystem had more velocity: KRT turning over ~500 per month versus UST at a mere 1.5 times with the caveat that the KRT ecosystem is very small. []
  4. The actual arbitrage opportunity would be if UST is trading for $1.10, a trader could exchange $1 of Luna for 1 UST, therein arbing a profit while increase UST supply and bring price down. Conversely, if UST is $.90, a trader could exchange 1 UST for $1 of Luna. []
  5. There are some similarities with the collapse of Titan / Iron bank last year, although part of that involved a discrepancy with the oracle feed. []
  6. A simple way to observe the troubling trend early on was the UST / Luna marketcap ratio (based on circulating supply). Below are specific numbers that appeared in a chatroom I was in:

    April 17 7:30pm EST — 63%
    April 30 11:30am EST — 66%
    May 7 5:00pm EST — 78%
    May 7 6:30pm EST — 81%
    May 8 9:00am EST — 90%
    May 9 1pm EST — 95%
    May 9 3pm EST — 113%
    May 9 11pm EST –125%
    May 10 7:30am EST –149%
    May 10 3:45pm EST– 166%
    May 10 5:30pm EST — 207%
    May 10 6pm EST — 211%
    May 11 5:30am EST — 291%

    In April, the ratio flirted with and fell below the 2/3rd mark. But due to the persistent bear market coupled by sell side pressure of both UST and Luna, by the morning of May 10th, ‘hyper hyperinflation’ was well underway with a massive expansion of Luna’s total supply. []

  7. As mentioned in the bLuna section: users can mint a bAsset called bLuna by depositing Luna into Anchor. Staked funds are effectively pooled together by a white list of validators (users collectively share emission rewards as well as slashing events). These staked funds are used as collateral for borrowers who are subsidized through what is now a money-market. Thus there are three different tokens active in the dapp and the “19.5%” headline figure largely consists of a recurring airdrop of the ANC governance token.  E.g., if Bob deposited bLuna as collateral, he is paid out in ANC (and UST fees) in lieu of his regular staking rewards (or at least pre-crisis that was the case).  And borrowers were subsidized in the form of ANC as well.  Those who deposited UST (not Luna) received 19.5% APY up until this month (where it dropped to 18%).  This came from ANC rewards as well as a reserve fund that TFL topped up on occasion. []
  8. Some analysts think that Anchor was not that big of a deal yet at a minimum it was important as a supply sink. It is not as important in terms of how the system got insolvent; that’s more because of the underlying mint / redeem mechanism. Or as Kevin Zhou concisely explained on Odd Lots: “And they [TFL] would also use that to keep basically topping up the Anchor protocol on their yield reserve. Because they were paying more interest to depositors than they were collecting from borrowers. And, you know, I think in the end stages of Luna in its final days, you could see that the, you know, the deposit amount was way, way higher than the borrowed amount. So, you know, they, they were bleeding.” […] “I think the system was way in the past, it was already insolvent, you know, it’s just that nobody realized because they had created such a strong supply sink in Anchor for this UST, you know, if that disappeared overnight, or even gradually, the entire system was insolvent.” []
  9. Several commentators have attempted to downplay Anchor as little more than a user acquisition strategy, stating “There was nothing wrong with Anchor, they just paid more yield than what was sustainable as a growth strategy. Tons of businesses operate at a loss as a customer acquisition growth strategy.” But we can clearly see, what works for tech platform business development does not apply generally. You probably cannot integrate a heavily subsidized GTM strategy into the incentive mechanisms of your dapp or L1 without contorting the financial system you are building. As one reviewer noted: “sustainable mechanism design needs to make pessimistic assumptions (where assumptions must be made) with respect to the behavior of actors. That means minimizing mercenary behavior (e.g., “I’ll come for the subsidy and immediately depart when the freebie is removed.”). []
  10. Lido is the largest and most popular liquid staking dapp for Ethereum, Terra, and several other blockchains. []
  11. A Luna holder can pledge their Luna as collateral and receive bLuna which pay out rewards in Terra-related tokens such as UST and ANC. []
  12. In this strawman example: a stabilized unit-of-account would not need expand much so as long as its usage is high velocity. “Velocity” is an economics term used to describe how quickly the average unit of money (e.g., dollars) turns over in a given year. If this stabilized unit-of-account is only used to top up loans or fulfill margin requirements, its aggregate size would be different than a synthetic store-of-value (which is what UST attempted to be). Thus $100,000 may be sufficient to help fulfill specific sets of on-chain uses (such as those around derivatives or prediction markets). []
  13. As a friend recently pointed out: “an ‘algo stablecoin’ like Luna / UST is a form of collateralized stablecoin just different from external collateral. In this case, TFL and others were making their own collateral and hoping it retains value. They seemed to believe the amount of Luna backing UST was relatively high enough it could absorb redemptions without going into a spiral because, say, people valued those Luna tokens independently from redemption sufficiently high enough due to its governance rights over the entire blockchain that had other important commercial applications. A small coin that had limited systemic impact could be used as some sort of collateral basis and potentially survive indefinitely.” []
  14. Ultimately all public chains need base layer transactional demand to survive post-block reward. “Hypothetically, an algorithmic stablecoin could survive in the long-run, if it were to have ongoing transaction-related demand (similar to a fiat currency)” from Global Markets Daily: The Economics of Algorithmic Stablecoins, by Rosenberg & Pandl at Goldman Sachs on May 16, 2022. []

How much electricity is consumed by Bitcoin, Bitcoin Cash, Ethereum, Litecoin, and Monero?

I recently created a thread that on Twitter regarding the lower-bound estimates for how much electricity the Bitcoin blockchain consumed using publicly available numbers.

The first part of this post is a slightly modified version of that thread.

The second part of this post, below part 1, includes additional information on Bitcoin Cash, Ethereum, Litecoin, and Monero using the same type of methodology.

Background

The original nested thread started by explaining why a proof-of-work (PoW) maximalist view tries to have it both ways.

You cannot simultaneously say that Bitcoin is – as measured by hashrate – the “most secure public chain” and in the same breath say the miners do not consume enormous quantities of energy to achieve that.  The fundamental problem with PoW maximalism is that it wants to have a free energy lunch.

All proof-of-work chains rely on resource consumption to defend their network from malicious attackers.  Consequently, a less resource intensive network automatically becomes a less secure network.1  I discussed this in detail a few years ago.

Part 1: Bitcoin

Someone recently asked for me to explain the math behind some of Bitcoin’s electricity consumption, below is simple model using publicly known numbers:

  • the current Bitcoin network hashrate is around 50 exahashes/sec
  • the most common mining hardware is still the S9 Antminer which churns out ~13 terahashes/sec

Thus the hashrate pointed at the Bitcoin network today is about 50,000,000 terashashes.

Dividing one from the other, this is the equivalent of 3,846,000 S9s… yes over 3 million S9s.

While there is other hardware including some newer, slightly more energy efficient gear online, the S9 is a good approximate.

Because the vast majority of these machines are left on 24/7, the math to estimate how much energy consumption is as follows:

  • in practice, the S9 draws about 1,500 watts
  • so 1,500 x 24 = 36kWh per machine per day

Note: here’s a good thread explaining this by actual miners.

In a single month, one S9 will use ~1,080 kWh.

Thus if you multiply that by 3,846,000 machines, you reach a number that is the equivalent of an entire country.

  • for a single day the math is: ~138.4 million kWh / day
  • annually that is: ~50.5 billion kWh / year

For perspective, ~50.5 billion kWh / year would place the Bitcoin network at around the 47th largest on the list of countries by electricity consumption, right between Algeria and Greece.

But, this estimate is probably a lower-bound because it doesn’t include the electricity consumed within the data centers to cool the systems, nor does it include the relatively older ASIC equipment that is still turned on because of local subsidies a farm might receive.

So what?

According to a recent Wired article:

In Iceland, the finance minister has warned that cryptocurrency mining – which uses more power than the nation’s entire residential demand – could severely damage its economy.

Recent analysis from a researcher at PwC places the Bitcoin network electricity consumption higher, at more than the level of Austria which is number 39th on that list above.  Similarly, a computer science professor from Princeton estimates that Bitcoin mining accounts for almost 1% of the world’s energy consumption.2

Or to look at it in a different perspective: the Bitcoin network is consuming the same level of electricity of a developed country – Austria – a country that generates ~$415 billion per year in economic activity.

Based on a recent analysis from Chainalysis, it found that Bitcoin – which is just one of many proof-of-work coins – handled about $70 million in payments processed for the month of June.  Yet its cost-per-transaction (~$50) is higher than at any point prior to November 2017.

You don’t have to be a hippy tree hugger (I’m not) to clearly see that a proof-of-work blockchains (such as Bitcoin and its derivatives) are currently consuming significantly more resources than they create. However this math is hand-waved away on a regular basis by coin lobbyists.

The figure also didn’t include the e-waste generated from millions of single-use ASIC mining machines that are useful for about ~12 months; or the labor costs, or building rents, or transportation, etc.  These ASIC-based machines are typically discarded and not recycled.

In addition to e-waste, many mining farms also end up with piles of discarded cardboard boxes and styrofoam (source)

Part 2: Bitcoin Cash

With Bitcoin Cash the math and examples are almost identical to the Bitcoin example above.  Why?  Because they both use the same SHA256 proof-of-work hash function and as a result, right now the same exact hardware can be used to mine both (although not simultaneously).3

So what do the numbers look like?

The BCH network hashrate has been hovering around 4 – 4.5 exahashes the past month. So let’s use 4.25 exahashes.

Note: this is about one order of magnitude less hashrate than Bitcoin so you can already guesstimate its electricity usage.  But let’s do it by hand anyways.

An S9 generates ~13 TH/s and 4.25 exahashes is 4.25 million terahashes.

After dividing: the equivalent of about 327,000 S9s are used.

Again, these machines are also left on 24/7 and consume about 36 kWh per machine per day.  So a single S9 will use ~1,080 kWh per month.

  • 327,000 S9s churning for one day: ~11.77 million kWh / day
  • Annually this is: ~4.30 billion kWh / year

To reuse the comparison above, what country’s total electricity consumption is Bitcoin Cash most similar to?

Around 124th, between Moldova and Cambodia.

How much economic activity does Moldova and Cambodia generate with that electricity consumption?  According to several sources, Cambodia has an annual GDP of ~ $22 billion and Moldova has an annual GDP of ~$8 billion.

For comparison, according to Chainalysis, this past May, Bitcoin Cash handled a mere $3.7 million in merchant payments, down from a high of $10.5 million in March a couple months before.

Also, the Bitcoin Cash energy consumption number is likely a lower-bound as well for the reasons discussed above; doesn’t account for the e-waste or the resources consumed to create the mining equipment in the first place.

This illustrates once again that despite the hype and interest in cryptocurrencies such as Bitcoin and Bitcoin Cash, there is still little real commercial “activity” beyond hoarding, speculation, and illicit darknet markets.  And in practice, hoarding is indistinguishable from losing a private key so that could be removed too.  Will mainstream adoption actually take place like its vocal advocates claim it will?

Discarded power supplies from Bitcoin mining equipment (source)

Part 3: Ethereum

So what about Ethereum?

Its network hashrate has been hovering very closely to 300 TH/s the past month

At the time of this writing, the Ethereum network is still largely dominated by large GPU farms. It is likely that ASICs were privately being used by a handful of small teams with the necessary engineering and manufacturing talent (and capital), but direct-to-consumer ASIC hardware for Ethereum didn’t really show up until this summer.

There are an estimated 10 million GPUs churning up hashes for the Ethereum network, to replace those with ASICs will likely take more than a year… assuming price stability occurs (and coin prices are volatile and anything but stable).

For illustrative purposes, what if the entire network were to magically switch over the most efficient hardware -the Innosilicon A10 – released next month?

Innosilicon currently advertises its top machine can generate 485 megahashes/sec and consumes ~ 850 W.

So what is that math?

The Ethereum network is ~300 TH/s which is around 300,000,000 megahashes /sec.

Quick division: that’s the equivalent of 618,557 A10 machines.

Again, each machine is advertised to consume ~850 W.

  • in a single day one A10 consumes: 20.4 kWh
  • in a month: ~612 kWh

So what would 618,557 A10 machines consume in a single day?
– about 12.6 million kWh / day

And annually:
– about 4.6 billion kWh / year

That works out to be between Afghanistan or Macau.  However…

Before you say “this is nearly identical to Bitcoin Cash” keep in mind that the Ethereum estimate above is the lowest of lower-bounds because it uses the most efficient mining gear that hasn’t even been released to the consumer.

In reality the total energy consumption for Ethereum is probably twice as high.

Why is Etherum electricity usage likely twice as high as the example above?

Because each of the ~10 million GPUs on the Ethereum network is significantly less efficient per hash than the A10 is. 4  Note: an example of a large Ethereum mine that uses GPUs is the Enigma facility.

For instance, an air-cooled Vega 64 can churn ~41 MH/s at around 135 W which as you see above, is much less efficient per hash than an A10.

If the Ethereum network was comprised by some of the most efficient GPUs (the Vega 64) then the numbers are much different.

Starting with: 300,000,000 MH/s divided by 41 MH/s.  There is the equivalent to 7.32 million Vega GPUs generating hashes for the network which is more in line with the ~10 million GPU estimate.

  • one Vega 64 running a day consumes ~3.24 kWh
  • one Vega 64 running a month: ~77.7 kWh

If 7.32 million Vega equivalent GPUs were used:

  • in a day: ~ 23.71 million kWh
  • in a year: ~8.65 billion kWh

That would place the Ethereum network at around 100th on the electricity consumption list, between Guatemala and Estonia.

In terms of economic activity: Guatemala’s GDP is around $75 billion and Estonia’s GDP is around $26 billion.

What is Ethereum’s economic activity?

Unlike Bitcoin and Bitcoin Cash, the stated goal of Ethereum was basically to be a ‘censorship-resistant’ world computer.  Although it can transmit funds (ETH), its design goals were different than building an e-cash payments platform which is what Bitcoin was originally built for.

So while merchants can and do accept ETH (and its derivatives) for payment, perhaps a more accurate measure of its activity is how many Dapp users there are.

There are a couple sites that estimate Daily Active Users:

  • State of the Dapps currently estimates that there are 8.93k users and 8.25K ETH moving through Dapps
  • DappRadar estimates a similar number, around 8.37k users and 8.57K ETH moving through Dapps

Based on the fact that the most popular Dapps are decentralized exchanges (DEXs) and MLM schemes, it is unlikely that the Ethereum network is generating economic activity equivalent to either Guatemala or Estonia.5

For more on the revenue Ethereum miners have earned and an estimate for how much CO2 has been produced, Dominic Williams has crunched some numbers.  See also this footnote.6

According to Malachi Salacido (above), their mining systems (in the background) are at a 2 MW facility, they are building a 10 MW facility now and have broken ground on a 20 MW facility. Also have 8 MW of facilities in 2 separate locations and developing projects for another 80 MW. (source)

Part 4: Litecoin

If you have been reading my blog over the past few years, you’ll probably have seen some of my Litecoin mining guides from 2013 and 2014.

If you haven’t, the math to model Litecoin’s electricity usage is very similar to both Bitcoin and Bitcoin Cash.  From a mining perspective, the biggest difference between Litecoin and the other two is that Litecoin uses a hash function called scrypt, which was intended to make Litecoin more “ASIC-resistant”.

Spoiler alert: that “resistance” didn’t last long.

Rather than diving into the history of that philosophical battle, as of today, the Litecoin network is composed primarily of ASIC mining gear from several different vendors.

One of the most popular pieces of equipment is the L3+ from Bitmain.  It’s basically the same thing as the L3 but with twice the hashrate and twice the power consumption.

So let’s do some numbers.

Over the past month, the Litecoin network hashrate has hovered around 300 TH/s, or 300 million MH/s.

Based on reviews, the L3+ consumes ~800 W and generates ~500 MH/s.

So some quick division, there are about 600,000 L3+ machines generating hashes for the Litecoin network today.

As an aggregate:

  • A single L3+ will consume 19.2 kWh per day
  • So 600,000 will consume 11.5 million kWh per day
  • An annually: 4.2 billion kWh per year

Coincidentally this is roughly the same amount as Bitcoin Cash does as well.

So it would be placed around 124th, between Moldova and Cambodia.

Again, this is likely a lower-bound as well because it assumes the L3+ is the most widely used ASIC for Litecoin but we know there are other, less efficient ones being used as well.

What about activity?

While there are a few vocal merchants and a small army of “true believers” on social media, anecdotally I don’t think I’ve spoken to someone in the past year who has used Litecoin for any good or service (besides converting from one coin to another).

We can see that — apart from the bubble at the end of last year — the daily transaction volume has remained roughly constant each day for the past 18 months.  Before you flame me with a troll account, consider that LitePay collapsed before it could launch, partly because Litecoin still lacks a strong merchant-adopting ecosystem.

In other words, despite some support by merchant payment processors, its current usage is likely as marginal as Bitcoin and Bitcoin Cash.

Genesis Mining facility with Zeus scrypt mining equipment (source)

Part 5: Monero

The math around Monero is most similar to Ethereum in that it is largely dominated by GPUs.

In fact, earlier this year, a large number of Monero developers convinced its boisterous userbase to fork the network to prevent ASICs from being used.  This resulted in four Monero forks and basically all of them are dominated by high-end GPUs.

For the purposes of this article, we are looking at the fork that has the highest hashrate, XMR.  Over the past month its hashrate has hovered around 475 MH/s.

Only 475 MH/s?  That may sound like a very diminutive hashrate, but it is all relative to what most CPU and GPU hashrate performance is measured in Monero and not other coins.

For example, MoneroBenchmarks lists hundreds of different system configurations with the corresponding hashrate.  Similarly there are other independent testing systems that provide public information on hashrates.

Let’s take that same Vega 64 used above from Ethereum.  For Monero, based on tweaking it generates around 2000 hashes/sec and consumes around 160 W.

So the math is as follows:

  • 475,000,000 hashes/sec is the current average hashrate
  • A single Vega 64 will generate about 2000 hashes/sec
  • The equivalent of 237,500 Vega 64s are being used
  • Each Vega 64 consumes about 3.84 kWh per day
  • So 237,500 Vega 64s consume 912,000 kWh per day
  • And in a year: 332 million kWh

The 332 million kWh / year figure is a lower-bound because like the Ethereum Vega 64 example above: it doesn’t include the whole mining system, all of these systems still need a CPU with its own RAM, hard drive, and so forth.

As a result, the real electricity consumption figure is much closer to Haiti than Seychelles, perhaps even higher.  Note: Haiti has a ~$8.4 billion economy and the GDP of Seychelles is ~$1.5 billion.

So what about Monero’s economic activity?  Many Monero advocates like to market it as a privacy-focused coin.  Some of its “core” developers publicly claimed it would be the best coin to use for interacting with darknet markets.  Whatever the case may be, compared to the four above, currently it is probably the least used for commercial activity as revealed by its relative flat transactional volume this past year.

A now-deleted image of a Monero mining farm in Toronto (source)

Conclusion

Above were examples of how much electricity is consumed by just five proof-of-work coins.  And there are hundreds of other PoW coins actively online using disproportionate amounts of electricity relative to what they process in payments or commerce.

This article did not dive into the additional resources (e.g., air conditioning) used to cool mining equipment.  Or the subsidies that are provided to various mining farms over the years.  It also doesn’t take into account the electricity used by thousands of validating nodes that each of the networks use to propagate blocks each day.

It also did not include the huge amount of semiconductors (e.g. DRAM, CPUs, GPUs, ASICs, network chips, motherboards, etc.) that millions of mining machines use and quickly depreciate within two years, almost all of which becomes e-waste.7 For ASIC-based systems, the only thing that is typically reused is the PSU, but these ultimately fail as well due to constant full-throttle usage.

In summation, as of this writing in late August 2018:

  • Bitcoin’s blockchain likely uses the same electricity footprint as Austria, but probably higher
  • Bitcoin Cash’s blockchain is at least somewhere between Moldova and Cambodia, but probably higher
  • Ethereum’s blockchain is at least somewhere between Guatemala and Estonia, but probably higher
  • Litecoin’s blockchain is at least somewhere between Moldova and Cambodia, but probably higher
  • One of Monero’s blockchains is at least somewhere between Haiti and Seychelles, but probably higher

Altogether, these five networks alone likely consume electricity and other resources at an equivalent scale as The Netherlands especially once you begin to account for the huge e-waste generated by the discarded single-use ASICs, the components of which each required electricity and other resources to manufacture.  Perhaps even higher when costs of land, labor, on-going maintenance, transportation and other inputs are accounted for.

The Netherlands has the 18th largest economy in the world, generating $825 billion per annum.

I know many coin supporters say that is not a fair comparison but it is.  The history of development and industrialization since the 18th century is a story about how humanity is increasingly more productive and efficient per unit of energy.

Proof-of-work coins are currently doing just the opposite.  Instead of being more productive (e.g., creating more outputs with the same level of inputs), as coin prices increase, this incentivizes miners to use more not less resources.  This is known as the Red Queen Effect.89

For years, proof-of-work advocates and lobbying organizations like Coin Center have been claiming that the energy consumption will go down and/or be replaced by renewable energy sources.

But this simply cannot happen by design: as the value of a PoW coin increases, miners will invest more capital in order to win those coins.  This continues to happen empirically and it is why over time, the aggregate electricity consumption for each PoW coin has increased over time, not decreased.  As a side-effect, cryptocurrency mining manufacturers are now doing IPOs.10

Reporters, if you plan to write future stories on this topic, always begin by looking at the network hashrate of the specific PoW coin you are looking at and dividing it by the most common piece of mining hardware.  These numbers are public and cannot be easily dismissed.  Also worth looking at the mining restrictions and bans in Quebec, Plattsburgh, Washington State, China, and elsewhere.

To front-run an example that coin promoter frequently use as a whataboutism: there are enormous wastes in the current traditional financial industry, removing those inefficiencies is a decades-long ordeal.  However, as of this writing, no major bank is building dozens of data centers and filling them with single-use ASIC machines which continuously generate random numbers like proof-of-work coins do.  That would be rightly labeled as a waste.

In point of fact, according to the Federal Reserve:

In the aggregate, U.S. PCS systems process approximately 600 million transactions per day, valued at over $12.6 trillion.

It shouldn’t take the energy footprint of a single country, big or small, to confirm and settle electronic payments of that same country.  The fact of the matter is that with all of its headline inefficiencies (and injustices), that the US financial system has — the aggregate service providers still manage to process more than three orders of magnitude more in transactional volume per day than all of the major PoW coins currently do.11 And that is just one country.

Frequent rejoinders will be something like “but Lightning!” however at the time of this writing, no Lightning implementation has seen any measurable traction besides spraying virtual graffiti on partisan-run websites.

Can the gap between the dearth of transactional volume and the exorbitantly high cost-per-transaction ratio be narrowed?  Does it all come down to uses?  Right now, the world is collectively subsidizing dozens of minuscule speculation-driven economies that in aggregate consumes electricity on par with the 18th largest real economy, but produces almost nothing tangible in exchange for it.

What if all mining magically, immediately shifted over to renewable energy?

Izabella Kaminska succinctly described how this still doesn’t solve the environmental impact issues:

Renewable is displacement. Renewable used by bitcoin network is still renewable not used by more necessary everyday infrastructure. Since traditional global energy consumption is still going up, that ensures demand for fossil continues to increase.

To Kaminska’s point, in April a once-shuttered coal power plant in Australia was announced to be reopened to provide electricity to a cryptocurrency miner.  And just today, a senator from Montana warned that the closure of a coal power plant “could harm the booming bitcoin mining business in the state.”

It is still possible to be interested in cryptocurrencies and simultaneously acknowledge the opportunity costs that a large subset of them, proof-of-work coins, are environmental black holes.12

If you’re interested in discussing this topic more, feel free to reach out.  If you’re looking to read detailed papers on the topic, also highly recommend the first two links listed below.

Recommended reading:

End notes

  1. If the market value of a coin decreases, then because hashrate follows price, in practice hashrate also declines.  See also a ‘Maginot Line’ attack []
  2. Another estimate is that Bitcoin’s energy usage creates as much CO2 as 1 million transatlantic flights. []
  3. There have been proposals from various developers over the years to change this hash function but at the time of this writing, both Bitcoin and Bitcoin Cash use the same one. []
  4. And because many of these mining systems likely use more-powerful-than-needed CPUs. []
  5. Note: Vitalik Buterin highlighted this discrepancy earlier this year with the NYT: The creator of Ethereum, Vitalik Buterin, is leading an experiment with a more energy-efficient way to create tokens, in part because of his concern about the impact that the network’s electricity use could have on global warming. “I would personally feel very unhappy if my main contribution to the world was adding Cyprus’s worth of electricity consumption to global warming,” Mr. Buterin said in an interview. []
  6. At 8.65 billion kWh * $0.07 / kWh comes to around $600 million spent on electricity per year.  Mining rewards as of this writing: 3 ETH * $267 / ETH * 6000 blocks / day equals to $4.8 million USD / day.  Or ~$1.7 billion per year.  This includes electricity and hardware.  Thanks to Vitalik for double-checking this for me. []
  7. Just looking at the hash-generating machines, according to Chen Min (a chip designer at Avalon Mining), as of early November 2017, 5% of all transistors in the entire semiconductor industry is now used for cryptocurrency mining and that Ethereum mining alone is driving up DRAM prices. []
  8. See Chapter 3 []
  9. As described in a Politico article this past spring: “To maintain their output, miners had to buy more servers, or upgrade to the more powerful servers, but the new calculating power simply boosted the solution difficulty even more quickly. In effect, your mine was becoming outdated as soon as you launched it, and the only hope of moving forward profitably was to adopt a kind of perpetual scale-up: Your existing mine had to be large enough to pay for your next, larger mine.” []
  10. Following the dramatic drop in coin prices since January, Nvidia missed its revenue forecast from cryptocurrency-related mining: Revenues from miners were $289 million in Q1, which was about 10% of Nvidia’s revenue. The forecast for Q2 was $100 million and the actual revenues ended up being $18 million. []
  11. On average, the Bitcoin network confirms about 300,000 transactions per day.  A lot of that is not commercial activity.  Let’s take the highest numbers from Chainalysis and assume that each major cryptocurrency is processing at least $10 million in merchant transactions a day.  They aren’t, but let’s assume that they are.  That is still several orders of magnitude less than what US PCS systems do each day. []
  12. The ideological wing within the cryptocurrency world has thus far managed to convince society that negative externalities are ‘worth the cost.’  This narrative should be challenged by both policy makers and citizens alike as everyone must unnecessarily bear the environmental and economic costs of proof-of-work blockchains.  See also the Bitcoin Energy Consumption Index from Digiconomist and also Bitcoin is not a good fit for renewable energy. Here’s why. []

Book Review: Cryptoassets

[Disclaimer: The views expressed below are solely my own and do not necessarily represent the views of my clients.  I currently own no cryptocurrencies.]

As a follow-on to my previous book reviews, an old colleague lent me a copy of Cryptoassets by Chris Burniske and Jack Tatar.

Overall they have several “meta” points that could have legs if they substantially modify the language and structure of multiple sections in the book.  As a whole it’s about on par with the equally inaccurate “Blockchain Revolution” by the Tapscotts.

As I have one in my previous book reviews, I’ll go through and provide specific quotes to backup the view that the authors should have waited for more data and relevant citations as some of their arguments lack definitive supporting evidence.

In short: hold off from buying this edition.

If you’re interested in understanding the basics of cryptocurrencies but without the same level of inaccuracies, check out the new The Basics of Bitcoins and Blockchains by Antony Lewis.  And if you’re interested in the colorful background of some of the first cryptocurrency investors and entrepreneurs, check out Digital Gold by Nathaniel Popper.

Another point worth mentioning at the beginning is that there are no upfront financial disclosures by the authors.  They do casually mention that they have bitcoin once or twice, but that’s about it.

I think this is problematic because it is not being transparent about potential conflicts of interest (e.g., promoting financial products you may own and hope to see financial gain from).

For instance, we learned that Chris Burniske carried around a lot of USD worth of cryptocurrencies on his phone from a NYT article last year:

But a particularly concentrated wave of attacks has hit those with the most obviously valuable online accounts: virtual currency fanatics like Mr. Burniske.

Within minutes of getting control of Mr. Burniske’s phone, his attackers had changed the password on his virtual currency wallet and drained the contents — some $150,000 at today’s values.

Some quick math for those at home.  The NYT article above was published on August 21, 2017 when 1 BTC was worth about $4,050 and 1 ETH was worth about $314.  So Burniske may have had around 37 BTC or 477 ETH or a combination of these two (and other coins).

That is not a trivial amount of money and arguably should have been disclosed in this book and other venues (such as op-eds and analyst reports).1 In the next edition, they should consider adding a disclosure statement.

A final comment is that several reviewers suggested I modify the review below to be (re)structured like a typical book review — comparing broad themes instead of a detailed dissection — after all who is going to read 38,000+ words?

That is a fair point.  Yet because many of the points they attempt to highlight are commonly repeated by promoters of cryptocurrencies, I felt that this review could be a useful resource for readers looking for different perspective to the same topics frequently discussed in media and at events.

Note: all transcription errors are my own.


Authors’ Note

On p. xi, the authors wrote:

When embarking on our literary journey, we recognized the difficulty in documenting arguably the world’s fastest moving markets. These markets can change as much in a day – up or down – as the stock market changes in a year.

It is only mentioned in passing once or twice, but we know that market manipulation is a real on-going phenomenon.  The next edition could include a subsection of cryptocurrencies and ICOs that the CFTC and SEC – among other regulators – have identified and prosecuted for manipulation.  More on that later below.

Foreword

On p. xiv, Brian Kelly wrote in the Foreword

The beauty of this book is that it takes the reader on a journey from bitcoin’s inception in the ashes of the Great Financial Crisis to its role as a diversifier in a traditional investment portfolio.

A small quibble: Satoshi actually began writing the code for Bitcoin sometime in mid-2007, before the GFC took place.  It may be a chronological coincidence that it came out when it did, especially since it was supposed to be a payment system, which is just one small function of a commercial bank.23

On p. xv Kelly writes:

As with any new model, there are questions about legality and sustainability, but the Silicon Valley ethos of “break things first, then ask for forgiveness” has found its way to Wall Street.

There are also two problems with this:

  1. Both the SEC and CFTC – among other federal agencies – were set up in the past because of the behavior that Kelly thinks is good: “break things first, then ask for forgiveness” is arguably a bad ethos to have for any fiduciary and prudential organizations.4
  2. Any organization can do that, that’s not hard.  Some have gotten away with it more than others.  For instance, Coinbase was relatively loose with its KYC / AML requirements in 2012-2014 and has managed to get away with it because it grew fast enough to become an entity that could lobby the government.

On p.xv Kelly writes

“Self-funded, decentralized organizations are a new species in the global economy that are changing everything we know about business.”

In point of fact, virtually all cryptocurrencies are not self-funded.  Even Satoshi had some kind of budget to build Bitcoin with.  And basically all ICOs are capital raises from external parties.  Blockchains don’t run and manage themselves, people do.

On p. xv Kelly writes:

“These so-called fat protocols are self-funding development platforms that create and gain value as applications are built on top.”

The fat protocol thesis has not really born out in reality, more on that in a later chapter below.  While lots of crytpocurrency “thought leaders” love to cite the original USV article, none of the platforms are actually self-funded yet.  They all require external capital to stay afloat because insiders cash out for real money.5 And because there is a coin typically shoehorned at the protocol layer, there is very little incentive for capable developers to actually create apps on top — hence the continual deluge of new protocols each month — few actors want to build apps when they can become rich building protocols that require coins. More on this later.6

Introduction

On p. xxii the authors write:

“… and Marc Andreessen developing the first widely used web browser, which ultimately became Netscape.”

A pedantic point: Marc Andreessen was leader of a team that built Mosaic, not to take away from that accomplishment, but he didn’t single handedly invent the web browser.  Maybe worth rewording in next edition.

On p. xxiii they write:

Interestingly, however, the Internet has become increasingly centralized over time, potentially endangering its original conception as a “highly survivable system.”

This is a valid point however it glosses over the fact that all blockchains use “the internet” and also — in practice — most public blockchains are actually highly centralized as well.  Perhaps that changes in time, but worth looking at “arewedecentralizedyet.”

On p. xxiii they write:

Blockchain technology can now be thought of as a general purpose technology, on par with that of the steam engine, electricity, and machine learning.

This is still debatable.  After all, there is no consensus on what “blockchains” are and furthermore, as we have seen in benchmark comparisons, blockchains (however defined) come in different configurations.  While there are a number of platforms that like to market themselves as “general purpose,” the fact of the matter is that there are trade-offs based on the user requirements: always ask who the end-users and the use-cases a blockchain was built around are.

On p. xxiv they cite Don and Alex Tapscott.  Arguably they aren’t credible people on this specific topic.  For example, their book was riddled with errors and they even inappropriately made-up advisors on their failed bid to launch and fund their NextBlock Global fund.

On p. xxiv the authors write:

Financial incumbents are aware blockchain technology puts on the horizon a world without cash – no need for loose bills, brick-and-mortar banks, or, potentially, centralized monetary policies.  Instead, value is handled virtually through a system that has no central authority figure and is governened in a centralized and democratic manner. Mathematics force order in the operations. Our life savings, and that of our heirs, could be entirely intangible, floating in a soup of secure 1s and 0s, the entire system accessed through computers and smartphones.

This conflates multiple things: digitization with automation.7  Retail banking has and will continue its march towards full digital banking.  You don’t necessarily need a blockchain to accomplish that — we see that with Zelle’s adoption already.8

Also, central banks are well aware that they could have some program adjust interest rates, but discretion is still perceived as superior due to unforeseen incidents and crisis. 9

On p. xxv they write:

The native assets historically have been called cryptocurrencies or altcoins but we prefer the term cryptoassets, which is the term we will use throughout the book.

The term seems to have become a commonly accepted term but to be pedantic: most owners and users do not actually utilize the “cryptography” part — because they house the coins in exchanges and other intermediaries they must trust (e.g., the user doesn’t actually control the coin with a private key).10

And as we continue to see, these coins are easily forkable.  You can’t fork physical assets but you can fork and clone digital / virtual ones.  That’s a separate topic though maybe worth mentioning in the next edition.

On p. xxv they write:

It’s early enough in the life of blockchain technology that no books yet have focused solely on public blockchains and their native cryptoassetss from the investing perspective. We are changing that because investors need to be aware of the opportunity and armed both to take advantage and protect themselves in the fray.

Might be worth rewording because in Amazon there are about 760 books that pop up when “investing in cryptocurrencies” is queried.  And many of those predate the publication of Cryptoassets.  For instance, Brian Kelly, who wrote the Forward, published a fluffy coin promotion book a few years ago.

On p. xv they write:

Inevitably, innovation of such magnitude, fueled by the mania of making money, can lead to overly optimistic investors. Investors who early on saw potential in Internet stock encountered the devastating dot-com bubble. Stock in Books-A-Million saw its price soar by over 1,000 percent in one week simply by announcing it had an updated website. Subsequently, the price crashed and the company has since delisted and gone private. Other Internet-based high flyers that ended up crashing include Pets.com, Worldcom, and WebVan. Today, none of those stocks exist.

So far, so good, right?

Whether specific cryptoassets will survive or go the way of Books-A-Million remains to be seen.  What’s clear, however, is that some will be big winners. Altogether, between the assets native to blockchains and the companies that stand to capitalize on this creative destruction, there needs to be a game plan that investors use to analyze and ultimately profit from this new investment theme of cryptoassets. The goal of this book is not to predict the future – it’s changing too fast for all but the lucky to be right- but rather to prepare investors for a variety of futures.

Even for 2017 when the book was publish, this statement is lagging a bit because there were already several “coin graveyard” sites around.  Late last month Bloomberg ran a story: more than 1,000 coins are dead according to Coinopsy.

It is also unclear, “that some will be big winners.”  Maybe modify this part in the next version.11

On p. xxvi they write:

“One of the keys to Graham’s book was always reminding the investor to focus on the inherent value of an investment without getting caught in the irrational behavior of the markets.”

There is a healthy debate as to whether cryptocurrencies and “cryptoassets” have any inherent value either.12  Arguably most coins traded on a secondary market depend on some level of ‘irrational’ behavior: many coin holders have short time horizons and want someone else to help push up the price so they can eventually cash out.13

Chapter 1

On p. 3 they write:

In 2008, Bitcoin rose like a phoenix from the ashes of near Wall Street collapse.

This a little bit of revisionist history.14

The Bitcoin whitepaper came out on October 31, 2008 and Satoshi later said that he/she had spent the previous 18 months coding it first before writing it up in a paper.  The authors even discuss this later on page 7.  Worth removing in next edition.

On p. 3 they write:

Meanwhile, Bitcoin provided a system of decentralized trust for value transfer, relying not on the ethics of humankind but on the cold calculation of computers and laying the foundation potentially to obviate the need for much of Wall Street.

This is not quite true.  At most, Bitcoin as it was conceived and as it is today — is a relatively expensive payment network that doesn’t provide definitive settlement finality.15 Banks as a whole, do more than just handle payments — they manage many other services and products.  So the comparison isn’t really apples-to-apples.

Note: banks again as a whole spend more on IT-related systems than nearly any other vertical — so there is already lots of “cold calculation” taking place within each of these financial institutions.16

Now, maybe blockchain-related ideas replace or enhance some of these institutions, but it is unlikely that Bitcoin itself as it exists today, will do any of that.

On p. 5 they write:

What people didn’t realize, including Wall Street executives, was how deep and interrelated the risks CMOs posed were. Part of the problem was that CMOs were complex financial instruments supported by outdated financial architecture that blended and analog systems.

That may have been part of a bigger problem.17

There were a dozen plus factors for how and why the GFC arose and evolved, but “outdated financial infrastructure” isn’t typically at the top of the list of culprits.  Would blockchain-like systems have prevented the entire crisis?  There are lots of op-eds that have made the claim, but the authors do not really provide much evidence to support the specific “blended” argument here.  Perhaps worth articulating in its own section next time.

Speaking of which, also on p. 5 they write:

Whether as an individual or an entity, what’s now clear is that Satoshi was designing a technology that if existent would have likely ameliorated the toxic opacity of CMOs. Due of the distributed transparency and immutable audit log of a blockchain, each loan issued and packaged into different CMOs could have been documented on a single blockchain.

This seems to conflate two separate things: Bitcoin as Satoshi originally designed it in 2008 (for payments) and later what many early adopters have since promoted it as: blockchain as FMI.18

Bitcoin was (purposefully) not designed to do anything with regulated financial instruments, it doesn’t meet the PFMI requirements.  He was trying to build e-cash that didn’t require KYC and was difficult to censor… not ways to audit CMOs.  If that was the goal, architecturally Bitcoin would likely look a lot different than it did (for instance, no PoW).

And lastly on p. 5 they write:

This would have allowed any purchaser to view a coherent record of CMO ownership and the status of each mortgage within.  Unfortunately, in 2008 multiple disparate systems – which were expensive and therefore poorly reconciled – held the system together by digital strings.

Interestingly, this is the general pitch for “enterprise” blockchains: that with all of the disparate siloed systems within regulated financial institutions, couldn’t reconciliation be removed if these same systems could share the same record and facts on that ledger?  Hence the creation of more than a dozen enterprise-focused “DLT” platforms now being trialed and piloted by a slew of businesses.

This is briefly discussed later but the next edition could expand on it as the platforms do not need a cryptocurrency involved.19

On p. 7 they write:

By the time he released the paper, he had already coded the entire system.  In his own words, “I had to write all the code before I could convince myself that I could solve every problem, then I wrote the paper.” Based on historical estimates, Satoshi likely started formalizing the Bitcoin concept sometime in late 2006 and started coding around May 2007.

Worth pointing out that Hal Finney and Ray Dillinger — and likely several others – helped audit the code and paper before any of it was publicly released.

On p. 8 they write:

Many years later people would realize that one of the most powerful use cases of blockchain technology was to inscribe immutable and transparent information that could never be wiped from the face of digital history and that was free for all to see.

There appears to be a little hyperbole here.

Immutability has become a nebulous word that basically means many different things to everyone.  In practice, the only thing that is “immutable” on any blockchain is the digital signature — it is a one-way hash.   All something like proof-of-work or proof-of-stake does are decide who gets to vote to append the chain.

Also, as mentioned above, there are well over 1,000 dead coins so it is actually relatively common for ‘digital history’ to effectively be wiped out.

On p. 8 they write:

A dollar invested then would be worth over $1 million by the start of 2017, underscoring the viral growth that the innovation was poised to enjoy.

Hindsight is always 20-20 and the wording above seems to be a little unclear with dates.  As often as the authors say “this is not a book endorsing investments,” other passages seem do just the opposite: by saying how smart you would’ve been if you had bought at a relative low, during certain (cherry picked) dates.

Also, what viral growth?  What are the daily active and monthly active user numbers they think are occurring on these chains?  In later chapters, they do cite some on-chain activity but this version lacks specific DAU / MAU that would strengthen their arguments.20 Worth revisiting in the next edition.

On p. 8 they write:

Diving deeper into Satoshi’s writings around the time, it becomes more apparent that he was fixated on providing an alternative financial system, if not a replacement entirely.

This isn’t quite right.  The very first thing Satoshi tried to build was a marketplace to play poker which was supposed to be integrated with the original wallet itself.

A lot of the talk about “alternative financial system” is arguably revisionist propaganda from folks like Andreas Antonopoulos who have tried to rewrite the history of Bitcoin to conform with their political ideology.

Readers should also check out MojoNation and what that team tried to accomplish.

On p. 9 they write;

While Wall Street as we knew it was experiencing an expensive death, Bitcoin’s birth cost the world nothing.

There are at least two issues that can be modified for the future:

  1.  Wall Street hasn’t died, maybe parts of the financial system are replaced or removed or enhanced, but for better and worse almost 10 years since the collapse of Lehman, the collective financial industry is still around.
  2.  Bitcoin cost somebody something, there were opportunity costs in its creation.  And as we now know: the ongoing environmental impact is enormous.  Yet promoters typically handwave it away as a “cost of doing anarchy.”  Thus worth rewording or removing in the next edition.

On p. 9 they also wrote:

It was born as an open-source technology and quickly abandoned like a motherless babe in the world. Perhaps, if the global financial system had been healthier, there would have been less of a community to support Bitcoin, which ultimately allowed it to grow into the robust and cantankerous toddler that it currently is.

This prose sounds like something from Occupy Wall Street and not something found in literature to describe a computer program.

For example, there are lots of nominally open source blockchains, hundreds or maybe even thousands.21 That’s not very unique (it is kind of expected since there is a financial incentive to clone them).

And again, Satoshi worked on it for at least a couple years.  It’s not like he/she dropped it off at an orphanage after immediate gestation.  This flowery wording acts like a distraction and should be removed in the next edition.

Chapter 2

On p. 12 they write:

Three reputable institutions would not waste their time, nor jeopardize their reputations, on a nefarious currency with no growth potential.

There is a bit of an unnecessary attitude with this statement.  The message also seems to go against the criticism earlier in the book towards banks.  For instance, the first chapter was critical of the risks that banks took leading up to the GFC.  You can’t have it both ways.  In the next edition, should either remove this or explain what level or risk is appropriate.

Also, what is the “growth potential” here?  Do the authors mean the value of a coin as measured in real money?  Or actual usage of the network?

Lastly, the statement above equates the asset value growth (USD value increases) with a bank’s interest. Bank’s do not typically speculate on the price, they usually only care about volumes which make revenues. A cryptocurrency could go to $0.01 for all they care; and if people want to use it then they could consider servicing it provided the bank sees an ability to make money.  For example, UK banks did not abandon the GBP even though it lost 20% of its value in 2016 following the Brexit referendum.

On p. 12 they write:

Certainly, some of the earliest adopters of Bitcoin were criminals. But the same goes for most revolutionary technologies, as new technologies are often useful tools for those looking to outwit the law.

This is a “whataboutism” and is actually wrong.  Satoshi specifically says he/she has designed Bitcoin to route around intermediaries (like governments) and their ability to censor.  It doesn’t take too much of a stretch to get who would be initially interested in that specific set of payment “rails” especially if there is no legal recourse.22

On p. 12 they also write:

We’ll get into the specific risks associated with cryptoassets, including BItcoin, in a later chapter, but it’s clear that the story of bitcoin as a currency has evolved beyond being solely a means of payment for illegal goods and services. Over 100 media articles have jumped at the opportunity to declare bitcoin dead, and each time they have been proven wrong.

The last sentence has nothing to do with the preceding sentence, this is a non sequitur.

Later in the book they do talk about other use cases but the one that they don’t talk about much is how — according to analytics — the majority of network traffic in 2017 was users moving cryptocurrencies from one exchange to another exchange.

For example, about a month ago, Jonathan Levin from Chainalysis did an interview and mentioned that:

So we can identify, it is quite hard to know how many people. I would say that 80% of transactions that occur on these cryptocurrency ledgers have a counterparty that is a 3rd party service. More than 80%.

Maybe mention in the second edition: the unintended ironic evolution of Bitcoin has had… where it was originally designed to route around intermediaries and instead has evolved into an expensive permissioned-on-permissionless network.23

On p. 13 they write:

It operates in a peer-to-peer manner, the same movement that has driven Uber, Airbnb, and LendingClub to be multibillion-dollar companies in their own realms. Bitcoin lets anyone be their own bank, putting control in the hands of a grassroots movement and empowering the globally unbanked.

Not quite.  For starters: Uber, Airbnb, and LendingClub all act as intermediaries to every transaction, that’s how they became multibillion-dollar companies.

Next, Bitcoin doesn’t really let anyone be their own bank because banks offer a lot more products and services beyond just payments.  At most, Bitcoin provides a way of moving bitcoins you control to someone else’s bitcoin address (wallet).  That’s it.24

And there is not much evidence that Bitcoin or any cryptocurrency for that matter, has empowered many beyond relatively wealthy people in developed or developing countries.  There have been a few feel-good stories about marginalized folks in developing countries, but those are typically (unfortunately) one-off theatrics displaying people living in squalor in order to promote a financial product (coins).  It would be good to see more evidence in the next edition.

