Book review: The Truth Machine

A friend of mine sent me a copy of The Truth Machine which was published in February 2018.  Its co-authors are Michael Casey and Paul Vigna, who also previously co-wrote The Age of Cryptocurrency a few years ago.

I had a chance to read it and like my other reviews, underlined a number of passages that could be enhanced, modified, or even removed in future editions.

Overall: I do not recommend the first edition. For comparison, here are several other reviews.

This book seemed overly political with an Occupy Wall Street tone that doesn’t mesh well with what at times is a highly technical topic.

I think a fundamental challenge for anyone trying to write book-length content on this topic is that as of 2018, there really aren’t many measurable ‘success’ stories – aside from speculation and illicit activities – so you end up having to fill a couple hundred pages based on hypotheticals that you (as an author) probably don’t have the best optics in.

Also, I am a villain in the book. Can’t wait?  Scroll down to Chapter 6 and also view these specific tweets for what that means.

Note: all transcription errors are my own. See my other book reviews on this topic.

Preface

on p. x they write:

The second impact is the book you are reading. In The Age of Cryptocurrency, we focused primarily on a single application of Bitcoin’s core technology, on its potential to upend currency and payments.

Would encourage readers to peruse my previous review of their previous book. I don’t think they made the case, empirically, that Bitcoin will upend either currency or payments. Bitcoin itself will likely exist in some form or fashion, but “upending” seems like a stretch at this time.

On p. xi they write in a footnote:

We mostly avoid the construct of “blockchain” as a non-countable noun.

This is good. And they were consistent throughout the book too.

Introduction

They spent several pages discussing ways to use a blockchain for humanitarian purposes (and later have a whole chapter on it), however, it is unclear why a blockchain alone is the solution when there are likely other additional ways to help refugees.

For instance, on p. 3 they write:

Just as the blockchain-distributed ledger is used to assure bitcoin users that others aren’t “double-spending” their currency holdings – in other words, to prevent what would otherwise be rampant digital counterfeiting – the Azraq blockchain pilot ensures that people aren’t double-spending their food entitlements.

But why can’t these food entitlements be digitized and use something like SNAP cards? Sure you can technically use a blockchain to track this kind of thing, but you could also use existing on-premise or cloud solutions too, right?  Can centralized or non-blockchain solutions fundamentally not provide an adequate solution?

On p. 4 they write:

Under this new pilot, all that’s needed to institute a payment with a food merchant is a scan of a refugee’s iris. In effect, the eye becomes a kind of digital wallet, obviating the need for cash, vouchers, debit cards, or smartphones, which reduces the danger of theft (You may have some privacy concerns related to that iris scan – we’ll get to that below.) For the WFP, making these transfers digital results in millions of dollars in saved fees as they cut out middlemen such as money transmitter and the bankers that formerly processed the overall payments system.

Get used to the “bankers” comments because this book is filled with a dozen of them. Intermediaries such as MSBs and banks do take cuts, however they don’t really dive into the fee structure. This is important because lots of “cryptocurrency”-focused startups have tried to use cryptocurrencies to supposedly disrupt remittances and most basically failed because there are a lot of unseen costs that aren’t taken into account for.

Another unseen cost that this book really didn’t dive into was: the fee to miners that users must pay to get included into a block.  They mention it in passing but typically hand-waved it saying something like Lightning would lower those costs.  That’s not really a good line of reasoning at this stage in development, but we’ll look at it again later.

On p. 6 they write:

That’s an especially appealing idea for many underdeveloped countries as it would enable their economies to function more like those of developed countries – low-income homeowners could get mortgages, for example; street vendors could get insurance. It could give billions of people their first opening into the economic opportunities that the rest of us take for granted.

That sounds amazing, who wouldn’t want that?  Unfortunately this is a pretty superficial bit of speculation.  For example, how do street vendors get insurance just because of the invention of a blockchain?  That is never answered in the book.

On p. 7 they write:

The problem is that these fee-charging institutions, which act as gatekeepers, dictating who can and cannot engage in commercial interactions, add cost and friction to our economic activities.

Sure, this is true and there are efforts to reduce and remove this intermediation. The book also ignores that every cryptocurrency right now also charges some kind of fee to miners and/or stakers. And with nearly all coins, in order to obtain it, a user typically must buy it through a trusted third party (an exchange) who will also charge a markup fee… often simultaneously requiring you to go through some kind of KYC / AML process (or at least connect to a bank that does).