For more on this topic, recommend listening to LTB episode 133 with Richard Boase.

On p. 13 they write:

Decentralizing a currency, without a top-down authority, requires coordinated global acceptance of a shared means of payment and store of value.

Readers should check out “arewedecentralizedyet” which illustrates that nearly all cryptourrencies in practice have some type of centralized, top-down hierarchy as of July 2018.

On p. 13 they write:

Bitcoin’s blockchain is a distributed, cryptographic, and immutal database that uses proof-of-work to keep the ecosystem in sync.

Worth modifying because the network is not inherently immutable — only digital signatures have “immutability.”25 Also, proof-of-work doesn’t keep any “ecosystem” in sync.  All proof-of-work does is determine who can append the chain.  The “ecosystem” thing is completely unrelated.

On p. 15 they write:

There is no subjectivity as to whether a transaction is confirmed in Bitcoin’s blockchain: it’s just math.

This isn’t quite true.26 Empirically, mining pools have censored transactions for various reasons.  For example, Luke-Jr (who used to run Eligius pool) thinks that SatoshiDice misuses the network; he is also not a fan of what OP_RETURN was being used for by Counterparty.

Also, humans control pools and also manage the code repositories… blockchains don’t fix and run themselves.  So it’s not as simple as: “it’s just math.”

On p. 15 they write an entire paragraph on “immutability”:

The combination of globally distributed computers that can cryptographically verify transactions and the building of Bitcoin’s blockchain leads to an immutable database, meaning the computers building Bitcoin’s blockchain can only do so in an append only fashion. Append only means that information can only be added to Bitcoin’s blockchain over time and cannot be deleted – an audit trail etched in digital granite. Once information is confirmed in Bitcoin’s blockchain, it’s permanent and cannot be erased. Immutability is a rare feature in a digital world where things can easily be erased, and it will likely become an increasingly valuable attribute for Bitcoin over time.

This seems to have a few issues:

  1. As mentioned several times before in this review, “immutability” is only a characteristic of digital signatures, which are just one piece of a blockchain.  Recommend Gwern’s article entitled “Bitcoin-is-worse-is-better” for more details.
  2. Empirically lots of blockchains have had unexpected and expected block reorgs and hard forks, there is nothing fundamental to prevent this from happening to Bitcoin.  See this recent article discussing a spate of attacks on various PoW coins: Blockchain’s Once-Feared 51% Attack Is Now Becoming Regular
  3. The paragraph above ignores the reality that well over 1,000 blockchains are basically dead and Bitcoin itself had a centralized intervention on more than one occasion, such as the accidental hardfork in 2013 and the Bitcoin block size debate from 2015-2018.

On p. 15 they introduce us to the concept of proof-of-work but don’t really explain its own origin as a means of combating spam email in the 1990s.

For instance, while several Bitcoin evangelists frequently (mistakenly) point to Hashcash as the original PoW progenitor, that claim actually legitimately goes to a 1993 paper entitled Pricing via Processing or Combatting Junk Mail by Cynthia Dwork and Moni Naor.  There are others as well, perhaps worth adding in the next edition.27

On p. 16 they write:

Competition for a financial rewad is also what keeps Bitcoin’s blockchain secure.  If any ill-motivated actors wanted to change Bitcoin’s blockchain, they would need to compete with all the other miners distributed globally who have in total invested hundreds of millions of dollars into the machinery necessary to perform PoW.

This is only true for a Maginot Line attack (e.g., attack via hashrate).28 There are  cheaper and more effective out of band attacks, like hacking BGP or DNS.  Or hacking into intermediaries such as exchanges and hosted wallets.  Sure the attacker doesn’t directly change the blocks, but they do set in motion a series of actions that inevitably result in thefts that end up in blocks further down the chain, when the transactions otherwise wouldn’t have taken place.

On p. 17 they write:

The hardware runs an operating system (OS); in the case of Bitcoin, the operating system is the open-source software that facilitates everything described earlier.  This software is developed by a volunteer group of developers, just as Linux, the operating system that underlies much of the cloud, is maintained by a volunteer group of developers.

This isn’t quite right in at least two areas:

  1. Linux is not financial market infrastructure software; Bitcoin originally attempted to be at the very least, a payments network.  There are reasons why building and maintaining FMI is regulated whereas building an operating system typically isn’t.  It has to do with risk and accountability when accidents happen.  That’s why PFMI exists.
  2. At least in the case of Bitcoin (and typically in most other cryptocurrencies), only one group of developers calls the shots via gating the BIP / EIP process.  If you don’t submit your proposals and get it approved through this process, it won’t become part of Bitcoin Core.  For more on this, see: Bitcoin Is Now Just A Ticker Symbol and Stopped Being Permissionless Years Ago

On p. 17 they discuss “private versus public blockchains”:

The difference between public and private blockchains is similar to that between the Internet and intranets.  The internet is a public resource.  Anyone can tap into it; there’s not gate keepers.

This is wrong.  All ISPs gate their customers via KYC.  Not just anyone can set up an account with an ISP, in fact, customers can and do get kicked off for violating Terms of Service.

“The Internet” is just an amalgamation of thousands of ISPs, each of whom have their own Terms of Service.  About a year ago I published an in-depth article about why this analogy is bad and should not be use: Intranets and the Internet.

On p. 18 they write:

Public systems are ones like BItcoin, where anyone with the right hardware and software can connect to the network and access the information therein.  There is no bouncer checking IDs at the door.

This is not quite right.  The “permissionless” characteristic has to do with block making: who has the right to vote on creating/adding a new block… not who has the ability to download a copy of the blockchain.  Theoretically there is no gatekeeper for block making in Bitcoin. Although, there are explicit KYC checks on the edges (primarily at exchanges).

In practice, the capital and knowledge requirements to actually create a new mining pool and aggregate hashpower that is sufficiently capable of generating the right hash and “winning” the scratch-off lottery is very high, such that on a given month just 20 or so block makers are actually involved.29

While there is no strict permissioning of these participants (some come and go over the years), it is arguably a de facto oligopoly based on capital expenditures and not some type of feel-good meritocracy described in this book.30

On p. 18 they write:

Private systems, on the other hand, employ a bouncer at the door. Only entities that have the proper permissions can become part of the network. These private systems came about after Bitcoin did, when enterprises and businesses realized they liked the utility of Bitcoin’s blockchain, but weren’t comfortable or legally allowed to be as open with he information propagated among public entities.

This is not nuanced enough.  What precisely is permissioned on a “permissioned” blockchain is: who gets to do the validation.

While there are likely dozens of “permissioned” blockchain vendors — each of which may have different characteristics — the common one is that the validators are KYC’ed participants.  That way they can be held accountable if there is a problem (like a fork).

For example, many enterprises and businesses tried to use Bitcoin, Ethereum, and other cryptocurrencies but because these blockchains were not built with their use cases in mind, unsurprisingly found that they were not a good fit.

This is not an insult: the “comfort” refrain is tiring because there have been a couple hundred proofs-of-concept on Bitcoin – and variants thereof – to look into whether those chains were fit-for-purpose… and they weren’t.  This passage should be reworded in the second edition.

On p. 18 they write:

Within financial services, these private blockchains are largely solutions by incumbents in a fight to remain incumbents.

Maybe that is the motivation of some stakeholders, but I don’t think I’ve ever been in a meeting in which the participants (banks) specifically said that.  It would be good to have a citation added in the next edition.  Otherwise, as Hitchens said: what can be presented without evidence can be dismissed without evidence.

On p. 18 they write:

While there is merit to many of these solutions, some claim the greatest revolution has been getting large and secretive entities to work together, sharing information and best practices, which will ultimately lower the cost of services to the end consumer. We believe that over time the implementation of private blockchains will erode the position held by centralized powerhouses because of the tendency toward open networks. In other words, it’s a foot in the door for further decentralization and the use of public blockchains.

This is a “proletariat” narrative that is frequently used in many cryptocurrency books.  While there is a certain truth to an angle – collaboration of regulated entities that normally compete with one another – many of the vendors and platforms that they are piloting are actually “open.”

Which brings up the euphemism that some vocal public blockchain promoters like to stake a claim in… the ill-defined “open.”  For instance, coin lobbyists such as Coin Center and coin promoters such as Andreas Antonopoulos regularly advertise that they are experts and advocates of “open” chains but their language is typically filled with strawmen.

For instance, enterprise-specific platforms such as Fabric, Corda, and Quorum are all open sourced, anyone can download and run the code without the permission of the vendors that contribute code or support to the platforms.

Thus, it could be argued that these platforms are “open” too… which they are.

But it is highly unlikely that ideological advocates would ever defend or promote these platforms, because of their disdain and aversion to platforms built by financial organizations. 31

Lastly, this “foot in the door” comment comes in all shapes and sizes; sometimes coin promoters use “Trojan horse” as well.  Either way it misses the point: enterprises will use technology that solves problems for them and will not use technology that doesn’t solve their problem.

In practice, most cryptocurrencies were not designed – on purpose – to solve problems that regulated institutions have… so it is not a surprise they do not use coin-based platforms as FMI.  It has nothing to do with the way the coin platforms are marketed and everything to do with the problems the coins solve.

On p. 19 they write:

Throughout this book, we will focus on public blockchains and their native assets, or what we will define as cryptoassets, because we believe this is where the greatest opportunity awaits the innovative investor.

The authors use the term “innovative investor” a dozen or more times in the book.  It’s not a particularly useful term.32

Either way, later in the book they don’t really discuss the opportunity cost of capital: what are the tradeoffs of an accredited investor who puts their money long term into a coin versus buys equity in a company.  Though, to be fair, part of the problem is that most of the companies that actually have equity to buy, do not publish usage or valuation numbers because they are still private… so it is hard to accurately gauge that specific trade-off.33

On p. 19 they write about Bitcoin maximalism (without calling it that):

We disagree with that exclusive worldview, as there are many other interesting consensus mechanisms being developed, such as proof-of-stake, proof-of-existence, proof-of-elapsed time, and so on.

Proof-of-existence is not a consensus mechanism.  PoE simply verifies the existence of a file at a specific time based on a hash from a specific blockchain.  It does not provide consensus.  This should be reworded in the next edition.

Furthermore, neither proof-of-stake or proof-of-elapsed-time are actual consensus mechanisms either… they are vote ordering mechanisms — a mechanism to prevent or control sybil attacks. 34  See this excellent thread from Emin Gun Sirer.

Chapter 3

On p. 22 they write:

Launched in February 2011, the Silk Road provided a rules-free decentralized marketplace for any product one could imagine, and it used bitcoin as the means of payment.

This isn’t quite true.  Certain guns and explosives were considered off-limits and as a result “The Armory” was spun off.

On p. 22 they write:

Clearly, this was one way that Bitcoin developed its dark reputation, though it’s important to know that this was not endorsed by Bitcoin and its development team.

Isn’t Bitcoin — like all cryptocurrences — supposed to be decentralized?  So how can there be a singular “it” to not endorse something?35

On p. 22 they write:

The drivers behind this bitcoin demand were more opaque than the Gawker spike, though many point to the bailout of Cyprus and the associated losses that citizens took on their bank account balances as the core driver.

This is mostly hearsay as several independent researchers have tried to identify the actual flows coming into and going out of Cyprus that are directly tied to cryptocurrencies and so far, have been unable to.36

On p. 23 they write about Google Search Trends:

We recommend orienting with this tool even beyond cryptoassets, as it’s a fascinating window into the global mesh of minds.

Incidentally, despite the authors preference to the term “cryptoassets” —  according to Google Search Trends, that term isn’t frequently used in search’s yet.

Source: Google

On p. 24 they write:

This diversity has led to tension among players as some  of these cryptoassets compete, but this is nothing like the tension that exists between Bitcoin and the second movement.

Another frequent name typically used to call “the second movement” was Bitcoin 2.0.

For example, back in 2014 and 2015 I interviewed a number of project organizers and attempted to categorize them into buckets, including things like “commodities” and “assets.”  See for instance my guest presentation in 2014 at Plug and Play: (video) (slides).

This label isn’t frequently used as much anymore, but that’s a different topic entirely.

On p. 25 they write an entire section entitled: Blockchain, Not Bitcoin

The authors stated:

Articles like one from the Bank of England in the third quarter of 2014 argued, “The key innovation of digital currencies is the ‘distributed ledger,’ which allows a payment system to operate in an entirely decentralized way, without intermediaries such as banks. In emphasizing the technology and not the native asset, the Bank of England left an open question whether the native asset was needed

[…]

The term blockchain, independent of Bitcoin, began to be used more widely in North America in the fall of 2015 when two prominent financial magazines catalyzed awareness of the concept.

Let’s pull apart the problems here.

First, the “blockchain not bitcoin” mantra was actually something that VCs such as Adam Draper pushed in the fall of 2015.

For instance, in an interview with Coindesk in October 2015 he said:

“We use the word blockchain now. I say bitcoin, and they think that’s the worst thing ever. It just feels like they put up a guard. Then, I switch to blockchain and they’re very attentive and they’re very interested.”

Draper seems ambivalent to the change, though he said he was initially against using it, mostly because he believes it’s superficial. After all, companies that use the blockchain as a payments rail, the argument goes, still need to interface with its digital currency, which is the mechanism for transactions on the bitcoin blockchain.

“When we talk about blockchain, I mean bitcoin,” Draper clarifies. “Bitcoin and the blockchain are so interspersed together, the incentive structure of blockchain is bitcoin.”

Draper believes it’s mostly a “vernacular change”, noting the ecosystem has been through several such transitions before. He rifles off the list of terms that have come and gone including cryptocurrency, digital currency and altcoin.

“It’s moved from bitcoin to blockchain, which makes sense, it’s the underlying tech of all these things,” he added. “I think in a lot of ways blockchain is FinTech, so it will become FinTech.”

If you’re looking for more specific examples of companies that began using “blockchain” as a euphemism for “bitcoin” be sure to check out my post: “The Great Pivot.”

The authors also fail to identify that there were lots of early stage vendors and entrepreneurs working in the background on educating policy makers and institutions on what the vocabulary was and how the various moving pieces worked throughout 2015.

Want evidence?

Check out my own paper covering this topic and a handful of vendors in April 2015: Consensus-as-a-service.  This paper has been cited dozens of times by a slew of academics, banks, regulators, and so forth.  And contra Draper: you don’t necessarily need a coin or token to incentivize participants to operate a blockchain.37

On p. 26 they write:

A private blockchain is typically used to expedite and make existing processes more efficient, thereby rewarding the entities that have crafted the software and maintain the computers. In other words, the value creation is in the cost savings, and the entities that own the computers enjoy these savings. The entities don’t need to get paid in a native asset as reward for their work, as is the case with public blockchains.

First, not all private blockchains are alike or commoditized.

Two, this statement is mostly true.  At least those were the initially pitches to financial institutions.  Remember the frequently cited Oliver Wyman / Santander paper from 2015?  It was about cost savings.  Since then, the story has evolved to also include revenue generation.

For more up-to-date info on the “enterprise” blockchain world, recommend reading:

On p. 26 they write:

On the other hand, for Bitcoin to incentivize a self-selecting group of global volunteers, known as miners, to deploy capital into the mining machines that validate and secure bitcoin transactions, there needs to be a native asset that can be paid out to the miners for their work. The native asset builds out support for the service from the bottom up in a truly decentralized manner.

This may have been true in January 2009 but is not true in July 2018.  There are no “volunteers” in Bitcoin mining as running farms and pools have become professionalized and scaled in industrial-sized facilities.

Also, that last sentence is also false: virtually every vertical of involvement is dominated by centralized entities (e.g., exchanges, hosted wallets, mining manufacturing, etc.).

On p. 27 they write:

Beyond questioning the need for native cryptoassets – which would naturally infuriate communities that very much value their cryptoassets – tensions also exist because public blockchain advocates believe the private blockchain movement bastardizes the ethos of blockchain technology. For example, instead of aiming to decentralize and democratize aspects of the existing financial services, Masters’s Digital Asset Holdings aims to assist existing financial services companies in adopting this new technology, thereby helping the incumbents fight back the rebels who seek to disrupt the status quo.

Ironically, virtually all major cryptocurrency exchanges now have institutional investors and/or partnerships with regulated financial institutions.38 Like it or not, but the cryptocurrency world is deep in bed with the very establishment that it likes to rail at on social media.

Also, Bitcoin again is at most a payments network and does not actually solve problems for existing financial service providers on their many other lines of business.

On p. 27 they write:

General purpose technologies are pervasive, eventually affecting all consumers and companies. They improve over time in line with the deflationary progression of technology, and most important, they are a platform upon which future innovations are built. Some of the more famous examples include steam, electricity, internal combustion engines, and information technology. We would add blockchain technology to this list. While such a claim may appear grand to some, that is the scale of the innovation before us.

If you’re not familiar with hyperbole and technology, I recommend watching and reading the PR for the Segway when it first came out.  Promoters and enthusiasts repeatedly claimed it would change the way cities are built.  Instead, it is used as a toy vehicle to shuffle tourists around at national parks and patrol suburban malls.

Maybe something related to “blockchains” is integrated into various types of infrastructure (such as trade finance), but the next edition should provide proof of some actual user adoption.

For example, the authors in the following paragraph say that “public blockchains beyond Bitcoin that are growing like gangbusters.”

Which ones?  In the approximately 9 months since this book was published, most “traction” has been issuing ICOs on these public blockchains.  Currently the top 3 Dapps at the time of this writings, run decentralized exchanges… which trade ICO tokens.  Now maybe that changes, that is totally within the realm of possibility.39  But let’s take the hype down a few notches until consistent measurable user growth is observed.

On p. 28 they write:

The realm of public blockchains and their native assets is most relevant to the innovative investor, as private blockchains have not yielded an entirely new asset class that is investable to the public.

The wording and attitude should be changed for the next edition.  This makes it sound as if the only real innovation that exists are network-based coins that a group of issuers continually create and that you, the reader, should buy.

By downplaying opportunities being tackled by enterprise vendors, the statement glosses over the operating environment enterprise clients reside in and how they must conduct unsexy due diligence and mundane requirements gathering because they have to follow laws and regulations otherwise their customers won’t use their specific platforms.

These same vendors could end up “tokenizing” existing financial instruments, it just takes a lot longer because there are real legal consequences if something breaks or forks.40

On p. 28 and 29 they ask “where is blockchain technology in the hype cycle.”

This section could be strengthened by revisiting and reflecting on the huge expectations that these coin projects have raised and were raising at the time the book was first being written.  How were expectations eventually managed?

Specifically, on p. 29 they write:

While it’s hard to predict where blockchain technology currently falls on Gartner’s Hype Cycle (these things are always easier in retrospect), we would posit that Bitcoin is emerging from the Trough of Disillusionment. At the same time, blockchain technology stripped of native assets (private blockchain) is descending from the Peak of Inflated Expectations, which it reached in the summer of 2016 just before The DAO hack occurred (which we will discuss in detail in Chapter 5).

The first part is probably wrong if measured by actual usage and interest (as shown by the Google Search image a few sections above).41

The second part of the paragraph is probably right, though the timing was probably a little later: likely in the last quarter of 2016 when the first set of pilots turned out to require substantially larger budgets.  That is to say, in order to be put platforms into production most small vendors with short runways realized they needed more capital and time to integrate solutions into legacy systems.  In some cases, that was too much work and a few vendors pivoted out of enterprise and created a coin or two instead.42

Chapter 4

On p. 31 they write:

Yes, the numbers have changed a lot since.  Crypto moves fast.

This isn’t a hill I want to die on, but historically “crypto” means cryptography.  Calling cryptocurrencies “crypto” is basically slang, but maybe that’s the way it evolves towards.

On p. 32 they write:

Historically, crypotassets have most commonly been referred to as cryptocurrencies, which we think confuses new users and constrains the conversation on the future of these assets. We would not classify the majority of cryptoassets as currencies, but rather most are either digital commodities (cryptocommodities), provisioning raw digital resources, or digital tokens (cryptotokens), provisioning finished digital goods and services.

They have a point but a literature review could have been helpful at showing this categorization is neither new nor novel.

For instance, the title of my last book was: The Anatomy of a Money-like Informational Commodity.  A bit long-winded?

Where did I come up with that odd title?

In 2014, an academic paper was published that attempted to categorize Bitcoin from an ontological perspective. Based on the thought process presented in that paper, the Dutch authors concluded that Bitcoin is a money-like informational commodity.  It isn’t money and isn’t a currency (e.g., isn’t actually used).434445

On p. 32 they write:

In an increasingly digital world, it only makes sense that we have digital commodities, such as computer power, storage capacity, and network bandwidth.

This book only superficially explains each of these and doesn’t drill down into why these “digital commodities” can’t be priced in good old fashioned money or why an internet coin is needed.  If this is a good use case, is it just a matter of time before Blizzard and Steam get on board?  Maybe worth looking at what entertainment companies do for the next edition.

On p. 33 they write about “why crypto” as shorthand for “cryptoassets” instead of “cryptography.”

For historical purposes, Matt Blaze, the most recent owner of crypto.com, provides a good explanation that could be included or cited next edition: Exhaustive Search Has Moved.

On p. 35 they write:

Except for Karma, the problem with all these attempts at digital money was that they weren’t purely decentralized — one way or another they relied on a centralized entity, and that presented the opportunity for corruption and weak points for attack.

This seems to be conflating two separate things: anonymity with electronic cash.  You can have one without the other and do.46

Also, the BIP process is arguably a weak point for attack.47

On p. 35 they write:

One of the most miraculous aspects of bitcoin is how it bootstrapped support in a decentralized manner.

The fundamental problem with this statement is that it is inaccurate.48 Large amounts of centralization continues to exist: mining, exchanges, BIP vetting, etc.

On p. 35 they write:

Together, the combination of current use cases and investors buying bitcoin based on the expectation for even greater future use cases creates market demand for bitcoin.

Is that a Freudian slip?

Speculators buy bitcoin because they think can sell bitcoins at a higher price because a new buyer will come in at a later date and acquire the coins from them.49

For example, last month Hyun Song Shin, the BIS’s economic adviser and head of research, said:

“If people pay to hold the tokens for financial gain, then arguably they should be treated as a security and come under the same rigorous documentation requirements and regulation as other securities offered to investors for a return.”

In the United States, recall that one condition for what a security is under the Howey framework is an expectation of profit.

Whether Bitcoin is a security or not is a topic for a different post.50

On p. 36 they write:

For the first four years of Bitcoin’s life, a coinbase transaction would issue 50 bitcoin to the lucky miner.

[…]

On November 28, 2012, the first halving of the block reward from 50 bitcoin to 25 bitcoin happened, and the second halving from 25 bitcoin to 12.5 bitcoin occurred on July 9, 2016.  The thrid will happen four years from that date, in July 2020. Thus far, this has made bitcoin’s supply schedule look somewhat linear, as shown in Figure 4.1.

Technically incorrect because of the inhomogeneous Poisson process and the relatively large amounts of hashrate that came online, the first “4 year epoch” was actually less than 4 years.

Whereas the genesis block was released in January 2009, the first halving should have occurred in January 2013, but instead it took place in November 2012.  Similarly, the second halving should have — if rigidly followed — taken place in November 2016, but actually occurred in July 2016 because even more hashrate had effectively accelerated block creation a bit faster than expected.

On p. 36 they write:

Based on our evolutionary past, a key driver for humans to recognize something as valuable is its scarcity. Satoshi knew that he couldn’t issue bitcoin at a rate of 2.6 million per year forever, because it would end up with no scarcity value.

This is a non sequitur.51

Maybe Satoshi did or did not think this way, but irrespective of his or her view, having a finite amount of something means there is some amount of scarcity… even if it is a relatively large amount.  Now this discussion obviously leads down the ideological road of maximalism which we don’t have time to go into today.52  Suffice to say that bitcoin is fundamentally not scarce due to its inability to prevent forks that could increase or decrease the money supply.

On p. 37 they write:

Long term, the thinking is that bitcoin will become so entrenched within the global economy that new bitcoin will not need to be issued to continue to gain support. At that point, miners will be compesnated for processing transaction and securing the network through fees on high transaction volumes.

This might happen but hasn’t yet.

For instance, Kerem Kaskaloglu (see p. 71) created a cartoon model to show what this should look like.

But the actual curves do not exist (yet).

Recommended reading: Analysing Costs & Benefits of Public Blockchains (with Data!) by Colin Platt.

Notice how reality doesn’t stack up to the idealized version (yet)?

On p. 39 they write about BitDNS, Namecoin, and NameID:

Namecoin acts as its own DNS service, and provides users with more control and privacy.

In the next edition they should mention how Namecoin ended up having one mining pool that consistently had over 51% of the network hashrate and as a result, projects like Onename moved over to Bitcoin and then eventually its own separate network altogether (Blockstack).

On p. 41 they write:

This is an important lesson, because all cryptocurrencies differ in their supply schedules, and thus the direct price of each cryptoasset should not be compared if trying to ascertain the appreciation potential of the asset.

One way to strengthen this section is to provide a consistent model or methodology to systemically value a coin that doesn’t necessarily involve future demand from new investors.  Maybe in the second edition they could provide a way to compare or at least say that no valuation model works yet, but here is a possible alternative?

On p. 42 they write:

A word to the wise for the innovative investor: with a new cryptocurrency, it’s always important to understand how it’s being distributed and to whom (we’ll discuss further in Chapter 12). If the core community feels the distribution is unfair, that may forever plague the growth of the cryptocurrency.

Two things:

  1. If a cryptocurrency or “cryptoasset” is supposed to be decentralized, how can it have a singular “core” community too?
  2. In practice, most retail buyers of coins don’t seem to care about centralization or even coin distribution.  Later in the book they mention Dash and its rapid coin creation done in the first month.  Few investors seem to care. 53

On p. 42 they write:

Ripple has since pivoted away from being a transaction mechanism for the common person and instead now “enables banks to send real-time international payments across network.” This focus plays to Ripple’s strengths, as it aims to be a speedy payment system that rethinks correspondent banking but still requires some trust, for which banks are well suited.

If readers have time, I recommend looking through the marketing material of OpenCoin, Ripple Labs, and Ripple from 2013-2018 because it has changed several times.54 Currently there are a couple of different products including xRapid and xCurrent which are aimed at different types of users and as a result, the passage above should be updated.

On p. 43 they write:

Markus used Litecoin’s code to derive Dogecoin, thereby making it one more degree of separation removed from Bitcoin.

This is incorrect.  Dogecoin was first based off of Luckycoin and Luckycoin was based on a fork of Litecoin.  The key difference involved the erratic, random block reward sizes.

On p. 45 they write about Auroracoin.

Auroracoin is a cautionary tale for both investors and developers. What began as a seemingly powerful and compelling use case for a cryptoasset suffered from its inability to provide value to the audience it sought to impact. Incelanders were given a cryptocurrency with little education and means to use it. Unsurprisingly, the value of the asset collapsed and most considered it dead. Nevertheless, cryptocurrencies rarely die entirely, and Auroracoin may have interesting times ahead if its developer team can figure out a way forward.

A few problems:

  1. Auroracoin is still basically dead
  2. Over 1,000 other coins have died, so “rarely” should be changed in the next edition
  3. Why does a decentralized cryptocurrency have a singular development team, isn’t that centralization?

On p. 46 they write:

Meanwhile, Zcash uses some of the most bleeding-edge cryptography in the world, but it is one of the youngest cryptoassets in the book and suitable only for the most experienced cryptoasset investors.

In the next edition it would be helpful to specifically detail what makes someone an experienced “cryptoasset” investor.

On p. 46 they write:

Adam Back is considered the inspiration for Satoshi’s proof-of-work algorithm and is president of Blockstream, one of the most important companies in the Bitcoin space.

While Hashcash was cited in the original Satoshi whitepaper, recall above, that the original idea can be directly linked to a 1993 paper entitled Pricing via Processing or Combatting Junk Mail by Cynthia Dwork and Moni Naor.  Also, it is debatable whether or not Blockstream is an important company, but that’s a different discussion altogether.

On p. 46 they write:

Bitcoin and the permissionless blockchain movement was founded on principles of egalitarian transparency, so premines are widely frowned upon.

What are the founding principles?  Where can we find them?   Maybe it exists, but at least provide a footnote.55

On p. 47 they write:

While many are suspicious of such privacy, it should be noted that it has tremendous benefits for fungibility.  Fungibility refers to the fact that any unit of currency is as valuable as another unit of equal denomination.

Cryptocurrencies such as Bitcoin are not fungible.  Be sure to listen to this interview with Jonathan Levin from May.  See also: Bitcoin’s lien problem and also nemo dat.

On p. 48 they write:

Monero’s supply schedule is a hybrid of Litecoin and Dogecoin. For monero, a new block is appended to its blockchain every 2 minutes, similar to Litecoin’s 2.5 minutes.

In the next edition I’d tighten the language a little because a new monero block is added roughly or approximately every 2 minutes, not exactly 2 minutes.

On p. 48 they write:

By the end of 2016, Monero had the fifth largest network value of any cryptocurrency and was the top performing digital currency in 2016, with a price increase over the year of 2,760 percent. This clearly demonstrates the level of interest in privacy protecting cryptocurrency. Some of that interest, no doubt, comes from less than savory sources.

That is a non sequitur.

Where are the surveys of actual Monero purchasers during this time frame and their opinions for why they bought it? 56

For instance, in looking at the two-year chart above, how much on-chain activity in 2016 was due to speculators interest in “privacy” versus coin flipping?  It is impossible to tell.  Even with analytics all you will be able to is link specific users with purchases.  Intent and motivation would require  surveys and subpoenas; worth adding if available in the next edition.

On p. 48 they write:

Another cryptocurrency targeting privacy and fungiblity is Dash.

Is Dash really fungible though?  That isn’t explored in this section.  Plus Dash has a CEO… how is that decentralized?

On p. 49 they write:

In fact, Duffield easily could have relaunched Dash, especially considering the network was only days old when the instamine began to be widely talked about, but he chose not to.  It would have been unusual to relaunch, given that other cyrptocurrencies have done so via the forking of original code. The creators of Monero, for example, specifically chose not to continue building off Bytecoin because the premine distribution had been perceived as unfair.

How is this not problematic: for a “decentralized” cryptocurrency to be controlled and run by one person who can unilaterally stop and restart a chain?

It actually is common, that’s the confusing part.  Why have regulators such as FinCEN and the SEC not provided specific guidance (or enforcement) on the fact that one or a handful of individuals actually are unlicensed / non-exempted administrators of financial networks?

On p. 49 they write:

The Bitcoin and blockchain community has always been excited by new developments in anonymity and privacy, but Zcash took that excitement to a new level, which upon issuance drove the price through the roof.

Putting aside the irrational exuberance for Zcash itself, why do the authors think so many folks are vocal about privacy and anonymity?

Could it be that a significant portion of the coins are held by thieves of exchanges and hosted wallets who want to launder them?  Here are a few recent examples:

On p. 49 they write:

Through his time at DigiCash and longstanding involvement in cryptography and cryptoassets, Zooko has become one of the most respected members in the community.

Let’s put aside Zooko and Zcash.  The phrase, “the community” frequently appears in this book and similar books.  It is an opaque, ill-defined (and cliquish) term that is frequently used by coin promoters to shun certain people that do not promote specific policies (and coins).57  It’s a term that should be clearly defined in the next edition.

On p. 50 they write:

While it is still early days for Zcash, we are of the belief that the ethics and technology chops of Zooko and his team are top-tier, implying that good things lie in wait for this budding cryptocurrency.

The statement above seems like an endorsement.  Did either of the authors own Zcash just as the book came out?  And what are the specific ethics they speak of?  And why do the authors call it a cryptocurrency instead of a “cryptoasset”?

Chapter 5

On p. 51 they write:

For example, the largest cryptocommodity, Ethereum, is a decentralized world computer upon which globally accessible and uncensored applications can be built.

How is it a commodity?  Maybe it is and while they use a lot of words in this chapter, they never really precisely why it is in a way that makes much sense.  Recommend modifying the first few pages of this chapter.

On p. 52 they write about “smart contracts” and mention Nick Szabo.

For a future edition I recommend diving deeper into the different uses and definitions of smart contracts.  Also could be worth following Tony Arcieri suggestion:

I really like “authorization programs” but people really seem married to the “smart contract” terminology. Never mind Martin Abadi’s work on authorization languages (e.g. Binder) predates Nick Szabo’s “smart contracts” by half a decade…

For instance, there has been a lot of work done via the Accord Project with Clause.io and others such as IBM and R3.  Also worth looking into Barclay’s and UCL’s effort with the Smart Contract Templates.  A second edition that aims to be up-to-date should look at these developments and how they have evolved from what Abadi and Szabo first proposed.

On p. 53 they mentioned that Counterparty “was launched in January 2014.”  Technically that is not true.  The fundraising (“proof-of-burn”) took place in January and it was the following month that it “launched.”

On p. 54 they write:

The reason Bitcoin developers haven’t added extra functionality and flexibility directly into its software is that they have prioritized security over complexity. The more complex transactions become, the more vectors there are to exploit and attack these transactions, which can affect the network as a whole. With a focus on being a decentralized currency, Bitcoin developers have decided bitcoin transactions don’t need all the bells and whistles.

This is kind of true but also misses a little history.

For instance, Zerocoin was first proposed as an enhancement directly built into Bitcoin but key, influential Bitcoin developers who maintained the repository, pushed back on that for various technological and philosophical reasons.  As a result, the main authors of that proposal went on to form and launch Zcash.58

On p. 56 they write:

Buterin understood that building a system from the ground up required a significant amount of work, and his announcement in January 2014 involved the collaboration of a community of more than 15 developers and dozens of community members that had already bought into the idea.

I assume the authors mean, following the Bitcoin Miami announcement in January 2014, but they don’t really say.  I’m not sure how they arrive at the specific headcount numbers they did above, would be good to add a footnote in the future.

On p. 56 they write:

The ensuing development of the Bitcoin software before launch mostly involved just two people, Satoshi and Hal Finney.

This assumes that Satoshi is not Hal Finney, maybe he was.  But it should also include the contributions of Ray Dillinger and others.

On p. 56 they write:

Buterin also knew that while Ethereum could run on ether, the people who designed it couldn’t, and Ethereum was still over a year away from being ready for release. So he found funding through the prestigious Thiel Fellowship.

This is inaccurate.

After reading this, I reached out to Vitalik Buterin and he said:59

That’s totally incorrect. Like the $100k made very little difference.

So that should be corrected in the next version.

On p. 57 they write:

Ethereum democratized that process beyond VCs. For perspective on the price of ether in this crowdsale, consider that at the start of April 2017, ether was worth $50 per unit, implying returns over 160x in under three years. Just over 9,000 people bought ether during the presale, placing the average initial investment at $2,000, which has since grown to over $320,000.

There are a few issues with this:

  1. Ethereum did a small private and a larger public sale.  We do have the Terms and Conditions of the public sale but we do not know how many participated in the private sale and under what terms (perhaps the T&Cs were identical).
  2. Over the past 12 months there has been a trend for the “top shelf” ICOs to eschew a public sale (like Ethereum did) and instead, conduct private placement offerings with a few dozen participants at most… typically VCs and HNWIs.
  3. There are lots of dead ICOs.  One recent study found that, “56% of crypto startups that raise money through token sales die within four months of their initial coin offerings.”  Ethereum is definitely an exception to that and should be highlighted as such.

On p. 57 they write:

The extra allocation of 12 million ether for the early contributors and Ethereum Foundation has proved problematic for Ethereum over time, as some feel it represented double dipping. In our view, with 15 talented developers involved prior to the public sale, 6 million ether translated to just  north of $100,000 per developer at the presale rate, which is reasonable given the market rate of such software developers.

Who are these 15 developers, why is that the number the authors have identified?

Also, how much should FOSS developers be compensated and/or the business model around that is a topic that isn’t really addressed at all in this book, yet it is a glaring omission since virtually all of the projects they talk about are set up around funding and maintaining a FOSS team(s).  Maybe some findings will be available for the next version.

On p. 57 they write:

That said, the allocation of capital into founders’ pockets is an important aspect of crowdsales. Called a “founder’s reward,” the key distinction between understandable and a red flag is that founders should be focused on building and growing the network, not fattening their pockets at the expense of investors.

Because coins do not typically provide coin holders any type of voting rights, it is legally dubious how you can hold issuers and “founders” accountable.60

That is why, as mentioned above, there has been an evolution of terms and conditions such that early investors in a private placement for coins may have certain rights and that the founders have certain duties that are all legally enforceable (in theory).

Because no one is publishing these T&Cs, it is hard to comment on what are globally accepted practices… aside from allowing early investors liquidity on secondary markets where they can quickly dump coins.61

Without the ability to legally hold “founders” accountable for enriching themselves at the expense of the project(s), the an interim solution has been to get on social media and yell alot… which is really unprofessional and hit or miss.  Another solution is class action lawsuits, but that’s a different topic.

Also, I put the “founders” into quotes because these seem to be administrators of a network, maybe in the next edition they will be described as such?

On p. 58 they write:

Everyone trusts the system because it runs in the open and is automated by code.

There is lots of different types of open source code that runs on systems that are automated.  For instance, the entire Linux, Apache, and Mozilla worlds predate Bitcoin.  That isn’t new here.62

Also, as mentioned in the previous chapter: Researchers: Last Year’s ICOs Had Five Security Vulnerabilities on Average.  As a result, this has led to the loss of nearly $400 million in ICO funds.

Readers and investors shouldn’t just trust code because someone created a GitHub repo and said their blockchain is open and automated.63

On p. 59 they write:

Most cryptotokens are not supported by their own blockchain.

This is actually true and problematic because it creates centralization risks and the ability for one party to unilaterally censor transactions and/or act as administrators.

For instance, a few days ago, Bancor had a bug that was exploited and about $13.5 million in ETH were stolen… and Bancor was able to freeze the BNT.  That’s because BNT is effectively a centrally administered ERC20 token on top of Ethereum.

Ignoring for the moment whether or not BNT is or is not a security, this is not the first time such issuance and centralization has occurred.  See the colored coin mania from 2014-2015.

On p. 60 they write about The DAO:

Over time, investors in these projects would be rewarded through dividends or appreciation of the service provided.

They mention regulators briefly later on – about SEC views – but most of the content surrounding crowdsales was non-critical and borderline promotional.64  Might be worth adding more meat around this in the next edition.

On p. 61 they write about The DAO:

The hack had nothing to do with an exchange, as had been the case with Mt. Gox and other widely publicized Bitcoin-related hacks. Insted, the flaw existed in the software of The DAO.

Is it really possible to call it a “flaw” or “hack” and not a feature?  See also: “Code is not law” as well as “Cracking MtGox.”

On p. 61 they write:

However, a hard fork would run counter to what many in the Bitcoin and Ethereum communities felt was the power of a decentralized ledger.  Forcefully removing funds from an account violated the concept of immutability.

Just a few pages earlier the authors were saying that the lead developer behind Dash should have restarted the network because that was common and now they’re saying that doing a block reorg is no bueno.  Which is it?

Why should the reader care what a nebulously defined “community” says, if it is is not defined?

The reason we have codes of conduct, terms of service, and EULAs is to specifically answer these types of problems when they arise.

Since public blockchains are supposed to be anarchic, the lack of formal governance is supposed to be a feature, right?   That’s a whole other topic but suffice to say that these two sentences should be reworded in the next edition to incorporate the wisdom found in the Lexicon paper.

On p. 62 they write:

Many complained of moral hazard, and that this would set a precdent for the U.S. government or other powerful entities to come in someday and demand the same of Ethereum for their own interests. It was a tough decision for all involved, including Buterin, who while not directly on The DAO developer team, was an admistrator.

This is the first and only time they point out that key participants collectively making governance decisions are administrators… a point I have been highlighting throughout this review.

I don’t think it is fair to label Vitalik Buterin as a singular administrator, because if he was, he wouldn’t have had to ask exchanges to stop trading ether and/or The DAO token.  Perhaps he was collectively involved in that process, but mining pool operators and exchange managers are arguably just as important if not more so.  See also: Sufficiently Decentralized Howeycoins

On p. 62 they write:

While hard fork are often used to upgrade a blockchain architecture, they are typically employed in situations where the community agrees entirely on the beneficial updates to the architecture. Ethereum’s situation was different, as many in the community opposed a hard fork. Contentious hard forks are dangerous, because when new software updates are released for a blockchain in the form of a hard fork, there are then two different operating systems.

A few things:

  1. Notice the continued use of an ill-defined “the community”
  2. How is agreement or disagreement measured?  During the Bitcoin block size debate, folks tried to use various means to express interest, most of which resulted in sybil attacks such as retweets and upvotes on social media by an army of bots.
  3. Is any fork non-contentious.  Surely if we looked hard enough, we could always find more than a handful of coin owners and/or developers that disagreed with the proposal.  Does that mean you should ignore them?  Whose opinion matters?  These types of questions were never really formally answered either in the case of the Bitcoin Segwit / Bitcoin Cash fork… or in the Ethereum / Ethereum Classic / The DAO fork.  Governance is pretty much an off-chain popularity contest, just like voting for politicians.65

On p. 63 they write:

The site for Ethereum Classic defines the cryptoasset as “a continuation of the original Ethereum blockchain–the classic version preserving untampered history; free from external interference and subjecitve tampering of transactions.”

This could be revised since Ethereum Classic itself has now had multiple forks.

As mentioned in a previous post last year:

Ethereum Classic: this small community has held public events to discuss how they plan to change the money supply; they video taped this coordination and their real legal names are used; only one large company (DCG) is active in its leadership; they sponsor events; they run various social media accounts

There has been lots of external interference, that’s been the lifeblood of public blockchains… because they don’t run themselves, people run and administer them.

Continuing on p. 63 they write:

While many merchants understably complain about credit card fees of 2 to 3 percent, the “platform fees” of Airbnb, Uber, and similar platform services are borderline egregious.

Maybe they are, maybe they are not.66 What is the right fee they should be?  Miners take a cut, exchanges take a cut, developers take a cut via “founder’s funds.”

The next edition should give a step-by-step comparison to show why fee structures are egregious (maybe they are, it just is not clear in this book).

On p. 64 they wrote about Augur.  Incidentally, Augur finally launched in early July while writing this review.  I have an origin story but will keep that for later.

On p. 65 they wrote about Filecoin:

For example, a dApp may use a decentralized cloud storage system like Filecoin to store large amounts of data, and another cryptocommodity for anonymized bandwidth, in addition to using Ethereum to process certain operations.

A couple thoughts:

  1. That’s the theory, though Filecoin hasn’t launched yet — why do they get the benefit of the doubt yet other projects don’t?
  2. There is no price or use comparison in this chapter or elsewhere… the book could be strengthened if it provided more evidence of adoption because we have seen that running decentralized services such as Tor or Freenet have been less than spectacular.

On p. 65 they write:

Returning to the fundamentals of investment theory will allow innovative investors to properly position their overarching portfolio to take advantage of the growth of cryptoassets responsibly.

It is still unclear what an “innovative investor” is — at least the way these authors describe it.67

Chapter 6

On p. 69 Tatar writes:

Not only did I decide to inveset in bitcoin, I decided to place the entirety of that year’s allocation for my Simplified Employee Pension (SEP) plan into bitcoin. When I announced what I had done in my article “Do Bitcoin Belong in your Retirement Portfolio?,” it created a stir online and in the financial planning community.

This was one of just a couple places where the authors actually disclose that they own specific coins, next edition they should put it up front.

On p. 70 Tatar writes:

Was I chasing a similar crash-and-burn scenario with bitcoin? Even my technologically and investment savvy son, Eric, initially criticized me about bitcoin. “They have these things called dollar bills, Dad. Stick to using those.”

Eric is probably right: that the authors of this book accepted traditional money for their book (Amazon doesn’t currently accept cryptocurrencies).

Based on their views presented in this book, the authors probably don’t spend (many) coins they may have in the portfolio, instead holding on to them with the belief that other investors will bid up the price (measured in actual money).

On p. 77 they write about the GFC prior to 2008:

Becoming a hedge fund manager became all the rage for business-minded students when it was revealed that the top 25 hedge fund managers earned a total of $22.3 billion in 2007 and $11.6 billion in 2008.

Coincidentally a similar “rage” for running cryptocurrency-related funds has occured in the past 18 months, especially for ICOs.

More than two hundred “funds” quickly popped up in order to gobble up coins during coin mania.  At least 9 have closed down through April and many more were down double digits due to a bear market (and not hedging).

Chapter 7

On p. 83 they write:

Bitcoin is the most exciting alternative asset in the twenty-first century, and it has paved the way for its digital siblings to enjoy similar success.

It is their opinion that this is the case, but the authors don’t really provide a lot of data to reinforce it yet, other than the fact that there have been some bull runs due to exuberance.68 Worth rewording in the next edition.

On p. 83 they write:

Because bitcoin can claim the title of being the oldest cryptoasset…

Historically it is not.  It may be the oldest coin listed on a liquid secondary market, but there were cryptocurrencies before bitcoin.

On p. 85 Berniske writes:

Similarly, I (Chris) didn’t even consider investing in bitcoin when I first heard about it in 2012. By the time I began considering bitcoin for my portfolio in late 2014, the price was in the mid $300s, having increased 460,000-fold from the initial exchange rate.

I believe this is the only time in the book that Burniske discloses any coin holdings.

On p. 85 they make some ridiculous comparison with the S&P 500, DJIA, NASDAQ 100… and Bitcoin.

The former three are indices of multiple regulated securities.  The latter is just one coin that is easily influenced and manipulated by external unaccountable parties.  How is that an apples to apples comparison?

On p. 87 they continue by comparing Bitcoin with Facebook, Google, Amazon, and Netflix.

Again, these are regulated securities that reflect cash flows and the financial health of multinational companies… Bitcoin has no cash flows and isn’t (yet) setup to be a company… and isn’t regulated (no KYC/AML at the mining farm or mining pool level).

Bitcoin was originally built to be an e-cash transmission network, a decentralized MSB.69 How is comparing it with non-MSBs a useful comparison?

On p. 88 they write:

Remember that, as of January 2017, bitcoin’s network value was 1/20, 1/22, 1/3, and 1/33 that of the FANG stocks respectively. Therefore, if bitcoin is to grow to a similar size much opportunity remains.

This whole section should be probably be modified because these aren’t apples-to-apples comparisons.  FANG stocks represent companies that have to build and ship multiple products in order to generate continuous revenue.

With Bitcoin, it is bitcoin that is the product, nothing else is being shipped nor is revenue being generated70

Maybe the price of a bitcoin — as measured with actual money — does reach a 1:1 or even surpass the stocks above.  But a new version of this book could be strengthened with an outline on how it could do so sustainably.

Also, the whole “market cap” topic should be removed from next edition as well.  About 20% of all bitcoins have been lost or destroyed and this is never reflected in those exuberant “market cap” stories.  See: Nearly 4 Million Bitcoins Lost Forever, New Study Says

On p. 92 they write about volatility:

Upon launch, cryptoassest tend to be extremely volatile because they are thinly traded markets.

Actually, basically all cryptocurrencies including the ones that the authors endorse throughout the book — are still very volatile.

Below is one illustration:

Source: JP Koning

The authors do have a couple narrow, daily volatility charts in the book, but none that provide a similar wideview comparison with something that is remotely comparable (Bitcoin versus Twitter doesn’t make any sense).

On p. 101 they write:

Cryptoassets have near-zero correlation to other captial market assets.

That’s loosey goosey at best.71

For instance, as pointed out in multiple articles this year: Bitcoin and other cryptocurrencies tend to be locked together – and that’s a big problem

On p. 102 they write:

In contrast, the past few years have been more nuanced: bitcoin’s volatily has calmed, yet it retains a low correlation with other assets.

That first part is untrue, as shown by the chart above from JP Koning.  The second part is relative.72

Chapter 8

On p. 107 they write:

The Securities and Exchange Commission has thus far steered clear of applying a specific label to all cryptoassets, though in late July 2017 it did release a report detailing how some cryptoassets can be classified as securities, with the most notable example being The DAO.

That’s pretty much the extent of the authors analysis of the issue.  Granted they aren’t lawyers but this is a pretty big deal, maybe in the next edition beef this up?

On p. 107 they write:

While it’s a great validation of cryptoassets that regulators are working to provide clarity on how to classify at least some of them, most of the existing laws set forth suffer from the same flaw: agencies are interpereting cryptoassets through the lens of the past.

From this wording it seems that the authors want laws changed or modified to protect their interests and the financial interests of their LPs.  This isn’t the first or last time that someone with a vested interest lobbies to get carve outs, exceptions, or entire moratoriums.

Maybe that it is deserved, but it’s not well-articulated in this chapter other than to basically call regulators “old-fashioned” and out of touch with technology.73 Could be worth rethinking the wording here.

On p. 107 they write:

Just as there is diversity in equities, with analsts segmenting companies depending on their market capitalization, sector, or geography, so too is there diversity in cryptoassets. Bitcoin, litecoin, monero, dash, and zcash fulfill the three definitions of a currency: serving as a means of exchange, store of value and unit of account.

This is empirically incorrect.  None of these coins functions as a unit of account, they all depend on and are priced in… actual money.74

There are lots of reasons for why this is case but that is beyond the scope of this review. 7576

On p. 110 they write about ETFs:

It should be noted that when we talk about asset classes we are not doing so in the context of the investment vehicle that may “house” the underlying asset, whether that vehicle is a mutual fund, ETF, or separately managed account.

They don’t really discuss it in the book, but just so readers are aware, there have been about 10 Bitcoin-only ETFs proposed in the US, all of which have been rejected by the SEC (or applications were voluntarily removed).

Curious to know why?  See the March 10, 2017 explanation from the SEC.

Note: this hasn’t stopped sponsors from re-applying.  In the process of writing this review, the CBOE filed for a Bitcoin ETF.

On p. 111 they write:

Much of the thinking in this chapter grew out of a collaboration between ARK Invest and Coinbase through late 2015 and into 2016 when the two firms first made the claims that bitcoin was ringing the bell for a new asset class.

Just to be clear: the joint paper they published in that time frame was a bit superficial as it lacked actual user data from Coinbase exchanges (both GDAX and the consumer wallet).  I pointed that out back then and this book is basically an expanded form of that paper: where is specific usage data on Coinbase?  The only way we have learned any real user numbers about Coinbase is from an IRS lawsuit.

For instance, a future edition should try to differentiate on-chain activity that is say, gambling winnings or miners payouts from exchange arbitrage or even coin shuffling.  Their analysis should be redone once they remove the noise from the signal (e.g., not all transactional activity is the same).

This is a real challenge and not a new issue.  For instance, see: Slicing data.

On p. 112 they write:

Cryptoassets adhere to a twenty-first century model of governance unique from all other asset classes and largely inspired by the open source software movement. The procurers of the asset and associated use cases are three pronged. First, a group of talented software developers decide to create the blockchain protocol or distributed application that utilizes a native asset. These developers adhere to an open contributor model, which means that over time any new developer can earn his or her way onto the development team through merit.

There is no new governance model.

In practice, changes are done via social media popularity contests.  We saw that with the Bitcoin blocksize debate and Ethereum hard fork.  And in some ways, strong vocal personalities (and cults of personality) is how other FOSS projects (like Python) are managed and administered.

The fluffy meritocracy feel-goodism is often not the order of the day and we see this in many projects such as Bitcoin where the commit access and BIP approval process is limited to a small insular clique.

Source: Jake Smith (section 3)

The 4 point plan above is a much more accurate break down of how most coin projects are setup.

On p. 112 they write:

However, the developers are not the only ones in charge of procuring a cryptoasset; they only provide the code. The people who own and maintain the computers that run the code–the-miners–also have a say in the development of the code because they have to download new software updates. The developers can’t force miners to update software. Instead, they must convince them that it makes sense for the health of the overall blockchain, and the economic health of the miner, to do so.

But in many projects: developers and miners are one in the same.  This is why it is so confusing to not have seen additional clarity or guidance from FinCEN because of how centralized most projects are in practice.

Be sure to look at “arewedecentralizedyet.”77

On p. 113 they write:

These companies often employ some of the core developers, but even if they don’t, they can assert significant influence over the system if they are a large force behind user adoption.

Maybe that is the case for some cryptocurrencies.78  Should “core” developers be licensed like professional engineers are?

Also, isn’t their statement above evidence that most projects are fairly centralized because the division of labor results in specialization?

On p. 113 they write:

These users are constantly providing feedback to the developers, miners, and companies, in whose interest it is to listen, because if users stop using the cryptoasset, then demand will go down and so too will the price.  Therefore, the procurers are constantly held accountable by the users.

Except this isn’t what happens in practice.

Relatively little activity takes place at all on most of these coin platforms and most of what does occur involves arbitrage trading and/or illicit activity.

This activity seems to have little direct connection to the price of the coin because the price of the coin is still largely determined by the whims of speculative demand.

For instance, above is a two-year transactional volume chart for bitcoin.  The price of bitcoin in the summer of 2016 was in the $600-$700 range whereas it is 10x that today.  Yet daily transaction volume is actually lower than it was back then.  Which means: the two are separate phenomenon.

Also, arguably the only direct way coin owners can — in practice —  hold maintainers accountable is via antics on social media.  That is why control of a specific reddit, Telegram, or Twitter account is very important and why hackers target those channels in order to influence prices.

On p. 113 they write about supply schedules:

For example, with oil, there’s the famous Organization of the Petroleum Exporting Countries (OPEC), which has had considerable control over the supply levels of oil.

Inadvertently they actually described how basically all proof-of-work coins operate: via a small clique of known miners and mining pools.  A cartel?

Source: Jameson Lopp

While these miners have not yet increased or decreased the supply of bitcoins, mining is a specialized task that requires certain capital and connections in order to be successful at.  These participants could easily collude to change the money supply, censor transactions, etc. and there would be no immediate legal recourse.

On p. 115 they write:

Cryptoassets, like gold, are often constructed to be scarce in their supply. Many will be even more scarce than gold and other precious metals. The supply schedule of cryptoassets typically is metered mathematically and set in code at the genesis of the underlying protocol or distributed application.

How to measure scarcity here?

Despite what alchemists tried for centuries to do: aside from particle accelators, on Earth the only way of increasing the supply of gold and silver is via digging it out of the ground.  For cryptocurrencies, it is relatively easy to fork and clone both code and chains.  Digital scarcity for most — if not all — public chains, seems to be is a myth.

In the next edition, maybe remove the “backed by maths” trope?  None of these chains run themselves, they all depend on humans to run the equipment and maintain the code.

On p. 115 they write:

As discussed earlier, Satoshi crafted the system this way because he needed initially to bootstrap support for Bitcoin which he did by issuing large amounts of the coin for the earliest contributors.  As Bitcoin matured, the value of its native asset appreciated, which means less Bitcoin is over eight years old, it provides strong utility to the world beyond as an investment, which drive demand.

Satoshi likely mined around 1 million bitcoins for himself/herself.  Because of how centralized and small the network originally was in 2009, he/she probably could have unilaterally stopped the network and relaunched it and effectively removed that insta-mine. 79

In addition, there was almost no risk to either be a developer or a miner… the entry/exit costs were very low… so why did he issue large amounts of coins for these contributors?80

Also, how does it provide strong demand beyond investment?  How many people do the authors know regularly use Bitcoin itself for retail payments?81

Also, through Bitcoin’s evolution, arguably some of its utility was removed by going down a specific block size path.  The counterargument is that payments will be done via some other networks (such as Lightning) attached to Bitcoin, but as of this writing, that hasn’t panned out.

One last comment about this passage, FOSS is historically charity work and difficult to build a sustainable operation. A couple notable exceptions are Red Hat and SUSE (which was just acquired by EQT).

On p. 115 they write:

The Ethereum team is currently rethinking that issuance strategy due to an intended change in its consensus mechanism.

In the second edition is it possible to be consistent on this one point: how is an “official” or “centralized” development team congruent with the idea of having a “decentralized ecosystem”?

Also, the administrators of Ethereum Classic modified the money supply last year and most folks were blasé.  Where is the relevant FinCEN guidance?

On p. 115 they write:

Steemit’s team pursued a far more complicated monetary policy with its platform, composed of steem (STEEM), steem power (SP), and steem dollars (SMD).

[…]

They have also chosen to modify their monetary policy post-inception.

The authors of this book need to be consistent in their wording because in other places they criticize centralized financial institutions but do not criticize centralized monetary supply decision of coin makers.  Also, again, why or how does a decentralized project have a singular team?

On p. 116 they write:

Crypotassets can be likened to silicon. They have come upon the scene due to the rise of technology, and their use cases will grow and change as technology evolves.  Currently, bitcoin is the most straightforward, with its use case being that of a decentralized global currency. Ether is more flexible, as developers use it for computational gas within a decentralized world computer.

This isn’t a good analogy.  Silicon exists as a naturally occurring element… whereas cryptocurrencies do not naturally arise — humans create them.

In addition, bitcoin is arguably not the most straightforward due to a long divorce and schism process the past three years.  One distinct group of promoters calls it “digital gold” and another distinct group calls it a “payment system” — the two groups are almost violently opposed to one another’s existence.

On p. 116 they write:

Then there are the trading markets, which trade 24/7, 365 days a year. These global and eternally open markets also differentiate cryptoassets from other assets discussed herein.

The FX markets are open globally almost 24/6 for most of the year, so that’s not really a braggable claim.82 There are legal, regulatory, and practical reasons why most capital markets operate in the time windows they do… it is not because of some technological limitation.  Worth rewording in the next edition.

On p. 116 they write:

In short, the use cases for cryptoassets are more dynamic than any preexisting asset class. Furthermore, since they’re brought into the world and then controlled by open-source software, the ability for cryptoassets to evolve is unbounded.

In the next edition, maybe remove the pomp and circumstance unless there is actual data to back up the platitudes.  We can all easily conjure up lots of potential use cases for just about any type of technology, but unless they are built and used, the hype should be turned down a few notches.

Also, there are many other open source software projects that have actually shipped frequently used productivity tools and no one is yelling from the mountain tops about how they have unbounded potential.  How are internet coins any different?

On p. 117 they write:

Cryptoassets have two drivers of their basis of value: utility and speculative.

In theory, perhaps.  But in practice, most coins just have potential utility because with few exceptions, most buyers typically hold with the expectation the coin will appreciate.  Maybe that change in the future.

On p. 117 the write:

For example, Bitcoin’s blockchain is used to transact bitcoin and therefore much of the value is driven by demand to use bitcoin as a means of exchange.

Perhaps, though in the next edition recommend modifying the wording to include: “… as a means of exchange or investment…”  Currently, we know a large portion of activity is likely movement (arbitrage) between exchanges.8384

But even ignoring this data (from analytics companies) this scenario has been diced-up elsewhere:

On p. 117 they write:

Speculative value is driven by people trying to predict how widely used a particular cryptoasset will be in the future.

If there are systematic surveys of actual buyers and sellers perhaps add those in the second edition.85

On p. 118 they write:

With cryptoassets, much of the speculative value can be derived from the development team. People will have more faith that a cryptoasset will be widely adopted if it is crafted by a talented and focused development team. Furthermore, if the development team has a grand vision for the widespread use of the cryptoasset, then that can increase the speculative value of the asset.

This is false.

For starters, the value of a new coin is almost entirely a function of the marketing effort from the coin issuers: that’s why nearly all ICOs carve out a portion of their funding pie to market, promote, and advertise… spreading the sexy gospel of the new coin.

This is a big bucks opaque industry, with all sorts of shenanigans that take place just to get listed on secondary markets… with coin issuers paying more than $1 million to get listed.

While $1 million or even $3 million may sound like a lot to get listed, the issuers know it is worth it because the retail speculators on the other end will at least temporarily pump the coin price up often long enough for the original insiders and investors to cash out.

Now the coin issuers may talk a big game and at eloquent length about how their grand vision: that their coin will end world hunger and save the environment, but they often have no ability to execute and build the product(s) they claimed in their whitepaper.

As mentioned above, one recent study found that, “56% of crypto startups that raise money through token sales die within four months of their initial coin offerings.”

Also, how does a decentralized cryptocurrency have an official singular development team?

On p. 118 they write:

As each cryptoasset matures, it will converge on its utility value. Right now, bitcoin is the furthest along the transition from speculative price support to uility price support because it has been around the longest and people are using it regularly for its intended utility use case.

And what is its intended use case?  The maximalist vision (digital gold) or the originalist payments vision?

On p. 118 they write:

For example, in 2016, $100,000 of bitcoin was transacted every minute, which creates real demand for the utility of the asset beyond its trading demand. A great illustration of bitcoin’s price support increasingly being tied to utility came from Pantera Capital, a well-respected investment firm solely focused on cryptoassets and technology. in Figure 8.2 we can see that in November 2013 bitcoin’s speculative value skyrocketed beyond its utility value, which is represented here by transactions per day using Bitcoin’s blockchain (CAGR is the compound annual growth rate).

But this didn’t happen.

Pantera has a habit of cherry picking dates and using different types of graphs (such as log versus linear) in order to talk its book.

For instance, they conjured up and pushed the “bitcoin absorbs the value of gold” narrative back in late 2014.  Then a year later, they became part of the “great pivot” by rebranding everything “blockchain” instead of bitcoin.

Putting those aside, the transactional part of the graph (Figure 8.2) from Pantera was published in early 2017 and has not held up to further scrutiny by mid-2018.

Source: Pantera

Compare that with the actual transactional volume for the past two years, including the most recent bull run:

Perhaps for some unknown reason the up-and-to-the-right hockey stick graph that Pantera tried to create with its dotted lines will germinate.  But for now, as of this writing, their transactional / utility thesis is incorrect.

Why?  Because the assumptions were the same as the authors of this book: they assume retail or institutional users will flock to using bitcoin for non-speculative reasons, but that has not occurred yet.

On p. 119 they write:

Speculative value diminishes as a cryptoasset matures because there is less speculation regarding the future markets the cryptoasset will penetrate. This means people will understand more clearly that demand for the asset will look like going forward. The younger the cryptoasset is, the more its value will be driven by speculative vlaue, as shown in Figure 8.3. While we expect cryptoassets to ossify into their primary use cases over time, especially as they become large system that supports significant amounts of value, their open-source nature leaves open the possiblity that they will be tweaked to pursue new tangential use cases, which could once again add speculative value to the asset.

Their wording in this and other passages has definitive certainty without any hedging.

This is unfounded.  Recall, what can be presented without evidence can be dismissed without evidence.  This also makes a circular argument that the next edition needs to provide evidence for (or just remove it).

Chapter 9

On p. 122 the write:

For example, currently the bond markets are undergoing significant changes, as a surprising amount of bond trading is still a “voice and paper market,” where trades are made by institutions calling one another and tangible paper is processed. This makes the bond market much more illiquid and opaque than the stock market, where most transactions are done almost entirely electronically: With the growing wave of digitalization, the bond markets are becoming increasingly liquid and transparent. The same can be said of markets for commodities, art, fine wine, and so on.

In re-reading this I can’t tell if the authors recognize that the bond market, as well as all of the other markets listed, started out in pre-electronic and even pre-industrial times.

That’s not to defend the status quo, only that if modern day trading platforms and automation existed a couple hundreds years ago, it is likely that bonds trading would have migrated much earlier than 2018… maybe even on a blockchain!

On p. 122 they write:

Cryptoassets have an inherent advantage in their liquidity and trading volume profile, because they are digital natives. As digital natives, cryptoassets have no physical form, and can be moved as quickly as the Internet can move the 1s and 0s that convey ownership.

This is conflating digitization/digitalization with blockchains.  You can have one without the other and in fact, do.

For instance, with US equities, beginning in the ’60s through the ’70s, stocks were dematerialized then immobilized in CSDs and ownership is now transferred electronically.86

Perhaps there is something to be said about this market infrastructure further evolving in time with a blockchain of some kind.

For example in the US, the DTCC (a large CSD) has:

Virtually every major CSD, stock exchange, and clearing house has likewise publicly opined or participated in some blockchain-related initiatives.  But that is a separate topic maybe worth looking into for the next edition.

On p. 123 they write:

Even though they are growing at an incredible clip, separation between cryptoasset markets and traditional investor capital pools still largely remains the case.

How much real money has actually entered the cryptocurrency market?

There have been several attempts to quantify it and it is still rather small, maybe up to $10 billion came in during 2017.

On p. 125 they write:

For example, in 2016, Monero experienced a sizeable increase in notoriety–largely because its privacy features began to be utilized by a well-known dark market–which sent its average trading volume skyrocketing. In December 2015, daily volume for the asset was $27,300, but by December 2016 it was $3.25M, well over a hunderfold increase. The price of the asset had appreciated more than 20-fold in the same period, so some of the increase in trading volume was due to price appreciation, but clearly a large amount was due to increased interest and trading activity in the asset.

But how do the authors know this “clearly” was the case?  Did they do some random sample surveys?  The next edition they need to prove their assumption, not just make them.  After all, it is hard — perhaps impossible — to externally ascertain what is going on at an exchange simply by looking at self-published volumes.

Also, the exchanges that these coins trade on are still typically unregulated, with little optics into how often manipulation occurs.  That is why a number of them have been subpoenaed by various governmental bodies; in the US this includes the SEC, CFTC, IRS, FBI, and even separate states acting in coordination.

On p. 129 they write:

From these trends, we can infer that this declining volatility is a result of increased market maturity. Certainly, the trend is not a straight line, and there are significant bumps in the road, depending on particular events. For example, monero had a spike in volatility in late 2016 because it experienced a significant price rise. This shows volatility is not only associated with a tanking price but also a skyrocketing price. The general trend, nonetheless, is of dampening volatility […].

This is not true either.  Maybe there are cherry picked dates in which there is relatively lower volatility than normal, but this year alone prices as measured in real money, declined between 60-100% for basically all crypotocurrencies and this involved a roller coaster to achieve.

In fact, in the process of writing this review, there were multiple days in which prices increased 5-10% for most coins and then a few days later, saw the same size of loses.  Erratic volatility has not disappeared.

On p. 133 they write:

Despite the many PBOC interventions, Chinese citizens used bitcoin to protect themselves against the erosion in value of their national currency.

Who in China did this?

I have spent an enormous amount of time visiting China the past several years on business trips and not once did someone say they had shifted their wealth from RMB into bitcoin because of RMB depreciation.  There are many speculators and miners, but to my knowledge there has not been a formal survey of buyers and their motivations… and the result being because of RMB depreciation.

The next edition should either remove this statement or add a citation.

On p. 134 they write:

As bitcoin rose and fell, so too did these assets. This reinforces the need for the innovative investor to become knowledgeable about these assets’ specific characteristics and recognize where correlations may or may not occur.

Recommend removing “innovative investor” in this location.87

Chapter 10

On p. 137 they write:

On its path to maturity, bitcoin’s price has experienced euphoric rise and harrowing drops, as have many cryptoassets. One of the most common complaints among bitcoin and cryptoasset naysayers is that these fluctuations are driven by the Wild West nature of the markets, implying that cryptoassets are a strange new breed that can’t be trusted. While each cryptoasset and its associated markets are at varying levels of maturity, associating Wild West behavior as unique to cryptoasset markets is misleading at best.

No it isn’t.  The authors do not even define or provide some kind of way to measure “maturity.”  This paragraph creates a strawman.

The burden-of-proof rests on the party making the positive claim.  In this case, the party claiming that a coin is becoming mature must provide objective evidence this is taking place.  Should reword in the next edition.

On p. 138 they write:

Broadly, we categorize five main patterns that lead to markets destabilizing: the speculation of crowds, “This time is different,” Ponzi schemes, Misleading information from asset issuers, Cornering.

Those are valid patterns, in full agreement here.  But this edition does not help in dispelling these problems and arguably even contributes to some of the speculative frenzy.

On p. 138 they write:

Sometimes they do this to capitalize on short-term information they believe will move the market, other times they do it because they expect to ride the momentum of the market, regardless of its fundamentals. In short, they try to profit within the roller-coaster ride.

What are the fundamentals of any coin described in this book?  Next edition, clearly write out 5-10 if possible.

On p. 139 they write:

As America was struggling through the Great Depression, which many pinned on the stock market crash of 1929, there was strong resentment against speculators. Every crisis loves a scapegoat.

And in Bitcoinland there is no difference.  Bitcoiners love to blame: bankers, the Illuminati, naysayers, concern trolls, academics, the government, Jamie Dimon, big blockers, small blockers, weak hands, statists, other coins, China, George Soros, Warren Buffett, Mike Hearn… virtually every month there is a new boogeyman to blame something on.  I’ve even been blamed many times and I’m not involved at all in the market.

On p. 143 they write:

Cheap credit often fuels asset bubbles, as seen with the housing bubble that led to the financial crisis of 2008. Similarly, cryptoasset bubbles can be created using extreme margin on some exchanges, where investors are effectively gambling with money they don’t have.

Fully agree, good point.

On p. 144 they write:

The best way to avoid getting burned in this manner is to do proper due diligence and have an investment plan that is adhered to.

Fully agree, good point.

On p. 145 they write:

The key to understanding bitcoin’s value is recognizing it has utility as “Money-over-Internet-Protocol”( MoIP)–allowing it to move large amounts of value to anyone anywhere in the world in a matter of minutes–which drives demand for it beyond mere speculation.

This might be partially true but is has the same feel-good narrative that folks like Andreas Antonopoulos have been getting paid handsomly to regurgitate.  Bitcoin (the network) does not move anything beyond bitcoins (the coin).  Users still have to convert bitcoins into actual money at end points.

Converting a large amount — greater than $10,000 — will likely require KYC and AML and maybe even sanctions checks.  This adds time and money which is one of the reason why the remittance use-case didn’t really get much traction after the hype in 2014 – 2015 and why companies such as Abra had to pivot a few times.

With that said, their metapoint is valid on the edges: despite the frictions that may exist, some participants are willing to go through this experience in order to gain more anonymity for uses they might not otherwise be able to do using traditional methods.88

Over the past three years there has also been an expansion of country- and region-based payment schemes worldwide to achieve near-real-time transfers, with Europe being one of the most significant accomplishments.89

In parallel, there are on-going experimentation and scaling of private blockchain-based ‘rails’ like Swift gpi or Alipay with GCash which have a potential to surpass volumes of the Bitcoin network.90

On p. 145 they write:

When Mt. Gox was established, bitcoin finally became accessible to the mainstream.

One nitpick:

Up until recently it was difficult for even diehard users to get onboarded onto most exchanges.  And specifically in 2010 with the launch of Mt. Gox, Jed McCaleb used Paypal to help facilitate the transfer of money… until Paypal dropped Mt. Gox because of too many chargebacks.  To get money into and out of Mt. Gox often was a frictionfull task, unless you lived in Japan.

On p. 149 they write:

As shown in Figure 10.4, steem’s price in bitcoin terms would fall from its mid-July peak by 94 percent three months later, and by 97 percent at the end of the year. This doesn’t mean the platform is bad. Rather, it shows the speculation and excitement about its prospects fueled a sharp rise and fall in price.

In hindsight, everything is 20-20.  The same truism in their last sentence can be said just about with every coin that sees the meteoric rise that Steemit did in 2016.91

On p. 150 they write:

While zcash has since stabilized and continues to hold great promise as a cryptoasset, its rocky start was caused by mass speculation.

Two comments:

  • Do the authors own any Zcash (or other cryptocurrencies mentioned in this book besides bitcoin)?
  • In late 2016 there were oodles of “thought leaders” talking about how Zcash was — for a moment — valued at a trillion dollars because of the very thin supply that was trading on exchanges.  It was a headscratching meme that illustrates a shortcoming to the common “market cap” valuation mehtod.92

On p. 152 they write:

The idea of valuation, which we will tackle in the next chapters, is a particularly challenging one for cryptoassets. Since they are a new asset class, they cannot be valued as companies are, and while valuing them based on supply and demand characteristics like that of commodiites has some validity, it doesn’t quite suffice.

Then why spend an entire chapter (Chapter 7) comparing coins such as bitcoin, to companies and their stock?

You can’t have it both ways.  Either heavily modify Chapter 7 in the next edition, or remove this comment.

Chapter 11

On p. 155 they write:

Given the emerging nature of the cryptoasset markets, it’s important to recognize that there is less regulation (some would say none) in this arena, and therefore bad behavior can persist for longer than it may in more mature markets.

And there are now full-time lobbyists and trade associations — sponsored by donors whom have benefited from this unregulated / underregulated market — that actively push back against sensible regulations being applied.  But that’s a different conversation beyond this post.

On p. 155 they write:

As activity grows in bitcoin and crypotasset markets, investors must look beyond the madness of the crowd and recognize that there are bad actors who seek easy prey in these young markets.

Even for a book published in late 2017, this is pretty much lip service.  Volumes of books can be written about the shenanigans within nearly every public ICO and high-profile coin project.  The authors should either modify the statement above or ideally expand it to detail specific egregious examples besides just OneCoin.

For instance, a new study found that: More Than Three-Quarters of ICOs Were Scams.  And these were ICOs done in 2017.

On p. 158 they write:

While a truly innovative crypotasset and its associated architecture requires a heroic coding effort from talented developers, because the software is open source, it can be downloaded and duplicated. From there, a new cryptoasset can be issued wrapped in slick marketing. If the innovative investors doesn’t do proper due diligence on the underlying code of read other trusted sources who have, then it’s possible to fall victim to a Ponzi scheme.

Enough with the “heroic” adjectives, let’s not put anyone on a pedestal, especially if the platform is not being used by anyone besides speculators and illicit actors.

Secondly, a minor grammar question: other uses of “open-source” in this book have a dash and the one above does not.

Lastly, recommend readers look into “Nakomoto Schemes” described in this article: The Problem with Calling Bitcoin a “Ponzi Scheme”

On p. 158 they write:

Millions of dollars poured into OneCoin, whose technology ran counter to the values of the cryptoasset community: its software was not open source (perhaps out of fear that developers would see the holes in its design), and it was not based on a public ledger, so no transactions could be tracked.

First, what are the “values” that the “community” has?  Are these explicity written somewhere?  Who decided those?

Second, those actually don’t sound too uncommon.

For instance, one recent study found: “Security researchers have found, on average, five security flaws in each cryptocurrency ICO (Initial Coin Offering) held last year. Only one ICO held in 2017 did not contain any critical flaws.”

And remember, these projects are “open source” yet most buyers and investors didn’t bother looking at the code.  OneCoin is par for the course.

On p. 159 they write:

The swift action revealed the strength of a self-policing, open-source community in pursuit of the truth.

In my most popular post last year, I went through in detail explaining how self-policing is an oxymoron in the cryptocurrency world.

For example, “the community” actively listed OneCoin on secondary markets and profited from its trading.  Did exchange operators return those gains to victims?  In addition, “the community” has thus far, not set up any self-regulating organization (SRO) that has any ability or teeth to enforce a code-of-conduct.

In fact, it was agencies from Sweden, the UK, and other governments that acted and cracked down on OneCoin… not a collective effort from exchanges or VCs or twitter personalities.

On p. 159 they explain googling for code on GitHub:

If nothing pops up with signs of the code on GitHub, then the cryptoasset is likely not open source, which is an immediate red flag that a cryptoasset and investment should be avoided.

Sure, but it doesn’t include the fact(s) that even in 2017 we knew that many coin projects had bugs in it… because there is no incentive to independently audit this code or to publish it in an objective manner.

For example, often when someone tries to help highlight problems, they are demonized as a “concern troll” as the coin tribes brigade their Twitter and reddit threads.  There are a couple of sites like ConcourseQ that now do help highlight problems, but most “crypto thought leaders” on social media spend their time rallying retail investors to buy coins instead of busting or calling out the legitimate coin scams.

On p. 161 they write about John Law:

Fortunately, today it’s quite easy to find information on just about anyone through Google searches.

Yes and no.  And that still doesn’t act as a shield against fraud.  The founders of Centra had shady, criminal pasts but were still able to raise more than $30 million in an ICO.  Their misdeeds only became widely known after a New York Times article explored it… this was not a story that was investigated by any of the “coin media” who collectively have a vested interested not to “self-police” the market they cover.

Furthermore, prior to getting busted and sued, Centra became a dues paying member of: Hyperledger, the Enterprise Ethereum Alliance, and the Chamber of Digital Commerce.  What are the filtering mechanisms in place at these types of organizations?  How do they determine who can join and if a coin is a security?

On p. 165 they write:

As with most panics, the contagion spread from the Gold Exchange.  Because of Gould’s cornering of the market, stock prices dropped 20 percent, a variety of agricultural exports fell 50 percent in value, and the national economy was disrupted for several months. Gould exited with a cool $11 million profit from the debacle, and scot-free from legal charges. It is all too common that character like Gould escape unscathed by the havoc they create, which then allows them to carry on with their machinations in other markets.

These kinds of panics and manipulation are part and parcel to retail traders on cryptocurrency exchanges.  Scapegoats and the blame game consist of a myriad of boogeymen — but typically the culprits are never found.93

On p. 167 they write:

In addition to miners, in Dash there are entities called masternodes, which are also controlled by people or groups of people. Masternodes play an integral role in performing near instant and anonymous transaction with Dash.

Putting aside whether Dash is or is not anonymous… the fact that the authors state that humans play a direct role in running the infrastructure raises a bunch of questions that I have repeated in this review.

How are these participants held accountable?  How is governance managed?  Have these participants registered with FinCEN?  Why or why not?

On p. 168 they write about the Bitcoin Rich List:

Another 116 addresses hold a total of 2.87 million bitcoin, or 19 percent of the total outstanding, which is sizeable. Unlike dash, however, these holders aren’t necessarily receiving half the newly minted bitcoin, and so their ability to push the price upward is less.

Should there be a thorough investigation of how any one party or set of parties can artificially move prices around based on control of the money supply?  In our current real-world framework, there are frequent public hearings and audits done.  When will minters of cryptocurrencies be publicly audited?

Chapter 12

On p. 171 they write:

Each cryptoasset is different, as are the goals, objectives, and risk profiles of each investor. Therefore, while this chapter will provide a starting point, it is by no means comprehensive. It’s also not investment advice.

Throughout the book the authors have repeatedly endorsed or not-endorsed specific coins.  The second edition needs to be a lot more consistent.

On p. 172 they write:

Currently, there is no such thing as sell-side research for cryptoassets, and this will require innovative investors to scour through the details on their own or rely on recognized thought leaders in the space.

This is a sad truth: it is nearly impossible to get neutral, objective research on any coin that has been created.

Why?  Because all coin holders basically have an incentive to promote and advertise the coins they own and talk down other coins they perceive as competition.  Paying “researchers” has happened and will continue to do so.

Also, here’s another appearance of “innovative investor” — can that be removed altogether?

And lastly, how to know who the “recognized thought leaders” are?  Based on the amount of twitter followers they have?  That has been gamed.  Based on how popular their Youtube account is?  That has been gamed.

For example, these two article explain some of this payola world:

Another instance, a couple weeks ago a government department in China (CCID) released its second ranking table of coins: China’s Crypto Ratings Index Puts EOS in Top Slot, Drops Bitcoin

It’s unclear if this is due to lobbying efforts or maybe the researchers owned a bunch of EOS coins.  At this time, the EOS block producing and arbitrator framework are both broken.  Block producers paused the network a few weeks ago and the arbitrators / constitutions will probably be scrapped.

How can this rating system be trusted?

On p. 173 they write about white papers:

Any cryptoasset worth its mustard has an origination white paper. A white paper is a document that’s often used in business to outline a proposal, typically written by a thought leader or someone knowledgeable on a topic. As it relates to cryptoassets, a white paper is the stake in the ground, outlining the problem the asset addresses, where the asset stands in the competitive landscape, and what the technical details are.

During the Consensus event this past May, someone accidentally dropped a napkin on the floor and someone loudly said: watch out, that’s the latest multimillion dollar white paper.

And that’s the situation where we are in now.  Readers: the passage above was not at all critical of the real mess we are in today.  For instance, Tron literally plagiarized in its whitepaper, raised a ton of money in its ICO and recently bought BitTorrent.

There is no direct connection between a “good” or “bad” whitepaper and the performance of the coin.  Retail investors do not typically care and haven’t done much research.  Yet another reason agencies such as the SEC will be overwhelmed in the coming years due to rampant fraud and deceit.  Worth looking into the next edition.

On p. 173 they write:

Some of these white papers can be highly technical, though at the very least perusing the introduction and conclusion is valuable.

This seems like an incongruent statement compared to other advice in the book about doing deep research.  Recommend revising.

On p. 174 they write:

A number of cryptoasset-based projects focus on social networks, such as Steemit and Yours, the latter of which uses litecoin. While we admire these projects, we also ask: Will these networks and their associated assets gain traction with competitors like Reddit and Facebook? Similarly, a cryptoasset service called Swarm City (formerly Arcade City) aims to decentralize Uber, which is already a highly efficient service. What edge will the decentralized Swarm City have over the centralized Uber?

And that in a nutshell is why the second edition of the book arguably needs to be slimmed down by 25%+.  Virtually all of the use cases in this book are simply potential use cases and have shown little or even no traction in reality.  For example, if the authors were as critical to Bitcoin and Zcash as they were to Swarm City then the second edition might be perceived as more balanced.

Specifically, in their promotion of Bitcoin as a payments platform, they have not done a deep dive into other existing payment networks, such as Visa or an RTGS from a central bank.94 They should do that in the next edition otherwise these come across as one-sided arguments.

Also, Yours switched from Litecoin over to Bitcoin Cash last year (around the time the book was published) and Swarm City is still not very active at the time this review was written.

On p. 175 they write about The Lindy Effect

The same applies to cryptoassets. The longest-lived cryptoasset, bitcoin, now has an entire ecosystem of hardware, software developers, companies, and users built around it. Essentially, it has created its own economy, and while a superior cryptocurrency could slowly gain share, it would have an uphill battle given the foothold bitcoin has gained.

This is untrue in theory and practice.

While maximalists would vocally claim that there can only be one-chain-to-rule-them-all, there is no real moat that Bitcoin has to prevent users from exiting or switching to other platforms (see discussion on substitute goods).

In practice, effectively all proof-of-work cryptocurrencies depend on external capital to stay afloat, often in the form of venture capital. ((See Robert Sams on rehypothecation, deflation, inelastic money supply and altcoins)) Part of the reason is that miners need to pay their bills in traditional currency and therefore must liquidate some or all of their coins to do so.  Another issue is that because many participants think or believe that coin prices as measured in real money will increase in the future, they hold.  Yet the expenses of service providers (exchanges, wallets, etc.) typically need to be paid with traditional money.

As a result, this creates sell-side pressure.  And unlike the traditional FX market which has “natural” buyers in the form of international merchants and multinational corporations: there still is no “natural” buyers of cryptocurrencies outside of illicit activity (e.g., darknet market participants).

To compound this situation is that there is still no real circular flow of income, no real economy for any of these cryptocurrencies.95  And with the exception of a few cases each year, miners typically do not directly invest their coin holdings into companies, so crypotcurrency-related startups are dependent on foreign currency.

On p. 175 they write:

The demise of The DAO significantly impacted Ethereum (which The DAO was built on), but through leadership and community involvement, the major issues were addressed, and as of April 2017 Ethereum stands solidly as the second largest cryptoasset in terms of network value.

In the second edition, could the authors explicitly lay out how they define “leadership” in this context as well as what the “community” is?  If it is singular and centralized, how is that fitting for an entity that is supposed to be decentralized?

Also, for readers interested in The DAO, here’s a short fiery thread on that topic.

On p. 176 they discuss “utility value and speculative value”

For bitcoin, its utility is that it can safely, quickly, and efficiently transfer value to anyone, anywhere in the world.

That may have been the original vision expressed in the whitepaper but it is not what the maximalists now claim Bitcoin is.  Who’s promotion around utility is something we should take into consideration?

Also, considering how easy and common it is to hack cryptocurrency intermediaries such as exchanges, I think it is debatable that Bitcoin is “safe” for unsophisticated retail users, but that’s a separate topic.

On p. 176 they write:

The merchants wants to use bitcoin because it will allow her to transfer that money within an hour as opposed to waiting a week or more. Therefore, the Brazilian merchant buys US$100,000 worth of bitcoin and sends it ot the Chinese manufacture.

They explain a little more but the difficulties with this example starts here.  The authors only focus on the bitcoins themselves, they don’t explore the actual full lifecycle that international merchants and manufacturers have to go through in order to exchange bitcoins into real money that they can use to pay bills.

That is to say: the Brazilian merchant and Chinese manufacture do not hold onto coins, so it is not just a matter of how fast they can send or receive the coins.  What ultimately matters to them is how quickly they can receive the real money from a bank.

So the next edition needs to include the full roundtrip costs and frictions including the on-ramps and off-ramps into the traditional financial system.  This is why many Bitcoin remittance companies struggled and ultimately had to pivot out of that cross-border use case (such as Abra).  For the next edition, a side-by-side cost comparison would be helpful.96

On p. 177 they write:

That means on average each of these addresses is holding US$5.5 million worth of bitcoin, and it’s fair to assume that these balances are not those of merchants waiting for their transactions to complete. Instead, these are likely balances of bitcoin that entities are holding for the long term based on what they think bitcoin’s future utility value will be. Future utility value can be thought of as speculative value, and for this speculative value investors are keeping 5.5 million bitcoin out of the supply.

This seems like euphemisms.  We understand that time preferences and discounted utility come into dramatic effect here.  Maybe worth rewording?

For example, a large portion of those coins could be permanently destroyed (e.g., someone deleted the private key or threw away the hard drive).  Though a significant portion could also be maximalists holding onto their coins with the hope that other investors create sufficient demand to move the price — as measured in real money — upward and upward.  So they can then cash out.

If daily and weekly anecdotes on twitter and reddit are any indication, that’s arguably the real utility value of most coins, not just bitcoin.  And there is some analytics to back up that argument too.

On p. 177 they write:

At the start of April 2017, there were just over 16 million bitcoin outstanding. Between international merchants needing 10 million bitcoin, and 5.5 million bitcoin held by the top 1,000 investors, there are only roughly 500,000 bitcoin free for people to use.

Citation needed. If the authors have any specific information that can share with the audience about any of these numbers, that’d be very helpful.  Especially regarding the merchants needing 10 million bitcoin.  If anything, there may be fewer merchants actively accepting bitcoin today than there were a couple years ago.

On p. 177 they write:

If demand continues to go up for bitcoin, then with a disinflationary supply schedule, so too will its price (or velocity).

Couple of things:

  • Bitcoin’s current supply schedule is perfectly inelastic (whereas say gold, is elastic).
  • It would be good to see what the authors think the velocity of bitcoin is.  I’ve tried to track down and write about it in the past.  See all of Chapter 9.

On p. 177 they write:

In other words, those investors no longer feel bitcoin has any speculative value left, and instead its price is only supported by current utility value.

As mentioned above, it would be helpful in the next edition if the authors included specific definitions and characteristics in a chart for what utility versus speculative value are.

Also, I don’t endorse the post in its entirety, but about five years ago Rick Falkvinge wrote an interesting note about the transactional value from illicit activity as it relates to Bitcoin.  That has some actual data in it (though very old now).

On p. 178 they write:

For bitcoin, instead of looking at the “domestically produced goods and services” it will purchase in a period, the innovative investor must look at the internationally produced goods and services it will prucahse. The global remittances market–currently dominated by companies that provide the ability for people to send money to one another internationally–is an easy graspable example of service within which bitcoin could be used.

This whole section should probably be culled because this isn’t really a viable, scalable use case that bitcoin itself can solve.

For example, between 2014-2016, tens of millions of dollars were invested in more than a dozen “rebittance” companies (Bitcoin-focused remittance) and most either failed or pivoted.

Those that still exist had to build additional services and bitcoin were a means to an end.  In all cases, these companies had to build their own cryptocurrency exchange and/or partner with several cryptocurrency exchanges in order to liquidate the coins — they need to hedge and limit their exposure to volatility.  Bitcoin also doesn’t solve for the last-mile problem at all… but that is a separate topic.97

On p. 179 they write:

If each bitcoin needs to be worth $952 to service 20 percent of the remittance market and $11,430 to service the demand for it as digital gold, then in total it needs to be worth $12,382. There is no limit to the number of use cases that can be added in this process, but what is extremely tricky is figuring out the percent share of the market that bitcoin will ultimately fulfill and what the velocity of bitcoin will be in each use case.

This is highly debatable.  And it is exactly what Pantera stated four years ago.  Sources should be cited in the next edition; and also provide a velocity estimate for the potential use cases.

On p. 180 they write:

Taking the concepts of supply and demand, velocity, and discounting, we can figure out what bitcoin’s value should be today, assuming it is to serve certain utility purposes 10 years from now. However, this is much easier said than done, as it involves figuring out the sizes of those markets in the future, the percent share that bitcoin will take, what bitcoin’s velocity will be, and what an appropriate discount rate is.

An actual asset would certainly need these blanks filled, but Bitcoin doesn’t behave like a normal asset.  For instance, it goes through enormous speculative bubbles and busts.  It reached just under $20,000 per coin in mid-December last year not for any utility reason but pure speculation… yet many of the “thought leaders” at the time said it was because new buyers were going to use it for its utility.

On p. 180 they write:

Already there have been reports, such as those from Spence Bogart at Needham & Company, as well as Gil Luria at Webush, that look at the fundamental value of bitcoin.

I’ve read most of their reports, they’re nearly all based on edge-case assumptions or one-off anecdotes that never saw much traction (such as remittances).  In addition, arguably both of their analysis may have been colored by their coin investments at the time they published their work.  That’s not to say their material is discredited but I would discount some of their cryptocurrency-related reports.98

On p. 180 they write:

The valuations these analysts produce can be useful guides for the innovative investor, but they should not be considered absolute dictations of the truth. Remember, “Garbage in, garbage out.” We suspect that as opposed to these reports remaining proprietary, as is currently the case with much of the research of equities and bonds, many of these reports will become open-source and widely accessible to all levels of investors in line with the ethos of cryptoassets.

This has not happened.  If anything, the market has been flooded with junk marketing material that masquerades as “research.”  Universities are now getting funded by coin issuers and asked to co-publish papers.  Even if there are no explicit shenanigans going on, there is now a shadow of doubt that hangs over these organizations.

Also, the next edition needs to define what “the ethos of cryptoassets” is somewhere up front.  And dispense with “innovative investor”?99

On p. 182 they write about getting to know “the community and the developers”:

In getting to know the community better, consider a few key points. How committed is the developer team, and what is their background? Have they worked on a previous cryptoasset and in that processrefined their ideas so that they now want to alunch another?

[…]

If information cannot be found on the developers, or the developers are overtly anonymous, then this is a red flag because there is no accountability if things go wrong.

Satoshi clearly wouldn’t have been able to pass this test.  Nor BitDNS originally (which later became Namecoin).

It is a double-standard to want accountability here yet promote an ill-defined “decentralization” throughout this book.  You really can’t have it both ways.

Remember, the reason why administrators and operators of financial market infrastructure are heavily regulated is to hold participants legally responsible and accountable for when mistakes and accidents occur.

Cryptocurrencies were designed to be anarchic and purposefully were designed to not make a single participant accountabile.  Trying to merge those two worlds creates the worst of both: permissioned-on-permissionless.

On p. 183 they write:

If Ethereum gets big enough, there may eventually be those who call themselves Ethereum Maximalists!

Yes, they exist and largely self-selected themselves into the Ethereum Classic world… you can see that by their antics on social media.

On p. 183 they write about issuance models:

Next, consider if the distribution is fair. Remember that a premine (where the assets are mined before the network is made widely available, as was the case with bytecoin) or an instamine (where many of the assets are mined at the start, as was the case with dash) are both bad signs because assets and power will accrue to a few, as opposed to being widely distributed in line with the egalitarian ethos.

Let’s tone down the talk on egalitarianism in a market fueled by greed and a perpetually high Gini coefficient.