Thus if fee-charging gatekeepers are considered a problem in the traditional world, perhaps this can be modified in the next edition because these type of gatekeepers exist throughout the coin world too.

On p. 8 they list a bunch of use-cases, some of which they go into additional detail later in the book. But even then the details are pretty vague and superficial, recommend updating this in the next edition with more concrete examples.

On p. 9 they write:

Silicon Valley’s anti-establishment coders hadn’t reckoned with the challenge of trust and how society traditionally turns to centralized institutions to deal with that.

There may have been a time in which the majority of coders in the Bay area were “anti-establishment” but from the nearly 5 years of living out here, I don’t think that is necessarily the case across the board. Recommend providing a citation for that in the future.

On p. 10 they write:

R3 CEV, a New York-based technology developer, for one, raised $107 million from more than a hundred of the world’s biggest financial institutions and tech companies to develop a proprietary distributed ledger technology. Inspired by blockchains but eschewing that lable, R3’s Corda platform is built to comply with banks’ business and regulatory models while streamlining trillions of dollars in daily interbank securities transfers.

This whole paragraph should be updated (later in Chapter 6 as well):

  • The Series A funding included over 40 investors, not 100+.
  • The ‘community’ version of Corda is open sourced and available on github, so anyone can download, use, and modify it. There is also a Corda Enterprise version that requires a license and is proprietary.
  • While initially eschewing the term “blockchain,” Corda is now actively marketed as a “blockchain” and even uses the handle @cordablockchain on Twitter, on podcast advertisements, and in public presentations.1
  • I am unaware of any current publicly announced project that involves streamlining trillions of dollars in daily interbank securities transfers. Citation?

On p. 10 they briefly mention the Hyperledger Project.  Recommend tweaking it because of its own evolution over the years.

For example, here is my early contribution: what is the difference between Hyperledger and Hyperledger.

On p. 11 they write:

While it’s quite possible that many ICOs will fall afoul of securities regulations and that a bursting of this bubble will burn innocent investors, there’s something refreshingly democratic about this boom. Hordes of retail investors are entering into early stage investment rounds typically reserved for venture capitalists and other professional.

This paragraph aged horribly since the book was published in February.

All of the signs were there: we knew even last year that many, if not all, ICOs involved overpromising features and not disclosing much of anything to investors. As a result, virtually every week and month in 2018 we have learned just how much fraud and outright scams took place under the guise and pretext of the “democratization of fund raising.”

For instance, one study published this summer found that about 80% of the ICOs in 2017 were “identified scams.” Another study from EY found that about 1/3 of all ICOs in 2017 have lost “substantially all value” and most trade below their listing price.

Future versions of this book should remove this paragraph and also look into where all of that money went, especially since there wasn’t – arguably – a single cryptocurrency application with a real user base that arose from that funding method (yet).

On p. 11 they write:

Not to be outdone, Bitcoin, the grandaddy of the cryptocurrency world, has continued to reveal strengths — and this has been reflected in its price.

This is an asinine metric. How exactly does price reflect strength? They never really explain that yet repeat roughly the same type of explanation in other places in this book.

Interestingly, both bitcoin’s price and on-chain transaction volume have dramatically fallen since this book was first published. Does that mean that Bitcoin weakened somehow?

On p. 12 they write:

Such results give credence to crypto-asset analysts Chris Burniske and Jack Tatar’s description of bitcoin as “the most exciting alternative investment of the 21st century.”

Firstly, the Burniske and Tatar book was poorly written and wrong in many places: see my review

Secondly, bitcoin is a volatile investment that is arguably driven by a Keynesian beauty contest, not for the reasons that either book describes (e.g., not because of remittance activity).

On p. 12 they write:

The blockchain achieves this with a special algorithm embedded into a common piece of software run by all the computers in the network.

To be clear: neither PoW nor PoS are consensus protocols which is implied elsewhere on page 12.

On p. 12 they write:

Once new ledger entries are introduced, special cryptographic protections make it virtually impossible to go back and change them.

This is not really true. For coins like Bitcoin, it is proof-of-work that makes it resource intensive to do a block reorganization. Given enough hashrate, participants can and do fork the network. We have seen it occur many times this year alone. There is no cryptography in Bitcoin or Ethereum that prevents this reorg from happening because PoW is separate from block validation.2

On p. 13 they write:

Essentially, it should let people share more. And with the positive, multiplier effects that this kind of open sharing has on networks of economic activity, more engagement should in turn create more business opportunities.

These statement should be backed up with supporting evidence in the next edition because as it stands right now, this sounds more like a long-term goal or vision statement than something that currently exists today in the cryptocurrency world.

On p. 13 they mention “disintermediation” but throughout the book, many of the cryptocurrency-related companies they explore are new intermediaries. This is not a consistent narrative.

On p. 14 they write:

If I can trust another person’s claims – about their educational credentials, for example, or their assets, or their professional reputation – because they’ve been objectively verified by a decentralized system, then I can go into direct business with them.

This is a non sequitur. Garbage in, garbage out (GIGO) — in fact, the authors make that point later on in the book in Chapter 7.

On p. 15 they write:

Blockchains are a social technology, a new blueprint for how to govern communities, whether we’re talking about frightened refugees in a desolate Jordanian output or an interbank market in which the world’s biggest financial institutions exchange trillions of dollars daily.

This is vague and lacks nuance because there is no consensus on what a blockchain is today. Many different organizations and companies define it differently (see the Corda example above).

Either way, what does it mean to call a blockchain “social technology”? Databases are also being used by refugee camp organizers and financial infrastructure providers… are databases “social technology” too?

Chapter 1

On p. 17 they write:

Its blockchain promised a new way around processes that had become at best controlled by middlemen who insisted on taking their cut of every transaction, and at worst the cause of some man-made economic disasters.

This is true and problematic and unfortunately Bitcoin itself doesn’t solve that because it also has middlemen that take a cut of every transaction in the form of a fee to miners. Future editions should add more nuance such as the “moral hazard” of bailing out SIFIs and TBTF and separate that from payment processors… which technically speaking is what most cryptocurrencies strive to be (a network to pay unidentified participants).

On p. 18 they write:

Problems arise when communities view them with absolute faith, especially when the ledger is under control of self-interested actors who can manipulate them. This is what happened in 2008 when insufficient scrutiny of Lehman Brother’s and other’s actions left society exposed and contributed to the financial crisis.

This seems to be a bit revisionist history. This seems to conflate two separate things: the type of assets that Lehman owned and stated on its books… and the integrity of the ledgers themselves. Are the authors claiming that Lehman Brother’s ledgers were being maliciously modified and manipulated? If so, what citation do they have?

Also a couple pages ago, the authors wrote that blockchains were social technology… but we know that from Deadcoins.com that they can die and anything relying on them can be impacted.

Either way, in this chapter the authors don’t really explain how something Bitcoin itself would have prevented Lehman’s collapse. See also my new article on this topic.

On p. 19 they write:

A decentralized network of computers, one that no single entity controlled, would thus supplant the banks and other centralized ledger-keepers that Nakamoto identified as “trusted third parties.”

Fun fact: the word “ledger” does not appear in the Bitcoin white paper or other initial emails or posts by Nakamoto.

Secondly, perhaps an industry wide or commonly used blockchain of some kind does eventually displace and remove the role some banks have in maintaining certain ledgers, but their statement, as it is currently worded, seems a lot like of speculation (projection?).

We know this because throughout the book it is pretty clear they do not like banks, and that is fine, but future editions need to back up these types of opinions with evidence that banks are no longer maintaining a specific ledger because of a blockchain.

On p. 20 they write:

With Bitcoin’s network of independent computers verifying everything collectively, transactions could now be instituted peer to peer, that is, from person to person. That’s a big change from our convoluted credit and debit card payment systems, for example, which routes transactions through a long sequence of intermediaries – at least two banks, one or two payment processors, a card network manager (such as Visa or Mastercard), and a variety of other institutions, depending on where the transaction take place.