In practice as of July 2018, many ICOs are pre-mined or pre-allocated, most as ERC20 tokens that are controlled by a singular entity (usually an off-shore foundation).100

Is this a “bad sign”?  It would be helpful to see what the explicit criteria around token distribution should be in the next edition.101

On p. 183 they write:

For example, Ethereum started with one planned issuance model, but is deciding to go with another a couple years into launch. Such changes in the issuance model may occur for other assets, or impact those assets that are significatnly tied to the Ethereum network.

Those decision are made by individuals.  Perhaps by the next edition we will know what FinCEN and other regulatory positions on individuals creating monetary policy and running financial market infrastructure.

On p. 184 they write:

With Dogecoin we saw that it needed lots of units outstanding for it to function as a tipping service, which justifies it currently having over 100 billion units outstanding, a significantly larger amount than Bitcoin. With many people turning to bitcoin as gold 2.0, an issuance model like Dogecoin’s would be a terrible idea.

What?  Why?  This passage conflates many different things.

  1. As Jackson Palmer has repeatedly said: Dogecoin was set up as a joke, based on a meme.  The authors seem to be taking its existence a little too seriously.
  2. Dogecoin was originally based on Luckycoin which had a random money supply, so its original hashrate charts were all over the map, bipolar.
  3. Its money supply was changed in part because it ran into an exitential crisis that it later (mostly) solved by merge mining with Litecoin in 2014

How does any of this have to do with maximalist narrative of “gold 2.0”?

On p. 186 they write:

The only way attackers can process invald transactions is if they own over half of the computer power of the network, so it’s critical that no single entity ever exceeds 50 percent ownership.

Technically this is not quite right.

The actual figure to sucessfully censor and/or reorg the chain may be as low as 33% and perhaps even 25% (dubbed “selfish mining“).102  More than 50% would mean the participants could do so repeatedly until their hashrate declines and/or a permanent fork occurs.

Aside from pressure on social media, there is nothing to prevent such “ownership” from taking place.  And there is no legal recourse or accountability in the event it happens.  And such “attacks” have occured on many different cryptocurrencies.103

On p. 186 they write:

In other words, miners are purley economically rational individuals–mercenaries of computer power–and their profit is largely driven by the value of the crypotasset as well as by transaction fees.

This should be reworded from the next edition because it is not true.  Miners and mining pools are operated by people and they have various incentives, including to attack networks or abandon them altogether.

On p. 186 they write:

A clearly positively reinforcing cycle sets in that ensures that the larger the asset grows, the more secure it becomes–as it should be.

This is not true for proof-of-work coins.

If anything, mining and development have both trended towards centralization.  For instance, it is estimated that Bitmain-manufactured hashing equipment currently generates 60-80% of the network hashrate and Bitmain-affiliated mining pools comprise about 50%+ of the current Bitcoin network.  Maybe that is just momentary but singular entities on the mining side dominate many other cryptocurrencies as well.  Perhaps that changes later in the year so it is worth revisiting in the next edition.

Recommended reading:

On p. 187 they write:

At the risk of being repetitive, more hash rate signifies more computers are being added to support the network, which signifies greater security.

This is a non sequitur.  A new hashing machine capable of generating 10 times the amount of hashes as the previous machine could — ceteris paribus — result in other machines being turned off.  In practice, you often have the Red Queen Effect take place (see Chapter 3).

Either way, depending on the costs of more efficient ASIC design, there could actually be fewer (or more) hashing machines added to a network depending on the expected price of the coin minus operating costs.

And in some cases, the network may become more centralized and therefore arguably less secure.  Worth revising in next edition.

On p. 188 they write:

While hash rate often follows price, sometimes price can follow hash rate. This happens in situations where miners expect good things of the asset in the future, and therefore proactively connect machines to help secure the network. This instills confidence, and perhaps the expected good news has also traveled to the market, so the price start going up.

This passage has entered Rube Goldberg territory, where a series of specific events turn into a virtuous cycle in which prices go up and up but not down?  How can we ever know what caused certain price increases or decreases with this type of asymmetric information occurring in the background?  Suggest scrapping it in the next edition.

On p. 188 they write:

Ethereum’s mining network, on the other hand, is less built out because it’s a younger ecosystem that stores less value. As of March 2017, a 230 megahash per second (MH/s) mining machine could be purchased for $4,195, and it would take 70,000 of these machines to recreate Ethereum’s hash rate, totaling $294 million in value. Also, because Ethereum is supported by GPUs and not ASICs, the machines can more easily be constructed piecemeal by a hobbyist on a budget.

There are a few issues with this:

  1. How do the authors measure or quantify “less built out”?  Is there a line that is crossed in which Ethereum or other coins are “more built out” or the right size?
  2. About a year ago a coin reporter asked me to detail the hypothetical lower bound costs for recreating the hashrate of the Bitcoin network.  I provided those numbers based on Bitmain’s latest device… but the article instead ignored any of that and instead quoted some random conspiracy theory from a Twitter personality.  Rather than rehashing the full story here, keep in mind that the geographic distribution and control of mining equipment is arguably as important as the aggregate network hashrate.
  3. Their last sentence does not make much sense.  How to define a hobbyist?  If a hobbyist is defined as an individual who can afford to spend $4,195… then they can probably also buy ASIC equipment as well for other cryptocurrencies, including Ethereum today.

On p. 188 they write:

This range is a good baseline for the innovative investor to use for other cryptoassets to ensure they are secured with a similar level of cpaital spend as Bitcoin and Ethereum, which are the two best secured assets in the blockchain ecosystem.

There is another appearance of the “innovative investor,” remove in next edition?

Also, if security is solely measured by hashrate then yes, Bitcoin (BTC) and Ethereum (ETH) might be the “best secured.”  But that assumes a purely Maginot Line attack and not a BGP or wrench attack.

On p. 189 they write:

Overall, hash rate is important, but so too is decentralization. After all, if the hash rate is extremely high but 75 percent of it is controlled by a single entity, then that is not a decentralized system. It is actually a highly centralized system and therefore vulnerable to the whims of that one entity.

This probably should come at the beginning of the chapter, not in this location.  Also recommend adding some citations to the Onename and BGP posts.

On p. 189 they write:

It’s apparent that Litecoin is the most centralized, while Bitcoin is the most decentralized. A way to quanitfy the decentralization is the Herfindahl Hirschman Index (HHI), which is a metric to measure competition and market concentration.

HHI is used with known, legally identifiable parties.  With cryptocurrencies such as Bitcoin, Litecoin, and Ethereum — the mining entities were not originally supposed to be known at all — over time they self-doxxed themselves.104

Should the Department of Justice and similar organizations coordinate and carry out HHI analysis on mining pools to prevent monopolization, oligopolization, and/or coordination?   What happens if participants refuse to comply?

On p. 191 they write:

Blockchain networks should never classify as a highly concentrated marketplace, and ideally, should always fall into the competitive market place category.

Okay, but what if they don’t and no one cares?  Who should enforce this?

Recommend reading a relevant paper published this past winter: Decentralization in Bitcoin and Ethereum Networks

On p. 193 they write:

At times, Bitcoin has been a moderately concentrated marketplace, just as Litecoin mining is currently a moderately concentrated marketplace. Litecoin recognizes the impact that large mining pools can have on the health of its ecosystem and the quality of its coin. To that point, Litecoin developers have instituted an awareness campaign called “Spread the Hashes” for those mining litecoin to consider spreading out their mining activies. The campaign recommends that litecoin computers mine with a variety of mining pools rather than concentraing solely in one.

The anthropomorphism needs to be removed in the second edition.  “Litecoin” does not recognize anything because Litecoin is not a singular autonomous entity.

There are individual people, developers who work on a certain implementation of Litecoin that may promote something — and if they coordinate (which they do) then perhaps they could be classified as administrators.

Either way, this “Spread the Hashes” campaign didn’t seem to work:

Source: Litecoinpool.org visited on July 11, 2018

As the pie chart above illustrates, just 5 entities currently account for about 90% of the network hashrate.  And the largest 3 effectively could coordinate to control the network if they wanted to.

Worth noting that similar marketing campaigns to “spread the hashes” have been done on other networks.  Back in 2014 when GHash.io reached the 50% mark, reddit was filled with discussions imploring miners to switch to P2Pool.

Why don’t miners move to smaller pools?  Two words: reliable revenue.  Recommended reading: The Gambler’s Guide To Bitcoin Mining

On p. 194 they write:

Not all nodes are made equal. A single node could have a large number of mining computers behind it, hence capturing a large percentage of the overall network’s hash rate, while another node could have mining computer supporting it, amounting to a tiny fraction of Bitcoin’s hash rate.

Sort of.  There are two different nodes: nodes that fully validate and attempt to append the blockchain by submitting a proof-of-work that meets the necessary difficulty threshold… and nodes that don’t.  In practice, today we call the former “mining pools” and the latter, just nodes.

For instance, in Bitcoinland there was a vicious war of words from 2015-2017 waged by several parties who did not operate mining pools, or nodes that generated proofs-of-work.105  One subset of these parties used various means and channels to insist that miners did not ultimately matter, that it was “users” who truly controlled the network and they labeled themselves “UASF.”  And some of the most vocal members of this “populism wing” insisted that the nodes run by mining pools were no more important than the nodes run by some hobbyist in an apartment.

The views were irreconcilable and the ultimate result is that one group involved in that battle, forked off and created a new chain called Bitcoin Cash (BCH), whereas many of the other parties coalesced with what is called Bitcoin (BTC).  There is a lot more to the story, a messy emotional divorce that still continues today.

Technically the decision to fork or not fork is made by mining pools and the nodes they each manage, but there are more nuances and politics involved that go beyond the scope of this review.

On p. 194 they write:

William Mougayar, author of The Business Blockchain, has written extensively about how to identify and evaluate new blockchain ventures and sums up the importance of developers succinctly: “Before users can trust the protocol, they need to trust the people who created it.” As we touched upon in the prior chapter, investigate the prior qualifications of lead developers for a protocol as much as possible.

Two problems with this:

  1. I wrote a lengthy book review of Mougayar’s book and found it disappointing and do not recommend because of statements like the one above.
  2. What were Satoshi’s qualifications?  No one knows, but no one really cares either.  Similarly, what were Vitalik Buterin’s qualifications?  He was 19 when he announced Ethereum at Bitcoin Miami and had recently dropped out of college.  Similarly, Gavin Wood was a 34 year-old developer building music-related apps prior to co-founding Ethereum.  Would these two key guys been deemed qualified?  What are the qualifications necessary to be a blockchain wizard?

On p. 194 they write:

Developers have their own network effect: the more smart developers there are working on a project, the more useful and intriguing that project becomes to other developers. These developers are then drawn to the project, and a positively reinforcing flywheel is created. On the other hand, if developers are exiting a project, then it quickly becomes less and less interesting to other developers, ultimately leaving no one to captain the software ship.

A couple of thoughts:

  1. This is a nice sounding theory, but that’s not really what happens with most of these projects.  Generally developers are attracted due to the compensation they can receive… they do a risk-reward analysis.  I’ve met and spoken to dozens, perhaps north of 100 cryptocurrency-related teams in the past 12 months across the globe.  Attracting talented developers is not nearly as easy and clear cut as the authors make it sound above.
  2. Also, having a single “captain of the ship” seems like a single point of failure and a centralization risk.  Is that part of the undefined ethos?

On p. 195 they write:

Recall that this is how Litecoin, Dash, and Zcash were created from Bitcoin: developers forked Bitcoin’s code, modified it, and then re-released the software with different functionality. Subscribers refer to people wanting to stay actively involved with the code. In short, the more code repository points, the more developer activity has occured around the cryptoasset’s code.

That’s not necessarily true, and in fact, has been gamed by coin issuers who want to make it look like there is a lot of independent activity and traction with developers… by creating spam accounts and very small changes to simple documents (like grammar).

It can be a helpful metric but you need someone technically inclined to dive into the code that is being added/removed/modified.  See: Increased Github Scrutiny Means Lazy ICO Developers Have No Place to Hide

Readers may also be interested in CoinGecko to see how this acitivity is weighted.

On p. 198 they write:

A different approach is to monitor the number of companies supporting a cryptoasset, which can be done by tracking venture capital investments. CoinDesk provides some of this information as seen in Figure 13.13. Though as we will address in Chapter 16 on ICOs, the trend in this space is moving away from venture funding and toward crowdfunding.

Actually, as mentioned a couple time earlier, there has been a noticeable divergence the past 12 months: coin sales that are done as private placements versus coin sales that have a public facing sale.

In general, most of the coins that have raised capital through private placement deals typically have less than 100 investors, many of which are the aforementioned “crypto hedge funds” and coin-focused venture funds such as Andreessen Horowitz and Union Square Ventures.

The public facing sales are generally eschewed by venture funds.  If venture funds are involved in a coin that does a public sale, they typically are involved in what is called a “pre-sale” where they receive preferential terms and conditions, such as discounted coins.

Upon the conclusion of the “pre-sale” the actual public sale begins with heavy marketing on social media towards retail investors.  Sometimes these sales have hundreds or even thousands of individual participants.  That could be called a “crowdsale” and these participants typically get worse terms than those who participated in the pre-sale.

On p. 199 they write:

Another good proxy for the increased acceptance of a cryptoasset and its growing offering by highly regulated exchanges is the amount of fiat currency used to purchase it.

Maybe consider revising because we have all been told that cryptocurrencies would not only displace “fiat currency” but also topple and replace the existing financial system… how does measuring these new internet coins with old money help achieve that?

For instance, at the time of this writing none of the US-based retail exchanges with domestic bank accounts have recently listed an ICO (with the exception of ETH and ETC).  This includes: itBit, Bitflyer, Coinbase, and Gemini.106  Kraken’s retail exchange uses payment processors and banking partners outside of the US.107

On p. 199 they write:

in the one-year period from March 2016 to March 2017, ether went from being traded 12 percent of the time with fiat currency to 50 percent of the time. This is a good sign of the maturation of an asset, and shows it is gaining wider recognition and acceptance.

Why is that specific ratio or percentage deemed good?  The next edition should include a table explaining this in further because it is unclear why it is good, neutral, or bad.

On p. 201 they write about wallets from Blockchain.info:

Clearly, having more users that can hold a cryptoasset is good for that asset: more users, more usage, more acceptance. While the chart shows an exponential trend, there are a few drawbacks for this metric. For one, it only shows the growth of Blockchain.info’s wallet users, but many other wallet providers exist. For example, as of March 2017, Coinbase had 14.2 million wallets, on par with Blockchain.info. Second, an individual can have more than one wallet, so some of these numbers could be due to users creating many wallets, a flaw which extends to other wallet providers and their metrics as well.

In the past I have written extensively on how these headline wallet numbers are basically gimmicks and don’t accurately measure users or user activity.

Why?  Because it costs nothing to open one.  And often there is no KYC or AML involved in creating one as well.  As a result, bots can be used to create many each day to inflate the metric.

Coinbase has actually removed usage data in the past and they still don’t define what the difference between a user or wallet is.  Nor do either company provide traditional DAU / MAU metrics.  It’s not hard to do and it is unclear why they don’t.  The only way we have some semblance of an idea of what Coinbase user numbers were between 2013-2015 is because of the IRS lawsuit mentioned above.

On p. 201 they write about a search trend, “BTC USD,” first described by Willy Woo:

If we assume this to be true, then Woo’s analysis indicating a doubling in bitcoin users every year and an order of magnitude growth every 3.375 years. He calls this Woo’s Law in honor of Moore’s Law […] It will be interesting to see how Woo’s Law holds up over time.

How has it done?  “Woo’s Law” has thus far not held up.

For instance, below is a 5 year trend chart of the same search term promoted by Woo and others last year:

As we can see above, this term has some correlation between interest in coins specifically during price bubbles.  But this has not translated into large quantities of new daily users.108

The next edition of this book should remove this faux eponym because it has not withstood the test of time and doesn’t measure actual users.

On p. 202 they write:

Figure 13.17 shows the hyper growth of Ethereum’s unique address count. With Ethereum, an address can either store a balance of either, like Bitcoin, or it can store a smart contract. Either denotes an increase in use.

Below is a screenshot of a recent address count:

Source: Etherscan

The next edition should include a caveat because it is unclear from this chart alone what kind of use is taking place.  Is it coin shuffling, miner payouts, gambling payouts, Crypokitty activity, etc.?  Maybe it is just someone spamming the network?

For instance, according to DappRadar which tracks 650 ethereum Dapps, over the past 24 hours there have only been 9,926 users sending 43,652 transactions.  That may sound intriguing but… nearly about 2/3rd of all these users are using decentralized exchanges (DEX).  If trading and arbitraging are the “killer apps” of cryptocurrencies, then the next edition of this book could be a lot slimmer than it is now.

As described in “Slicing data,” not all transactions are the same and a deep dive needs to be done to fully describe the behavior taking place.

On p. 204 they cite a “Dollar Value of Transactions” chart:

Source: Blockchain.info

But this is just an estimate from Blockchain.info and is likely widely exaggerated because Blockchain.info — like most wallet providers — probably has no idea what the intent behind those transactions are.  We need data from all of the exchanges, payment processors, and merchants that accept coins in order to conclusively know what activity was commercial versus non-commercial in nature.

For instance, a large portion of those transactions could simply be “change address.”

Not to get too technical, but with Bitcoin, in order to manually send X amount of bitcoin on-chain, users typically must enter a “change address” unless the whole amount of UTXO is consumed.  It’s kind of like a bank teller moving money from one till to another between shifts.  No new economic activity is actually taking place in the bank or in the real economy, but in this specific chart above, there is no way to differentiate “change address” activity with real commercial activity and so it all gets mixed and muddied.

On p. 204 they write:

If the network value has outpaced the transactional volume of that asset, then this ratio will grow larger, which could imply the price of the asset has outpaced its utility. We call this the crypto “PE ratio,” taking inspiration from the common ratio used for equities.

Except, without a thorough deep dive from an analytics provider who has mapped out activity into all of the exchanges, payment processors, and merchants — it is very difficult to actually differentiate the noise from the actual transactional utility.109

Here the authors take all on-chain transaction volume at face value.  The next edition should scrap this section unless they get access to a thorough deep dive.

On p. 204 they write:

One would assume that an efficient price for an asset would indicate a steadiness of network value to the transaction volume of the asset. Increasing transactional volume of an asset should be met by a similar increase in the value of that asset. Upside swings in pricing without similar swings in transaction volume could indicate an overheating of the market and thus, overvaluation of an asset.

That is a popular model but could be incorrect.

I recommend readers check-out this excellent recent thread started by Nathaniel Popper as well as Debunking Bitcoin’s Remittance Valuation. Featuring a Lead Pipe by Anshuman Mehta.

On p. 207 they write about technical analysis:

In Figure 13.22 the top line is called the resistance line, indicating a price that bitcoin is having trouble breaking through. Often these lines can be numbers of psychological weight, in this case the $300 mark.

I looked it up and couldn’t find a definition for what “psychological weight” is, so this should either be defined in the book or removed in the next edition.110

On p. 209 they write:

You’ll find many instances of newer cryptoassets experiencing wild price swings after their creation, but over time these younger assets begin to follow the rules of technical analysis. This is a sign that these assets are maturing, and as such, are being followed by a broader group of traders. This indicates they can be more fully analyzed and evaluated using technical analysis, allowing the innovative investor to better time the market and identify buy and sell opportunities.

Technical analysis may have its uses but by itself it is basically cargo cult science.

Recommend rephrasing it and maybe inserting this great reference: The Vomiting Camel has escaped from Bitcoin zoo

Chapter 14

On p. 211 they write:

Since cryptoassets are digital bearer instruments, they are unlike many other investments that are held by a centralized custodian. For example, regardless of which platform an investor uses to buy stocks, there is a centralized custodian who is “housing” the assets and keeping track of the investor’s balance. With cryptoassets, the innovative investor can opt for a similar situation or can have full autonomy and control in storage. The avenue chosen depends on what the innovative investor most values, and as with much of life there are always trade-offs.

This is true: there are many choice.  But in practice, as noted above by Jonathan Levin, a significant majority of transactions typically involves a 3rd party intermediary.

Why?  Because Securing a bearer instrument can be a major hassle, as a result companies like Coinbase and Xapo offer custodial services.  While re-introducing an intermediary helps with coin management that kind of defeats the purpose of having a pseudonymous bearer asset in the first place.111 But that’s a different discussion.112

On p. 212 they write:

Anyone with a computer can connect to Bitcoin’s network, download past blocks, keep track of new transactions, and crunch the necessary data in pursuit of the gold hash. Such open architecture is one of Bitcoin’s strongest points.

It may sound like a irrelevant nitpick but this is not unique to Bitcoin.  Nearly every cryptocurrency listed on Coinmarketcap has the same set of “features.”  Similarly, many enterprise vendors also are open source and anyone could set up their own network with the software.  Future editions should include a more nuanced definition of “open.”

On p. 213 they write:

The first computer – or mining rig – with ASIC chips that were specifically manufactured for the process was connected in January 2013.

The citation the authors included was for Avalon.  This is true insomuch as these systems were available for purchase to the general retail public.  But the first known ASIC-mining system was launched in late 2012: ASICMiner privately run out of Hong Kong (from BitQuan and BitFountain). 113

On p. 214 they write:

For perspective, the combined compute power of Bitcoin’s network is over 100,000 times faster than the top 500 supercomputers in the world combined.

This type of stat is frequently repeated throughout the Bitcoin world but it is not an apples-to-apples comparison and should be removed in the next edition.  The supercomputers are largely comprised of CPUs and GPUs which — as their names suggest — are flexible and capable of handling many different types of general purpose tasks.

ASICs on the other hand, are focused and specialized: capable of doing just one set of tasks over and over.  ASICs found in a Bitcoin mining farm are not even capable of creating blocks to propagate on the network: they simply generate hashes.  That is how limited they are in functionality.

On p. 214 they write:

Conceptually, mining networks are a perfect competition, and thus as margins increase, new participants will flood in until economic equilibrium is once again achieved. Thus the greater the value of the asset, the more money miners make, which draws new miners into the ecosystem, thereby increasing the security of the network. It’s a virtuous cycle that ensures the bigger the network value of a cryptoasset, the more security there is to support it.

I think this could be rewritten in the next edition to be closer with what happens in practice.114

For instance, as coin prices decrease, margins are squeezed and “marginal” operators exit, leaving fewer overall miners.  In the past this has led to bankruptcies, such as KnC and HashFast.

Does this lead to a less secure network?

Maybe, maybe not.  Depends on how we define secure and insecure.  Pure hashrate is just one attribute… geographical location, amount of participants, and diversity of participants could be others as well.  For example, see the discussion earlier on selfish-mining.

On p. 215 they write:

Before investing in a cloud-based mining pool, conduct research on the potential investment. If it sounds too good to be true, it probably is.

This is good advice.

Also worth mentioning that “cloud-based mining” kind of the defeats the purpose of pseudonymous mining.  If you have to trust the infrastructure provider to manage and operate the hashing equipment, why not just buy the coins?  Why take that risk and also have to divulge your identity?

Incidentally, NiceHash is one of the most well-known cloud mining services available today.  It partly cemented its notoriety (this is not an endorsement) as its mining units have been rented and used to attack several different cryptocurrencies.  A site called Crypto51.app categorizes the costs of doing a brute force attack on dozens of coins and even lists the amount of hashrate NiceHash has in order to perform a hypothetical attack.

On p. 216 they write:

However, Ethereum will potentially switch to proof-of-stake early in 2018, as it is more efficient from an energy perspective, and therefore many claim is more scalable.

Quick note: this transition has been delayed again until at least the end of 2018 and more likely sometime in 2019 (although it has been moved many times before as well).

On p. 217 they write:

To this end, today numerous quality exchange are available to investors looking to gain and transact the more than 800 cryptoassets that currently exist.

In the next edition it is worth clarifying and defining what “quality” means because just about every retail / consumer-facing exchange has had its share of problems, including hacks and thefts.115 This is one of the reasons the SEC has denied ETF proposals.

With that said, there are a number of OTC trading desks run by reputable financial organizations that enable investors to trade, however, typically the minimum order size (buy/sell) is $100,000.116

On p. 218 they write:

Cryptoasset transactions are irreversible; therefore chargebacks are impossible. While an irreversible transaction may sound scary, it actually benefits the efficiency of the overall system. With credit card chargebacks, everyone has to bear the cost, whereas with cryptoassets only those who are careless bear the cost.

Two comments worth considering for the next edition:

  1. Transactions in cryptocurrencies are possible through block reversals, which can and do happen.  Often times they are relatively expensive to do, but during a “51% attack” it can occur, thus it is not impossible.  In fact, as part of the Nano class action lawsuit, one of the suggested remedies is a roll-back.
  2. As far as credit card chargebacks: this is largely borne by the merchant (not everybody).  In fact, charge backs are largely a consumer-friendly feature, a type of insurance.117

On p. 221 they discuss insurance at exchanges.

At this time, no retail cryptocurrency exchange actually insures a users coin deposit.  As a result, most custodians and intermediaries have had to self-insure (e.g., create their own insurance entity).  There are institutional products (vaults) which are attempting to get 3rd party insurance.

For example, see: Insurers gingerly test bitcoin business with heist policies

On p. 224 they write:

Prior to the hack, Bitfinex had settled with the CFTC for $75,000 primarily because its cold storage of bitcoin ran afoul of CFTC regulations. The move to place all clients’ assets into hot wallets is cited by many as due to the fine and CFTC regulations. Either way, this hack proved that no matter the security protocols put in place, hot wallets are always more insecure than properly executed cold storage because the hot wallet can be accesssed from afar by anyone with an Internet connection.

This passage should be revised in the next edition for a few reasons:

First, as mentioned earlier, Bitcoiners like to find a good boogeyman and in this hacking incident, they blamed the CFTC.

For example, Andreas Antonopoulos tweeted:

Source: Twitter

Several people told him he got the facts wrong.

For instance, I reached out to Zane Tackett who — at the time — was head of communications for Bitfinex.

According to Tackett: “We migrated to the bitgo setup before any discussions or anything with the CFTC happened”

I then publicly pointed out, to Antonopoulos and others, that the CFTC blame game was false.  But instead of deleting that tweet and focusing on who actually hacked Bitfinex, the ideological wing of the Bitcoin tribe continues to push this false narrative.

Tackett even explicitly answered this question in detail on reddit that same day.

So either Tackett is lying or Antonopoulos is wrong.  In this case, it is likely the latter.

The second point worth adding to the passage above in the book is that after nearly two years we still haven’t been told exactly what happened with the hack and theft.  This, despite the fact that Bitfinex has said on more than one occasion that it would provide an audit and public explanation.

Incidentally, this hack and the response, set in motion a series of events that included socialized loses, a lost correspondent banking relationship, and even a heightened reliance on Tether.118 For more, see: How newer regtech could be used to help audit cryptocurrency organizations

Chapter 15

On p. 231 they write:

Founded by Barry Silbert, a serial entrepreneur and influential figure in the Bitcoin community, some would say that DCG is in the early stages of becoming the Berkshire Hathaway of Bitcoin.

Perhaps DCG achieves that, however it hasn’t been done in a classy manner.  For example, see: Ex-banker cheerleads his way to cryptocurrency riches and Barry Silbert and the Cost of Bitcoin’s Malfeasance Culture

On p. 235 they write

An ETF is arguably the best investment vehicle to house bitcoin.

This is debatable.  Last year Jack Bogle – founder of Vanguard, a firm that popularized broad market index ETFs – implored the public to avoid bitcoin like the plague for several reasons.  Critics say he is out of touch, but even if that were true that doesn’t mean his expert views on structuring ETFs should be dismissed.

On p. 238 they write:

Regardless of what people expected going into the SEC decision most everyone was taken aback by the rigidity of the SEC’s rejection. Notably the SEC didn’t spend much time on the specifics of the Winklevoss ETF but focused more on the overarching nature of the bitcoin markets. Saying that these markets were unregulated was an extra slap to the Winklevosses, who had spent significant time and money on setting up the stringently regulated Gemini exchange. In focusing on the bitcoin markets at large, the rejection implied that an ETF will not happen in the United States for some time.

For the next edition, this paragraph should probably be removed.

The facts of the Bitcoin markets today are as follows:

  1. Mining is the process of minting new coins as well as processing transactions and… is largely unregulated in any jurisdiction.
  2. Many exchanges, in particular those outside the US, comply with a hodge podge of regulations, often without the same strict KYC / AML / sanctions checks required for US exchanges.

Gemini and the Winklevoss have no ability to police these unregulated trading venues and unregulated coin minters.  That probably won’t change in the near future.

Perhaps the SEC will eventually approve an ETF, but they arguably were not being rigid — they were being practical.  In their view: why allow an unregulated asset whose underlying genesis and trading market is still very opaque and frequently is used for illicit activity?

Lastly the next edition should include a citation for who “most everyone” includes, because in my own anecdotal experience, the majority of traders at US exchanges I interact with did not think it would be allowed at that time.  Note: my deep dive on the COIN ETF and its ever changing history, can be found here.

On p. 238 they write:

On Monday, naysarers were faced with the reality that bitcoin was once again back over $1,200, and the network for all cryptoassets had increased $4 billion since the SEC decision. Yes, $4 billion in three days.

A couple of thoughts:

  1. Typo: naysarers should be naysayers
  2. Recommend removing this sentence in the next edition because the attitude comes off as a little smug and has an ad hominem.  People are allowed to have different views on the adoption of technology which is separate from what the price of a coin will be.  And justifying a trading position based on price movements which are based on the mood of retail investors should probably not be the takeaway message for a mainstream book.

On p. 240 they write:

By purchasing XBT Provider, GABI strengthened the reliability of the counterparty to the bitcoin ETNs and added a nice asset to its growing bitcoin investing platform for institutions.

For the next edition, recommend removing “nice” because that is a subjective word.  There are other ways to describe this acquisition.

On p. 242 they write:

It also created an independent advisory committee, including bitcoin evangelist Andreas Antonopoulos to oversee its pricing model, which utilized prices from various exchanges throughout the world.

Why is this specific person considered an expert on futures?  There are a lot of articulate developers involved in promoting cryptocurrencies, but their expertise is typically not in finance.  If anything, this specific person has a vocal disdain for regulators, financial institutions, and regulated instruments… just see his tweet above in Chapter 14.119

Maybe in the next edition discuss the controversy of having a futures contract that is not physically deliverable.  Could also include how the CFTC has subpoenaed the four partner exchanges working with the CME: Coinbase, Kraken, itBit, and Bitstamp.  These four exchanges create the price used in bitcoin futures by the CME.

Chapter 16

On p. 249 they write:

For first-time founders who want to approach venture capitalists for an investment, often they must know someone-who-knows-someone. Having such a connection allows for a warm introduction as opposed to being among the hundreds of cold calls that venture capitalists inevitably receive. To know someone-who-knows-someone requires already being in the know, which creates a catch-22.

This is a very good point.  However, it would be worth adding in the next version how most ICOs and coin sales now require knowing someone because most private sales involve roughly the same insular, exclusive set of funds and investors as the “old method” did.

On p. 252 they write:

Before we dive into the specifics of how a cryptoasset offering is carried out, the innovative investor needs to understand that the model of crowdfunding cryptoassets is doubly disruptive. By leveraging crowdfunding, cryptoasset offering are creating room for the average investor to stand alongside venture capitalists, and the crowdfunding structure is potentially obviating the need for venture capitalists and the capital markets entirely.

In the next edition, worth mentioning that this was the general pitch for ICOs starting with Mastercoin (2013) all the way up through 2016.  But over the past two years and certainly in the past 12 months it has dramatically shifted back towards the traditional venture route.

One of the reasons why is because of the filtering and diligence process.  Those that don’t get selected and/or those ICOs that don’t meet the requirements of this small group of funds often decide to do a public sale.  And many of these ideas were half-baked and sometimes fraudulent, according to one recent report: More Than Three-Quarters of ICOs Were Scams

On p. 253 they write:

Monegro’s thesis is as follows: The Web is supported by protocols like the transmission control protocol/Internet protocol (TCP/IP), the hypertext transfer protocol (HTTP), and simple mail transfer protocol (SMTP), all of which have become standards for routing information around the internet. However, these protocols are commotidized, in that while they form the backbone of our internet, they are poorly monetized.

It could be argued that Monegro’s thesis has failed to live up to its hype thus far.  And counterfactually, if “tcpipcoin” existed, it may have actually stunted the growth of the internet as Vinton Cerf and Bob Kahn would have allocated more time promoting the coin rather than the technology.    We can disagree about this alternative scenario, but I have mentioned it before in Section 8.

For example, we frequently see that dozens of nonsensical conferences and meetups conducted on a weekly basis globally try to promote a shiny new protocol coin of some kind.  Trying to monetize a public good with a coin thus far has not removed the traditional incentive and sustainability issues around a public good.  That would also be worth discussing in the next edition.120

On p. 253 they write:

All the applications like Coinbase, OpenBazaar, and Purse.io rely on Bitcoin, which drives up the value of bitcoin.

Worth updating this because Purse.io added support to Bitcoin Cash.  And OpenBazaar switched over to Bitcoin Cash altogether.

Also, Coinbase has become less maximalist over time and now provides trading support for four different coins.121  Though it probably wouldn’t be technically correct to call Coinbase or Purse a Bitcoin application.  In the case of Coinbase, users use an off-chain database to interact and Coinbase controls the private key as a custodian / deposit-taking institution.

On p. 254 they write:

Interestingly, once these blockchain protocols are released, they take on lives of their own. While some are supported by foundations, like the Ethereum Foundation or Zcash Foundation, the protocols themselves are not companies. They don’t have income statements, cash flows, or shareholders they report to. The creation of these foundations is intended to help the protocol by providing some level structure and organization, but the protocol’s value does not depend on the foundation.

This is another reason to heavily modify chapter 7 in future versions because it is not an apples-to-apples comparison: coins and coin foundations are not the same thing as for-profit companies that issue regulated instruments (stocks, bonds, etc.).

Also, the very last sentence is highly debatable because of how often foundation and foundation staff are integral to the longevity of a coin.

Recall that blockchains do not maintain or market themselves, people do.  And is often the case: staff and contractors of these foundations frequently use social media to promote potential upgrades as well as publicize the coins attributes to a wider audience.  In many cases it could be the case that the protocol’s value does depend on the work and efforts of others including specifically those at a coin foundation.122

On p. 254 they write:

Furthermore, as open-source software projects, anyone with the proper merits can join the protocol development team. These protocols have not need for the capital markets because they create self-reinforcing economic ecosystems. The more people use the protocol, the more valuable the native assets within it become, drawing more people to use the protocol, creating a self-reinforcing positive feedback loop. Often, core protocol developers will also work for a company that provides application(s) that use the protocol, and that is a way for the protocol developers to get paid over the long term. They can also benefit from holding the native asset since inception.

There are several points here that should be modified or removed in the next edition:

For instance, with Bitcoin, due to a variety of political fights and personality conflicts, multiple “core” developers have had their access rights removed including: Jeff Garzik, Mike Hearn, Gavin Andresen, and Alex Waters.  Thus it is not true that anyone can join a team.  It is also unclear what those merits may be as most of the projects don’t explicitly provide those in written format yet.

In addition, internet coins are often traded on secondary markets in order to provide liquidity to coin holders such as developers.  They all need access to capital markets to stay afloat.  No project is self-sustainable at this time because no coin is being used as a unit of account — miners and developers must liquidate coins in order to pay their bills which are denominated in foreign currency.

Lastly, in practice, there are many coins that have died or lost any developer support yet initially they may have had a small army of programmers and media attention.  According to Coinopsy, more than 1,000 coins are dead.  Thus in the next edition the “self-reinforcing” loop should probably be removed too.

On p. 256 they write:

ICOs have a fixed start and end date, and often there is a bonus structure involved with investing earlier. For instance, investing at an early stage may get an investor 10 to 20 percent more of a cryptoasset. The bonus structure is meant to incentivize people to buy in early, which helps to assure that the ICO will hit its target offering. There’s nothing like bonuses followed by scarcity to drive people to buy.

This should definitely be removed.  In May, the SEC released a parody website called “HoweyCoins” which explicitly points to this precise FOMO behavior as a big no-no for both issuers and investors alike.

Also recommend the inclusion of the Munchee Order in this chapter as it would help illustrate what regulators such as the SEC perceive as improper fundraising techniques.  Specifically, include this in the “announcing the ICO” section.

On p. 258 and 259 they discuss the Howey Test.  It is strongly recommended that these two pages be reworded and modified based on the enforcement actions and guidance from the SEC and other securities regulators.

For instance, they write:

A joint effort by Coinbase, Coin Center, ConsenSys, and Union Square Ventures with the legal assistance of Debevoise & Plimpton LLP, produced a document called, “A Securities Law Framework for Blockchain Tokens.” It is especially important for the team behind an ICO to utilize this document in conjunction with a lawyer to determine if a cryptoasset sale falls under SEC jurisdiction. The SEC made it clear in July 2017 that some cryptoassets can be considered securities.

The first sentence should probably be moved into a footnote and the second sentence removed altogether because this document did not age well.

In fact, the current version of the document – as it exists on Coinbase – informs readers in bright red that:

Please note that since this document was originally published on December 7, 2016, the regulatory landscape has changed. The information contained in this document, including the Framework may no longer be accurate. You should not rely on this document as legal advice and you should seek advice from your own counsel, who is familiar with the particular facts and circumstances of what you intend and can give you tailored advice. This Framework is provided “as is” with no representations, warranties or obligations to update, although we reserve the right to modify or change this Framework from time to time. No attorney-client relationship or privilege is created, nor is this intended to be attorney advertising in any jurisdiction.

On p. 259 they write:

Does the token sale tout itself as an investment? It should instead be promoted for its functionality and use case and include appropriate disclaimers that identify it as a product, not an investment.

This is arguably not good advice and should be removed.  Why?  Courts in the US will likely see through this euphemism.  For other things not to do, recommend reading the ICO Whitepaper Whitepaper from Stephen Palley.

On p. 260 they write:

One of the oldest groups of angel investors in the blockchain and bitcoin space is called BitAngels. Michael Terpin of BitAngels has been active in angel investing in blockchain companies for as long as the opportunities have existed. Terpin’s annual conference, CoinAgenda, is one of the best opportunities for investors to see and hear management from blockchain startups present their ideas and business models.

For the next edition, I’d reconsider including this type of endorsement.123 There are some interesting stories that involving these specific entities worthy of a different post.

Chapter 17

On p. 263 they write:

For instance, if Bitcoin influences how remittances are handled, what impact may that have on stocks like Western Union, a remittances kingpin? If Ethereum takes off as a decentralized world computer, will that have any effect on companies with cloud computing offerings, such as Amazon, Microsoft, and Google? If companies can get paid more quickly with lower transaction fees using the latest cryptocurrency, will that have an impact on credit card providers like Visa and American Express.

For the next edition, this paragraph — or at least argument — should come earlier, perhaps even in Chapter 7 (since there is a discussion of specific publicly traded companies).

Another thing that should have been added to this section is actual stock prices for say, the past five years of the companies mentioned: Western Union, Visa, and American Express.

I have included those three below:

If the narrative is that Bitcoin or the “latest cryptocurrency” will erode the margins and even business models of existing payment providers, then at some point that should be reflected in their share prices.

As shown above, that does not seem to be the case (yet).

Perhaps that will change in the future, but consider this: all three of the companies above have either directly invested in and/or are collaborating in blockchain-related platforms — most of which do not involve any coin.  Perhaps these firms never use a blockchain.  In fact, maybe they find blockchains to be unhelpful as infrastructure altogether.

That is possible, hence the need to update this chapter to reflect the actual realities.

In addition, the other three companies listed by the authors have publicly discussed various blockchain-related efforts beyond just pilot offerings.

For instance, both Amazon and Microsoft have supported blockchain-as-a-service (BaaS) offerings in production for over a year.  Google has been a laggard but has internal projects attempting to leverage some of these ideas as well.

On p. 266 they write:

In 2016, the father-son team of Don and Alex Tapscott published the book Blockchain Revolution: How the Technology behind Bitcoin Is Changing Money, Business, and the World, and William Mougayar published the book, The Business Blockchain: Promise, Practice, and Application of the Next Internet Technology.

I wrote lengthy reviews of both.  The short summary is that both were fairly superficial in their dive into use cases and vendors.  The Mougayar book felt like it could use a lot more detailed meat.  The Tapscott book was riddled with errors and unproven assertions.  Would reconsider citing them in the next edition (unless they each dramatically update their content).

On p. 266 they write:

For companies pursuing a DLT strategy, they will utilize many of the innovations put forth by the developers of public blockchains, but they don’t have to associate themselves with those groups or share their networks. They pick and choose the parts of the software they want to use and run it on their own hardware in their own networks, similar to intranets (earlier referred to as private, permissioned blockchains).

These are pretty broad sweeping comments that should be modified in the next edition.  Not every vendor or platform provider uses the same type of chain or ledger.  These are not commoditized (yet).

There are many nuances and trade-offs for each platform.  For the next edition, it would be helpful worth doing a comparison of: Fabric, Pantheon, Quorum, Corda, and other enterprise-focused platforms.  In some cases, they may have an on-premise requirement and in others, nodes can run in a public cloud.

But the language of “intranets and the internet” should not be used in the next edition as it is a misleading analogy.

On p. 267 they write:

We see many DLT solutions as band-aids to the coming disruption. While DLT will help streamline existing processes–which will help profit margins in the short term–for the most part these solutions operate within what will become increasingly outdated business models.

Perhaps that it is true, but again, this language is very broad sweeping and definitive.  It needs citations and references in the next edition.

On p. 267 they write:

The incumbents protect themselves by dismissing cryptoassets, a popular example being JPMorgan’s Jamie Dimon, who famously claimed bitcoin was “going to be stopped.” Mr. Dimon and other financial incumbents who dismiss cryptoassets are playing exactly to the precarious mold that Christensen outlines:

[…]

Disruptive technologies like cryptoassets initially gain traction because they’re “cheaper, simpler, smaller.” This early traction occurs on the fringe, not in the mainstream, which allows incumbents like Mr. Dimon to dismiss them. But cheaper, simpler, smaller things rarely stay on the fringe, and the shift to mainstream can be swift, catching the incumbents off guard.

For the next edition it would be good to remove the misconceptions repeated in the statement above.  Jamie Dimon was specifically dismissing the exuberance of coin mania, not the idea of enhancing IT operations with something like a blockchain.

Worth adding to future versions: JPMorgan has financial sponsored Quorum, an open-source fork of Ethereum modified for enterprise-related uses.  The bank has also invested in Digital Asset.  It is also a member of three industry organizations: EEA, Hyperledger, and IC3.  In addition, JP Morgan has filed blockchain-related patents, has launched a blockchain-based payment network with several banking partners, and also partnered with the parent company of Zcash to integrate ZSL into Quorum.

While Jamie Dimon may not share the same bullish views about coins as the authors do, the firm he is the CEO seems to be taking “blockchains” seriously.

On p. 267 they write:

One area long discussed as ripe for disruption is the personal remittances market, where individuals who work outside of their home countries send money back home to provide for their families.

This specific use case is a bit repetitive as it has been mentioned 5-6 times before in other chapters.  Should probably remove this in future editions unless there is something different to add that wasn’t already explained before.

On p. 268 they write:

It’s no stretch then to recognize that bitcoin, with its low cost, high speed, and a network that operates 24/7, could be the preferred currency for these types of international transactions. Of course, there are requirements to make this happen. The recipient needs to have a bitcoin wallet, or a business needs to serve as an intermediary, to ultimately get the funds to the recipient. While the latter option creates a new-age middleman–which potentially has its own set of problems–thus far these middlemen have provided to be much less costly than Western Union. The middleman can be a pawnshop owner with a cell phone, who receives the bitcoin and pays out local currency to the intended recipient.

This should be modified in the next versions because it is a stretch to make those claims.  That is the reason why multiple Bitcoin-focused remittance companies have pivoted or branched out because “moving” bitcoins across borders is the only easy part of the entire process.  For instance, the KYC / AML checks during the on- and off-ramps are costly and are required in most countries.  This should be included in any analysis.

Also, there are no citations in this paragraph.  And the last sentence is describing the pawnshop owner as a money transmitter / money service business which is a regulated operation.  Maybe the laws change, which is possible.  But for the next version, the authors should include specific corridors and the costs and margins for MSBs operating in those corridors.

Lastly, any future analysis on this topic should also include the online and app-based product offerings from traditional remittance players such as Western Union.  In nearly all cases, these products and services are faster and cheaper in the same corridors relative to traditional in-person visits.

Recommended reading:

On p. 268 they write:

The impact of this major disruption in teh remittance market should be recognized by the innovative investor not only because of the threat it creates to a publicly traded company like Western Union (WU) but for the opportunities it provides as well.

It is strange to hear this repeated multiple times without providing quantifiable specifics on how to measure this threat.

As mentioned a few pages earlier, if competitors (including, hypothetically cryptocurrencies) were to erode the margins of publicly traded companies, we should be able to see that eventually reflected in the share price.  But Western Union has been doing more or less the same as it has the past couple of years.

What about others?

Above is the five year performance of Moneygram, another remittance service provider.

What happened the past two years?  Did Bitcoin or another cryptocurrency pound its share value into the ground?  Nope.

What happened is that one of Alibaba’s affiliates – Ant Financial – attempted to acquire Moneygram.  First announced in early January 2017, Ant Financial wanted to acquire it for $880 million.  Despite approval from the Moneygram board, the deal faced scrutiny from US regulators.  Then in January 2018, the deal was axed as the US government blocked the transaction on national security grounds.

This hasn’t stopped Alibaba and its affiliates with finding other areas to grow.  For instance, last month Alipay (part of Ant Financial) announced it had partnered with G Cash to in the Hong Kong – Philippines corridor, using a blockchain platform for remittances.  No coin was needed in this process so far.

There may be some success stories of new and old MSBs that utilize cryptocurrencies in ways that make them more competitive, those should be included in the next edition along with more metrics readers can compare.124

On p. 270 they write:

For the long term investor, careful analysis should be undertaken to understand if insurance companies are pursing DLT use cases that will provide a lasting and meaningful solution. Lastly, some of the major consulting firms may be so entrenched in incumbent ideology that they too may be blind to the coming distruption.

A few comments that should be finnesed in the next version:

  1. What is the definition of “incumbent ideology”?
  2. Virtually every major insurance and reinsurance company is hands-on involved with some kind of blockchain-related consortium and/or enterprise-focused platform.  This includes both B3i and RiskBlock as well as Asia-based reinsurers.  Recommended reading: RiskBlock’s blockchain targets entire insurance industry
  3. Similarly, every major consulting company and systems integrator has a team or two dedicated to helping clients build and integrate applications with specific enterprise-related “blockchain” platforms.  Many of them have joined related consortia too.  There are too many to even list here so it is unlikely they will get collectively blind-sighted as alluded to in the passage above.

On pgs. 272 and 273 they write about consortia:

Another consortium, The Hyperledger Project, offers more open membership than R3. Remember, one of the strengths and defining aspects of an effective blockchain project is its open source ethos.

[…]

While the [EEA] consoritum will work on software outside of Ethereum’s public blockchain, the intent is for all software to remain interoperable in case companies want to utilize Ethereum’s open network in the future.

Based on the passages above the next edition should incorporate a few changes.

The Hyperledger Project (HLP) is a non-profit group that does not itself aim to commercialize or deploy or operate any technology.125 The membership dues are largely used to maintain code repositories and sponsor events which educate attendees on projects incubated within HLP.  It currently has around 200 members, including R3 which was a founding member.  There are more than 5 codebases that are officially incubated, the most well-known is Fabric.  However, HLP seeks to maintain a neutral position on which platform its members should use.  Other notable platforms incubated within HLP include Iroha and Sawtooth (Lake).

In contrast, R3 is a for-profit company that set up a consortium in order to commercialize and deploy technology within the regulated financial industry.126 Its membership model has changed over time and it is the main sponsor for Corda, an open source platform.  The consortium composition initially started with 42 banks and now includes about 200 entities including insurance companies, central banks, financial market infrastructure operators, and others.

The third most known consortium is the Enterprise Ethereum Alliance (EEA).  It is kind of like the combination of the two above.  It is a non-profit organization and itself does not aim to commercialize or deploy or operate any technology.  It seeks to be a neutral entity within the greater Ethereum ecosystem and has many different working groups that span topics similar as the other two consortia above.  It has hundreds of members and the main efforts have been around formalizing an enterprise-focused specification (EEA 1.0) that other vendors can create implementations of (such as Pantheon).

Like the members of the other two consortia above, nothing prevents an EEA member from using any other platform.  Thus the authors usage of “open network” is superfluous because all of the codebases in each of these three consortia is open, anyone can download and use.  The key differences are: what are the trade-offs with using each platform versus what are the benefits of membership for joining the consortia.  These are two separate points that could be discussed further in the next edition.

On p. 276 they write:

The CFTC Director of Enforcement, Aitan Goelman, tried to clarify his opinion with this satement, “While there is a lot of excitement surrounding bitcoin and other virtual currencies, innovation does not excuse those acting in this space from following the same rules applicable to all participants in the commodity derivatives markets.” It is clearly confusing that the Direct of Enforcement of the agency that ruled bitcoin a commodity also called it a “virtual currency.”

For the next edition the authors should remove the unnecessary attitude in the last sentence.

Up through 2017, most US and even foreign regulators used the term “virtual currency” — not as a slight against Bitcoin or cryptocurrencies, but because that was the catchall term of art used for many years.

For instance, in March 2013, FinCEN released its guidance and it was entitled: “Application of FinCEN’s Regulations to Persons Administering, Exchanging, or Using Virtual Currencies”

Throughout the guidance, the term “virtual currency” is used more than 30 times.

And one relevant passage – especially for this book review – involves the definition of an administrator.  According to FinCEN’s guidance:

“An administrator is a person engaged as a business in issuing (putting into circulation) a virtual currency, and who has the authority to redeem (to withdraw from circulation) such virtual currency.”

As it relates to the CFTC, earlier this year a federal judge in New York ruled that: “virtual currencies can be regulated by CFTC as a commodity.”

The ruling (pdf) specifically uses the phrase “virtual currency” not as a slight, but as a term of art.  Perhaps other terms are used over time.  For instance, in its new customer advisory issued this week, the CFTC mentioned potential scams that describe themselves as “utility coins” or “consumption coins.”  Worth revisiting in the next edition.

Chapter 18

On p. 280 they write:

Here’s another Burniske-Tatar Rule: Don’t invest in bitcoin, ether, or any other cryptoasset just because it’s doubled or tripled in the last week. Before investing, be able to explain the basics of the asset to a friend and ascertain if it fits well given the risk profile and goals of your investment portfolio.

This is good advice.  And while the eponymous rule was coined several chapters ago,  future editions should probably drop the name of that rule… because similar advice with slightly different wording has existed for decades (e.g., don’t invest more than you can afford to lose, do your own research, etc.).

On p. 282 they write:

Are millenials turning to bitcoin and cryptoassets for their investment? Is a Vanguard fund or a small investment in Apple any better?  Whereas the Vanguard fund has a minimum investment amount and buying an equity will require commission, millennials see cryptoasset markets as a way to begin investing with a modest amount of money and in small increments, which is is often not possible with stocks or funds.

They also include a footnote that reads:

Each bitcoin can be divided into 100 million units, making it easy to buy 1/2, 1/10, 1/100 or 1/1000 of a bitcoin

Would recommend removing this passage altogether because there really aren’t many good surveys that indicate who actually bought coins versus who was just interested in them.

For instance, a flawed Finder.com survey that is still being cited, says that 8% of Americans have invested in cryptocurrencies.127  While it says the majority of investors are “millenials,” the survey doesn’t ask the most important question: does the investor control the private key.  If you do not control the private key then you do not control the coin, someone else does.

In addition, there are online brokerages that do allow investors to invest with modest amounts, the most notable being Robinhood (which coincidentally also allows users to purchase several different cryptocurrencies).  There are also a variety of spare change investment apps and robo-advisor products that allow users to have some exposure to regulated capital market too.

Lastly, regarding the footnote they provide: due to the fees required by Bitcoin miners, in practice over the past several months 1/1000 of a bitcoin is typically the minimum transaction fee.  This is one reason why many investors simply leave coins on cryptocurrency exchanges: so they don’t have to pay fees to move them to other wallets.128

On p. 282 they write:

The important point is that at least they’re doing something to invest their funds and build the groundwork for a healthy financial future. We have seen firsthand millenials who have learned about investing from buying cryptoassets and have implemented investing approaches, such as taking profits at certain price points, seeking diversification into multiple assets, and so on.

This should probably be removed too because the same thing can be said to a new cohort of investors twenty years ago, such as the ones that invested in dotcom-related companies.  Who remembers Beenz?

Conclusion

I fully expect some reaction towards this review along the lines that it was too picky or too pedantic.  Perhaps this a little true but consider: what is the right size for a thorough book review in the age of so-so fact-checking?129 Also, most of my previous reviews were about the same length, or at least used the same page-by-page model.

There is obvious room for disagreement in areas involving opinions, but there are many technical and non-technical mistakes that the authors made, not just a small handful.  By highlighting these, not only could the next edition be significantly improved but it helps readers new to this space get a better understanding of what the prevalent themes versus realities are.

The goal of this review was not to be overbearing but to be dispassionate about supposed common wisdom promoted in the cryptocurrency world.

For example, just the other day I noticed in a chatroom the following statement from a maximalist:

HODLer = DAU.  Bitcoin has the most DAUs on any protocol.

HODLing is bitcoinspeak for “hoarding.”

Several people in the room agreed with those this statement and they are not alone.  If the reader is interested in learning about the sociology and subculture of many Bitcoin enthusiasts, its worth skimming reddit and twitter occasionally to see how passionate coin investors think.130

But for businesspeople who are not part of the inner sanctum of Bitcoinland, the statement above from the chatroom may make you shrug.

After all, HODLing a dollar doesn’t make you a dollar user.  HODLing a barrel of oil doesn’t make you a oil user.  HODLing a brick of gold doesn’t make you a gold user.  HODLing a digitized Pokemon card doesn’t make you a Pokemon user.  HODLing a Stradivarius violin doesn’t make you a violin player.  HODLing an Olympic medal doesn’t make you an Olympic athlete.  And so forth.  The valuation of an auction house isn’t measured by the amount of rare collectibles it sells in a day, why should internet coins and their platforms be an exception to that rule?131

Inactivity isn’t how activity is measured.  Or to look at this argument from another angle: HODLing is not ‘active’ anything.  If all an investor did was buy bitcoin and then lose their keys, they would accomplish the same thing described in the chatroom.132

Sure it is possible to redefine what Bitcoin or cryptocurrencies are supposed to do, but that’s after the fact.  For example, if Satoshi had wanted to explicitly build “digital gold” he/she would likely have mentioned it in the original paper at least once and even architected Bitcoin to be something different than what it looked like in 2009.133  As mentioned above, the first app he looked at building was for poker.

This is definitely a topic worth including in the next edition, but I digress.134

Other general areas for improvement:

  • Add a glossary.
  • Add financial disclosures of coins owned by each author.
  • Provide specific definitions for vague terms like “the community,” “administrator,” and the attributes of a target investor; ditch the “innovative” investor nomenclature.
  • Chapter 7 probably should be removed until more accurate comparisons can be found and Chapter 17 seemed a bit unfocused and covered a wide array of topics instead of just one or two… even dropping in thoughts about regulators. Future versions likely need an entire set of chapters focused on regulations, not just mentioned in passing.
  • Based on the incorrect view of financing mentioned in Chapter 5, interview Vitalik Buterin and other co-founders regarding how Ethereum was bootstrapped.
  • In one of the future regulatory chapters, would be good to have a discussion around PFMI, CBDCs, and settlement finality.
  • Provide a lot more references and citations regarding cryptocurrency-focused use cases, especially remittance providers.  This seemed to be the most repeated use case but nary a mention of a specific Bitcoin remittance company, its valuation, or volume corresponding to the use case.

Have a book or paper you’d like me to look at?  Feel free to send it across.  Also, it just came out but this one sounds like a doozy already.  See my other book reviews.

End notes

  1. To be fair, Burniske is not the only analyst-turned-VC who has not publicly disclosed his trading positions of coins, but that’s a separate topic. []
  2. One reviewer mentioned: “Likely it was partially intentional to release in late 2008 / early 2009, but did in fact coincide mainly with internal constraints. We could also argue that the GFC commenced in mid-2007 when BNP Paribas froze two mortgage-backed security funds which became the catalyst of the summer 2007 credit crunch, but that is neither here nor there. I also debate the argument that it was ‘intended’ as anything other than a solution to the double-spend problem, be it a payments system or an investment.” []
  3. As an aside, Brian Kelly, frequently promotes various coins on CNBC.  Unclear what his trading positions are on each coin at the time of recording.  While that may not be illegal, it’s arguably not classy. []
  4. One reviewer mentioned: “This was literally the ethos that led to the GFC. Securitization and Mark-to-model were heralded as “innovation” and championed for their ability to move faster than the academic foundation and until 2007 seen as a way to ‘completely engineer risk out of from the system.'” []
  5. See: Robert Sams on rehypothecation, deflation, inelastic money supply and altcoins []
  6. See tcpipcoin in Section 8 []
  7. See: Digitalization or Automation – Is There a Difference? from Gartner []
  8. One reviewer mentioned: “The authors also miss that “value” is still a function of ‘the market’, i.e. supply and demand. Simply by fixing supply does not equalize demand. I also take massive issue with the governance in “a [de]centralized and democratic manner.” Are the authors able to write C++ or GOLang protocol code for Bitcoin Core or GETH? Likely not. So if anything this walks us towards a new form of governance, except where we elect leaders in the US who ultimately appoint Fed governors in cryptocurrencies there are generally no elections. Long story short, in all cases, it ain’t democratic and it probably remained at least partially centralised at a given point in time.” []
  9. See Central bank digital currencies from the BIS.  I know, I’ll get spammed by all the “sound money” promoters out there who insist that Bitcoin will replace central banks — it’s a religious zeal to many. []
  10. For example, about a month ago, Jonathan Levin from Chainalysis did an interview and mentioned that: “So we can identify, it is quite hard to know how many people. I would say that 80% of transactions that occur on these cryptocurrency ledgers have a counterparty that is a 3rd party service. More than 80%.” []
  11. For instance, on p. xxvi they list “the top 50” coins at the end of 2016 and don’t disclose if they own any specific ones at all, but talk about many of them in positive ways.  Adding a disclosure would be helpful. []
  12. Bitcoin has ‘no intrinsic value,’ Brookfield CEO says: ‘It’s not for us’ from Financial Post []
  13. The Economist wrote a nice short article on this behavior — the greater fool – last year. []
  14. For example, on p. 9 they write: “Shortly thereafter, Satoshi vanished.  Some speculate it was for the good of Bitcoin. After all, being the creator of a technology that has the potential to replace much of the current financial system is bound to eventually invoke the wrath of powerful government and private sector forces.”  This seems like a strawman.  Bitcoin was designed for just one simple thing: payments.  The financial system is an interwoven network of hundreds of regulated and unregulated goods and services, not just payments.  Also, this paragraph, like a few others later, has elements of conspiratorial boogeymanism.  Just around the corner, the government is preparing to shut down Bitcoin!  Nothing like that has happened in the past 9+ years.  In fact, the opposite has been true as most jurisdictions have been pretty accommodating, arguably even too lenient on the issuance and usage of cryptocurrencies, but that is a topic for a different post. []
  15. See Layer 2 and settlement []
  16. See Breakthrough IT Banking from McKinsey and Bank IT spending to hit $241bn across four major global regions from ComputerWeekly []
  17. One reviewer mentioned: “Are the authors aware that CMOs first appeared in 1983, and that in many countries where they were heavily utilised including in the late 2000s they worked as advertised? In fact many CMOs in the US performed as modelled. The issue was, and is, always liquidity, over-leverage and most of all deteriorating lending standards. Cryptocurrencies will most likely be looked at as catalysts of these risks should their notional rise substantially, not their saviour.” []
  18. One reviewer commented: “Are they arguing that people would have been more able to pay their mortgages or that home values wouldn’t have fallen if CMOs were on a blockchain?” []
  19. One reviewer explained: “When someone claims that blockchain would have prevented the mortgage crisis, they are revealing their ignorance of their ignorance.  I worked with some of that CMO data. One former colleague works for one of the large consulting firms ‘blockchain’ practices. He posted something about how blockchain would address the problems with mortgage servicing . When I privately asked him how it would do so,and that the problems with mortgage servicing that I was aware of were either failure to do certain required activities or their failure to record that they did them, as opposed to someone changing the record after it was entered, he did not respond.” []
  20. See also: The Problem with Calling Bitcoin a “Ponzi Scheme” by Preston Byrne []
  21. For example, at the time of this writing, Coinmarketcap tracks 1641 different types of coins and tokens.  Many of these are likely ERC20 tokens and thus rely on Ethereum itself and are not independent blockchains. []
  22. Worth re-reading the recent DoJ indictment of GRU officers as the DoJ provides a reason for why Bitcoin was used versus other transmission methods. []
  23. Someone should create a website that tracks all of the gigantic bullish claims from Bitcoin promoters on how it will topple banks and destroy governments.  There are at least more than 100 such public predictions each month. []
  24. But “be your own payment processor” isn’t a catchy phrase. []
  25. Readers should check out: “The Path of the Blockchain Lexicon (and the Law)” by Angela Walch. []
  26. It ignores how mining pools can unilaterally determine what transactions to include and how much a fee a transaction should include in order to be included in a block. []
  27. For example, KARMA : A Secure Economic Framework for Peer-to-Peer Resource Sharing by Vivek Vishnumurthy, Sangeeth Chandrakumar and Emin Gun Sirer []
  28. Recommended reading: The Economic Limits of Bitcoin and the Blockchain by Eric Budish []
  29. Some literature describes the proof-of-work process used in Bitcoin as a “scratch-off puzzle.” []
  30. One reviewer mentioned: “A model that I like to describe this with is how the main professional soccer leagues are selected in Europe and other regions. For example, France specifically has an annual selection of the “League 1” after the Coupe de French. Basically any team can enter, but practically there is minimal turnover because a team from a town of 5,000 people is unlikely to reasonably beat a team like Paris or Lyon which has multi-million euro budgets. There are few upsets, but these can generally be modeled by statistical chance.” []
  31. For example, Coin Center circulated a borderline defamatory note to ESMA with regards to Corda – even before the Corda introductory whitepaper was released – likely because its author was unfamiliar with how the platform actually worked. []
  32. It seems to be a euphemism and code word for “someone with money who should buy coins.” []
  33. Based on public information, over the past four years pretty much the only cryptocurrency-related companies that probably were profitable equity investments were: exchanges and handful of mining companies operating outside of the US (e.g., some service providers have also generated steady income including several law firms and conference organizers). []
  34. In both cases, consensus is achieved by the longest chain rule. []
  35. May not be a Freudian slip here, but keep in mind all blockchains have operators and maintainers.  See “arewedecentralizedyet” for more. []
  36. It arguably could have been a self-fulfilling prophecy: investors outside of Cyprus hear news about the Cyprus bailout and bitcoin… thereby marketing bitcoin to new retail investors who then go out and buy bitcoins to try it out. []
  37. See also the background of R3 / DLG as well. []
  38. It is common to see Bitcoin promoters regularly demonize these companies who are trying to improve and automate infrastructure, vilified as a bourgeoisie activity that must be shunned.  Worth revisiting to see if this changes over time. []
  39. One of the few exceptions is the Brave browser. []
  40. Creating and marketing coins to retail investors is relatively easy… building infrastructure that customers actually regularly use for commerce is another level altogether. []
  41. If measured by price, there was a large bubble that popped in December 2017, but that was something that happened after publication. []
  42. I have given several public presentations in the past year explaining the “trough of disillusionment” phenomenon in this context, including in Seoul and Tokyo during July 2017. []
  43. See also: Tokens: Investment Vehicle or Medium of Exchange (Not Both) by Cathy Barrera and MV=P…Que? Love and Circularity in the Time of Crypto by Anshuman Mehta and Brian Koralewski []
  44. Furthermore, in September 2014 I gave a presentation (video) (slides) that similarly tried to bucket different types of proposed coins as “commodities” and the like.  And I know I wasn’t the first to try and do so.  Recommend readers do a bit more digging on this topic if they’d like to see a more thorough origin story. []
  45. One reviewer mentioned: “The native tokens / coins / assets inside a ledger are “cryptocurrencies”, they are currency in the single sense that they the only form of compensation accepted by the miner / staker in a network. This cryptoasset business really only makes sense in the context of units which are not used to pay for the security of a blockchain.” []
  46. But that doesn’t necessarily excite speculators and coin holders. []
  47. See: Bitcoin Is Now Just A Ticker Symbol and Stopped Being Permissionless Years Ago []
  48. There are few religious undertones here that could be removed in the next edition. []
  49. As mentioned above, The Economist wrote a nice short article on this behavior — the greater fool – last year. []
  50. The authors of this book are likely unintentionally promoting coin buying with a security-like mentality, the wording could be modified in the next edition. []
  51. One reviewer mentioned: “Unless the authors explain how ETH is worth precisely zero based on the same logic then their statement seems disingenuous. Not that I believe that is the case, but I am not the one stating that scarcity in the future is the reason for the value.” []
  52. See Saifedean Ammous: The Bitcoin Standard — making the Austrian School case for Bitcoin by David Gerard, The Bitcoin Standard – a critical review by Frances Coppola, and The Politics of Bitcoin by David Golumbia []
  53. Why?  Most probably are unaware and the typical retail investors seems to just want the USD number to go up so they can sell the coin to someone else. []
  54. Also worth reviewing Consensus-as-a-service and The Blockchain Threat Has Drastically Sped Up Cross-Border Payments []
  55. Since the authors are making this claim, would they be willing to disclose or be transparent about their own coin holdings for the date when they published this book? []
  56. The most likely answer is: speculators bought these coins because they knew others would buy it too thus driving the price higher. []
  57. Or conversely, you are considered “one of us” if you promote the policies and antics of said coin promoters. []
  58. Note: it should be apparent at this stage that “Bitcoin developers” should be in quotes because it is certain key individuals — and centralized organizations such as “Core” — who have the power to sway decisions such as BIP approval.  These are arguably administrators of financial market infrastructure.  See also: In Code(rs) We Trust: Software Developers as Fiduciaries in Public Blockchains []
  59. Personal correspondence on June 5, 2018 []
  60. This is mentioned in the new CFTC warning: CFTC Issues Customer Advisory on Digital Tokens []
  61. It is these types of passages that make a reader scratch their head as to whether or not the lessons for why equity ownership — and the rights afforded to equity holders — evolved to where they have in developed countries. []
  62. This narrative needs to be buried but probably won’t. []
  63. This is a common refrain that needs to stop being repeated. []
  64. A few months before Cryptoassets was published, the SEC published a report that said they found The DAO to have all the hallmarks of a security but they never enforced any specific legal action on its creators. []
  65. See Appendix A: Internal governance []
  66. On p. 63 they write: “For example, a fully functional decentralized insurance company, Airbnb, or Uber all hold great promise, and developer teams are working on similar use cases.”  Why do these hold great promise?  Because everyone else says that on stage? []
  67. One takeaway is that other speculators may buy your coins at a later date when the prices go up, so you should get in before they do. []
  68. One of the biggest flaws in Chapter 7 is that all of the pricing information for the coins are based on markets that are opaque and unregulated… some of whom may be considered bucket shops of yesteryear.  Lack of transparency is one of the reasons why all of the Bitcoin-related ETFs have been (so far) axed by the SEC.  See: Comments on the COIN ETF. []
  69. Are Public Blockchain Systems Unlicensed Money Services Businesses in Disguise? by Ciaran Murray []
  70. With the exception from maybe transaction fees to miners, but those could arguably also be classified as donations.  See p. 65 in The Anatomy []
  71. See: Spurious correlations []
  72. For example, later on p. 104 they write: “More surprisingly, the portfolio with bitcoin would have had lower volatility.” Because of the time period?  We could probably find other things with the same or lower volatility.  That seems like cherry picking. []
  73. Maybe they are both, but that still doesn’t mean that the coins, say that Placeholder Capital invested in, shouldn’t be classified as securities. []
  74. See also: Tokens: Investment Vehicle or Medium of Exchange (Not Both) by Cathy Barrera and MV=P…Que? Love and Circularity in the Time of Crypto by Anshuman Mehta and Brian Koralewski []
  75. Also, these are all arguably poor stores of value because of their relatively high volatility.  For instance, “number goes up” or rapid price increases is not the definition for a store of value.  Claiming bitcoin is a good store of value because it sees swift increases in price appreciation as measured by actual money is a contortionist view which ignores the empirical reality of how money is used. []
  76. For example, later on p. 110 they write: “While many cryptoassets are priced by the dynamics of supply and demand in markets, similar to more traditional C/T assets, for some holder of bitcoin — like holder of gold bars — it is solely a store of value. Other investors use cryptoassets beyond bitcoin in a similar way, holding the asset in the hope that it appreciated over time.” Spoiler alert: everyone that owns internet coins hope they appreciate over time. []
  77. And there are specific projects — such as Bitcoin — in which one clique of developers waged an effective propaganda campaign against miners.  For more on this, look into the actors and organizations behind the Segwit / Segwit2x / UASF online debates. []
  78. Not to rekindle the flames of the Bitcoin blocksize debate but in retrospect, several Blockstream employees and contractors were arguably more effective at swaying public opinion than Coinbase was, even though the latter generates significantly more revenue and has actual customers whereas the former is largely just a R&D dev shop. This discussion deserves its own post but neither company is very forthcoming about client or partnerbase… although Coinbase has published a bit more information over the years relative to Blockstream. []
  79. See also: The Problem with Calling Bitcoin a “Ponzi Scheme” by Preston Byrne []
  80. A large portion of blocks between 2009-2010 also included relatively few transactions, yet miners were being rewarded the same revenue irrespective of the volume or labor involved. []
  81. This is a topic I’ve written extensively about in the past, see (1) A pre-post-mortem on BitPay and (2) Looking at public information for quarterly usage []
  82. There is a small window between when FX markets in San Francisco close on a Friday afternoon and when FX markets open in New Zealand on Monday morning. []
  83. See Bitcoin’s $30 billion sell-off from Chainalysis []
  84. Does trading between exchanges represent 90+% of the total volume on- and off-exchanges?  Without full optics into all major intermediaries, that would be a tough claim to definitively prove. []
  85. In informal surveys most speculators of coins have the same mentality of speculators of other things that are traded on secondary markets: they think the number will go up. []
  86. See When Paper Paralyzed Wall Street: Remembering the 1960s Paperwork Crisis from Finra and The Remaking of Wall Street, 1967 to 1971 from HBS and Dole Food Had Too Many Shares from Matt Levine []
  87. Also recommend Spurious correlations []
  88. The book downplays illicit activity as if it is not a valid, reliable use case when it is.  For instance, the GRU allegedly used bitcoin to finance some of its operations focused on the 2016 US elections and they did so to obfuscate their tracks. []
  89. See The new TARGET instant payment settlement (TIPS) service from the ECB []
  90. For more on this, see: (1) Debunking Bitcoin’s Remittance Valuation. Featuring a Lead Pipe by Anshuman Mehta and (2) Does Bitcoin/Blockchain make sense for international money transfers? from SaveOnSend []
  91. A fundamental problem with this book is that it wants to have it both ways, with no clear goal posts for what a good or bad platform is and how to measure it.  How can an investor know if a coin is any good?  A table of attributes is recommended for the next edition. []
  92. Simply multiplying the amount of mined / pre-mined / pre-allocated coins by the market price to arrive at a “market cap” is a disservice to how market capitalization is actually determined.  See Section 6. []
  93. As an aside, even though there is no law preventing consumers and merchants from using or accepting gold (or silver) as a means of payment in the US, basically no one does because they’d rather hold it with the expectation of future price appreciation. I am sure lots of angry trolls will point out that legal tender laws in the US do not currently include precious metals and neither are cryptocurrencies.  Yet there are other economic reasons why people would rather hold onto an internet coin or a gold bar versus use it as money, and simply blaming legal tender laws is missing those. []
  94. Recommended reading: Distributed ledger technology in payments, clearing, and settlement by the Federal Reserve and Central bank digital currencies from the BIS []
  95. See several articles: The myth of a cheaper Bitcoin network: a note about transaction processing, currency conversion and BitcoinlandWhat is the “real” price of bitcoin?, and What impact have various investment pools had on Bitcoinland? []
  96. Also, as a pre-emption: one of the main reasons why these merchants and manufacturers do not hold on to these coins is because of… volatility.  As shown earlier in this review, that still hasn’t disappeared despite years of promotion that it has.  See also: (1) Debunking Bitcoin’s Remittance Valuation. Featuring a Lead Pipe by Anshuman Mehta and (2) Does Bitcoin/Blockchain make sense for international money transfers? from SaveOnSend []
  97. And as mentioned in the section above, both Zelle and Swift (gpi) will likely make a lot of inroads in the same national and international areas that cryptocurrency advocates were touting… but without needing a coin.  The struggle is real. []
  98. Note: both have since left those jobs.  Bogart became a partner at Blockchain Capital (a venture fund focused on coins) and Luria joined D.A. Davidson []
  99. In the next edition if possible, try to include Placeholder’s research so we can have an idea of the firm’s internal thinking on these issues. []
  100. Recommended: Digital Tulips? Returns to Investors in Initial Coin Offerings by Hugo Benedetti and Leonard Kostovetsky []
  101. Does Placeholder Capital invest in such ICOs? []
  102. Note that selfish mining has some odd game theoretic properties which may not hold up in the real world. But if the selfish mining pool manages to stay a block ahead on average, they can reveal a longer chain whenever they see transactions they want to censor.  It comes with the caveats that it’s not completely reliable in that they aren’t guaranteed to be a block ahead of the rest of the network 100% of the time (due to the inhomogenous Poisson process mentioned earlier). However, if they manage to effect a cohort of self-interested selfish miniers, they could… and that’s the equivalent of a “51% attack.” []
  103. Recommended reading: The Economic Limits of Bitcoin and the Blockchain by Eric Budish []
  104. Recommended: Analysing Costs & Benefits of Public Blockchains (with Data!) by Colin Platt. []
  105. Based on hash rate, the vast majority of mining pools supported Segwit2x and did not support UASF. []
  106. Coincidentally, these have all obtained a Bitlicense from NYS DFS. []
  107. Kraken uses Silvergate for its OTC trading. []
  108. A user can be defined as a person who controls their private keys without relying on a 3rd party intermediary. []
  109. Several analytics providers include: Chainalysis, Blockseer, Elliptic, Scorechain, and CipherTrace. []
  110. This is reminiscent of the BearWhale nonsense a few years ago. []
  111. Recall that historically, humanity went from only having to bearer assets up through the 19th century.  And that for a variety of reasons these became registered and immobilized and then later dematerialized altogether.  Cryptocurrencies recreates a financial order that had already existed. []
  112. See Learning from the past to build an improved future of fintech and Distributed Oversight: Custodians and Intermediaries []
  113. Butterfly Labs began accepting pre-orders in the summer of 2012 but delivered them late in 2013… and got sued by the FTC. []
  114. Regarding ‘perfect competition,’ four years ago Jonathan Levin opined that: “Another simple thing about this is that it is unsurprising that the bitcoin network got into this mess as it is economically rational to join the biggest pool. Minimises variance and ceteris paribus reduce orphans increasing expected return per hash. The other point is that there is still hardware bottlenecks so designing the theoretically most robust system may fail due to market imperfections. Implicitly in many arguments I hear about mining people assume perfect competition. Do we need to remind people what are the necessary conditions for perfect competition? Perfect information, equal access to markets, zero transportation costs, many players ……. this is clearly not going to be a perfectly competitive decentralised market but it certainly should not favour inherently the big players.”  See p. 114 of The Anatomy []
  115. Some of these are detailed in: Comments on the COIN ETF []
  116. For illustrative purposes, this includes: Circle, JUMP Trading, and Cumberland (DRW). []
  117. See also: New Visa chargeback system aims to speed dispute resolution by John Egan []
  118. See U.S. Regulators Subpoena Crypto Exchange Bitfinex, Tether from Bloomberg []
  119. In his public speaking events and social media accounts, Andreas Antonopoulos is quite candid about his dislike of the establishment. []
  120. See Chapter 2 in The Anatomy []
  121. See Brian Armstrong’s tweet in Section 5 []
  122. This raises questions that related to FinCEN and SEC purview but neither has opined at this time on this specific point. []
  123. CoinAgenda Singapore, which took place in June 2018, only had 168 attendees — with ticket prices up to $3,000 apiece. []
  124. Coins.ph and Luno come to mind as examples. []
  125. See What is the difference between Hyperledger and Hyperledger? []
  126. See A brief history of R3 – the Distributed Ledger Group []
  127. Needs a larger sample size conducted in a public venue, and/or with the help of an experienced sampling organization. []
  128. This then leads to incentives to attack and hack exchanges, because they end up acting as deposit-taking institutions, aka banks. []
  129. There were probably 50% more hand-written notes or comments that I could have added that I skipped over. []
  130. The HODLing “digital gold” meme which was only passingly mentioned in this book ultimately degenerates into goldbugism but that’s a topic for a different post. HODLing arguably became a thing once the ideologues realized Bitcoin itself wasn’t a competitive payment system.  An enormous amount of revisionism has taken place since 2014 regarding what Bitcoin was and is and should be. []
  131. Debunking Bitcoin’s Remittance Valuation. Featuring a Lead Pipe by Anshuman Mehta []
  132. One reviewer mentioned: “By hoarding then actively purchasing more coins to hoard, they might temporarily create an effect whereby each marginal contribution to Bitcoin through mining rewards in expanding the effective monetary base is partially neutralized.  In addition to marketing campaigns, this can lead to higher USD values and may incentivize additional mining power, which in turn creates higher hashrate.  However, you cannot make the same argument for gold because simply driving the price of gold up doesn’t make gold harder to find or more secure, and in fact we see the opposite.” []
  133. For instance, the supply of gold is actually elastic whereas many cryptocurrencies including Bitcoin have an inelastic money supply.  Where in the whitepaper does it talk about a store of value?  If that was the goal, surely it would’ve been mentioned in the whitepaper or the first few emails upon Bitcoin’s initial release. []
  134. Recommended reading: The Economic Limits of Bitcoin and the Blockchain by Eric Budish []

Is the Pitato why we can’t have nice things?

[Note: I originally wrote the bulk of this article as an unpublished memo about 18 months ago. I have updated it to include new information.  The views and opinions expressed in this article are mine and do not necessarily reflect the views of my clients.]

The big news this past week was that Coinbase acquired Earn.com (née 21.co, née 21e6 LLC). According to Recode, the offer “was slightly more than $100 million” but also lower than Earn.com’s most recent valuation (in 2015) which was $310 million.

From the current coverage, it is unclear what the revenue for any of the products or services for Earn.com was.  Instead most stories have focused on one specific aspect: the current Earn.com CEO, Balaji Srinivasan, will join Coinbase as the CTO.

There have been a lot of questions around why Coinbase would purchase a company that seemed to have poor product-market fit with unknown KPIs. This post will look into several areas for answers.

Taking a step back

Following the official acquisition announcement from Coinbase, Srinivasan published a self-congratulatory Medium post that basically paints him as the savior of 21.co: that it was the previous management that were bad and he came in and turned it all around.1

His revisionism arguably whitewashed what happened, so let’s dive into a little bit of the company’s history.

In May 2013, 21inc (formerly 21e6 LLC) was co-founded by five men including Balaji Srinivasan. According to a story from Nathaniel Popper:

The company was also structured as an limited liability company, rather than the C Corp typical of startups, so that people could invest with their own money.

Why is that important to some investors?

According to Popper:

The 21e6 investment was attractive in part because venture capital firms generally felt that they couldn’t buy Bitcoins directly. 21e6, on the other hand, offered to pay its investors back with Bitcoin dividends, allowing the firm to get Bitcoins without buying them outright.

What does this mean?

Venture funds often have clauses restricting their partners from investing in asset classes that may be seen as a conflict of interest or something that could reduce the firm’s reputation (e.g., cannabis startups). In this case, cryptocurrencies may be seen as a direct speculative bet on a commodity or foreign exchange which could be prohibited by an investment funds by-laws.2

Altogether the 21e6 team, over three separate rounds, raised approximately $116 – 125 million – which at the time was more money than any other cryptocurrency-related company.3 The sum total varied depending on news source but Srinivasan frequently made it a point to casually insert comments such as: we are the “most funded” or “best funded” company in Bitcoin into interviews and talks during 2015-2016.

In the beginning

In its early days 21e6 focused exclusively on designing custom ASIC chips for Bitcoin mining and then integrating and deploying Bitcoin mining hardware for private, non-retail usage. This included installing hundreds of hashing systems in data centers which for several reasons eventually became uncompetitive against those based in China and the Republic of Georgia.45

Based on publicly available information and allegedly leaked slides we know that:6

It closed its Series A for $5 million in May 2013.

  • Investors included: Peter Thiel, David Sacks, Max Levchin, Marc Andreessen, Ben Horowitz, Naval Ravikant, Winklevoss Capital, Mark Pincus
  • Estimated $3.8 million revenue in 2013

In June 2013, then-CEO Matthew Pauker filed a Form D, Notice of Exempt Offering of Securities, which stated that 55 investors had already invested in its offering.7 While that may sound unusual for an early stage company to have so many investors, recall what Popper pointed out above, that individual investors could invest directly into 21e6 because of its LLC status.

It closed its Series B for approximately $65 million in December 2013.

  • Andreessen Horowitz (the VC fund) invested $25 million as the lead investor; and $10 million came from existing investors (such as $100,000 from Pantera)
  • $30 million also came in the form of “venture debt”
  • Estimated $41 million in revenue in 2014
  • 19 employees in November 2014

The funds from its first two rounds were used in part to design and deploy “Gandalf” (its 2nd generation ASIC chip) and “Yoda” (its 3rd generation ASIC chip) in the aforementioned data centers.

How much capital is required to build a state-of-the-art ASIC chip? Depending on how much is done in-house or out-sourced as well as the fabrication facilities, it can be upwards of $15 – $20 million.8

First major pivot

The company rebranded from 21e6 to 21.co and announced its Series C on March 10, 2015, with $56 million led by RRE Ventures. 9

That morning, The Wall Street Journal led with the story:

Secretive Bitcoin Startup 21 Reveals Record Funds, Hints at Mass Consumer Play

This marked the beginning of its pivot from purely building mining hardware and instead marketing itself as supposedly moving into the Internet of Things (IoT) and API marketplace.  Around this time you frequently saw 21.co and its supporters publicly talk about machine-to-machine (M2M) payments as being a killer app.10 One of the 21.co engineers was even interviewed on a (now deleted) podcast where he spoke about how drone owners would pay tolls denominated in bitcoin to cut across airspace over yards in your neighborhood. You know, the usual word salad and shower thoughts on social media.

When I first drafted this memo 18 months ago, based on LinkedIn profiles, 21.co had about 25 full-time employees; as of now their page says 22 employees but most of them are just people adding 21.co in their profiles without formally being affiliated with it. Most of the current employees unsurprisingly have shifted to Earn.com’s official LinkedIn profile. Its tally is 63 people but again, some of these profiles are from people who are likely unaffiliated with the organization.

Other known investors through 2016:11

  • Data Collective
  • Khosla Ventures
  • Yuan Capital
  • Drew Houston
  • Dara Khosrowshahi
  • Avant Global
  • Karl Mehta
  • Capricorn Management / Jeff Skoll Group
  • Qualcomm Ventures
  • World Innovation Labs

Other board members/observers:

  • Alan Chang (Jeff Skoll’s family office via Capricorn Management) in Series B
  • Richard Tapalaga (Qualcomm Ventures) in Series C
  • Gen Isayama (World Innovation Labs) in Series C

According to Nathaniel Popper, as of March 2015 when it announced the closing of its Series C round, “the company has paid back all of its investors.” It did so partially via payouts in bitcoin.

In his self-canonization this week, Srinivasan wrote that:

And with this deal, the total value of cash, cryptocurrency, and equity returned to our shareholders is now in excess of the capital invested in the company.

How much of the cryptocurrency above is from the not-yet-released Earnable Token? Get the whitepaper while you still can.

Since March 2015, there has also been noticeable churn at the top:12

  • Matthew Pauker, co-founder, was replaced as CEO in spring 2015 by Balaji Srinivasan
  • Albert Esser was the COO from December 2013 through August 2015
    • Replaced by John Granata from March 2016 to the present
  • Nigel Drego co-founder, was chief architect from May 2013 through March 2016
    • Replaced by Jian Li as CTO from March 2016 through 2017
  • Lily Liu became CFO during summer 2015 to the present

Because of the economic incentives that tilt in favor of mining countries like China, 21.co stopped its operations in the Bitcoin mining sector and those subject-matter experts seem to have left the ranks.

Second major pivot. Or part of the first?

What has it built since the pivot after Series C?

The 21 Bitcoin Computer was their first consumer-facing product that was announced on September 21, 2015 and released with great fanfare as an exclusive to Amazon Launchpad on November 16, 2015 at a price of $400.  It also picked up the “toaster” nickname from the Financial Times.13

Several enthusiasts explored the component prices via a piece-by-piece breakdown and found that it likely cost around $247 to build each 21 Computer.14 It was subsequently nicknamed the “Pitato” because the main component at its heart was basically a Raspberry Pi, a popular DIY kit that sells for less than $200.

The only other notable piece of tech was a custom built ASIC chip that could be used for mining.  However, ever before it had shipped, the mining chip was already uncompetitive and obsolete.  Even if you had free electricity you likely would not generate enough bitcoin in order to recoup the full cost of buying the 21 Computer, especially since the few satoshi you generated would be stuck as dust.15

What were the maths behind this?

In September 2015, after it was announced, Vitalik Buterin crunched the numbers and worked out that:

So you’re paying $399 upfront and getting $0.105 per day or $38.3 per year, and this is before taking into account network difficulty increases, the upcoming block halving (yay, your profit goes down to $0.03 per day!) and, of course, the near-100% likelihood that you won’t be able to keep that device on absolutely all of the time. I seriously hope they have multiple mining chips inside of their device and forgot to mention it; otherwise you can outcompete this offering pretty easily by just preloading a raspberry pi with $200 of your favorite cryptotokens.

Why the relatively large markup for a device?  Part of it is that Amazon Launchpad gets a 25% cut.

But like just about all things Bitcoin, sales numbers were so bad that they were never disclosed and it was eventually discontinued. Prior to its discontinuation, 21.co representatives approached multiple well-known Bitcoin developers to help resell the devices. In short, these developers were offered to buy 21.co devices at wholesale prices and expected to resell them at the retail price. It is unclear how many (if any) developers did so.

For real, the second major pivot

On April 1, 2016, 21.co launched an app “marketplace” and initially seeded it with 50 apps that were built in-house. At the time, the only way to externally measure usage or traction is to manually observe the amount of ratings (stars) an app had each day. Interestingly, in early July 2016 the amount of apps stood at 95 whereas six weeks later it fell to 76 and basically fluctuated for the remainder of the year.

In May 2016, Srinivasan took the stage at Consensus and announced his vision of a “machine payable web” and introduced several ideas but notably did not mention the Bitsplit which was rumored to have been in the works for over a year.16

Throughout the remainder of the year, 21.co sponsored and hosted meetups and had an active Slack room, and most of the ideas that were used or borrowed as API and app ideas, languished due to… a lack of users.17  If you are new to my site, one reoccurring observation is that in general: cryptocurrency owners typically are not actual users, but that’s a whole different discussion.

The 21.co Marketplace now redirects to the Earn.com homepage.

Pivot three

On October 27, 2017, 21.co emailed its users that it was ending server-side support for three things: the Bitcoin Computer, 21 command line interface (CLI), and marketplace. 18

Three days later, 21.co announced that it was rebranding as Earn.com and pivoting away from its second vision as a VC-backed quasi protocryptojacking play towards taking on Amazon Mechanical Turk, but with Bitcoin. It also announced a non-ICO ICO called Earnable Token, which as you can tell from its name: was earnable from doing the same kind of tasks as you could before like: filling out surveys or answering bots who email you.

Earn.com also migrated the unique profile pages it first introduced with 21.co, which is basically a static page that users can claim and use a bit like LinkedIn, but with more Bitcoin-related spam.19

Source: Twitter

Unregistered securities?

This last part is of particular interest in today’s regulatory climate because Earn.com, which hosts these user-controlled accounts, has accidentally assisted and enabled the promotion of alleged unregistered securities (ICOs) as a business line.  Recall that Google, Facebook, Snap, Twitter, Mailchimp, and other tech companies have reduced or removed the ability for ICOs and cryptocurrency promoters to solicit retail investors, Earn.com has done the opposite and been a refuge.  At what point is this an unsuitable risk profile for a “bank” like Coinbase?20

What does that mean?

In its January 2018 update, Earn.com announced that:

This week we were thrilled to announced the launch of Earn.com Airdrops — a new way for blockchain entrepreneurs to give 100,000+ Earn.com users a free trial of any new coin or token. Airdrops allows token projects to instantly bootstrap your new blockchain project with 100,000+ cryptocurrency early adopters.

We announced our first Airdrop partner, CanYa — a decentralized marketplace for services — as well as the next three upcoming Airdrops: Bloom, Bee Token, and Vezt. Sign up for an account on Earn.com, verify your account, and download the Earn.com mobile apps on iOS or Android apps to become eligible.

I am not a lawyer but in the past – like the dotcom era – companies (including startups) have attempted to give away equity in some very creative ways… and depending on the circumstances, it can be a no-no.21 That’s not to say that the tokens above are securities or that any airdrop is a violation of securities laws. But highlighting this type of feature has inadvertently led to Earn.com becoming a magnet for ICO issuance and promotion.

Where’s the beef?

What was the long term deliverable for roughly $125 million in nearly 5 years?

Throughout 2016 – including at Consensus in NYC – Srinivasan explained that they will announce a “surprise” in the coming months, maybe all of the aforementioned products and chips were the alpha phase of a much larger operation?  Maybe they were, but we probably won’t find out.

Either way, it is worth keeping in mind that between 2013-2016, cryptocurrency-specific startups collectively received a little more than $1 billion in external funding, with nearly 15% of that funneled into just one startup. One who has had to pivot multiple times to find the right product-market fit and tech-market fit.  Keep in mind too that other companies such as Bitfury and Bitmain were able to make superior chips and do so initially without major venture backing.22

If the most funded, best connected startup continually struggled to see consumer traction, what are the prospects for less funded and less connected cryptocurrency startups?  This is worth revisiting in another long-read, especially in seeing what the $125 million was actually spent on (salaries? chips? toasters?).

How involved was he?

Source: Twitter

One of the investors in 21.co responded to Nathaniel Popper above claiming that Srinivasan wasn’t actively involved in the first two years.

Does it matter? Sure, when you are claiming successes and denying failures that should or shouldn’t be attributed to you.

Below is a quick series of interrelated anecdotes.

In December 2014, Srinivasan and I both attended and presented at what would become the second of three round table events organized by R3 (a family office then called R3 CEV).  This was prior to the formal creation of the DLG consortium.23 Unfortunately I do not have his presentation, but the layout and design were nearly identical to the leaked slides that have circulated for years — just with different content.  For instance, the design of his slides at a public talk in the spring of 2015 is pretty close to the other two decks.

In January 2015, I was unexpectedly shown a long set of slides for a company called 21e6, most of which look similar to what has been leaked in the past and linked to above.24

Later that same month – due to a variety of circumstances – I met up with Srinivasan in Palo Alto and he quickly paged through the leaked presentation and stated it was an older deck from October / November 2014.