If we look back too 2009, this is factually correct of Bitcoin at a high level.3 The nuance that is missing is that today in 2018, the majority of bitcoin transactions route through a third party, some kind of intermediary like a deposit-taking exchange or custodial wallet.4 There are still folks who prefer to use Bitcoin as a P2P network, but according to Chainalysis, last year more than 80% of transactions went through a third party.5

On p. 20 they write:

Whereas you might think that money is being instantly transferred when you swipe your card at a clothing store, in reality the whole process takes several days for the funds to make all those hops and finally settle in the storeowner’s account, a delay that create risks and costs. With Bitcoin, the idea is that your transaction should take only ten to sixty minutes to fully clear (not withstanding some current capacity bottlenecks that Bitcoin developers are working tor resolve). You don’t have to rely on all those separate, trusted third parties to process it on your behalf.

This is mostly incorrect and there is also a false comparison.

In the first sentence they gloss over how credit card payment systems confirm and approve transactions in a matter of seconds.6 Instead they focus on settlement finality: when the actual cash is delivered to the merchant… which can take up to 30+ days depending on the system and jurisdiction.

The second half they glowingly say how much faster bitcoin is… but all they do is describe the “seen” activity with a cryptocurrency: the “six block” confirmations everyone is advised to wait before transferring coins again. This part does not mention that there is no settlement finality in Bitcoin, at most you get probabilistic finality (because there is always chance there may be a fork / reorg).

In addition, with cryptocurrencies like Bitcoin you are only transferring the coins. The cash leg on either side of the transaction still must transfer through the same intermediated system they describe above. We will discuss this further below when discussing remittances.

On p. 20 they write:

It does so in a way that makes it virtually impossible for anyone to change the historical record once it has been accepted.

For proof-of-work chains this is untrue in theory and empirically. In the next edition this should be modified to “resource intensive” or “economically expensive.”

On p. 20 they write:

The result is something remarkable: a record-keeping method that brings us to a commonly accepted version of the truth that’s more reliable than any truth we’ve ever seen. We’re calling the blockchain a Truth Machine, and its applications go far beyond just money.

It is not a “truth machine” because garbage in, garbage out.

In addition, while they do discuss some historical stone tablets, they don’t really provide a metric for how quantitatively more (or less) precise a blockchain is versus other methods of recording and witnessing information. Might be worth adding a comparison table in the next edition.

On p. 21 they write:

A lion of Wall Street, the firm was revealed to be little more than a debt-ravaged shell kept alive only by shady accounting – in other words, the bank was manipulating its ledgers. Sometimes, that manipulation involved moving debt off the books come reporting season. Other times, it involved assigning arbitrarily high values to “hard-to-value” assets – when the great selloff came, the shocking reality hit home: the assets had no value.

The crash of 2008 revealed most of what we know about Wall Street’s confidence game at that time. It entailed a vast manipulation of ledgers.

This was going well until that last sentence. Blockchains do not solve the garbage in, garbage out problem. If the CFO or accountant or book keeper or internal counsel puts numbers into blocks that do not accurately reflect or represent what the “real value” actually is, blockchains do not fix that. Bitcoin does not fix that.

Inappropriate oversight, rubber stamp valuations, inaccurate risk models… these are off-chain issues that afflicted Lehman and other banks. Note: they continue making this connection on pages 24, 28, and elsewhere but again, they do not detail how a blockchain of some kind would have explicitly prevented the collapse of Lehman other other investment banks.

See also: Systemically important cryptocurrency networks

On p. 22 they write:

The real problem was never really about liquidity, or a breakdown of the market. It was a failure of trust. When that trust was broken, the impact on society – including on our political culture – was devastating.

How about all of the above? Pinning it on just one thing seems a little dismissive of the multitude of other interconnecting problems / culprits.

On p. 22 they write:

By various measures, the U.S. economy has recovered – at the time of writing, unemployment was near record lows and the Dow Jones Industrial Average was at record highs. But those gains are not evenly distributed; wage growth at the top is six times what it is for those in the middle, and even more compared to those at the bottom.

If the goal of the authors is to rectify wealth inequalities then there are probably better comparisons than using cryptocurrencies.

Why? Because – while it is hard to full quantify, it appears that on cursory examination most (if not all) cryptocurrencies including Bitcoin have Gini coefficients that trends towards 1 (perfectly unequal).

On p. 23 they write about disinformation in the US and elsewhere.  And discuss how trust is a “vital social resource” and then mention hyperinflation in Venezuela. These are all worthy topics to discuss, but it is not really clear how any of these real or perceived problems are somehow solved because of a blockchain, especially when Venezuela is used as the example. The next edition should make this more clear.