While there is a little more to our subsequent interactions, I think the key part here and the only reason I brought up this personal anecdote is the fact that Srinivasan was able to dismiss the deck of having any relevance on the current fundraising 21e6 was doing (remember, this was less than two months before the round was publicly announced).25

So while he may not have been “day to day” as he disclaims in his post, he clearly was involved in the fundraising process if not more (deck creation?).  He said as much in a post published in March 2015.

So what to make of all of this news?

An exit is an exit, right?

What ultimately appears to have happened is that Andreessen Horowitz took one of its floundering portfolio companies and merged it with another portfolio company… and declared it a great success.2627

The circle of life...

Source: Twitter

There also appear to be a few parallels with Juicero.28 For those unfamiliar, Juicero is a now-defunct Silicon Valley-based startup that built and sold a custom $400 machine that would squeeze juice packets.  It raised $120 million and unceremoniously shut down last year after reporters showed that the hands from mere humans were capable of squeezing the same juice packets.

In much the same way, during the second pivot of 21.co, no one really bothered to buy the “Pitato” because users could easily do the math: that it was far more effective to either buy bitcoins outright or buy and use more capable mining hardware.

Why hasn’t anyone written about this before?

Most of the knowledge above is public, or at least, pretty well known if you have spent much time in Bitcoinland.  Other reasons involve some tinfoil hat theories around retaliation.29

Funnily enough, back in March 2015 I had a long email exchange with Michael Casey and Paul Vigna over at The Wall Street Journal regarding 21.co and other several other topics.

This culminated in the quote:

Tim Swanson, a consistently skeptical digital-currency consultant who makes a habit of challenging bitcoiners’ unbridled optimism, is unequivocal. 21′s plan is “a dumb idea,” he says, adding that “the investors deserve to get what’s coming to them.”

And while a few of those investors probably did, it is Coinbase share holders that likely got it on the chin this week.30 If you’re looking for more memorable gems, be sure to read this older WSJ article.  It is chocked-full of hubris, kind of like Juicero.31

In closing, raise your hand if you’d like to get paid every time you respond to an email and moreso to a cold email?  I know I would.

So maybe with all of the kinks, toasters, pivot denialism, and chest thumping there is still a future for a pay-to-respond model to thrive.  Maybe Coinbase can turn the ICO sanctuary of Earn.com into a legitimate mainstream product that is integrated with various webmail providers and social media platforms. Or maybe this ends up like ChangeTip, whose platform was basically used to spam coin dust on Twitter… to ultimately shutting down after an acquihire from Airbnb.

Either way, there was a bit more to this story than what was let on in Srinivasan’s original Medium post on Monday.

Update: (see note) 32

Endnotes

  1. Would that be a Bitcoin-powered bus that the management team was thrown under? []
  2. Over the past several years, multiple venture funds have had their by-laws amended or re-written to allow them to purchase cryptocurrencies and directly invest into ICOs. []
  3. In March 2015, 21inc announced that it had raised a total of $116 million, however according to Nathaniel Popper’s account of their history, they had raised about $125 million. For one reason or another, historically many cryptocurrency companies do not typically reveal their active user numbers or revenue figures. Instead they prefer talking about how much outside funding they have raised. And 21.co was not an exception to this. []
  4. There are several reasons why this was the case.  With the right guanxi: a combination of electricity, land, and taxes could be cheaper in certain parts of China versus the US.  In addition, 21e6 and other US-firms were consistently unable to manufacture mining machines and operate farms at a similar scale as their peers.  Part of this was logistics as well: large portions of the supply chain were based overseas (primarily in Guangdong and Taiwan). I have written about this in multiple different posts over the past several years, such as this piece. []
  5. One of the interesting things that Srinivasan’s article confirms was a rumor I first heard two years ago from one of their mining competitors: that 21e6 had signed leases with data centers whose energy rates were so abysmal that you might as well just bought coins instead as it would basically be impossible to recoup those costs. Another unconfirmed rumor was around immersion cooling: that between 2014-2015 21e6 had experimented and burnt through a large quantity of chip inventory in a radical attempt to reduce the cooling needs and costs of mining chips. []
  6. Some of this information comes from: reddit, CoinDesk, Financial Times, and Jorge StolfiGoogling around too. []
  7. Form D – note that the domains 21e6.com and .net and .org all registered around March/April 2013. []
  8. Why Are Computer Chips So Expensive? from Forbes. In addition to non-recoverable engineering, there are also component costs and testing thereof: PCB, SMT, power supply, fans, integration. Testing and trouble-shooting cannot be ignored. For instance, Hashfast was an example of a company who built a relatively fast chip but had problems with managing the power source and consequently went bankrupt. []
  9. At the time it was frequently reported that 21.co had raised $116 million but that was the sum total of all funding rounds.  The Series C was ~$56 million. []
  10. Srinivasan did talk about micropayments as early as March 2014. []
  11. Sources: CrunchBase / AngelList []
  12. In May 2015 it was reported that Cisco may invest or may have invested in 21inc. Padma Warrior, former Chief Technology and Strategy Officer at Cisco, was rumored to be a key individual involved in that deal. Note: as of August 2016, a site redesign on 21.co removed investors and corporate information from the homepage. []
  13. This is mainly because an earlier 21e6 pitch stated that the company would integrate mining chips in always-on consumer electronics and appliances. []
  14. Breakdown of Hardware Costs for New 21 Inc Bitcoin Computer by Sam Patterson []
  15. One reviewer commented: “I’d say one more thing worth adding is that it’s worth critiquing not just the feasibility of the Pitato but also the ethics. Because Pitatoes are inherently less efficient than regular mining farms due to economies of scale, the only way that they could be competitive relative to just buying bitcoin is if they were using free electricity; that is, basically all profitable usage of Pitatoes would be people using other people’s electricity in workplaces, universities, Starbucks, hotels, homes if the landlord pays for it, etc. I predict that if it actually became popular, then we’d see all the places that provide free electricity today become much more cautious about it, which could greatly reduce convenience for everyone but bitcoin miners.” []
  16. In one of its incarnations, Bitsplit was basically a euphemism for socializing CPU labor and privatizing some of the gains… now commonly called cryptojacking. []
  17. One reviewer said: “That earn.com pivot was done through the 21.co meetups that would host with Bitcoin engineers trying to buils apps on the 21 computer, which was eventually bricked. The idea for paying engineers for github pull requests led to earn.com’s business model.” []
  18. Note: in between the second and third pivot, during January 2017, Srinivasan deleted his tweets and interviewed for the top job at the FDA in Washington DC. []
  19. One reviewer commented that: “My personal view is that the current Earn.com concept is fundamentally legitimate and probably will see some usage (I can totally imagine consultants charging $50 for replying to emails, as that’s a very low-transaction-cost way to get one-time advice from people), but it deserves to exist as one of the 173 configurable settings in an email provider or social media service, not an independent multi-hundred-million dollar company. Perhaps the Coinbase acquisition actually will be utility-improving, in that gives the Earn.com team an ability to try to be useful by making gadgets for an existing company that has a userbase and services, rather than trying to build their own ecosystem which never made any sense (though it’s still a pretty disappointing end relative to Balaji’s original hype and aspirations).” []
  20. Is Coinbase a bank?  From the outside they seem to be a bit like a non-licensed deposit taking institution. []
  21. The line of reasoning is as follows: some startups attempted to randomly give away shares to strangers via various gimmicks but ultimately had to either take it back and/or were sued. If certain ICOs are deemed securities, you might not be able to just give them away to anonymous people. Reminder: I am not a lawyer, talk to a securities lawyer. []
  22. One competitor noted that: “21e6’s decision to go the Intel fabrication route was a non-starter. []
  23. Someone should remind me to talk about the dinner conversation that evening as well. []
  24. Coincidentally a few days prior to receiving those slides, I spoke with a NYC-based investor who was asking about the pros and cons of embedded ASICs for mining cryptocurrencies.  Specifically: should the fund invest in a startup designing embedded ASICs for bitcoin mining.  I provided my view point (the answer was no, still is a no).  During this same time frame there was a big meme being pushed by many Bitcoin boosters: that mining would somehow become re-decentralized via some unknown magic bullet.  Some of these promoters believed that 21.co would be the one to do it, without much evidence that the company could (or that anyone could). Note: there have been multiple other attempts at building and shipping embedded ASIC mining chips including from Midea and Bitfury.  None have been successful by any measure. []
  25. Remind me to mention the coincidence at Chipotle. []
  26. One reviewer asked: “Is this self-dealing?” []
  27. Another reviewer said: “This is acquisition theater, everyone is just trying to save face because this wasn’t a great idea, had wasteful execution, and the hype and hoopla reflects poorly on all involved.  The players fundamentally misunderstood the tech, the economics and use cases. I get that a VCs job is to make unsubstantiated bets on tech entrepreneurs they like. But here, an outright $116m investment in Bitcoin would have yielded X billions. And the “we returned all capital” probably because of BTC dividends and its price hike than cash returns.” []
  28. See Section 4 of a popular post last year. []
  29. What are the repercussions for publicly asking critical questions regarding bold claims such as those from a fireside chat with both Srinivasan and Andreessen?  Being blocked on ol’ Twitter. []
  30. Since we are going into the anecdote highway: in March 2015, at the Stanford Blockchain Workshop event, I approached Adam Ludwin after his panel discussion. On the panel he had mentioned that there could be a “redecentralization” of mining through an upcoming “Silicon Valley moment.” I assume he was talking about 21e6’s plan for mining chips being integrated into always-on devices because he was affiliated with one of its investors. When I told him I had seen a 21e6 deck and that it was making some very wild, likely incorrect assumptions, he basically said: we will see about that. Well, we have seen that once again: the difficulty rating rises with prices thereby diluting existing hash generating devices making them obsolete. []
  31. Some of the comments from the 21.co spokesperson are enjoyable. These hashing devices still wouldn’t be profitable at the current prices today because the difficulty rating has increased in proportion to the price yet all of the hashing units inside phone chargers and toasters had a fixed unit of labor. It’s a no-win situation for device owners as they would still have to pay for both the depreciating capital good (the device) as well as the electricity. []
  32. A couple hours after publishing this, a reader reached out and mentioned that: “I’m a proud owner of a Pitato. You forgot to mention that Balaji taught a course at Stanford about cryptocurrency and basically used it to promote 21co and Pitato to students. He gave it for free to students but all the labs were on this hardware. IMO it’s a conflict of interests for him as a professor <-> manager. The instructional material and repo is still online: (1) (2) (3) (4)”.  Note: I don’t think this is a conflict of interest, professors and lecturers sometimes have their students purchase a book they may have authored/co-authored as they are the subject-matter expert. []

Six bedtime stories from 2017

[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:

(1) “Legitimization”

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 Economist called 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?

Source: Twitter

The sensationalism (above) is factually untrue yet look how many people retweeted and liked the quickly debunked conspiracy theory.  It’s almost as if, in the current mania, no one cares about facts.

As Hitchens might say: that which can be asserted without evidence, can be dismissed without evidence.  So to are the conspiracies around Bitcoin in China:

  • Is the Chinese government nationalizing Bitcoin?  No.
  • Is the Chinese government responsible for Bitcoin Cash.  No.
  • Is the Chinese government behind the rise in CryptoKitties. No.

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 public information.

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!

Source: Twitter

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 View column 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.

Data source: BitInfoCharts

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).

(3b) Energy usage upperbound

So what are the upperbound costs?

Source: Twitter

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.3435

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:

  1. 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.
  2. 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 public comments 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.

Source: Twitter

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.

Your holiday reading list in no particular order:

One of my favorite articles this year should be yours too:

Just a few short months after Stephen Palley published the article above, a lawsuit occurred in which, surprise surprise, the plaintiffs highlighted specific claims in the white paper:

Source: Twitter

Note: that the SEC’s order against the Munchee ICO also relied on highlighting specific claims in the white paper.

Concluding remarks

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?

Coda

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.]

Acknowledgements

Many thanks to the following for their constructive feedback: VB, YK, RD, CM, WG, MW, PN, JH

End notes

  1. 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. []
  2. How many of these unsophisticated buyers have subsequently lost the corresponding private keys?  See “Nearly 4 Million Bitcoins Lost Forever, New Study Says” from Fortune []
  3. 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.” []
  4. 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.” []
  5. 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. []
  6. Note: this is not an endorsement of Visa, I do not have any equity or financial stake in Visa. []
  7. 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.” []
  8. 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.” []
  9. 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.” []
  10. 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. []
  11. 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. []
  12. Movements occurred in other areas too, on the enterprise side, Chain was perhaps the most well known company to pivot away from that vertical. []
  13. 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?” []
  14. 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. []
  15. 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 []
  16. Worth pointing out that Ryan Selkis is attempting to push forward with a the self-regulatory effort called Messari.  See also: The Brooklyn Project. []
  17. 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. []
  18. 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.” []
  19. 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. []
  20. 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. []
  21. Yea, I know, “money” is already digital… I didn’t give them that name, they did. []
  22. 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?” []
  23. 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. []
  24. 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. []
  25. In fact, many regulators, such as the ECB, categorize cryptocurrency as a type of “virtual currency,” separate from a “digital currency.” []
  26. 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. []
  27. 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. []
  28. Many thanks to Vitalik Buterin for his feedback and suggestions here. []
  29. See also: Some Crypto Quibbles with Threadneedle Street from Robert Sams []
  30. There are other mining manufacturers, including some who only build for themselves, such as Bitfury. []
  31. 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. []
  32. There are many walk-throughs of bitcoin mining facilities, including this video from Quartz. []
  33. 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? []
  34. 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. []
  35. 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.” []
  36. 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 described elsewhere but we’re not going down that rabbit hole today. []
  37. 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.” []
  38. 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. []
  39. It is not $1 million straight, there are multiple levels and tiers. []
  40. 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.” []
  41. 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. []
  42. 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. []
  43. To start with, see the Principles for Financial Market Infrastructures. []
  44. 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. []
  45. 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. []
  46. For instance, CoinDesk currently has 229 entries for “lightning,” 279 entries for “DLT,” and 257 entries for “permissioned.” []
  47. 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). []
  48. 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. []
  49. 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. []
  50. 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.” []
  51. 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? []
  52. ERC20 and ERC721 tokens may end up causing a top-heavy problem for Ethereum. See Watermarked tokens and also Integrating, Mining and Attacking: Analyzing the Colored Coin “Game” []

External facing appearances for the final months of the year

The past several months have been pretty productive especially in terms of education.

For instance, my “Eight Things” article had over 100,000 views in its first week alone thanks largely to landing on the front page Hacker News and reshares on social media. I may write-up an article breaking down its reception at a later date.

And interestingly, one of my older articles from 2014 recently ended up on the front of /r/DataIsBeautiful generating 15k+ views over a couple of days.

Below are some of my outward facing appearances.  If you’re interested in chatting about the topics below, feel free to reach me via Post Oak Labs.

Interviews

Cited and acknowledged

Panels and presentations

How the CME (un)intentionally weighed in on chain splits

For background, this post assumes you have read some (or ideally all) of the previous posts:

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 several articles 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.

Concluding remarks

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.

Bitcoin Is Now Just A Ticker Symbol and Stopped Being Permissionless Years Ago

Financial market infrastructure in just one country (Source)

What is FMI?  More on that later.  But first, let’s talk about Bitcoin.

If you aren’t familiar with the Bitcoin block size war and its endless online shouting matches which have evolved into legal and even death threats, then you have probably been a very productive human being and should sell hugs and not wander into a non-stop social media dance off.

Why?  Because tens of thousands of man (and woman) hours have collectively been obliterated over a struggle that has illuminated that Bitcoin’s development process is anything but permissionless.

It also illuminates the poor fiduciary care that some VCs have towards their LPs.  In this case, more than a handful of VCs do not seem to really care about what a few of their funded companies actually produce, unless of course the quarterly KPIs include “have your new Bitcoin meme retweeted 1,000 times once a week.”

In some documented cases, several dozen executives from VC-backed Bitcoin companies have spent thousands of hours debating this size attribute instead of building and shipping commercializable products.  But hey, at least they sell cool hats and built up very large Twitter followings, right?

Fact #1: Satoshi Nakomoto did not ask anyone’s permission to launch, change, or modify the codebase she unilaterally released in 2009.

Fact #2: In 2009, when Satoshi Nakomoto issued and minted a new currency (or commodity or whatever these MLIC are) she did so without asking anyone else’s approval or for their “ack.”

In the approximately seven years since she stopped posting under her pseudonym, influential elements of Bitcoin’s anarchic community have intentionally created a permissioned developer system commonly referred to as the Bitcoin Improvement Proposal (BIP) process.  “Bitcoin Core” is the name for the group that self-selected itself to vet BIPs; involvement is empirically permissioned because you can get kicked off the island.1 There are a small handful of decision makers that control access to the code repository.

For example, if you’re a developer that wants to create and launch a new implementation of Bitcoin that includes different block sizes… and you didn’t get it approved through this BIP process, guess what?  You are doing permissionlessness wrong because you didn’t get permission from the BIP approval committee to do so.

Oh, but you realize that and still want to launch this new Bitcoin implementation with the help of other elements of the community, such as some miners and exchanges?

According to some vocal members of the current BIP approval committee (Bitcoin Core) and its surrogates, this is an attack on Bitcoin.  Obviously this is absurd because there is no de jure or legally defined process for changing or forking Bitcoin, either the chain itself or the code.

There is no terms of service or contract which explicitly states what Bitcoin is and who controls its development process.  Or more historically: if Satoshi didn’t need permission from a (non-existent) BIP approval committee to launch a cryptocurrency, then no other Bitcoin developer needs to either.

Tickers

Fast forward to this current moment in time: if the Bitcoin Cash or Segwit2X forks are an attack on network because either fork did not get ack’ed (approved) by the right people on the BIP approval committee or retweeted by the right “thought leaders” on social media, then transitively every 10 minutes (when a block is generated by a miner) arguably could be an attack on Bitcoin.

Why?  At any time a block maker (miner) could use a different software implementation with different consensus rules.  They, like Satoshi before them, do not need permission to modify the code.

Oh, but other miners may not build on top of that block and some exchanges may not recognize those blocks as “legitimate” Bitcoin blocks?

That is certainly a risk.  In fact, several exchanges are now effectively white listing and black listing — permissioning — Bitcoin-related blocks.

For instance, Bittrex, a large crypto-to-crypto exchange, has said:

The “BTC” ticker will remain the Bitcoin Core chain before the hard fork block. Bittrex will observe the Bitcoin network for a period of 24 to 48 hours to determine if a chain split has occurred and the outcome.

In the event of a chain split, “BTC” will remain the existing Bitcoin chain with 1 MB blocks until the industry and ecosystem demonstrates a clear chain preference for Bitcoin.

Bitfinex, the largest (and most nebulous) cryptocurrency exchange in the world, took this even further by stating:

The incumbent implementation (based on the existing Bitcoin consensus protocol) will continue to trade as BTC even if the B2X chain has more hashing power.

After heavy public (and private) lobbying by members and surrogates of Bitcoin Core, other exchanges have instituted similar policies favoring the incumbent.2  So what can alternative implementations to do?  Bend the knee?

Daenerys Targaryen, Breaker of Chains

Historically miners have built on the chain that is both the longest and also has the most accumulated difficulty… and one that has enough profitability to pay for the electricity bills.  It just happens that this collective block building activity is never called an “attack” because in general, most participants have been happy enough with the status quo.

Visions of what Bitcoin is and how it should be defined have clearly, empirically shifted over time.  But since this network was purposefully designed to be self-sovereign and anarchic — lacking contracts and hooks into any legal system — no one group can claim legitimacy over its evolution or its forks.

As a result, recent war cry’s that Segwit2X is a “51% attack” on Bitcoin are a red herring too because there is no consensus on the definition of what Bitcoin is or why the previous block – in which approximately 51% of the hashrate created a block – is not an attack on Bitcoin. 3

This has now morphed into what the “BTC” ticker on exchanges represents.  Is it the longest chain?  The chain with the most accumulated difficulty?  The chain maintained by Bitcoin Core or now defunct NYA developers?  If a group of block makers can build blocks and exchanges are willing to list these coins as “BTC” then that specific chain has just as much legitimacy as any other fork other miners build on top of and exchanges may list.

Furthermore, if the BIP approval committee gets to say what software miners or exchanges should or should not use (e.g., such as increasing or decreasing the block size), that could mean that existing network is a managed and even administered.  And this could have legal implications.  Recall that in the past, because block making and development were originally separate, FinCEN and other regulators issued guidance stating that decentralized cryptocurrencies were exempt from money transmission laws.

Despite what the trade associations and Bitcoin lobbying groups would like the narrative to be, I recently published an article that went into this very topic in depth and have publicly asked several prominent “crypto lawyers” to provide evidence to the contrary (they have yet to do so).  An argument could be made that these dev groups are not just a loose collective of volunteers.

Financial market infrastructure

I’m not defending S2X or XT or Bitcoin Unlimited.  In fact, I have no coins of any sort at this time.

But even if you don’t own any bitcoins or cryptocurrencies at all, the block size debate could impact you if you have invested in the formal financial marketplace.

For example, if and when the CME (and similar exchanges) get CFTC approval to list cryptocurrency-related futures products and/or the NYSE (and similar exchanges) get SEC approval to list cryptocurrency-related ETFs, these products will likely result in a flood of institutional money.

Once institutions, regulators, and sophisticated investors enter the picture, they will want to hold people accountable for actions.  This could include nebulous “general partnerships” that control GitHub repositories.  Recall, in its dressing down of The DAO, the SEC defined the loose collective building and maintaining The DAO as a ‘general partnership.’  Is Bitcoin Core or other identifiable development teams a “general partnership”?

Maybe.  In fact, the common refrain Bitcoin Core and its surrogates continually use amounts to arguments in favor of a purported natural monopoly.

For instance, Joi Ito, Director of MIT’s MediaLab, recently stated that:

“We haven’t won the battle yet. [But] I think the thing that is interesting is that Bitcoin Core has substantially more brain fire power than any of the other networks.”

This is problematic for a couple reasons.

First, Joi Ito is not a disinterested party in this debate.  Through Digital Garage (which he co-founded) it has invested in Blockstream, a company that employs several influential Bitcoin Core devs.4  Ignoring the potential conflict of interest, Ito’s remarks echo a similar sentiment he also made last year, that Core is basically “The Right Stuff” for NASA: they are the only team capable of sending humans into space.

But this is an empirically poor analogy because it ignores technology transfer and aerospace education… and the fact that multiple countries have independently, safely sent humans, animals, and satellites into space.

It also ignores how competitive verticals typically have more than just one dominant enterprise: aerospace, automobiles, semiconductor manufacturers, consumer electronic manufacturers (smart phones), etc.  Each of these has more than one company providing goods and services and even usually more than just one product development team developing those.  Intel, for example, has dozens of design teams working on many new chips at any given time of the year.  And they are just one of the major semiconductor companies.

Even in the highly regulated markets like financial services there is more than one bank.  In fact, most people are unaware of this but banks themselves utilize what is called “Core Banking Software” and there are more than a dozen vendors that build these (see image below).

It is a bit ironic that Bitcoin Core seeks to have a monopoly on the BIP process yet even banks have more than one vendor to choose from for mission critical software securely managing and processing trillions of dollars in assets each day.5

On the enterprise (non-anarchic) blockchain side of the ecosystem, there are well over a dozen funded teams shipping code, some of which is being used in pilots by regulated institutions that are liable if a system breaks.  Note: this is something I discussed in my keynote speech (slides) at the Korea Financial Telecommunications and Clearings Institute last year.

But as one vocal Core supporter in a WeChat room recently said, Bitcoin Core is equivalent to Fedwire or Swift, there is only one of each; so too does it make sense for only one Bitcoin dev team to exist.

Firstly, this conflates at least four different things: a specific codebase, with permissioned dev roles, with acceptance processes, with a formal organization.

It is also not a good analogy because there are many regulatory reasons why these two systems (Swift and Fedwire) exist the way they do, and part of it is because they were either setup by regulators and/or regulated organizations.  In effect, they have a bit of a legally ring-fenced marketplace to solve specific industry problems (though this is somewhat debatable because there are some alternatives now).6

If this supporter is equating Core, the codebase, with real financial market infrastructure (FMI), then they should be prepared to be potentially regulated.  Bitcoin Core and many other centralized development teams are comprised of self-appointed, vocal developers that are easy to identify (they have setup verified Twitter accounts and attend many public events), so subpoenas and RFI’s can be sent their way.

As I mentioned in my previous article: with great power comes great accountability.  Depending on the jurisdiction, Core and other teams could end up with regulatory oversight since they insist on having a monopoly on the main (only) implementation and process by which the implementation is managed.7

Remember that Venn diagram at the very top?  The companies and organizations that manage FMI today for central banks (RTGSs), central securities depositories (CSDs), and other intermediaries such as custodians and CCPs, have specific legal and contractual obligations and liabilities.

Following the most recent financial crisis, the G-20 and other counties and organizations established the Financial Stability Board (FSB) to better coordinate and get a handle on systemic risks (among other issues).  And while the genesis of the principles for financial market infrastructures (PFMI) had existed prior to the creation of the FSB, how many of the international PFMI standards and principles does Bitcoin Core comply with?

Spoiler alert: essentially none, because Satoshi intentionally wasn’t trying to solve problems for banks.  So it is unsurprising that Bitcoin isn’t up to snuff when it comes to meeting the functional and non-functional requirements of a global payments platform for regulated institutions.  Fact-check me by reading through the PFMI 101 guide.

When presented with these strong legal accountability and international standards that are part and parcel with running a payment system, there is lots of hand waving excuses and justifications from Core supporters (and surrogates) as to why they are exempt but if Core wants to enforce its monopoly it can’t have it both ways.  Depending on the jurisdiction they may or may not be scrutinized as FMI.

But in contrast, in looking at the evolution and development of the enterprise chain ecosystem – as I described in multiple previous articles – there are valuable lessons that can be learned from these vendors as to how they plan to operate a compliant network.  I recall one conversation with several managing directors at a large US investment bank over a year ago: maybe the enterprise side should just have CLS run a blockchain system since they have all the right business connections and fulfill the legal and regulatory check boxes.

Note: CLS is a very important FMI operator.  Maybe existing FMI operators will do just that.  Speaking of which, will Bitcoin Core (or other dev teams) apply to participate with organizations like the FSB that monitor systemically important financial institutions and infrastructure?

Angela Walch has argued (slides) that some coders, especially of anarchic chains, are a type of fiduciary.8  Even if this were not true, many countries have anti-monopoly and anti-trust laws, with some exceptions for specific market segments and verticals.  There are also laws against organized efforts involved in racketeering; in the US these are found within the RICO Act.

Watch the Godfather trilogy

I haven’t seen a formal argument as to why Core or other development teams could meet the litmus test for being prosecuted under RICO laws (though the networks they build and administer are frequently used for money laundering and other illicit activity).  But trying to use the “decentralization” trump card when in fact development is centralized and decisions are made by a few key individuals, might not work.

Look no further than the string-pulling Mafia which tried to decentralize its operations only for the top decision makers to ultimately be held liable for the activities of their minions.9  And using sock puppets and pseudonyms might not be full proof once forensic specialists are brought in during the discovery phase.10

Concluding remarks

Based on observations from how Bitcoin Core evolved and consolidated its power over time (e.g. removing participants who have proposed alternative scaling solutions), the focus on what Bitcoin is called and defined has landed in the hands of exchanges and really just highlights the distance that Bitcoin has walked away from a “peer-to-peer electronic cash” that initially pitched removing intermediaries.  To even care about what ticker symbol ‘Bitcoin’ is on an exchange is to acknowledge the need for a centralized entity that establishes what the “price” is and by doing so takes away the bitcoin holder’s “self-sovereignty.”11

While the power struggles between various factions within the Bitcoin development community will likely rage on for years, by permissioning off the development process, Bitcoin Core (and any other identifiable development groups), have likely only begun to face the potential regulatory mine field they have foisted on themselves.12

Historically blockchain-based systems have and still are highly dependent on the input and decision-making by people: somebody has to be in charge or nothing gets done and upgrades are a mess.  And the goal of appointing or choosing specific teams on anarchic chains seems to be based around resolving political divisions without disruptive network splits.13

The big questions now are: once these teams are in charge, what will governments expectations be?  What legal responsibilities and regulatory oversight will the developers have?  Can they be sued for anti-trust and/or RICO violations?  With billions of dollars on the line, will they need to submit upgrade and road map proposals for approval?

Endnotes

  1. Examples of developers who were removed: Alex Waters, Jeff Garzik, Gavin Andresen []
  2. Thanks to Ciaran Murray for identifying these exchanges. []
  3. Bitcoin mining is in fact based on an inhomogeneous Poisson process; a participant could theoretically find a block with relatively little hash rate.  Although due to the probabilities involved, most miners pool their resources together to reduce the variance in payouts. []
  4. According to one alleged leak, Digital Garage is testing Confidential Assets, a product of Blockstream. []
  5. According to a paper from the Federal Reserve: payment, clearing, and settlement systems in the United States “process approximately 600 million transactions per day, valued at over $12.6 trillion.” []
  6. On AngelList, there are about 3,400 companies categorized as “payments” — most of these live on top of existing FMI, only a handful are trying to build new independent infrastructure. []
  7. A key difference between Bitcoin and say Ethereum is that with Ethereum there are multiple different usable implementations managed by independent teams and organizations; not so with how Bitcoin has evolved with just one (Bitcoin Core) used by miners.  In addition, the Ethereum community early on formally laid out a reference specification of the EVM in its yellow paper; Bitcoin lacks a formal reference specification beyond the Core codebase itself. []
  8. See also The Bitcoin Blockchain as Financial Market Infrastructure: A Consideration of Operational Risk from Angela Walch []
  9. Thanks to Stephen Palley for providing this observation. []
  10. It is unclear why the current Bitcoin Core team is put onto a pedestal.  There are many other teams around the world building and shipping blockchain-related system code used by companies and organizations (it is not like there is only just one dev team that can build all databases or operating systems).  At the time of this writing Core has not publish any papers in peer-reviewed journals and many of them do not have public resumes or LinkedIn profiles because they have burned business and professional relationships in the past.  Irrespective of what their bonafides may or may not be, it is arguably a non sequitur that ‘permissionless’  coordination in open-source code development has to lead to a monopoly on said development. []
  11. Thanks to Colin Platt for this “appeal to authority” observation. []
  12. Bitcoin stopped being permissionless when developers, miners, and exchanges needed to obtain permission to make and use different code.  And likely there are and will be more other cryptocurrency development teams that follow that same path. []
  13. For an informed contrarian view on governance and distributed ledger technology, see The blockchain paradox: Why distributed ledger technologies may do little to transform the economy by Vili Lehdonvirta []

A note from Bob on the transparency of Tether

[Note: below is a note from a friend, Bob, who is a former attorney turned tech entrepreneur who closely follows the cryptocurrency world.  This was published with his permission.]

Hope all is well.  I am writing to share some alarming signs of Bitcoin price manipulation.

Bitcoin price is about 10 times of what it was a year ago. The exchange that decisively sets Bitcoin price is Bitfinex, a secretive institution with unknown beneficiary structure and place of organization.

Bitfinex had its wire services suspended by Wells Fargo in April.  To resume trading, Bitfinex enlisted the help of Tether, another company with unknown beneficiary structure and place of organization, but based on announcements is likely under common share holder control with Bitfinex.  Tether sells crypto-tokens known as USD Tethers, or USDTs, that are purportedly backed by an equal number of US dollars.  In other words, each USDT is a digital good priced at USD 1.00.

Despite the promise of “100% reserve” and the vague reference to “24×7 access to your funds” on Tether’s website, there is no contractual right, either tacit or express, for one USDT to be redeemed for one US dollar.  It is probably through this legal construct that Tether hopes to characterize its USDTs as digital goods and not “convertible” virtual currency covered by FinCEN regulations.

The invention of USDTs led to the proliferation of numerous crypto-currency exchanges.  Examples include Bitfinex, Binance, HitBTC, KKex, Poloniex, and YoBit.  Instead of providing crypto-to-fiat trading pairs, these “coin-to-coin” exchanges offer crypto-to-tether trading exclusively.  Therefore, USDTs not only help these exchanges remove the need for formal banking arrangement, but also enables these exchanges to organize in lesser known jurisdictions (e.g., the Republic of Seychelles) and operate outside of the regulation and supervision of major economies.  Most of these exchanges claim to screen-off visitors from the United States and other countries with laws on coin-to-coin trading, but the screen-off is often perfunctory. In almost all cases, the screen can be defeated with a simple mouse click.1

It is doubtful that these exchanges perform meaningful due diligence beyond identity verification to combat money laundering, financing of terrorism, and corruption of politically exposed persons. Bitfinex, for example, requires no identity verification at all for most trading activities and imposes no trading amount limits on unverified accounts.  The enablement of these exchanges where rampant money laundering is possible is outside of the scope of this note. Instead, I would like to bring to your attention the distinct possibility that Bitfinex, as the likely controller of Tether, is a bad actor.

Strong circumstantial evidence suggests that Bitfinex is creating USDTs out of thin air to prop up Bitcoin prices.  Namely, Bitfinex is likely acting as a central bank that issues a fiat money called USDTs. The sole mandate of this central bank is to enrich itself through market manipulation.

The first image (above) attached to this email illustrates how mysterious amounts of USDTs were minted and injected into Bitfinex at precise moments when a crash seemed imminent.

The second image (above) illustrates a strong correlation (but admittedly not causation) between the total amount of USDTs in circulation and Bitcoin price.

Bitfinex released an internal memo in September to allay concerns that USDTs might have been created at will.  The memo purportedly shows that Tether maintained sufficient US dollars to match all USDTs in circulation as of a day in September.  The memo, however, is of no probative value.  Among other strange things, the author of the memo didn’t verify with banks (names redacted) that account balances from Tethers were in fact correct, couldn’t promise that the balances weren’t overnight borrowings for purposes of producing the memo, and couldn’t promise that Tether indeed had access to those funds.

I therefore urge you to consider the possibility that the current price of Bitcoin is the result of Bitfinex’s manipulation and may collapse when regulators take action.

For example, Tether is almost certainly an administrator of virtual currency — it centrally puts into and withdraws from circulation USDTs, a virtual currency squarely intended as a substitute for real currency as admitted by Tether in the internal memo.

Tether has nominally registered as a money transmitter with FinCEN, but it is unclear if they fulfill any of the BSA filing requirements (e.g., filing SARs).2 As a company, Tether’s USDTs enables large crypto-currency exchanges (including US-based exchanges like Poloniex) to exist and powers trades thereon in the amount of millions every day.  So it wouldn’t be surprising if FinCEN eventually decides to enforce its rules against Tether as it did against Liberty Reserve.

Further, CFTC approved recently various swap execution facilities, designated contract markets and derivative clearing organizations with Bitcoin flavor.  And the Chicago Mercantile Exchange is expected to launch cash-settled futures on Bitcoin soon.  Manipulation of Bitcoin prices referenced by these entities is prosecutable by the CFTC, an agency with broad statutory authority to prosecute manipulation of commodity prices under the Commodity Exchange Act (including Section 753 as amended by the Dodd-Frank Act.).

Although none of these CFTC-registered entities are currently including Bitfinex in the calculation of their Bitcoin reference rates (CME used to), it is well understood and could be easily established (partially because of the transparency of Bitcoin blockchain) that Bitfinex-initiated price movements ripple through all exchanges via manual and automated trading.3  CFTC could then have grounds to investigate Bitfinex’s possible manipulation of Bitcoin price via Tether.

If you are considering investing into Bitcoin at this time, please look closer at the exchanges involved in price discovery and give it a second thought.

References

  1. For an example, see FinCEN ruling from August 15, 2015. []
  2. Tether Limited did do a basic registration which takes around 5 minutes and about 45 dollars. But they probably didn’t do what come after the registration, which includes many other filings to FinCEN such as submitting suspicious activity reports. []
  3. The initial reference rate announced by the CME included Bitfinex.  Similarly, the Winklevoss Bitcoin ETF used a reference rate (called the “Winkdex”) whose comprising exchanges fluctuated over time.  See Comments on the COIN ETF (SR-BatsBZX-2016-30). []

Eight Things Cryptocurrency Enthusiasts Probably Won’t Tell You

[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.

Background

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):

(1) Bitfinex

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

Source: Tether LTD

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

Last month a report from Xinhua found that:

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

Source: Tweet from Linke Yang, co-founder of BTCC

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:

  1. for X amount of BTC the CM will actively solicit and get your coin listed on various exchanges;
  2. 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.

Scene from Boiler Room

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 [2017].”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.

Source: Twitter

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.

Source: Twitter (1 2)

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!

(6) Market caps

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

Yeah, no.

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

Source: Twitter

Source: Twitter

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 SaveOnSend article 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

Source: LinkedIn

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.

(8) Analytics

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.

Final Remarks

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.]

Acknowledgements

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.

End notes

  1. 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” []
  2. 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?” []
  3. Not unique to cryptocurrencies, but by enabling such bad actors, certain platform operators may even increase their short term profit. []
  4. Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO []
  5. For an in-depth look at how the various moving pieces of the ecosystem interact, see: The flow of funds on the Bitcoin network in 2015, Cryptocurrency KYSF: Know Your Source of Funds, and Cryptocurrency KYSF: Know Your Source of Funds part 2 []
  6. Bitcoin Exchange Was a Nexus of Crime, Indictment Says from The New York Times []
  7. 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. []
  8. 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.” []
  9. It has a complex corporate structure and is nominally based in Hong Kong, operations and incorporation of subsidiaries are in other jurisdictions including BVI. []
  10. 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. []
  11. 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. []
  12. Bitfinex also recently announced that they will be doing an ICO (called NEC) to capitalize on the current token mania. []
  13. Bitfinex does do KYC and AML when a user withdraws USD and when they receive subpoenas. []
  14. ERC20 tokens are arguably not the same thing as a cryptocurrency, they are more like colored coins. See “Watermarked tokens and pseudonymity on public blockchains” by Tim Swanson. []
  15. Tether brings tokenised USD to Ethereum network from Finextra []
  16. We only know who is involved through various reddit threads wherein users dox and identify themselves as employees and founders. []
  17. Tether brings tokenised USD to Ethereum network from Finextra []
  18. This wouldn’t be the first time that a peg “broke the buck;” money market funds have been propped up by a parent organization in the past. []
  19. Tether Update []
  20. 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.”  []
  21. Source for some of these questions. []
  22. 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?” []
  23. 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.” []
  24. 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. []
  25. Described in further detail, “Comments on the COIN ETF (SR-BatsBZX-2016-30)” by Tim Swanson []
  26. See the section “Stopping Predators” within A Kimberley Process for Cryptocurrencies []
  27. China Central Bank Said to Call Bitcoin Exchanges for Talks from Bloomberg []
  28. 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. []
  29. Central bank warns Bitcoin exchanges over margin trading, money laundering from Xinhua and Chinese bitcoin exchanges resume withdrawals after freeze from Reuters []
  30. Li Xiaolai: Yunbi Is Winding Down In 3 Months from 8BTC []
  31. BTCC to Cease China Trading as Media Warns Closures Could Continue from CoinDesk []
  32. Sources: CNLedger and ICOcoinOfficial []
  33. Huobi, OKCoin to Stop Yuan-to-Bitcoin Trading By October’s End from CoinDesk []
  34. 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. []
  35. Something similar was done with voucher codes sold on Taobao in 2014 as well.  See After Crackdown, A New Bitcoin King Emerges in China from Wired []
  36. 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? []
  37. 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.” []
  38. These are mostly ERC20 tokens, not coins. []
  39. One reviewer mentioned: “Depending on the jurisdiction, these pre-arranged discounts might be deemed as structured products.” []
  40. Is There a Cryptocurrency Bubble? Just Ask Doge. from The New York Times []
  41. “How the ICO, OCO, and ECO ecosystem works at a high level” by Tim Swanson and “Comments on the COIN ETF (SR-BatsBZX-2016-30)” by Tim Swanson []
  42. 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. []
  43. 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.” []
  44. 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. []
  45. 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). []
  46. This same phenomenon occurred several years ago with “wealth management products” doing the same re-investment into other WMPs; revisiting the P2P Lending scams that came to light in the past two years as well is helpful.  See China’s ICO ban makes more sense in light of its history with fintech by Nik Milanovic []
  47. 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.” []
  48. Whalepool and The Coin Farm on Telegram are both examples of this type of coordination. []
  49. ICO被定性为涉嫌非法集资,想一夜暴富的“韭菜”们醒醒吧 from Huxiu []
  50. Based on translated stories from after the investigations as well as conversations with observers of these training sessions. []
  51. 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 []
  52. 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. []
  53. China bans companies from raising money through ICOs, asks local regulators to inspect 60 major platforms from CNBC []
  54. Cryptocurrency chaos as China cracks down on ICOs from Reuters []
  55. Ibid []
  56. China shuts down Bitcoin industry; bans executives from leaving the country from Australian Financial Review []
  57. Another ICO Conference Cancels in Wake of China Ban from CoinDesk []
  58. He had to refund the ICOs he promote (plus with an added premium). []
  59. 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.” []
  60. 14,000 Coinbase Customers Could Be Affected by IRS Tax Summons from CoinDesk and Legitimate? IRS Defends Coinbase Customer Investigation in Court Filing from CoinDesk []
  61. 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. []
  62. 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. []
  63. 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. []
  64. Another tech company that supposedly struggled raising funding and later issued its own coin (through an ICO) is Kik, through its Kin Foundation. []
  65. 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. []
  66. 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?” []
  67. 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.” []
  68. 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. []
  69. 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. []
  70. 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?” []
  71. 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.” []
  72.  In mid-September, vocal promoters and owners of cryptocurrencies such as Bitcoin collectively spent thousands of hours yelling on social media and conducting letter writing campaigns all to channel their anger towards comments made by Jamie Dimon.  A couple worthwhile followups include: JPMorgan handles bitcoin-related trades for clients despite CEO warning from Reuters and  MUFG CEO on Dimon Remarks: Bank Cryptocurrencies Have ‘Nothing to Do With Bitcoin’ from CoinDesk []
  73. Bitcoin was only used as an example, nearly all cryptocurrencies listed on CoinMarketCap have the same issue in terms of calculating a real “market cap.” []
  74. Learning from Bitcoin’s past to improve its future from Tim Swanson []
  75. 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). []
  76. To be fair, this is not unique to the cryptocurrency space. []
  77. 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 []
  78. Research: How Investors’ Reading Habits Influence Stock Prices by Anastassia Fedyk and Effects of Misinformation on the Stock Return: A Case Study by Ahsan et al. []
  79. 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? []
  80. A great paper on this topic is The Path of the Blockchain Lexicon (and the Law) by Angela Walch []
  81. 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? []
  82. 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. []
  83. For an example, see Cracking Mt. Gox by WizSec []
  84. 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. []
  85. Partially inspired by this tweet. []
  86. Click farms are being used by various ICO and Bitcoin-related online personalities to boost their perceived importance. []

What’s the deal with DAOs?

[Disclaimer: I do not own any cryptocurrencies nor have I participated in any DAO crowdfunding.]

This post will look at the difference between a decentralized autonomous organization (DAO) and a project called The DAO.

Brief explanation

The wikipedia entry on DAOs is not very helpful.  However, Chapters 2 through 5 may be of some use (although it is dated information).

In terms of the uber hyped blockchain world, at its most basic kernel, a DAO is a bit of code — sometimes called a “smart contract” (a wretched name) — that enables a multitude of parties including other DAOs to send cryptographically verifiable instructions (such as a digitally signed vote) in order to execute the terms and conditions of the cloud-based code in a manner that is difficult to censor.

One way to think of a simple DAO: it is an automated escrow agent that lives on a decentralized cloud where it can only distribute funds (e.g., issue a dividend, disperse payroll) upon on receiving or even not receiving a digital signal that a task has been completed or is incomplete.

For instance, let us assume that a small non-profit aid organization whose staff primarily work in economically and politically unstable regions with strict capital controls, set up a DAO — an escrow agent — on a decentralized cloud to distribute payroll each month.

This cloud-based escrow agent was coded such that it would only distribute the funds once a threshold of digital signatures had signed an on-chain contract — not just by staff members — but also from independent on-the-ground individuals who observed that the staff members were indeed doing their job.  Some might call these independent observers as oracles, but that is a topic for a different post.1

Once enough signatures had been used to sign an on-chain contract, the escrow agent would automatically release the funds to the appropriate individuals (or rather, to a public address that an individual controls via private key).  The terms in which the agent operated could also be amended with a predetermined number of votes, just like corporate board’s and shareholder’s vote to change charters and contracts today.

The purported utility that decentralization brings to this situation is that it makes censoring transactions by third parties more difficult than if the funds flowed through a centralized rail.  There are trade-offs to these logistics but that is beyond the scope of this post.

The reason the DAO acronym includes the “organization” part is that the end-goal by its promoters is for it to provide services beyond these simple escrow characteristics such as handling most if not all administrative tasks such as hiring and firing.

Watch out Zenefits, the cryptocurrency world is going to eat your lunch!  Oh wait.

A short history

It is really easy to get caught up in the euphoria of a shiny new toy.  And the original goal of a DAO sounds like something out of science fiction —  but these undertones probably do it a disservice.

Prior to 2014 there had been several small discussions around the topic of autonomous “agents” as it related to Bitcoin.

For instance, in August 2013, Mike Hearn gave a presentation at Turing Festival (see above), describing what was effectively a series of decentralized agents that operated logistical companies such as an autonomous car service.

Several months later, Vitalik Buterin published the Ethereum white paper which dove into the details of how to build a network — in this case a public blockchain — which natively supported code that could perform complex on-chain tasks: or what he dubbed as a decentralized autonomous organization.

Timing

The impetus and timing for this post is based on an ongoing crowdsale / crowdfunding activity for the confusingly named “The DAO” that has drawn a lot of media attention.

Over the past year, a group of developers, some of whom are affiliated with the Ethereum Foundation and others affiliated with a company called Slock.it have created what is marketed as the first living and breathing DAO on the Ethereum network.