On p. 29 they write:

On October 31, 2008, whil the world was drowning in the financial crisis, a little-noticed “white paper” was released by somebody using the pen name “Satoshi Nakamoto,” and describing something called “Bitcoin,” an electronic version of cash that didn’t need state backing. At the heart of Nakamoto’s electronic cash was a public ledger that could be viewed by anybody but was virtually impossible to alter.

One pedantic note: it wasn’t broadly marketed beyond a niche mailing list on purpose… a future edition might want to change ” a little-noticed” because it doesn’t seem like the goal by Nakamoto was to get Techcrunch or Slashdot to cover it (even though eventually they both did).

Also, it is not virtually impossible to alter.7 As shown by links above, proof-of-work networks can and do get forked which may include a block reorganization. There is nothing that technically prevents this from happening.

See also: Interview with Ray Dillinger

On p. 31 they write:

Szabo, Grigg, and others pioneered an approach with the potential to create a record of history that cannot be changed – a record that someone like Madoff, or Lehman’s bankers, could not have meddled with.

I still think that the authors are being a little too liberal with what a blockchain can do. What Madoff did and Lehman did were different from one another too.

Either way, a blockchain would not have prevented data – representing fraudulent claims – from being inserted into blocks. Theoretically a blockchain may have allowed auditors to detect tampering of blocks, but if the information in the blocks are “garbage” then it is kind of besides the point.

On p. 32 they write:

Consider that Bitcoin is now the most powerful computing network in the world, one whose combined “hashing” rate as of August 2017 enabled all its computers to collectively pore through 7 million trillion different number guesses per second.

[…]

Let the record show that period of time is 36,264 trillion trillion times longer than the current best-estimate age of the universe. Bitcoin’s cryptography is pretty secure.

This should be scrapped for several reasons.

The authors conflate the cryptography used by digital signatures with generating proofs-of-work.8 There are not the same thing. Digital signatures are considered “immutable” for the reasons they describe in the second part, not because of the hashes that are generated in the first.9

Another problem is that the activity in the first part — the hash generation process — is not an apples-to-apples comparison with other general computing efforts. Bitcoin mining is a narrowly specific activity and consequently ASICs have been built and deployed to generate these hashes. The single-use machines used to generate these hashes cannot even verify transactions or construct blocks. In contrast, CPUs and GPUs can process a much wider selection of general purpose applications… including serialize transactions and produce blocks.

For example: it would be like comparing a Falcon 9 rocket launch vehicle with a Toyota Prius. Sure they are nominally both “modes of transportation” but built for entirely different purposes and uses.

An additional point is that again, proof-of-work chains can and have been forked over the years. Bitcoin is not special or unique or impervious to forks either (here’s a history of the times Bitcoin has forked). And there are other ways to create forks, beyond the singular Maginot Line attack that the authors describe on this page.10

On p. 33 they write:

Whether the solution requires these extreme privacy measures or not, the broad model of a new ledger system that we laid out above – distributed, cryptographically secure, public yet private – may be just what’s needed to restore people’s confidence in society’s record-keeping systems. And to encourage people to re-engage in economic exchange and risk-taking.

This comes across as speculation and projecting. We will see later that the authors have a dim view of anything that is not a public blockchain. Why is this specific layout the best?

Either way, future versions should include a citation for how people’s confidence level increase because of the use of some kind of blockchain. At this time, I am unaware of any such survey.

On p. 34 they quote Tomicah Tilleman from the Global Blockchain Business Council, a lobbying organization:

Blockchain has the potential to push back against that erosion and it has the potential to create a new dynamic in which everyone can come to agree on a core set of facts but also ensure the privacy of facts that should not be in the public domain.

This seems like a non sequitur. How does a blockchain itself push back on anything directly? Just replace the word “blockchain” with “database” and see if it makes sense.

Furthermore, as we have empirically observed, there are fractures and special interest groups within each of these little coin ecosystems. Each has their own desired roadmap and in some cases, they cannot agree with one another about facts such as the impact larger block sizes may have on node operators.

On p. 35 they write:

If it can foster consensus in the way it has been shown to with Bitcon, it’s best understood as a Truth Machine.

This is a non sequitur. Just because Nakamoto consensus exists does not mean it that blockchains are machines of truth. They can replicate falsehoods if the blocks are filled with the incorrect information.

Chapter 2

On p. 38 they write:

Consider how Facebook’s secret algorithm choose the news to suit your ideological bent, creating echo chambers of like-minded angry or delighted readers who are ripe to consume and share dubious information that confirms their pre-existing political biases.

There are some really valid points in this first part of the chapter. As it relates to cryptocurrencies, a second edition should also include the astroturfing and censoring of alternative views that take place on cryptocurency-related subreddits which in turn prevent people from learning about alternative implementations.

We saw this front-and-center in 2015 with the block size debate in which moderators of /r/bitcoin (specifically, theymos and BashCo) banned any discussion from one camp, those that wanted to discuss ways of increasing the block size via a hardfork (e.g., Bitcoin XT, Bitcoin Classic).

This wasn’t the first or last time that cryptocurrency-related topics on social media have resulted in the creation of echo chambers.

On p. 43 they write:

The potential power of this concept starts with the example of Bitcoin. Even though that particular blockchain may not provide the ultimate solution in this use case, it’s worth recalling that without any of the classic, centrally deployed cybersecurity tools such as firewalls, and with a tempting “bounty” of more than $160 billion in market cap value at the time we went to print, Bitcoin’s core ledger has thus far proven to be unhackable.

There is a lot to unpack here but I think a future edition should explain in more detail how Bitcoin is a type of cybersecurity tool. Do they mean that because the information is replicated to thousands of nodes around the world, it is more resilient or redundant?

Either way, saying that “Bitcoin’s core ledger” is “unhackable” is a trope that should be removed from the next edition as well.

Why? Because when speaking about BTC or BCH or any variant of Bitcoin, there is only one “ledger” per chain… the word ‘core’ is superfluous. And as described above, the word “unhackable” should be changed to “resource intensive to fork” or something along those lines. “Unhackable” is anarchronistic because what the authors are probably trying to describe is malicious network partitions… and not something from a ’90s film like The Net.

Continuing on p. 43 they write:

Based on the ledger’s own standards for integrity, Bitcoin’s nine-year experience of survival provides pretty solid proof of the resiliency of its core mechanism for providing decentralized trust between users. It suggest that one of the most important non-currency applications of Bitcoin’s blockchain could be security itself.

This last sentence makes no sense and they do not expand on it in the book. What is the security they are talking about? And how is that particularly helpful to “non-currency applications of Bitcoin’s blockchain”? Do they mean piggy-backing like colored coins try to do?

On p. 44 they write:

The public ledger contains no identifying information about the system’s users. Even more important, no one owns or controls that ledger.

Well technically speaking, miners via mining pools control the chain. They can and do upgrade / downgrade / sidegrade the software. And they can (and do) fork and reorg a chain. Is that defined as “control”? Unclear but we’ll probably see some court cases if real large loses take place due to forks.

On p. 44 they write:

As such there is no central vector of attack.

In theory, yes. In practice though, many chains are highly centralized: both in terms of block creation and in terms of development. Thus in theory it is possible to compromise and successfully “attack” a blockchain under the right circumstances. Could be worth rephrasing this in the next edition.

On p. 44 they write:

As we’ll discuss further in the book, there are varying degrees of security in different blockchain designs, including those known as “private” or “permissioned” blockchains, which rely on central authorities to approve participants. In contrast, Bitcoin is based on a decentralized model that eschews approvals and instead banks on the participants caring enough about their money in the system to protect it.

This is a bit of a strawman because there are different types of “permissioned” blockchains designed for different purposes… they’re not all alike. In general, the main commonality is that the validators are known via a legal identity. How these networks are setup or run does not necessarily need to rely on a centralized authority, that would be a single point of trust (and failure). But we’ll discuss this later below.

On p. 44 they write:

On stage at the time, Adam Ludwin, the CEO of blockchain / distributed ledger services company Chain Inc., took advantage of the results to call out Wall Street firms for failing to see how this technology offers a different paradigm. Ludwin, whose clients include household names like Visa and Nasdaq, said he could understand why people saw a continued market for cybersecurity services, since his audience was full of people paid to worry about data breaches constantly. But their answers suggested they didn’t understand that the blockchain offered a solution. Unlike other system-design software, for which cybersecurity is an add-on, this technology “incorporates security by design,” he said.

It is unclear from the comments above exactly how a blockchain solves problems in the world of cybersecurity. Maybe it does. If so, then it should be explored in more detail than what is provided in this area of the book.

As an aside, I’m not sure how credible Ludwin’s comments on this matter are because of the multiple pivots that his companies have done over the past five years.11

On p. 45 they write:

A more radical solution is to embrace open, “permissionless” blockchains like Bitcoin and Ethereum, where there’s no central authority keeping track of who’s using the network.

This is very much a prescriptive pitch and not a descriptive analysis. Recommend changing some of the language in the next edition. Also, they should define what “open” means because there basically every mining pool doxxes themselves.

Furthermore, some exchanges that attempt to enforce their terms-of-service around KYC / AML / CTF do try to keep track of who is doing what on the network via tools from Chainalysis, Blockseer, Elliptic and others. Violating the ToS may result in account closures. Thus, ironically, the largest “permissioned” platforms are actually those on the edges of all cryptocurrencies.

See: What is Permissioned-on-Permissionless

On p. 45 they write:

It’s not about building a firewall up around a centralized pool of valuable data controlled by a trusted third party; rather the focus is on pushing control over information out to the edges of the network, to the people themselves, and on limiting the amount of identifying information that’s communicated publicly. Importantly, it’s also about making it prohibitively expensive for someone to try to steal valuable information.

This sounds all well and good, definitely noble goals. However in the cryptocurrency world, many exchanges and custodial wallets have been compromised and the victims have had very little recourse. Despite the fact that everyone is continually told not to store their private keys (coins) with an intermediary, Chainalysis found that in 2017 more than 80% of all transactions involved a third-party service.

On p. 45 they write:

Bitcoin’s core ledger has never been successfully attacked.

They should define what they mean by “attacked” because it has forked a number of times in its history. And a huge civil war took place resulting in multiple groups waging off-chain social media campaigns to promote their positions, resulting in one discrete group divorcing and another discrete group trying to prevent them from divorcing. Since there is only de facto and not de jure governance, who attacked who? Who were the victims?

On p. 45 they write:

Now, it will undoubtedly be a major challenge to get the institutions that until now have been entrusted with securing our data systems to let go and defer security to some decentralized network in which there is no identifiable authority to sue if something goes wrong. But doing so might just be the most important step they can take to improve data security. It will require them to think about security not as a function of superior encryption and other external protections, but in terms of economics, of making attacks so expensive that they’re not worth the effort.

This seems a bit repetitive with the previous couple of page, recommend slimming this down in the next edition. Also, there are several class action lawsuits underway (e.g., Ripple, Tezos) which do in fact attempt to identify specific individuals and corporations as being “authorities.” The Nano lawsuit also attempted to sue “core developers.”

On p. 46 they write:

A hacker could go after each device, try to steal the private key that’s used to initiate transactions on the decentralized network, and, if they’re lucky, get away with a few thousand dollars in bitcoin. But it’s far less lucrative and far more time-consuming than going after the rich target of a central server.

The ironic part of this is that generally speaking, the private keys controlling millions of bitcoins are being housed in trusted third parties / intermediaries right now. In some cases these are stored on a centralized server. In other cases, the cold wallet managed by hosting providers such as Xapo (which is rumored to secure $10 billion of bitcoin) does geographically split the keys apart into bunkers. Yet at some point those handling the mutli-sig do come together in order to move the coins to a hot wallet.12

On p. 47 they write:

It seems clear to us that the digital economy would benefit greatly from embracing the distributed trust architecture allowed by blockchains – whether it’s simply the data backups that a distributed system offers, or the more radical of an open system that’s protected by a high cost-to-payout ratio.

What does this mean? Are they saying to add proof-of-work to all types of distributed systems? It is only useful in the Bitcoin context in order to make it expensive to Sybil attack the network… because participants were originally unknown. Does that same problem exist in other environments that they are thinking of? More clarity should be added in the next edition.

On p. 48 they write:

The idea, one that’s also being pursued in different forms by startups such as Gem of Los Angeles and Blockchain Health of San Francisco, is that the patient has control over who sees their records.