The organizers kicked off a month long token sale and at the time of this writing just over 10 million ether (the native currency of the Ethereum blockchain) — or approximately 13% of all mined ether — has been sent to The DAO.  This is roughly equivalent to over $100 million based on the current market price of ether (ETH).

In return for sending ether to The DAO, users receive an asset called a DAO Token which can be used in the future to vote on projects that The DAO wants to fund.2 It is a process that Swarm failed at doing.

An investment fund or a Kickstarter project?

I would argue that, while from a technical standpoint it is possible to successfully set up a DAO in the manner that The DAO team did, that there really isn’t much utility to do so in an environment in which censorship or the theft of funds by third parties will probably not occur.

That is to say, just as I have argued before that permissioned-on-permissionless is a shortsighted idea, The DAO as it is currently set up, is probably a solution to a problem that no one really has.3

Or in short, if you “invested” in The DAO crowdsale thinking you’re going to make money back from the projects via dividends, you might be better off investing in Disney dollars.

Why?

Putting aside securities regulations and regulators such as the SEC for a moment, most of the crowdsale “investors” probably don’t realize that:

  1. crowdfunding in general has a checkered track record of return-on-investment4
  2. crowdfunding in the cryptocurrency world almost always relies on the future appreciation of token prices in order to break-even and not through the actual creation of new features or tools (e.g., see Mastercoin/Omni which effectively flopped)
  3. that the funds, when dispersed to Slock.it and other “products,” could take years, if ever to return a dividend

Why would this pool of capital provide any better expected return-on-investment than others?

Or as Nick Zeeb explained to me:

My sense about The DAO is that it’s a fascinating experiment that I do not want to be part of. I also do not think that a committee of over 1,000 strangers will make wise investment decisions. Most good investment decisions are taken by courageous individuals in my opinion. Anything that can get past a big committee will probably not be the next Google. Imagine this pitch: “Hi I’m Larry and this is Sergey and we want to build the world’s 35th search engine.”

While it probably wasn’t the 35th search engine, tor those unfamiliar with the history of Google, Larry Page and Sergey Brin are the co-founders who created a search engine in what was then though a very crowded market.

So why the excitement?

I think part of it is quite simply: if you own a bunch of ether, there really isn’t much you can do with it right now.  This is a problem that plagues the entire cryptocurrency ecosystem.

Despite all the back-patting at conferences, the market is already filled with lots of different tokens. There is a glut of tokens which do not currently provide many useful things that you couldn’t already do with existing cash systems.5

Part of it also is that most probably think they will some become rich quick through dividends, but that probably won’t happen anytime soon, if at all.

With The DAO, only the development teams of projects that are voted and approved by The DAO (e.g., the thousands of users with DAO Tokens), will see any short term gains through a steady paycheck.  And it is only after they build, ship and sell a product that the original investors may begin seeing some kind of return.

Or in other words: over the past several weeks, the pooling of capital has taken place for The DAO.  In the future there will be various votes as to where that capital goes.  Shortly thereafter, some capital is deployed and later KPI’s will be assessed in order to determine whether or not funding should continue.  All the while some type of profit is sought and dividend returned.

Why, I asked another friend, would this pool of capital offer any better risk adjusted return-on-investment than other asset classes?

In his view:

The return might be high but so is the risk. Always adjust for risk. I think The DAO is better compared to a distributed venture capital firm. Whether that’s better or worse I don’t know — I mean you have the crowd deciding on investments. Or more realistically: nerds who know how to obtain ether (ETH) get to decide on investments.

Does that make them better VCs? Probably not. However, The DAO can decide to hire people with actual credentials to manage and select the investments, admitting its own weakness which would then turn into a strength. I think this can go either way but given the regulator is not prepared for any of this it will probably not work out in the short term.

Does the ‘design-by-giant-nerd-committee’ process work?

Over the past year we have already seen the thousands, probably tens-of-thousands of man-hours dropped into the gravity well that is known as the “block size debate.”  In which hundreds of passionate developers have seemingly argued non-stop on Slack, Twitter, reddit, IRC, conferences and so forth without really coming to an amicable decision any one group really likes.

So if block size-design-by-committee hasn’t worked out terribly well, will the thousands of investors in The DAO take to social media to influence and lobby one another in the future?  And if so, how productive is that versus alternative investment vehicles?

Redistributing the monetary base

Assuming Ethereum has an economy (which it probably doesn’t by most conventional measures), will The DAO create a deflationary effect on the Ethereum economy?

For instance, at its current rate, The DAO could absorb about 20% of the ether (ETH) monetary base.

Does that mean it permanently removes some of the monetary base?  Probably not.

For example, we know that there will be some disbursements to projects such as Slock.it, so there will be some liquidity from this on-chain entity.  And that future DAOs will spend their ether on expenses and development like a normal organization.

But we also know that there is a disconnect between what The DAO is, an investment fund, with what many people see it as: a large vault filled with gold laying in Challenger Deep that will somehow appreciate in value and they will be able to somehow extract that value.

Sure, we will all be able to observe that the funds exist at the bottom of the trench, but someone somewhere has to actually create value with the DAO Tokens and/or ether.

For the same reason that most incubators, accelerators and VC funds fail, that entrepreneur-reliant math doesn’t change for The DAO.  Not only does The DAO need to have a large volume of deal flow, but The DAO needs to attract legitimate projects that — as my friend point out above — have a better risk adjusted return-on-investment than other asset classes.

Will the return-on-investment of the DAO as an asset class be positive in the “early days”?  What happens when the operators and recipients of DAO funds eventually confront the problem of securities regulation?

So far, most of the proposals that appear to be geared up for funding are reminiscent to hype cycles we have all seen over the past couple of years.

Let’s build a product…

  • 2014: But with Bitcoin
  • 2015: But with Blockchain
  • 2016: But with DAO

Maybe the funds will not all be vaporized, but if a non-trivial amount of ETH ends up being held in this DAO or others, it could be the case that with sluggish deal flow, a large portion of the funds could remain inert.  And since this ether would not touching any financial flows; it would be equivalent to storing a large fraction of M0 in your basement safe, siloed off from liquid capital markets.

Ten observations

  1. Since the crowdsale / crowdfund began on April 30, the market price of ETH has increased ~30%; is that a coincidence or is there new demand being generated due to The DAO crowdsale?
  2. A small bug has been discovered in terms of the ETH to DAO Token conversion time table
  3. The DAO surpassed the Ethereum Foundation to become the largest single holder of ether (note: the linked article is already outdated)
  4. In terms of concentration of wealth: according to Etherscan, the top 50 DAO Token holders collectively “own” 38.49% of The DAO
  5. The top 500 DAO Token holders collectively “own” 71.39% of The DAO
  6. As of this writing there are over 15,000 entities (not necessarily individuals) that “own” some amount of a DAO Token
  7. Why is “own” in quotation marks? Because it is still unclear if controlling access to these private keys is the same thing as owning them.  See also: Watermarked Tokens as well as The Law of Bitcoin
  8. Gatecoin, which facilitated the crowdsale of both The DAO and DigixDAO was recently hacked and an estimated $2 million in bitcoins and ether were stolen
  9. Yesterday Gavin Wood, a co-founder of Ethereum, announced that he is stepping down as a “curator” for The DAO.  Curators, according to him, are effectively just individuals who identify whether someone is who they say they are — and have no other duties, responsibilities or authority.
  10. Three days ago, the Slock.it dev team — some of whom also worked on creating The DAO — did a live Q/A session that was videotaped and attempted to answer some difficult questions, like how many DAO Tokens they individually own.

Conclusion

About 17 months ago I put together a list of token crowdsales.  It would be interesting to revisit these at some point later this year to see what the return has been for those holders and how many failed.

For instance, there hasn’t really been any qualitative analysis of crowdsales or ICOs in beyond looking at price appreciation.6 What other utility was ultimately created with the issuance of say, factoids (Factom tokens) or REP (Augur tokens)?

Similarly, no one has really probed Bitcoin mining (and all POW mining) through the lens of a crowdsale on network security. Is every 10 minutes an ICO? After all, the scratch-off contest ties up capital seeking rents on seigniorage and in the long run, assuming a competitive market, that seigniorage is bid away to what Robert Sams has pointed out to where the marginal cost equals the marginal value of a token. So you end up with this relatively large capital base — divorced from the real world — that actually doesn’t produce goods or services beyond the need to be circularly protected via capital-intensive infrastructure.

Other questions to explore in the future include:

  • what are the benefits, if any, of using a centralized autonomous organization (CAO) versus decentralized autonomous organization (DAO) for regulated institutions?
  • how can a party or parties sue a decentralized autonomous organization? 7
  • what are the legal implications of conducting a 51% attack on a network with legally recognized DAOs residing on a public blockchain?8
  • will the continued concentration of ether and/or DAO Tokens create a 51% voting problem identified in the “Curator” section?

Still don’t fully understand what The DAO is?  Earlier this week CoinDesk published a pretty good overview of it.

[Special thanks to Raffael Danielli, Robert Sams and Nick Zeeb for their thoughts]

Endnotes

  1. Note: for the purposes of The DAO, “curators” are effectively identity oracles. []
  2. It appears that currently, once a quorum is achieved, a relatively small proportion of token holders can vote “yes” to a proposal to trigger a large payout. []
  3. The current line-up of goods and services are not based around solving for problems in which censorship is a threat, such as those facing an aid worker in a politically unstable region. []
  4. That is not to say that they all fail. In fact according to one statistic from Kickstarter, there was a 9% failure rate on its platform. Thus, it depends on the platform and what the reward is. []
  5. CoinGecko is tracking several hundred tokens. []
  6. ICO stands for “initial coin offering” — it is slight twist to the term IPO as it relates to securities. []
  7. An added wrinkle to identifying liable parties is: what happens when systems like Zcash launch? []
  8. This presupposes that a DAO will gain legal recognition and/or a public blockchain gains legal standing as an actual legal record. []

Book Review: The Business Blockchain

[Disclaimer: The views expressed below are solely my own and do not necessarily represent the views of my employer or any organization I advise.]

William Mougayar is an angel investor who has been investigating the cryptocurrency and broader distributed ledger ecosystem over the past several years.

He recently published a book entitled The Business Blockchain that attempts to look at how enterprises and organizations should view distributed ledgers and specifically, blockchains.

While it is slightly better than “Blockchain Revolution” from the Tapscott’s, it still has multiple errors and unproven conjectures that prevent me from recommending it.  For instance, it does not really distinguish one blockchain from another, or the key differences between a distributed ledger and a blockchain.

Note: all transcription errors below are my own.  See my other book reviews.

Introduction

On p. xxii he writes:

“These are necessary but not sufficient conditions or properties; blockchains are also greater than the sum of their parts.”

I agree with this and wrote something very similar two years ago in Chapter 2:

While the underlying mathematics and cryptographic concepts took decades to develop and mature, the technical parts and mechanisms of the ledger (or blockchain) are greater than the sum of the ledger’s parts.

On p. xxiv he writes:

“Just like we cannot double spend digital money anymore (thanks to Satoshi Nakamoto’s invention), we will not be able to double copy or forge official certificates once they are certified on a blockchain.”

There are two problems with this:

  1. Double-spending can and does still occur, each month someone posts on social media how they managed to beat a retailer/merchant that accepted zero-confirmation transactions
  2. Double-spending can and is prevented in centralized architectures today, you don’t need a blockchain to prevent double-spending if you are willing to trust a party

Chapter 1

[Note: recommend that future editions should include labeled diagrams/tables/figures]

On p. 11 he writes:

“Solving that problem consists in mitigating any attempts by a small number of unethical Generals who would otherwise become traitors, and lie about coordinating their attack to guarantee victory.”

It could probably be written slightly different: how do you coordinate geographically dispersed actors to solve a problem in which one or more actor could be malicious and attempt to change the plan?  See also Lamport et al. explanation.

On p.13 he writes compares a database with a blockchain which he calls a “ledger.”

I don’t think this is an accurate comparison.

For instance, a ledger, as Robert Sams has noted, assumes ties to legal infrastructure.  Some blockchains, such as Bitcoin, were intentionally designed not to interface with legal infrastructure, thus they may not necessarily be an actual ledger.

To quote Sams:

I think the confusion comes from thinking of cryptocurrency chains as ledgers at all. A cryptocurrency blockchain is (an attempt at) a decentralised solution to the double spending problem for a digital, extra-legal bearer asset. That’s not a ledger, that’s a log.

That was the point I was trying to make all along when I introduced the permissioned/permissionless terminology!  Notice, I never used the phrase “permissionless ledger” — Permissionless’ness is a property of the consensus mechanism.

With a bearer asset, possession of some instrument (a private key in the cryptocurrency world) means ownership of the asset. With a registered asset, ownership is determined by valid entry in a registry mapping an off-chain identity to the asset. The bitcoin blockchain is a public log of proofs of instrument possession by anonymous parties. Calling this a ledger is the same as calling it “bearer asset ledger”, which is an oxymoron, like calling someone a “married bachelor”, because bearer assets by definition do not record their owners in a registry!

This taxonomy that includes the cryptocurrency stuff in our space (“a public blockchain is a permissionless distributed ledger of cryptocurrency”) causes so much pointless discussion.

I should also mention that the DLT space should really should be using the phrase “registry” instead of “ledger”. The latter is about accounts, and it is one ambition too far at the moment to speak of unifying everyone’s accounts on a distributed ledger.

Is this pedantic?  Maybe not, as the authors of The Law of Bitcoin also wrestle with the buckets an anarchic cryptocurrency fall under.

On p. 14 he writes about bank accounts:

“In reality, they provided you the illusion of access and activity visibility on it.  Every time you want to move money, pay someone or deposit money, the bank is giving you explicit access because you gave them implicit trust over your affairs.  But that “access” is also another illusion.  It is really an access to a database record that says you have such amount of money.  Again, they fooled you by giving you the illusion that you “own” that money.”

This is needless inflammatory.  Commercial law and bankruptcy proceedings will determine who owns what and what tranche/seniority your claims fall under.  It is unclear what the illusion is.

On p. 14 he writes:

“A user can send money to another, via a special wallet, and the blockchain network does the authentication, validation and transfer, typically within 10 minutes, with or without a cryptocurrency exchange in the middle.”

Which blockchain is he talking about?  If it is not digital fiat, how does the cash-in/cash-out work?  To my knowledge, no bank has implemented an end-to-end production system with other banks as described above.  Perhaps that will change in the future.

On p. 18 he writes:

“Sometimes it is represented by a token, which is another form of related representation of an underlying cryptocurrency.”

This isn’t very well-defined.  The reason I went to great lengths in November to explain what a “token” is and isn’t is because of the confusion caused by the initial usage of a cryptographic token, a hardware device from companies like RSA.  This is not what a “token” in cryptocurrency usage means. (Note: later on p. 91 he adds a very brief explanation)

On p. 18 he cites Robert Sams who is quoting Nick Szabo, but didn’t provide a source.  It is found in Seigniorage Shares.

On p. 18 he also writes:

“As cryptocurrency gains more acceptance and understanding, its future will be less uncertain, resulting in a more stable and gradual adoption curve.”

This is empirically not true and actually misses the crux of Sams’ argument related to expectations.

On p. 20 he writes:

“As of 2016, the Bitcoin blockchain was far from these numbers, hovering at 5-7 TPS, but with prospects of largely exceeding it due to advances in sidechain technology and expected increases in the Bitcoin block size.”

This isn’t quite correct.  On a given day over the past year, the average TPS is around 2 TPS and Tradeblock estimates by the end of 2016 that with the current block size it will hover around just over 3 TPS.

What is a sidechain?  It is left undefined in that immediate section.  One potential definition is that it is a sofa.

On p. 20 he writes:

“Private blockchains are even faster because they have less security requirements, and we are seeing 1,000-10,000 TPS in 2016, going up to 2,000-15,000 TPS in 2017, and potentially an unlimited ceiling beyond 2019.”

This is untrue.  “Private blockchains” do not have “less” security requirements, they have different security requirements since they involve known, trusted participants.  I am also unaware of any production distributed ledger system that hits 10,000 TPS.  Lastly, it is unclear where the “unlimited ceiling” prediction comes from.

On p. 20 he writes:

“In 2014, I made the strong assertion that the blockchain is the new database, and warned developers to get ready to rewrite everything.”

Where did you warn people?  Link?

On p. 21 he writes:

“For developers, a blockchain is first and foremost a set of software technologies.”

I would argue that it is first and foremost a network.

On p. 22 he writes:

“The fact that blockchain software is open source is a powerful feature. The more open the core of a blockchain is, the stronger the ecosystem around it will become.”

Some, but not all companies building blockchain-related technology, open source the libraries and tools.  Also, this conflates the difference between code and who can validate transactions on the network.  A “private blockchain” can be open sourced and secure, but only permit certain entities to validate transactions.

On p. 24 he writes:

“State machines are a good fit for implementing distributed systems that have to be fault-tolerant.”

Why?

On p. 25 he writes:

“Bitcoin initiated the Proof-of-Work (POW) consensus method, and it can be regarded as the granddaddy of these algorithms. POW rests on the popular Practical Byzantine Fault Tolerant algorithm that allows transactions to be safely committed according to a given state.”

There are at least two problems with this statement:

  • The proof-of-work mechanism used in Bitcoin is apocryphally linked to Hashcash from Adam Back; however this does not quite jive with Mougayar’s statement above. Historically, this type of proof-of-work predates Back’s contribution, all the way to 1992.  See Pricing via Processing or Combatting Junk Mail by Dwork and Naor
  • Practical Byzantine Fault Tolerance is the name of a specific algorithm published in 1999 by Castro and Liskov; it is unrelated to Bitcoin.

On p. 26 he writes:

“One of the drawbacks of the Proof-of-Work algorithm is that it is not environmentally friendly, because it requires large amounts of processing power from specialized machines that generate excessive energy.”

This is a design feature: to make it economically costly to change history.  It wasn’t that Satoshi conjured up a consensus method to be environmentally friendly, rather it is the hashrate war and attempt to seek rents on seigniorage that incentivizes the expenditure of capital, in this case energy.  If the market price of a cryptocurrency such as bitcoin declined, so too would the amount of energy used to secure it.

Chapter 2

On p. 29 he writes:

“Reaching consensus is at the heart of a blockchain’s operations.  But the blockchain does it in a decentralized way that breaks the old paradigm of centralized consensus, when one central database used to rule transaction validity.”

Which blockchain is he talking about?  They are not a commodity, there are several different unique types.  Furthermore, distributed consensus is an academic research field that has existed for more than two decades.

On p. 29 he writes:

“A decentralized scheme (which the blockchain is based on) transfers authority and trust to a decentralized network and enables its nodes to continuously and sequentially record their transactions on a public “block,” creating a unique” chain” – the blockchain.”

Mougayar describes the etymology of the word “blockchain” specific to Bitcoin itself.

Note: a block actually is more akin to a “batch” or “bucket” in the sense that transactions are bundled together into a bucket and then propagated.  His definition of what a blockchain is is not inclusive enough in this chapter though because it is unclear what decentralization can mean (1 node, 100 nodes, 10,000 nodes?).  Also, it is important to note that not all distributed ledgers are blockchains.

On p. 31 he writes:

“Credit card companies charge us 23% in interest, even when the prime rate is only at 1%”

Which credit card companies are charging 23%?  Who is being charged this?  Also, even if this were the case, how does a blockchain of some kind change that?

On p. 32 he writes:

“Blockchains offer truth and transparency as a base layer. But most trusted institutions do not offer transparency or truth. It will be an interesting encounter.”

This is just a broad sweeping generalization.  What does truth and transparency mean here?  Which blockchains?  Which institutions?  Cannot existing institutions build or use some kind of distributed ledger to provide the “truth” and “transparency” that he advocates?

On p. 33 he writes:

“The blockchain challenges the roles of some existing trust players and reassigns some of their responsibilities, sometimes weakening their authority.”

Typo: should be “trusted” not “trust.”

On p. 34 he writes:

“There is a lesson from Airbnb, which has mastered the art of allowing strangers to sleep in your house without fear.”

This is not true, there are many examples of Airbnb houses that have been trashed and vandalized.

On p. 34, just as the Tapscott’s did in their book, Mougayar talks about how Airbnb could use a blockchain for identity and reputation.  Sure, but what are the advantages of doing that versus a database or other existing technology?

On p. 37 he writes:

“Enterprises are the ones asking, because the benefits are not necessarily obvious to them.  For large companies, the blockchain presented itself as a headache initially. It was something they had not planned for.”

First off, which blockchain?  And which enterprises had a headache from it?

On p. 39 he writes: “Prior to the Bitcoin invention…”

He should probably flip that to read “the invention of Bitcoin”

On p. 40 he writes:

“… it did not make sense to have money as a digital asset, because the double-spend (or double-send) problem was not solved yet, which meant that fraud could have dominated.”

This is empirically untrue.  Centralized systems prevent double-spending each and every day.  There is a double-spending problem when you are using a pseudonymous, decentralized network and it is partially resolved (but not permanently solved) in Bitcoin by making it expensive, but not impossible, to double-spend.

On p. 41 he writes:

“They will be no less revolutionary than the invention of the HTML markup language that allowed information o be openly published and linked on the Web.”

This is a little redundant and should probably be rewritten as “the invention of the hypertext markup language (HTML).”

On p. 43 he writes:

“Smart contracts are ideal for interacting with real-world assets, smart property, Internet of Things (IoT) and financial services instruments.”

Why are smart contracts ideal for that?

On p. 46 he writes: “Time-stamping” and in other areas he writes it without a dash.

On p. 46 he writes:

“And blockchains are typically censorship resistant, due to the decentralized nature of data storage, encryption, and peer controls at the edge of the network.”

Which blockchains?  Not all blockchains in the market are censorship resistant.  Why and why not?

On p. 48 he mentions “BitIID” – this is a typo for “BitID”

On p. 51 he writes:

“Enter the blockchain and decentralized applications based on it. Their advent brings potential solutions to data security because cryptographically-secured encryption becomes a standard part of blockchain applications, especially pertaining to the data parts. By default, everything is encrypted.”

This is untrue.  Bitcoin does not encrypt anything nor does Ethereum.  A user could encrypt data first, take a hash of it and then send that hash to a mining pool to be added to a block, but the network itself provides no encryption ability.

On p. 52 he writes:

“Consensus in public blockchains is done publicly, and is theoretically subject to the proverbial Sybil attacks (although it has not happened yet).”

Actually, it has on altcoins.  One notable occurrence impacted Feathercoin during June 2013.

On p. 54 he writes:

“The blockchain can help, because too many Web companies centralized and hijacked what could have been a more decentralized set of services.”

This is the same meme in the Tapscott book.  There are many reasons for why specific companies and organizations have large users bases but it is hard to see how they hijacked anyone; but that is a different conversation altogether.

On p. 54 he writes:

“We can also think of blockchains as shared infrastructure that is like a utility. If you think about how the current Internet infrastructure is being paid for, we subsidize it by paying monthly fees to Internet service providers.  As public blockchains proliferate and we start running millions of smart contacts and verification services on them, we might be also subsidizing their operation, by paying via micro transactions, in the form of transaction fees, smart contract tolls, donation buttons, or pay-per-use schemes.”

This is a very liberal use of the word subsidize.  What Mougayar is describing above is actually more of a tax than a charitable donation.

The design behind Bitcoin was intended to make it such that there was a Nash equilibrium model between various actors.  That miners would not need to rely on charity to continue to secure the network because as block rewards decline, the fees themselves would in the long run provide enough compensation to pay for their security services.

It could be argued that this will not happen, that fees will not increase to offset the decline in block rewards but that is for a different article.

As an aside, Mougayar’s statement above then intersects with public policy: which blockchains should receive that subsidy or donation?  All altcoins too?  And who should pay this?

Continuing:

“Blockchains are like a virtual computer somewhere in a distributed cloud that is virtual and does not require server setups. Whoever opens a blockchain node runs the server, but not users or developers.”

This is untrue.  The ~6,400 nodes on the Bitcoin network are all servers that require setup and maintenance to run.  The same for Ethereum and any other blockchain.

On p. 58 he writes:

“It is almost unimaginable to think that when Satoshi Nakamoto released the code for the first Bitcoin blockchain in 2009, it consisted of just two computers and a token.”

A couple issues:

  1. There is a typo – “first” should be removed (unless there was another Bitcoin network before Bitcoin?)
  2. Timo Hanke and Sergio Lerner have hypothesized that Satoshi probably used multiple computers, perhaps more than a dozen.

On p. 58 he writes:

“One of the primary differences between a public and private blockchain is that public blockchains typically have a generic purpose and are generally cheaper to use, whereas private blockchains have a more specific usage, and they are more expensive to set up because the cost is born by fewer owners.”

This is not true.  From a capital and operation expenditure perspective, public blockchains are several orders of magnitude more expensive to own and maintain than a private blockchain.  Why?  Because there is no proof-of-work involved and therefore private blockchain operators do not need to spend $400 million a year, which is roughly the cost of maintaining the Bitcoin network today.

In contrast, depending on how a private blockchain (or distributed ledger) is set up, it could simply be run by a handful of nodes on several different cloud providers – a marginal cost.

Chapter 3

On p. 68 he writes:

“Taken as an extreme case, just about any software application could be rewritten with some blockchain and decentralization flavor into it, but that does not mean it’s a good idea to do so.”

Yes, fully agreed!

On p. 68 he writes:

“By mid-2016, there were approximately 5,000 developers dedicated to writing software for cryptocurrency, Bitcoin or blockchains in general. Perhaps another 20,000 had dabbled with some of that technology, or written front-end applications that connect to a blockchain, one way or the other.”

Mougayar cites his survey of the landscape for this.

I would dispute this though, it’s probably an order of magnitude less.

The only way this number is 5,000 is if you liberally count attendees at meetups or all the various altcoins people have touched over the year, and so forth.  Even the headcount of all the VC funded “bitcoin and blockchain” companies is probably not even 5,000 as of May 2016.

On p. 71 he writes:

“Scaling blockchains will not be different than the way we have continued to scale the Internet, conceptually speaking.  There are plenty of smart engineers, scientists, researchers, and designers who are up to the challenge and will tackle it.”

This is a little too hand-wavy.  One of the top topics that invariably any conversation dovetails into at technical working groups continues to be “how to scale” while keeping privacy requirements and non-functional requirements intact.  Perhaps this will be resolved, but it cannot be assumed that it will be.

On p. 72 he writes:

“Large organizations, especially banks, have not been particularly interested in adopting public blockchains for their internal needs, citing potential security issues. The technical argument against the full security of public blockchains can easily be made the minute you introduce a shadow of a doubt on a potential scenario that might wreak havoc with the finality of a transaction.  That alone is enough fear to form a deterring factor for staying away from public blockchain, although the argument could be made in favor of their security.”

This is a confusing passage.  The bottom line is that public blockchains were not designed with the specific requirements that regulated financial institutions have.  If they did, perhaps they would be used.  But in order to modify a public blockchain to provide those features and characteristics, it would be akin to turning an aircraft carrier into a submarine.  Sure it might be possible, but it would just be easier and safer to build a submarine instead.

Also, why would an organization use a public blockchain for their internal needs?  What does that mean?

On p. 78 he writes:

“Targeting Bitcoin primarily, several governments did not feel comfortable with a currency that was not backed by a sovereign country’s institutions.”

Actually, what made law enforcement and regulators uncomfortable was a lack of compliance for existing AML/KYC regulations.  The headlines and hearings in 2011-2013 revolved around illicit activities that could be accomplished as there were no tools or ability to link on-chain activity with real world identities.

Chapter 4

On p. 87 he writes:

“The reality is that customers are not going to the branch as often (or at all), and they are not licking as many stamps to pay their bills.  Meanwhile, FinTech growth is happening: it was a total response to banks’ lack of radical innovation.”

There are a couple issues going on here.

Banks have had to cut back on all spending due to cost cutting efforts as a whole and because their spending has had to go towards building reporting and compliance systems, neither of which has been categorized as “radical innovation.”

Also, to be balanced, manyh of the promises around “fintech” innovation still has yet to germinate due to the fact that many of the startups involved eventually need to incorporate and create the same cost structures that banks previously had to have.  See for instance, financial controls in marketplace lending – specifically Lending Club.

On p. 88 he writes:

“If you talk to any banker in the world, they will admit that ApplePay and PayPal are vexing examples of competition that simply eats into their margins, and they could not prevent their onslaught.”

Any banker will say that?  While a couple of business lines may change, which banks are being displaced by either of those two services right now?

On p. 89 he writes:

“Blockchains will not signal the end of banks, but innovation must permeate faster than the Internet did in 1995-2000.”

Why?  Why must it permeate faster?  What does that even mean?

On p. 89 he writes:

“This is a tricky question, because Bitcoin’s philosophy is about decentralization, whereas a bank is everything about centrally managed relationships.”

What does this mean?  If anything, the Bitcoin economy is even more concentrated than the global banking world, with only about a dozen exchanges globally that handle virtually all of the trading volume of all cryptocurrencies.

On p. 89 he writes:

“A local cryptocurrency wallet skirts some of the legalities that existing banks and bank look-alikes (cryptocurrency exchanges) need to adhere to, but without breaking any laws. You take “your bank” with you wherever you travel, and as long as that wallet has local onramps and bridges into the non-cryptocurrency terrestrial world, then you have a version of a global bank in your pocket.”

This is untrue.  There are many local and international laws that have been and continue to be broken involving money transmission, AML/KYC compliance and taxes.  Ignoring those though, fundamentally there are probably more claims on bitcoins – due to encumbrances – than bitcoins themselves.  This is a big problem that still hasn’t been dealt with as of May 2016.

On p. 95 he writes:

“The decentralization of banking is here. It just has not been evenly distributed yet.”

This is probably inspired by William Gibson who said: ‘The future is already here — it’s just not very evenly distributed.’

On p. 95 he writes:

“The default state and starting position for innovation is to be permissionless. Consequently, permissioned and private blockchain implementations will have a muted innovation potential.  At least in the true sense of the word, not for technical reasons, but for regulatory ones, because these two aspect are tie together.”

This is not a priori true, how can he claim this?  Empirically we know that permissioned blockchains are designed for different environments than something like Bitcoin.  How can he measure the amount of potential “innovation” either one has?

On p. 95 he writes:

“We are seeing the first such case unfold within the financial services sector, that seems to be embracing the blockchain fully; but they are embracing it according to their own interpretation of it, which is to make it live within the regulatory constraints they have to live with. What they are really talking about is “applying innovation,” and not creating it. So, the end-result will be a dialed down version of innovation.”

This is effectively an ad hominem attack on those working with regulated institutions who do not have the luxury of being able to ignore laws and regulations in multiple jurisdictions.  There are large fines and even jail time for ignoring or failing to comply with certain regulations.

On p. 95 he writes:

“That is a fact, and I am calling this situation the “Being Regulated Dilemma,” a pun on the innovator’s dilemma. Like the innovator’s dilemma, regulated companies have a tough time extricating themselves from the current regulations they have to operate within.  So, when they see technology, all they can do is to implement it within the satisfaction zones of regulators. Despite the blockchain’s revolutionary prognosis, the banks cannot outdo themselves, so they risk only guiding the blockchain to live within their constrained, regulated world.”

“It is a lot easier to start innovating outside the regulatory boxes, both figuratively and explicitly. Few banks will do this because it is more difficult.”

“Simon Taylor, head of the blockchain innovation group at Barclays, sums it up: “I do not disagree the best use cases will be outside regulated financial services. Much like the best users of cloud and big data are not the incumbent blue chip organizations.  Still their curioisity is valuable for funding and driving forward the entire space.” I strongly agree; there is hope some banks will contribute to the innovation potential of the blockchain in significant ways as they mature their understanding and experiences with this next technology.

An ending note to banks is that radical innovation can be a competitive advantage, but only if it is seen that way. Otherwise innovation will be dialed down to fit their own reality, which is typically painted in restrictive colors.

It would be useful to see banks succeed with the blockchain, but they need to push themselves further in terms of understanding what the blockchain can do. They need to figure out how they will serve their customers better, and not just how they will serve themselves better. Banks should innovate more by dreaming up use cases that we have not though about yet, preferably in the non-obvious category.

The fundamental problem with his statement is this: banks are heavily regulated, they cannot simply ignore the regulations because someone says they should.  If they fail to maintain compliance, they can be fined.

But that doesn’t mean they cannot still be innovative, or that the technology they are investigating now isn’t useful or helpful to their business lines.

In effect, this statement is divorced from the reality that regulated financial institutions operate in.  [Note: some of his content such as the diagram originated from his blog post]

On p. 102 he writes:

“Banks will be required to apply rigorous thinking to flush out their plans and positions vis-à-vis each one of these major blockchain parameters. They cannot ignore what happens when their core is being threatened.”

While this could be true, it is an over generalization: what type of business lines at banks are being threatened?  What part of “their” core is under attack?

On p. 103 he writes:

“More than 200 regulatory bodies exist in 150 countries, and many of them have been eyeing the blockchain and pondering regulatory updates pertaining to it.”

Surely that is a typo, there are probably 200 regulatory bodies alone in the US itself.

On p. 105 he writes:

“Banks will need to decide if they see the blockchain as a series of Band-Aids, or if they are willing to find the new patches of opportunity.  That is why I have been advocating that they should embrace (or buy) the new cryptocurrency exchanges, not because these enable Bitcoin trades, but because they are a new generation of financial networks that has figured out how to transfer assets, financial instruments, or digital assets swiftly and reliably, in essence circumventing the network towers and expense bridges that the current financial services industry relies upon.”

This is a confusing passage.

Nearly all of the popular cryptocurrency exchanges in developed countries require KYC/AML compliance in order for users to cash-in and out of their fiat holdings.  How do cryptocurrency exchanges provide any utility to banks who are already used to transferring and trading foreign exchange?

In terms of percentages, cryptocurrency exchanges are still very easy to compromise versus banks; what utility do banks obtain by acquiring exchanges with poor financial controls?

And, in order to fund their internal operations, cryptocurrency exchanges invariably end up with the same type of cost structures regulated financial institutions have; the advantage that they once had effectively involved non-compliance – that is where some of the cost savings was.  And banks cannot simply ignore regulations because people on social media want them to; these cryptocurrency sites require money to operate, hence the reason why many of them charge transaction fees on all withdrawals and some trades.

Chapter 5

On p. 115 he mentions La’Zooz and Maidsafe, neither of which – after several years of development, actually work.  Perhaps that changes in the future.

On p.118 he writes:

“There is another potential application of DIY Government 2.0. Suppose a country’s real government is failing, concerned citizens could create a shadow blockchain governance that is more fair, decentralized and accountable. There are at least 50 failed, fragile, or corrupt states that could benefit from an improve blockchain governance.”

Perhaps this is true, that there could be utility gain from some kind of blockchain.  But this misses a larger challenge: many of these same countries lack private property rights, the rule of law and speedy courts.

On p. 119 he writes about healthcare use cases:

“Carrying a secure wallet with our full electronic medical record in it, or our stored DNA, and allowing its access, in case of emergency.”

What advantage do customers gain from carrying this around in a secure wallet?  Perhaps they do, but it isn’t clear in this chapter.

On p. 126-127 he makes the case for organizations to have a “blockchain czar” but an alternative way to pitch this without all the pomp is simply to have someone be tasked with becoming a subject-matter expert on the topic.

On p. 131 he writes:

“Transactions are actually recorded in sequential data blocks (hence the word blockchain), so there is a historical, append-only log of these transaction that is continuously maintained and updated.  A fallacy is that the blockchain is a distributed ledger.”

It is not a fallacy.

Chapter 7

On p. 149 he writes: “What happened to the Web being a public good?”

Costs.  Websites have real costs.  Content on those websites have real costs.  And so forth.  Public goods are hard to sustain because no one wants to pay for them but everyone wants to use them.  Eventually commercial entities found a way to build and maintain websites that did not involve external subsidization.

On p. 150 he writes:

“Indeed, not only was the Web hijacked with too many central choke points, regulators supposedly continue to centralize controls in order to lower risk, whereas the opposite should be done.”

This conflicts with the “Internet is decentralized” meme that was discussed throughout the book.  So if aspects of the Internet are regulated, and Mougayar disagrees with those regulations, doesn’t this come down to disagreements over public policy?

On p. 153 he writes:

“Money is a form of value.  But not all value is money. We could argue that value has higher hierarchy than money. In the digital realm, a cryptocurrency is the perfect digital money.  The blockchain is a perfect exchange platform for digital value, and it rides on the Internet, the largest connected network on the planet.”

Why are cryptocurrencies perfect?  Perhaps they are, but it is not discussed here.

On p. 153 he also talks about the “programmability” of cryptocurrencies but doesn’t mention that if fiat currencies were digitally issued by central banks, they too could have the same programmable abilities.

On p. 160 he predicts:

“There will be dozens of commonly used, global virtual currencies that will be considered mainstream, and their total market value will exceed $5 trillion, and represent 5% of the world’s $100 trillion economy in 2025.”

Perhaps that occurs, but why?  And are virtual currencies now different than digital currencies?  Or are they the same?  None of these questions are really addressed.

Conclusion

This book is quick read but unfortunately is weighed down by many opinions that are not supported by evidence and consequently, very few practical applications for enterprises are explained in detail.

For regulated businesses such as financial institutions, there are several questions that need to be answered such as: what are the specific cost savings for using or integrating with some kind of blockchain?  What are the specific new business lines that could be created?  And unfortunately the first edition of this book did not answer these types of questions.  Let us look again at a future version.

See my other book reviews.

AFA Presentation: Cryptocurrencies, Blockchains and the Future of Financial Services

The slideshow below was first presented at an AFA panel on January 4, 2016 in San Francisco.

References:

Some housekeeping of events and interviews

It has been a little while since I posted the events, panels and presentations I have been involved with.  Below is some of the public activity over the past 5-6 months.

Interviews with direct quotes:

Indirect quotes:

Academic citations:

Presentations, panels and events:

Buckets of Permissioned, Permissionless, and Permissioned Permissionlessness Ledgers

A few hours ago I gave the following presentation to Infosys / Finacle in Mysore, India with the Blockchain University team.  All views and opinions are my own and do not represent those of either organization.

Learning from the past to build an improved future of fintech

[Note: below is a slightly edited speech I gave yesterday at a banking event in Palo Alto.  This includes all of the intended legalese, some of which I removed in the original version due to flow and time.  Special thanks to Ryan Straus for his feedback.  The views below are mine alone and do not represent those of any organization or individual named.]

Before we look to the future of fintech, and specifically cryptocurrencies and distributed ledgers, let’s look at the most recent past.  It bears mentioning that as BNY Mellon is the largest custodial bank in the world, we will see the importance of reliable stewardship in a moment below.

In January 2009 an unknown developer, or collective of developers, posted the source code of Bitcoin online and began generating blocks – batches of transactions – that store and update the collective history of Bitcoin: a loose network of computer systems distributed around the globe.

To self-fund its network security, networks like Bitcoin create virtual “bearer assets.” These assets are automatically redeemable with the use of a credential.  In this case, a cryptographic private key.  From the networks point of view, possession of this private key is the sole requirement of ownership.  While the network rules equivocate possession and control, real currency – not virtual currency – is the only true bearer instrument.  In other words, legal tender is the only unconditional exception to nemo dat quod non habet – also known as the derivative principal – which dictates that one cannot transfer better title than one has.

Several outspoken venture investors and entrepreneurs in this space have romanticized the nostalgia of such a relationship, of bearer assets and times of yore when a “rugged individual” can once again be their own custodian and bank.1 The sentimentality of a previous era when economies were denominated by precious metals held – initially not by trusted third parties – but by individuals, inspired them to invest what has now reached more than $800 million in collective venture funding for what is aptly called Bitcoinland.

Yet, the facts on the ground clearly suggests that this vision of “everyone being their own bank” has not turned into a renaissance of success stories for the average private key holder.  The opposite seems to have occurred as the dual-edged sword of bearer instruments have been borne out.  At this point, it is important to clearly define our terms.  The concepts of “custody” and “deposit” are often conflated.  While the concepts are superficially similar, they are very different from a legal perspective.  Custody involves the transfer of possession/control.  A deposit, on the other hand, occurs when both control and title is transferred.

Between 2009 and early 2014, based on public reports, more than 1 million bitcoins were lost, stolen, seized and accidentally destroyed.2 Since that time, several of the best funded “exchanges” have been hacked or accidentally sent bitcoins to the wrong customer.  While Mt. Gox, which may have lost 850,000 bitcoins itself, has attracted the most attention and media coverage – rightfully so – there is a never ending flow of unintended consequences from this bearer duality.3

For instance, in early January 2015, Bitstamp – one of the largest and oldest exchanges – lost 19,000 bitcoins due to social engineering and phishing via Gmail and Skype on its employees including a system administrator.4 Four months later, in May, Bitfinex, a large Asian-based exchange was hacked and lost around 1,500 bitcoins.5 In another notable incident, last September, Huobi, a large Bitcoin exchange in Beijing accidentally sent 920 bitcoins and 8,100 litecoins to the wrong customers.6  And ironically, because transactions are generally irreversible and the sole method of control is through a private key they no longer controlled them: they had to ask for the bitcoins back and hope they were returned.

A study of 40 Bitcoin exchanges published in mid-2013 found that at that time 18 out of 40 – 45% — had closed doors and absconded with some portion of customer funds.7 Relooking at that list today we see that about another five have closed in a similar manner.  All told, at least 15% if not higher, of Bitcoin’s monetary base is no longer with the legitimate owner.  Can you imagine if a similar percentage of real world wealth or deposits was dislocated in the same manner in a span of 6 years?8

In many cases, the title to this property is encumbered, leading to speculation that since many of these bitcoins are intermixed and pooled with others, a large percentage of the collective monetary base does not have clean title, the implications of which can be far reaching for an asset that is not exempted from nemo dat, it is not fungible like legal tender.9

As a consequence, because people in general don’t trust themselves with securing their own funds, users have given – deposited – their private keys with a new batch of intermediaries that euphemistically market themselves as “hosted wallets” or “vaults.” What does that look like in the overall scheme?  These hosted wallets, such as Coinbase and Xapo, have collectively raised more than $200 million in venture funding, more than a quarter of the aggregate funding that the whole Bitcoin space has received. Simultaneously, the new – often unlicensed – parties collectively hold several million bitcoins as deposits; probably 25-30% of the existing monetary base.10 Amazingly, nobody is actually certain whether a “hosted wallet” is a custodian of a customers bitcoin or acquired title to the bitcoin and is thus a depository.

Yet, in recreating the same financial intermediaries that they hoped to replace – in turning a bearer asset into a registered asset – some Bitcoin enthusiasts have done so in fashion that – as described earlier – has left the system ripe for abuse.  Whereas in the real world of finance, various duties are segregated via financial controls and independent oversight.11 In the Bitcoin space, there have been few financial controls.  For example, what we call a Bitcoin exchange is really a broker-dealer, clearinghouse, custodian, depository and an exchange rolled into one house which has led to theft, tape painting, wash trading, and front-running.12 All the same issues that led to regulatory oversight in the financial markets in the first place.

And while a number of the better funded and well-heeled hosted wallets and exchanges have attempted to integrate “best practices” and even third-party insurance into their operation, to date, there is only one Bitcoin “vault” – called Elliptic — that has been accredited with meeting the ISAE 3402 custodial standard from KPMG. Perhaps this will change in the future.

But if the point of the Bitcoin experiment, concept, lifestyle or movement was to do away or get away from trusted third parties, as described above, the very opposite has occurred.

What can be learned from this?  What were the reasons for institutions and intermediation in the first place?  What can be taken away from the recent multi-million dollar educational lesson?

We have collectively learned that a distributed ledger, what in Bitcoin is called a blockchain, is capable of clearing on-chain assets in a cryptographically verifiable manner, in near-real time all with 100% uptime because its servers – what are called validators – are located around the world.  As we speak just under sixty four hundred of these servers exist, storing and replicating the data so that availability to any one of them is, in theory, irrelevant.13

Resiliency, accountability and transparency, what’s not to like?  Why wouldn’t financial institutions want to jump on Bitcoin then, why focus on other distributed ledger systems?

One of the design assumptions in Bitcoin is that its validators are unknown and untrusted – that there is no gating or vetting process to become a validator on its open network.  Because it is purposefully expensive and slow to produce a block that the rest of the network will regard as valid, in theory, the rest of the network will reject your work and you will have lost your money.  Thus, validators, better technically referred to as a block maker, attempt to solve a benign math problem that takes on average about 10 minutes to complete with the hope of striking it rich and paying their bills. There are exceptions to this behavior but that is a topic for another time.14

The term trust or variation thereof appears 13 times in the final whitepaper.  Bitcoin was designed to be a solution for cypherpunks aiming to minimize trust-based relationships and mitigate the ability for any one party to censor or block transactions. Because mining validators were originally unknown and untrusted, to protect against history-reversing attacks, Bitcoin was purposefully designed to be resource-intensive and inefficient.15 That is to say attackers must expend real world resources, energy, to disrupt or rewrite history.  The theory is that this type of economic attack would stave off all but the most affluent nation-state actors; in practice this has not been the case, but that again is a topic for another speech.

Thus Bitcoin is perhaps the world’s first, commodity-based censorship resistance-as-a-service.  To prevent attackers on this communal network from reversing or changing transactions on a whim, an artificially expensive anti-Sybil mechanism was built in dubbed “proof of work” – the 10 minute math problem.  Based on current token value, the cost to run this network is roughly $300 million a year and it scales in direct proportion to the bitcoin market price.16

Thus there are trade-offs that most financial institutions specifically would not be interested in.

Why you may ask?

Because banks already know their customers, staff and partners. Their counterparties and payment processors are all publicly known entities with contractual obligations and legal accountability.  Perhaps more importantly, the relationship created between an intermediary and a customer is clear with traditional financial instruments.  For example, when you deposit money in your bank account, you know (or should know) that you are trading your money for an IOU from the bank.17 On the other hand, when you place money in a safe deposit box you know (or should know) that you retain title to the subject property.  This has important considerations for both the customer and intermediary.  When you trade your money for an IOU, you are primarily concerned with the financial condition of the intermediary.  However, when you retain title to an object held by somebody else, you care far more about physical and logical security.