This is one of the difficulties in writing a long-form book on this general topic right now: projects and companies frequently pivot.

For instance, a couple months after the book was published, Gem announced its “Universal Token Wallet,” a product which currently dominates its front page and social media accounts of the company. There have been no health care-related announcements from the company in over a year.

Similarly, Blockchain Health no longer exists. Its CEO left and joined Chia as a co-founder and the COO has joined the Neighborly team.

On p. 50 they write:

It was a jury-rigged solution that meant that the banking system, the centralized ledger-keeping solution with which society had solved the double-spend problem for five hundred years, would be awkwardly bolted onto the ostensibly decentralized Internet as its core trust infrastructure.

I think there are some legitimate complaints to made towards how online commerce evolved and currently exists but this seems a tad petty. As backwards as financial institutions are (rightly and wrongly) portrayed, it’s not like their decision makers sat around in the early ’90s trying to figure out how to make integrating the Web an awkward process.

On p. 50 they write:

Under this model, the banks charged merchants an interchange fee of around 3 percent to cover their anti-fraud costs, adding a hidden tax to the digital economy we all pay in the form of higher prices.

Again, like their statement above: there are some very legitimate gripes to be had regarding the existing oligopolistic payment systems, but this specific gripe is kind of petty.

Fraud exists and as a result someone has to pay for it. In the cryptocurrency world, there is no recourse because it is caveat emptor. In the world of courts and legal recourse, fees are levied to cover customer service including fraud and insurance. It may be possible to build a payment system in which there is legal recourse and simultaneously no oligopolistic rent seeking but this is not explored in the book. Also, for some reason the fee to miners is not brought up in this section, yet it is a real fee users must pay… yet they do not receive customer service as part of it.

Lastly, the Federal Reserve (and other central banks) monitor historical interchange fees. Not all users are charged the ~3% as mentioned in the book.

For instance (see below): Average Debit Card Interchange Fee by Payment Card Network

Source: Statista

On pages 52 and 53 they write uncritically about Marc Andresseen and VCs who have invested in Bitcoin and cryptocurrencies.

a16z, the venture firm co-founded by Andresseen, arguably has a few areas that may be conflicts-of-interest with the various coin-related projects it has invested in and/or promoted the past several years (e.g., investing in coins which are listed on an exchange they also are an investor and board member of such as 0x). Those ties are not scrutinized in a chapter that attempts to create a black and white narrative: that the legacy players are centralized rent-seekers and the VCs are not. When we know empirically that some VCs, including a16z, have invested in what they believe will become monopolies of some kind.

On page 54 and 55 they write about “Code is not law,” a topic that I have likewise publicly presented on.

Specifically they state:

One risk is that regulators, confused by all these outside-the-box concepts, will overreact to some bad news – potentially triggered by large-scale investors losses if and when the ICO bubble bursts and exposes a host of scams. The fear is that a new set of draconian catchall measures would suck the life out of innovation in this space or drive it offshore or underground. To be sure, institutions like the Washington-based Coin Center and the Digital Chamber of Commerce are doing their best to keep officials aware of the importance of keeping their respective jurisdictions competitive in what is now a global race to lead the world in financial technology.

This is word for word what coin lobbyists have been pitching to policy makers around the world for years. Both Coin Center and Digital Chamber of Commerce lobby on behalf of their sponsors and donors to prevent certain oversight on the cryptocurrency market.13 An entire book could probably be written about how specific people within coin lobbying organizations have attempted to white wash and spin the narrative around illicit usage, using carefully worded talking points. And they have been effective because these authors do not question the motivations and agenda these special interest groups have.

Either way, Bitcoin and many other cryptocurrencies were born in the “underground” and even “offshore.” It is unclear what the authors are trying to excuse because if anything, regulators and law enforcement have arguably been very light handed in the US and most regions abroad.

If anything, once a foreign registered ICO or coin is created, often the parent company and/or foundation opens an office to recruit developers in San Francisco, New York, and other US cities. I know this because all the multiple “blockchain” events I have attended overseas the past two years in which organizers explain their strategy. The next edition of this book could explore this phenomenon.

On p. 57 they write:

By The DAO founders’ own terms, the attacker had done nothing wrong, in other words. He or she had simply exploited one of its features