As my friend Robert Sams has pointed out on numerous occasions, permissionless consensus as it is called in Bitcoin, cannot guarantee irreversibility, cannot even quantify the probability of a history-reversing attack as it rests on economics, not technology.18 Bitcoin is a curious design indeed where in practice many participants on the network are now known, gated and authenticated except the transaction validators.  Why use expensive proof-of-work at all at this point if that is the case?  What is the utility of turning a permissionless system into a permissioned system, with the costs of both worlds and the benefits of neither?

But lemonade can still be squeezed from it.

Over the past year more than a dozen startups have been created with the sole intent to take parts of a blockchain and integrate their utility within financial institutions.19 They are doing so with different design assumptions: known validators with contractual terms of service. Thus, just as PGP, SSL, Linux and other open source technology, libraries and ideas were brought into the enterprise, so too are distributed ledgers.

Last year according to Accenture, nearly $10 billion was invested in fintech related startups, less than half of one percent of which went to distributed ledger-related companies as they are now just sprouting.20

What is one practical use?  According to a 2012 report by Deutsche Bank, banks’ IT costs equal 7.3% of their revenues, compared to an average of 3.7% across all other industries surveyed.21)  Several of the largest banks spend $5 billion or more in IT-related operating costs each year.  While it may sound mundane and unsexy, one of the primary use cases of a distributed ledger for financial institutions could be in reducing the cost centers throughout the back office.

For example, the settlement and clearing of FX and OTC derivatives is an oft cited and increasingly studied use case as a distributed ledger has the potential to reduce counterparty and systemic risks due to auditability and settlement built within the data layer itself.22

How much would be saved if margining and reporting costs were reduced as each transaction was cryptographically verifiable and virtually impossible to reverse? At the present time, one publicly available study from Santander estimates that “distributed ledger technology could reduce banks’ infrastructure costs attributable to cross-border payments, securities trading and regulatory compliance by between $15-20 billion per annum by 2022.”23

With that said, in its current form Bitcoin itself is probably not a threat to retail banking, especially in terms of customer acquisition and credit facilities.  For instance, if we look at on-chain entities there are roughly 370,000 actors.  If the goal of Bitcoin was to enable end-users to be their own bank without any trusted parties, based on the aggregate VC funding thus far, around $2,200 has been spent to acquire each on-chain user all while slowly converting a permissionless system into a permissioned system, but with the costs of both.24

That’s about twice as much as the average bank spends on customer acquisition in the US.  While there are likely more than 370,000 users at deposit-taking institutions like Coinbase and Xapo, they neither disclose the monthly active users nor are those actual Bitcoin users because they do not fully control the private key.

If we were to create a valuation model for the bitcoin network (not the price of bitcoins themselves), the network would be priced extremely rich due to the wealth transfer that occurs every 10 minutes in the form of asset creation.  The network in this case are miners, the block makers, who are first awarded these bearer instruments.

How can financial institutions remove the duplicative cost centers of this technology, remove this $300 million mining cost, integrate permissioned distributed ledgers into their enterprise, reduce back office costs and better serve their customers?

That is a question that several hundred business-oriented innovators and financial professionals are trying to answer and we will likely know in less time it took Bitcoin to get this far.

Thanks for your time.

Endnotes:

  1. Why Bitcoin Matters by Marc Andreessen []
  2. Tabulating publicly reported bitcoins that were lost, stolen, seized, scammed and accidentally destroyed between August 2010 and March 2014 amounts to 966,531 bitcoins. See p. 196 in The Anatomy of a Money-like Informational Commodity []
  3. Mt. Gox files for bankruptcy, hit with lawsuit from Reuters []
  4. Bitstamp Incident Report []
  5. Bitfinex Warns Customers to Halt Deposits After Suspected Hack from CoinDesk []
  6. Why One Should Think Twice Before Trading On The Bitcoin Exchanges from Forbes []
  7. See Beware the Middleman: Empirical Analysis of Bitcoin-Exchange Risk by Tyler Moore and Nicolas Christin []
  8. This has occurred during times of war.  See The Monuments Men []
  9. Bitcoin’s lien problem from Financial Times and Uniform Commercial Code and Bitcoin with Miles Cowan []
  10. Based on anecdotal conversations both Coinbase and Xapo allegedly, at one point stored over 1 million bitcoins combined. See also: Too Many Bitcoins: Making Sense of Exaggerated Inventory Claims []
  11. See Distributed Oversight: Custodians and Intermediaries []
  12. See Segregation of Duties in the CEWG BitLicense comment []
  13. See Bitnodes []
  14. See Majority is not Enough: Bitcoin Mining is Vulnerable from Ittay Eyal and Emin Gün Sirer []
  15. See Removing the Waste from Cryptocurrencies: Challenges and More Challenges by Bram Cohen and Cost? Trust? Something else? What’s the killer-app for Block Chain Technology? by Richard Brown []
  16. See Appendix B []
  17. See A Simple Explanation of Balance Sheets (Don’t run away… it’s interesting, really!) by Richard Brown []
  18. Needing a token to operate a distributed ledger is a red herring []
  19. See The Distributed Ledger Landscape and Consensus-as-a-service []
  20. Fintech Investment in U.S. Nearly Tripled in 2014 from Accenture []
  21. IT in banks: What does it cost? from Santander []
  22. See No, Bitcoin is not the future of securities settlement by Robert Sams []
  23. The Fintech 2.0 Paper: rebooting financial services from Santander []
  24. One notable exception are branchless banks such as Fidor which is expanding globally and on average spends about $20 per customer.  See also How much do you spend on Customer Acquisition? Are you sure? []

A blockchain with emphasis on the “a”

Over the past month a number of VCs including Chris Dixon and Fred Wilson use the term “the blockchain” in reference to Bitcoin, as if it is the one and only blockchain.1

There are empirically, many blockchains around.  Some of them do not involve proof-of-work, some of them are not even cryptocurrencies.  Yet despite this, Dixon blocked Greg Slepak on Twitter (creator of okTurtles and DNSChain) for pointing that out just a couple weeks ago.

But before getting into the weeds, it is worth reflecting on the history of both virtual currencies and cryptocurrencies prior to Bitcoin.

The past

Below are several notable projects that pre-date the most well-known magic internet commodity.

  • DigiCash (1990)
  • e-gold (1996)
  • WebMoney (1998)
  • PayPal (1998) “Bitcoin is the opposite of PayPal, in the sense that it actually succeeded in creating a currency.”  — Peter Thiel
  • Beenz (1998)
  • Flooz (1999)
  • Liberty Reserve (2006)
  • Frequent flyer points / loyalty programs
  • WoW gold, Linden Dollars, Nintendo Points, Microsoft Points

According to an excellent article written a couple years ago by Gwern Branwen:

Bitcoin involves no major intellectual breakthroughs, so Satoshi need have no credentials in cryptography or be anything but a self-taught programmer! Satoshi published his whitepaper May 2009, but if you look at the cryptography that makes up Bitcoin, they can basically be divided into:

  • Public key cryptography
  • Cryptographic signatures
  • Cryptographic hash functions
  • Hash chain used for proof-of-work
    • Hash tree
    • Bit gold
  • cryptographic time-stamps
  • resilient peer-to-peer networks

And what were the technological developments, tools and libraries that spearheaded those pieces?  According to Branwen:

  • 2001: SHA-256 finalized
  • 1999-present: Byzantine fault tolerance (PBFT etc.)
  • 1999-present: P2P networks (excluding early networks like Usenet or FidoNet; MojoNation & BitTorrent, Napster, Gnutella, eDonkey, Freenet, i2p etc.)
  • 1998: Wei Dai, B-money
  • 1997: HashCash; 1998: Nick Szabo, Bit Gold; ~2000: MojoNation/BitTorrent; ~2001-2003, Karma, etc
  • 1992-1993: Proof-of-work for spam
  • 1991: cryptographic timestamps
  • 1980: public key cryptography
  • 1979: Hash tree

Other prior art can be found in The Ecology of Computation from Huberman.2 One open question for permissionless systems is whether or not a blockchain is a blockchain if it is neither proof-of-work-based or proof-of-stake-based (“Cow system” in Bram Cohen’s terminology).  But that’s a topic for another post.

The present

About two weeks ago, /r/bitcoin learned that Bitcoin was not the creator of all this fundamental technology.  That indeed, there were over 30 years of academic corpus that cumulatively created the system we now call “a blockchain,” in this case, Nakamoto consensus.  And this has spawned a sundry of other experiments and projects that have since been kickstarted.

For example:

  • CoinMarketCap currently tracks 592 cryptocurrencies / 59 assets
  • CoinGecko tracks 225 cryptocurrencies/assets
  • Ray Dillinger’s “Necronomicon” includes over 100 dead altcoins
  • Map of Coins is currently tracking 686 derivatives of various cryptocurrencies; this includes all hashing functions (e.g., scrypt, X11, X13) and includes existing and defunct chains
  • These are just publicly known blockchains and there are likely dozens if not hundreds of private trials, proof of concepts in academia, institutions and from hobbyists (e.g., Citibank announced in July 2015 that it was testing out three blockchains with a “Citicoin” to better understand use-cases)

So it appears that there are more than one in the wild.

Yet, a couple weeks ago Fred Wilson wrote that:

If you think of the blockchain as an open source, peer to peer, massively distributed database, then it makes sense for the transaction processing infrastructure for it to evolve from individuals to large global corporations. Some of these miners will be dedicated for profit miners and some of them will be corporations who are mining to insure the integrity of the network and the systems they rely on that are running on it. Banks and brokerage firms are the obvious first movers in the second category.

He later clarified in the comments and means the Bitcoin blockchain, not others.

One quibble is that transaction processing is not clearly defined relative to hashing.  Today, bitcoin transactions are actually processed by very small, non-powerful computers (even a Raspberry Pi).

What about the pictures with entire rooms filled with computers?  Why does it cost so much to run a hashing farm then?

Because of the actual workhorse of the network: ASICs designed to generate proofs-of-work.  These hashing systems do not do any transaction processing, in fact, they cannot even run a Bitcoin client on them.3

Tangentially William Mougayar, investor and author, stated the following in the AVC thread:

Only trick is that mining is not cheap initially, and the majority is done in China. It presents an interesting energy challenge: you need lots of electricity to run the computers, but also to keep them cool. So, if you’re using solar you still need to cool them. And if you put them in cool climates like near the north pole, there is no solar. Someone needs to solve that equation.

Mining cannot be made “cheaper” otherwise the network becomes cheaper to attack.

In fact, as Bram Cohen mentioned last week, “energy efficient” proofs-of-works is a contradiction in terms.

Thus, there is no “equation to solve.”  In the long run, miners will bid up the marginal costs to which they equal the marginal value (MC=MV) of a bitcoin in the long run.  We see this empirically, there is no free lunch.  If hashing chips somehow became 50% more efficient, hashing farms just add 50% more of them — this ratcheting effect is called the Red Queen effect and this historically happens in a private seigniorage system just as it does in proof-of-work cryptocurrencies.4

organ proportionalismAs shown in the chart above, hashrate follows price; the amount of resources expended (for proof-of-work) is directly proportional to market value of a POW token.

Furthermore, in terms of Wilson’s prediction that banks will begin mining: what benefit do banks have for participating in the mining process?  If they own bitcoins, perhaps it “gives them a seat at the table.”  But if they do not own any, it provides no utility for them.

Why?  What problem does mining solve for organizations such as banks?  Or to put another way: what utility does proof-of-work provide a bank that knows its customers, staff and transaction processors?5

Permissioned Permissionlessness, BINO-style

One goal and innovation for Bitcoin was anonymous/pseudonymous consensus which comes with a large requirement through trade-offs: mining costs and block reorganization risk.

To quote Section 1 of the Nakamoto whitepaper regarding the transaction costs of the current method of moving value and conducting commerce:

These costs and payment uncertainties can be avoided in person by using physical currency, but no mechanism exists to make payments over a communications channel without a trusted party

Thus:

  • Bitcoin was designed with anonymous consensus to resist censorship by governments and other trusted third parties.
  • If you are running a ledger between known parties who abide by government regulations, there is no reason to pay that censorship-resistance cost.  Full stop.

Today several startups and VC funds have (un)intentionally turned an expensive permissionless system into a hydra, a gated permissioned network without the full benefits of either.  Consequently, through this mutation, some of these entities have also turned a bearer asset into a registered asset with the full costs of both.

For instance, it is currently not possible to build a censorship-resistant cash system on top of a permissioned ledger (due to the KYC requirements) yet this is basically what has attempted with many venture funded wallets such as Coinbase.

The end result: Bitcoin in name only (BINO).  In which a permissionless network is (attempted to be) turned into a permissioned network.  It bears mentioning that companies such as Peernova and Blockstack are not trying to compete with Bitcoin — they are not trying to build censorship-resistant cash.

While financial institutions can indeed download a client and send tokens around, Bitcoin was purposefully designed not to interface with financial intermediaries as it was modeled on the assumption that no one can be trusted and that parties within the network are unknown.  Therefore if parties transacting on the network are both known and trusted, then there probably is no reason to use Bitcoin-based proof-of-work.  Instead, there are other ways to secure transactions on a shared, replicated ledger.

Ask the experts

I reached out to several experts unaffiliated with Bitcoin itself to find out what the characteristics of a blockchain were in their view.

Ian Grigg has spent twenty years working in the cryptocurrency field and is the author of the Financial Cryptography blog as well as the Ricardian Contract and most recently the “Nakamoto signature.”  Below are his thoughts:

As far as *history* is concerned, it looks like just about every individual component of Bitcoin was theorised before 2009.  The last thing that I’d thought was new was the notion of a shared open repository of transactions, but it seems Eric Hughes actually proposed it in the 1990s.  And of course Todd Boyle was banging the triple entry drum in the late 1990s.

Bitcoin has no monopoly on any term except bitcoin and BTC as far as I can see. The big question is really between permissioned and permissionless ledger designs.

If you go for a permissioned ledger, then you can do some more analysis and also reduce the need for the consensus signing to be complicated. At the base level, just one signatory might be enough, or some M of N scheme. But we don’t need the full nuclear PoW-enfused Nakamoto Signature.

But also, the same analysis says we don’t need a block. What’s a block? It’s a batch of transactions that the ‘center’ works on to make them so. But if we’ve got permissioned access, and we’ve reduced the signing to some well-defined set, why not go for RTGS and then we haven’t got a block.

The block in the blockchain exists because of the demands of the networking problem – with a network of N people all arguing over multiple documents, we know it can’t be done in less than a second for a small group and less than 10 seconds for a large group. So to get the scaling up, we *have to make a block* or batch of *many* transactions so we can fit the consensus algorithm over enough tx to make it worthwhile.

Therefore the block, the Nakamoto Signature, PoW and the incentive structure all go together. That’s the blockchain.

Zaki Manian, co-founder of SKUChain and all around Bay-area crypto guru:

Cryptography is interesting right now because the primitives have matured and pre-cryptographic systems are becoming less and less robust.

Commitment schemes are widely used in cryptography. Nakamoto signatures (if Adam Back wants to concede the naming rights) are the thermodynamic commitment to a set of values. A conventional signature in attributable commitment.

A cryptocurrency is an application of a ledger. A distributed ledger needs to syndicate the order of stored transaction. There is a lot of value to syndicating and independently validating the commitments to interested parties. Generalized Byzantine Agreement, n-of-m signatures and transaction syndication decrease the discretion in the operating of systems. Ultimately, discretion is a source of fragility. I think Ian’s reference to RTGS is somewhat disingenuous. Systems with a closed set of interacting parties aren’t particularly helpful. Open participation systems are fundamentally different.

There don’t seem to be any settle lines between the properties of permissioned and permission-less systems. We have both and time will tell.

Pavel Kravchenko, formerly chief cryptographer at Stellar, now chief cryptographer at Tembusu Systems:

I’ve seen the discussion, it seems rather political and emotional. Since the term blockchain is not clearly defined people tend to argue. To make everything clear I would start from security model – who is the adversary, what security assumptions we are making, what is the cost of a particular attack etc. For now (still very early days of crypto-finane) using blockchain as a common word for such variety of conditions is acceptable for me.

Vlad Zamfir, who has helped spearhead the cryptoeconomics field alongside others at Ethereum (such as Vitalik).  In his view:

“Blockchains” are a class of consensus protocols (hence why I like to pedantically refer to them as blockchain-based consensus protocols).  They are not necessarily ledgers, although blocks always do contain ordered logs.

These logs need not be transactions – although we can call them transactions if we want, and so you can call it a ledger if you want – it’s just misleading.

Blockchains are characterized by the fact that they have a fork-choice rule – that they choose between competing histories of events.

Traditional consensus protocols don’t do this, so they don’t need to chain their blocks – for them numbering is sufficient.

Economic consensus protocols contain a ledger in their consensus state, in which digital assets are defined – assets who are used to make byzantine faults expensive.

It is much less misleading to refer to this class of protocols as ledgers, than to blockchains generally speaking – although it is still misleading.

You can make an economic consensus protocol that lets people play chess. It would have a ledger, but it wouldn’t be fair to call it a distributed ledger – it’s a distributed chess server.

Economic consensus allows for public consensus, which acts as a (crappy) public computer.

Public consensus protocols have no “permissioned” management of the computers that make up this crappy public computer.

Non-public consensus protocols have “permissioned” management of these computers.

I think the main thing that is consistently lacking from these discussions is the fact that you can have permissioned control of the state of a public consensus protocol without “permissioning” the validator set.

Robert Sams, co-founder of Clearmatics who has done a lot of the intellectual heavy lifting on the “permissioned ledger” world (I believe he first coined the term in public), thinks that:

If I were to guess, I’d say that the block chain design will eventually yield to a different structure (eg tree chains). It’s the chaining that’s key, not the particular object of consensus (although how the former works is parasitic on the latter).

I think Szabo’s use of “block chain” rather than “blockchain” is more than a question of style. Out of habit I still merge adjective and noun like most people, but it’s misleading and discourages people from thinking about it analytically.

I tell you though, the one expression that really gets on my nerves is “the blockchain” used in contexts like “the blockchain can solve problem X”. Compound the confusion with the definite article. As if there’s only one (like “the internet”). And even when the context assumes a specific protocol, “the” subconsciously draws attention away from the attacker’s fork, disagreements over protocol changes and hard forks.

Anyway this debate with people talking up their Bitcoin book and treating innovation outside its “ecosystem” as apostasy is tiresome and idle.

Christopher Allen, who has had a storied career in this space including co-authoring the TLS standard:

I certainly was an early banner waiver — I did some consulting work with Xanadu, and later for very early Digicash. At various points in the growth of SSL both First Virtual and PGP tried to acquire my company. When I saw Nick’s “First Monday” article the day it came out, as it immediately clicked a number of different puzzle pieces that I’d not quite put together into one place. I immediately started using the term smart contracts and was telling my investors, and later Certicom, that this is what we really should be doing (maybe because I was getting tired of battles in SSL/TLS standards when that wasn’t what Consensus Development had been really founded to solve).

However, in the end, I don’t think any thing I did actually went anywhere, either technically or as a business, other than maybe getting some other technologists interested. So in the end I’m more of a witness to the birth of these technologies than a creator.

History in this area is distorted by software patents — there are a number of innovative approaches that would be scrapped because of awareness of litigious patent holders. I distinctly remember when I first heard about some innovative hash chain ideas that a number of us wanted to use hash trees with it, but we couldn’t figure out how to avoid the 1979 Merkle Hash Tree patent whose base patent wouldn’t expire until ’96, as well as some other subsidiary hash tree and time stamp patents that wouldn’t expire until early 2000s.

As I recall, at the time were we all trying to inspired solve the micropayment problem. Digicash had used cryptography for larger-sized cash transactions, whereas First Virtual, Cybercash and others were focused on securing the ledger side and needed larger transaction fees and thus larger amounts of money to function. To scale down we were all looking at hash chain ideas from Lamport’s S/KEY from the late 80’s and distributed transactional ledgers from X/Open’s DTP from the early 90s as inspirations. DEC introduced Millicent during this period, and I distinctly remember people saying “this will not work, it requires consumers to hold keys in a electronic wallet”. On the cryptographic hash side of this problem Adam Back did Hashcash, Rivest and his crew introduced PayWord and Micromint. On the transaction side CMU introduced NetBill.

Nick Szabo wrote using hashes for post-unforgeable transaction logs in his original smart contract paper in ’97, in which he referred to Surety’s work (and they held the Merkle hash tree and other time signature patents), but in that original paper he did not look at Proof of Work at all. It was another year before he, Wei Dai, and Hal Finney started talking about using proof-of-work as a possible foundational element for smart contracts. I remember some discussions over beer in Palo Alto circa ’99 with Nick after I became CTO of Certicom about creating dedicated proof-of-work secure hardware that would create tokens that could be used as an underlying basis for his smart contract ideas. This was interesting to Certicom as we had very good connections into cryptographic hardware industry, and I recommended that we should hire him. Nick eventually joined Certicom, but by that point they had cancelled my advanced cryptography group to raise profits in order to go public in the US (causing me to resign), and then later ceased all work in that area when the markets fell in 2001.

I truly believe that would could have had cryptographic smart contracts by ’04 if Certicom had not focused on short-profits (see Solution #3 at bottom of this post for my thoughts back in 2004 after a 3-year non-compete and NDA)…

What is required, I believe, is a major paradigm shift. We need to leave the whole business of fear behind and instead embrace a new model: using cryptography to enable business rather than to prevent harm. We need to add value by making it possible to do profitable business in ways that are impossible today. There are, fortunately, many cryptographic opportunities, if we only consider them.

Cryptography can be used to make business processes faster and more efficient. With tools derived from cryptography, executives can delegate more efficiently and introduce better checks and balances. They can implement improved decision systems. Entrepreneurs can create improved auction systems. Nick Szabo is one of the few developers who has really investigated this area, through his work on Smart Contracts. He has suggested ways to create digital bearer certificates, and has contemplated some interesting secure auctioning techniques and even digital liens. Expanding upon his possibilities we can view the ultimate Smart Contract as a sort of Smart Property. Why not form a corporation on the fly with digital stock certificates, allow it to engage in its creative work, then pay out its investors and workers and dissolve? With new security paradigms, this is all possible.

When I first heard about Bitcoin, I saw it as having clearly two different parts. First was a mix of old ideas about unforgeable transaction logs using hash trees combined into blocks connected by hash chains. This clearly is the “blockchain”. But in order for this blockchain to function, it needed timestamping, for which fortunately all the patents had expired. The second essential part of Bitcoin was through a proof-of-work system to timestamp the blocks, which clearly was based on Back’s HashCash rather than the way transactions were timestamped in Szabo’s BitGold implementation. I have to admit, when I first saw it I didn’t really see much in Bitcoin that was innovative — but did appreciate how it combined a number of older ideas into one place. I did not predict its success, but thought it was an interesting experiment and that might lead to a more elegant solution. (BTW, IMHO Bitcoin became successful more because of how it leveraged cypherpunk memes and their incentives to participate in order to bootstrap the ecosystem rather than because of any particularly elegant or orginal cryptographic ideas).

In my head, Bitcoin consists of blocks of cryptographic transactional ledgers chained together, plus one particular approach to time-stamping this block chain that uses proof-of-work method of consensus. I’ve always thought of blockchain and mining as separate innovations.

To support this separation for your article, I have one more quote to offer you from Nick Szabo:

Instead of my automated market to account for the fact that the difficulty of puzzles can often radically change based on hardware improvements and cryptographic breakthroughs (i.e. discovering algorithms that can solve proofs-of-work faster), and the unpredictability of demand, Nakamoto designed a Byzantine-agreed algorithm adjusting the difficulty of puzzles. I can’t decide whether this aspect of Bitcoin is more feature or more bug, but it does make it simpler.

As to your question of when the community first started using the word consensus, I am not sure. The cryptographic company I founded in 1988 that eventually created the reference implementation of SSL 3.0 and offered the first TLS 1.0 toolkits was named “Consensus Development” so my memory is distorted. To me, the essential problem has always been how to solve consensus. I may have first read it about it in “The Ecology of Computation” published in 1988 which predicted many distributed computational approaches that are only becoming possible today, which mentions among other things such concepts as Distributed Scheduling Protocols, Byzantine Fault-Tolerance, Computational Auctions, etc. But I also heard it from various science fiction books of the period, so that is why I named my company after it.

The future

What about tokens?

Virtual tokens may only be required for permissionless ledgers – where validators are unknown and untrusted – in order to prevent spam and incentivize the creation of proofs-of-work.  In contrast, if parties are known and trusted – such as a permissioned ledger – there are other historically different mechanisms (e.g., contracts, legal accountability) to secure a network without the use of a virtual token. 6

Is everything still too early or lack an actual sustainable use-case?

Maybe not.  It may be the case, as Richard Brown recently pointed out, that for financial institutions looking to use shared, replicated ledgers, utility could be derived from mundane areas, such as balance sheets.  And you don’t necessarily need a Tom Sawyer botnet to protect that.

What attracts or repels use-cases then?

  • Folk law: “Anything that needs censorship-resistance will gravitate towards censorship-resistant systems.”
  • Sams’ law: “Anything that doesn’t need censorship-resistance will gravitate towards non censorship-resistant systems.”

Many financial institutions (which is just one group looking at shared, replicated ledgers) are currently focused on: fulfilling compliance requirements, reducing cost centers, downscaling branching and implementing digital channels.  None of this requires censorship-resistance.  Obviously there are many other types of organizations looking at this technology from other angles and perhaps they do indeed find censorship-resistance of use.

In conclusion, as copiously noted above, blockchains are a wider technology than just the type employed by Bitcoin and includes permissioned ledgers.  It bears mentioning that “permissioned” validators are not really a new idea either: four years ago Ben Laurie independently called them “mintettes” and Sarah Meiklejohn discussed them in her new paper as well.

Endnotes

  1. See The financial cloud from Adam Ludwin []
  2. Thanks to Christopher Allen for pointing this out. []
  3. See The myth of a cheaper Bitcoin network: a note about transaction processing, currency conversion and Bitcoinland []
  4. See Bitcoins: Made in China []
  5. Why would banks want to use a communal ledger, validated by pseudonomyous pools whom are not privy to a terms of service or contractual obligation with? See Needing a token to operate a distributed ledger is a red herring and No, Bitcoin is not the future of securities settlement []
  6. See also Needing a token to operate a distributed ledger is a red herring and Consensus-as-a-service []

Panel with financial service professionals involved with baking shared, replicated ledgers into organizations

The last part of the PwC discussion 10 days ago involved a panel with myself moderating, Peter Shiau (COO of Blockstack) and Raja Ramachandran (co-founder of eFXPath and an advisor at R3CEV).  Robert Schwentker (from Blockchain University) also helped provide a number of questions for us.

We cover a number of topics including use-cases of distributed ledgers for financial institutions.

Q&A regarding the Distributed Ledger Landscape

About 10 days ago I had the pleasure of speaking at Blockchain University (hosted over at PwC) regarding distributed ledgers (permissioned and permissionless).  One of the slides was intentionally taken out of context by a user on reddit and unsurprisingly the subsequent /r/bitcoin thread covering it involved a range of ad hominem attacks that really missed what was being discussed at the actual talk: what are the characteristics of a blockchain.

I will likely write a post on this topic at length in the next couple of days.  In the meantime, below is the video which incidentally pre-emptively answered a few of the questions from that thread.

Also, for those curious to know who were asking the good questions in the audience, this included: Jeremy Drane (PwC), Christopher Allen (co-creator of the TLS standard) and Nick Tomaino (Coinbase) among others.

Needing a token to operate a distributed ledger is a red herring

Over the last few weeks a number of posts and interviews on social media have promoted the position that “you cannot separate bitcoin from the blockchain” and that only Bitcoin (and no other distributed or decentralized ledger) is the future of finance.

In prose form this includes Adam Ludwin, CEO of Chain (here), Martin Tiller (here) and many more on reddit.

Others include Jerry Brito, executive director at Coin Center, who recently tweeted:

jerry brito tweet

Source: Twitter

At the most recent Inside Bitcoins NYC event, Barry Silbert, co-founder of DCG, spoke about several myths surrounding Bitcoin (video):

[The second myth] is that the technology is great, but the currency is not necessary. […] The reason why Bitcoin blockchain is transformative is because it’s a secure ledger and you have the ability to process large amounts of transactions.

The only reason why it is secure and it has that transaction capacity is because you have thousands of miners around the world that have been provided a financial incentive to invest resources, capital to build the facilities that is what makes the ledger secure and gives the protocol the capacity to do transactions.

So if you eliminate the financial incentive which is the currency there is no incentive for miners to mine and thereby you don’t have a secure network and you don’t have the ability to process large amounts of transactions.

Why the “only-Bitcoin” narrative is (probably) incorrect for Financial Institutions

In the other corner, Robert Sams described in detail why Bitcoin will not be the future of securities settlement, Piotr Piasecki explored a couple different attack vectors on proof-of-work blockchains (as it relates to smart contracts) and even Ryan Selkis pointed out a number of problems with the Bitcoin-for-everything approach.

So why is the Bitcoin maximalism narrative at the very top probably incorrect for financial institutions?

Because these well-meaning enthusiasts may not be fully looking at what the exact business requirements are for these institutions.

  • What do financial institutions want?  Cryptographically verifiable settlement and clearing systems that are globally distributed for resiliency and compliant with various reporting requirements.
  • What don’t they need?  Censorship resistance-as-a-service and artificially expensive anti-Sybil mechanisms.

The two lists are not mutually exclusive.  I published a report (pdf) two months ago that covered this in more detail.

Bitcoin tries to be both a settlement network and a provider of a pseudonymous/anonymous censorship resistant virtual cash.  This comes with a very large trade-off in the form of cost: as the network funds mining operations to the tune of $300 million this year (at current market prices) for the service of staving off Sybil attacks.1 This cost scales in direct proportion with the token value (see Appendix B).

The financial institutions that I have spoken with (and perhaps my sample size is too small) are interested in operating a distributed ledger with known, legally accountable parties.  They do not need censorship resistant virtual cash or proof-of-work based systems.  They do not have a network-based Sybil problem.2

If you do not need censorship resistant as a feature, then you do not need proof-of-work

Recall that one of the design assumptions in the Bitcoin whitepaper is that the validators are unknown and untrusted.

In section 1, Nakamoto wrote:

What is needed is an electronic payment system based on cryptographic proof instead of trust, allowing any two willing parties to transact directly with each other without the need for a trusted third party.   Transactions that are computationally impractical to reverse would protect sellers from fraud, and routine escrow mechanisms could easily be implemented to protect buyers.  In this paper, we propose a solution to the double-spending problem using a peer-to-peer distributed timestamp server to generate computational proof of the chronological order of transactions.  The system   is   secure   as   long   as   honest   nodes   collectively   control   more   CPU   power   than   any cooperating group of attacker nodes.

And later in section 4:

To implement a distributed timestamp server on a peer-to-peer basis, we will need to use a proof- of-work system similar to Adam Back’s Hashcash [6], rather than newspaper or Usenet posts.

Financial institutions operate under completely different conditions.  They not only know the identities of their customers, staff and partners but their processing providers are also known, legally accountable entities.  There is no Sybil problem to solve for them on the network.  There is no need for proof-of-work or $300 million in annual mining costs.

If you don’t need proof-of-work, you don’t need necessarily a token to incentivize validation or secure the network

Instead, validation can be done by entities with contractual obligations that are legally enforced: known validators with real-world identities and reputations.

Permissioned distributed ledgers using this type of known validator, such as Hyperledger and Clearmatics (disclosure: I am an advisor to both), are not trying to be “cryptocurrencies” or even entrants in the virtual cash marketplace.

Nor are they trying to provide pseudonymous-based censorship resistant services.  Instead they are attempting to provide a solution for the financial institution requirements above.

But if Bitcoin has the largest user base of pseudonymous virtual cash, wouldn’t concepts like sidechains allow systems like Hyperledger to be run on a sidechain and therefore we should all focus on Bitcoin?

Again, permissioned ledger systems like Hyperledger are not a cyrptocurrency, so sidechains (as they are currently proposed) would probably not provide any benefit to them.  Bitcoin may – temporarily or permanently – have the largest mind share for cryptocurrency as whole and for censorship resistant services but this does not seem to really be a top priority for most financial institutions.

Thus, it would be comparable to saying why don’t we connect all Excel workbooks directly onto the Bitcoin blockchain?

goodyear-dirigible

Source: Gizmag

Or akin to the Wright brothers trying to sell a biplane to modern day international air carriers.  Just because you created the first proof-of-concept and own a lot of equity in the companies in the supply chain for Wright brothers wooden airplanes (because you know aeronautical vehicles is a growth industry), does not mean the first model will not be iterated on and evolved from.  Even modern day dirigibles provide different utility than large wide-body air cargo planes.

There is a case to be made that you only need a token as an incentive within proof-of-work-based (and proof-of-stake) cryptocurrency networks.  Yet as described elsewhere, there are other ways to build distributed networks and economic consensus mechanisms that do not need follow the Nakamoto design (see Vlad Zamfir’s forthcoming Reformalizing Consensus paper).

Thus, the authors cited at the beginning of this post are likely asking the wrong question.  What these writers seem to be collectively saying is: “Hey banks, you want a better settlement method?  Then you need Bitcoin.”  Instead they should be asking banks, “What problems do you have?  Would a censorship-resistant service like Bitcoin’s blockchain sustainably solve that problem?”

Financial institutions each face different problems and challenges but it is unlikely that  proof-of-work necessarily solves them.3  Nor is it the case that banks need yet another currency to manage and hedge.  Though to be even handed, perhaps other financial institutions like hedge funds will find it useful for speculation.

Blocks and miners

Not to pick on Barry Silbert (this is just an example), but his statement above is wrong: “you have the ability to process large amounts of transactions.”

Bitcoin, with the current 1MB block size, is in theory able to process about 7 transactions per second.  If some of the expansion proposals under discussion are enacted, then block sizes may increase to 20 MB in the coming year.  This, again in theory, would mean that the Bitcoin blockchain would be able to process about 140 transactions per second.

One bullish narrative has been that Bitcoin will one day be able to handle transaction processing rates on part with networks like Visa (which on average handles 2,000 – 3,000  transactions per second each day).4   For comparison, in 2013 PayPal had 128 million active accounts in 193 markets and 25 currencies around the world and processed more than 7.6 million payments every day.

Baring something like a full roll-out of the Lightning Network, is unlikely to occur without the use of trusted parties.

Thus it is unclear what metric Silbert is using when he references the “large amounts” being processed, because in practice the Bitcoin network only handles about 1.5 transactions per second on any given day, and most traffic is comprised of spam and long-chains transactions and not the actual commerce that Visa handles.

trade block 1trade block 2

Source: TradeBlock

Above are two charts from TradeBlock which recently published some analysis on block sizes and capacity.  Based on their analysis and following the current trend in block size usage, the 1 MB capacity will be reached in about 18 months, so only in December 2016 will 2.8 transactions per second be achieved.  Dave Hudson ran simulations last year and came to a similar conclusion.

Further, Visa’s network — although centralized — is actually very secure (with moats and all).  No one hacks Visa, they hack the edges, institutions like Target and Home Depot.  This is similar to Bitcoin, where it is cheaper to hack Bitstamp, Bitfinex, Mt. Gox and countless others (which have all been hacked over the past 18 months), than it is to do a Maginot Line attack via hash rate.

In fact, if we measure adoption and usage by actual end users (i.e., where most transactions actually take place), the adoption is not with Bitcoin’s blockchain, but instead with trusted third parties like Coinbase, Circle, Xapo and dozens of other hosted wallets and exchanges.  As I mentioned in my review of The Age of Cryptocurrency, one of the funnier comments I saw on reddit last month was someone saying, “You should try using Bitcoin instead of Coinbase.”

blockchain longtail

Source: the long tail usage of blockchains by Vitalik Buterin

Are permissioned distributed ledgers the solution for financial institutions?

Maybe, maybe not.  It depends on if they securely scale in a production environment..  It also depends on the specific business requirements.  It could turn out that distributed databases like Chubby or HyperDex are a better fit for some problems.

It is also hard to say that a large enterprise can axiomatically replace its existing systems with a new distributed ledger network and save X amount of money.  There are a variety of costs that have to be factored in: compliance costs, reconciliation costs, legal costs, IT costs, costs from capital tied up in slow settlement times, etc. 5  Add them all together and there is, in theory, room for large saving, but this is still unknown.  It cannot be derived a priori.

Another common claim is, “Bitcoin is a larger, better supported blockchain and therefore will win out since it has market makers and market support.”

But Bitcoin, as a censorship-resistance payment rail and virtual cash, is a solution for cypherpunks, not for financial institutions who again, have known counterparties.  A proof-of-work blockchain only matters for untrusted networks and pseudonymous validators.

It may seem repeitive, but if you are designing a semi-trusted/trusted networks, then the token itself is more akin to a receipt than an informational commodity.  Bitcoin, in its current form, likely needs a token because it needs to pay its pseudonymous validators for the censorship-resistance service.  If you operate a bank, with a state charter and KYC/AML requirements, this is probably not a must-have feature.

Either way, it is too easy to become caught up in this red herring and miss the utility of a distributed settlement system for the roller coaster ride surrounding the token.

But isn’t using known validation just centralization by any other name?

No, it could be institutionalized (which is different than centralization) in that the nodes are globally separated and controlled by different keypairs and organizations.6  In effect, distributed ledgers are a new, additional tool for financial controls — and an attempt to abuse the network would require additional compromises and collusion that the edges of a proof-of-work networks are also prone to.

Yet in the event an attack occurs on a permissioned ledger, the validators are contractually and legally accountable to a terms of service — pseudonymous validators are not and thus end users for something like Bitcoin have no recourse, legal or otherwise, and are left with options like begging mining pools on reddit.7

Conclusions

Bitcoin may be a solution to some market needs, but it is likely not the silver bullet that many of its promoters claim it is.  This is especially true for financial institutions, particularly once the costs of mining and censorship-resistance, is added into the mix.

There is room for both types of networks in this world, just like there is room for dirigibles and jumbo jet freighters.  Yet it is impossible to predict who will ultimately adopt one or the other or even both.8

But as shown in the picture below, the Bitcoin mining game (within a game) includes mining pools that are not always incentivized to include transactions.9  Which raises the question: how can you require them to since there is no terms of service?

blockchain block 1 tx

Source: Block 358739

Every day there is always one or two blocks (sometimes more) that include a lonesome transaction, the coinbase transaction. In fact, in the process of writing this post, F2Pool included no additional transactions in block 359422, this despite the fact that there are  unconfirmed transactions waiting for insertion onto the communal chain.

Mining pools have differing incentives as to whether or not to include actual transactions, to them the bulk — roughly 99.5% of their revenue still comes from block rewards so sometimes they find it is not worth processing low fee transactions and instead propagate smaller blocks so as to lower orphan races and instead work on the next hash; see for instance Chun Wang’s comment related to F2Pool and large block sizes posted last week.

I reached out to Robert Sams, CEO of Clearmatics, who has written on this topic in the past.  According to him:

To me the crux of the issue is that permissionless consensus cannot guarantee irreversibility, cannot even quantify the probability of a history-reversing attack (rests on economics, not tech).

It’s a curious design indeed where everyone on the Bitcoin network is now known and authenticated… except the transaction validators!

I also reached out to Dan O’Prey, CEO of Hyperledger.  According to him:

It all comes down to starting assumptions. If you want the network to be censor-resistant from even governmental attacks, you need validators to be as decentralised as possible, so you need to allow anyone to join and compensate them so they do, so you need to use proof of work to prevent Sybil attacks and have a token.

If you’re dealing with legal entities that governments could shut down then you don’t get past step one. If you’re dealing with a private network between multiple participants then you don’t need to incentivise validators – it’s just a cost of doing business, just as web servers are.

Fun fact: according to Blockr.io, there have been 85275 blocks with one transaction and 12438 blocks with 2 transactions (the bulk of which occurred in the first year and a half).10

Is that the type of game theoretic situation upon which to build a mission-critical, time sensitive settlement system for off-chain assets with real-world identities on top of?11 Maybe, maybe not.  Both types of networks have their trade-offs but focusing on a token is probably missing the bigger picture of meeting business requirements which vary from organization to organization.

[Acknowledgements: thanks to Pinar Emirdag, Todd McDonald, Dan O’Prey, Robert Sams and John Whelan for their feedback.]

Endnotes:

  1. This annualized number comes from the following calculation: money supply creation (1,312,500 bitcoins) multiplied by current market price (~$230). []
  2. Large institutions and enterprises may have issues with authentication and identification of customers/users but that is a separate operational security issue. []
  3. It is important to note that if the costs of mining somehow decreased then so too would the costs to successfully attack a proof-of-work network.  See The myth of a cheaper Bitcoin network: a note about transaction processing, currency conversion and Bitcoinland []
  4. Note: In the UK, Visa Europe currently settles over RTGS though Mastercard does not.  See: The UK Payments landscape []
  5. Thanks to Dan O’Prey for his thoughts on the matter. []
  6. It bears mentioning that having 15 banks in 15 different countries operating validators is more decentralized than a few mining pools in a couple of countries, although it is not a fully direct comparison. []
  7. In theory on-chain “identity” starts pseudonymously and later users can either fully identity themselves (via traditional KYC, or signing of coinbase transactions) or attempt to remain anonymous by not reusing addresses and through other operational security methods.  Miners themselves can be both known and unknown in theory and practice.  Other terminology refers to them as a dynamic- membership multi-party signature (DMMS). []
  8. Peter Todd has argued that financial institutions can take a hash from a permissioned ledger and insert it into a proof-of-work chain as a type of “audit in depth” strategy. []
  9. According to John Whelan who reviewed this post, “The science of incentives is far more complex than just ‘show me the money’.  Indeed, workplace incentive specialists have coined the term ‘total rewards of work’ that recognizes that there are many levers other than compensation that may be pulled to motivate employees to perform at their maximum potential (e.g., workplace rewards).  With distributed ledger systems there is a lot of room to gain a clearer understanding of the kinds of incentives that will motivate transaction validators or nodes that offer other services such as KYC/AML, etc.  It is definitely not a one-size-fits-all.” []
  10. For comparison, Litecoin has 245447 blocks with 1 transaction and 105765 blocks with two. []
  11. At an event in NYC last month Peter Todd opined that perhaps some firms will take this risk and will encode a series of if/then stipulations in the event that a history-reversing attack occurs. []

The final version of the BitLicense was released

A reporter from CoinDesk reached out yesterday to ask if there were any questions I had in relation to the final version of the BitLicense being released.

They subsequently posted a follow-up story with one of the comments I sent.  Below are the remaining questions and comments that came to mind after quickly reading through the final BitLicense.

The current wording in the final version still seems to leaves a few unanswered questions:

1) When a miner (hasher) sends work to a pool, the pool typically keeps the reward money on the pool before sending it to the miner or until the miner manually removes it.  Would mining pools be considered a custodian or depository institution since they control this asset?  What if a pool begins offering other services to the miner and these assets remain on the pool? (e.g., some pools have vertically integrated with exchanges)  Update:  The mining pool BTC Guild has announced it is closing down and citing concerns over the BitLicense with respect to these issues.

2) Are there any distinguishing factors or characteristics for entities that issue or reissue virtual currencies?  For instance, both non-profit groups (like Counterparty, Augur) and for-profit organizations (like Factom, Gems) issued virtual currencies and it appears that federated nodes that operate a sidechain, in theory, will effectively (re)issue assets as well.  Are they all custodians?  In light of the FinCEN enforcement action with Ripple, do these projects need to be filing suspicious activity reports (SAR) as well?

3) How hosted wallets comply with 200.9(c) and whether startups like Coinbase violate that given this UCC filing (pdf)? (E.g., assuming the bitcoins held by Coinbase for customers are covered by the filing, it seems as if it could violate 200.9)

Housing all financial controls under one roof, managed by one person

A new story up on FusionFormer Mt. Gox CEO: Current Bitcoin exchanges are a ‘disaster waiting to happen’ — looks at a recent post from Mark Karpeles regarding the segregation of financial controls within the Bitcoin exchange framework.  I provided a couple of quotes for some perspective.

In addition to the snippets in the article, it bears mentioning that I would disagree with his view that it is possible to make a fully decentralized exchange today due to the fact that cash is centrally created and thereupon controlled by a variety of agencies.  He is right about the intersection of AML and how some companies are unable (or more likely, unwilling) to legally comply with it due to how they operate (such as LocalBitcoins and Purse.io).

As an aside, virtually most (if not all) VC-funded, US-based hosted wallet and exchange is likely in non-compliance of a variety of custodian/depository regulations though it is unclear if/when any jurisdiction will prosecute them:

One last comment about that story, there may be ways to create financial controls to reduce the ability for maleficence to occur but as Karpeles ironically pointed out (he did not acknowledge it but probably is aware of it), by converting bitcoins into an altcoin, you effectively are delinking provenance and creating a money laundering mechanism.  Based on a number of conversations with altcoin traders I suspect that a non-negligible portion of the litecoin trading volume on a daily basis (on BTC-e and ShapeShift.io) are related to money laundering type of activities.  Though this would be hard to verify and prove without building a good network heuristic and/or access to the server logs at these companies.

See also: CEWG BitLicense comment

In what ways does Bitcoin resemble a command economy?

I have a new article up over at Let’s Talk Bitcoin which attempts to answer that question.

The feedback I have received so far (including the comments at LTB) makes it pretty clear that many adopters simply do not understand how, in general, economics or finance works or how developing countries struggle with credit expansion.  And that is fine, but can be disastrous when making what amounts to investment decisions.  Again, a vocal minority (majority?) of these adopters think they will be lounging on yachts and private islands because the price of bitcoin reaches $1 million.

And that likely will never play out for a variety of reasons that I have described in numerous articles.

Below is a list of pieces and papers that I have published covering these issues over the past three months in chronological order: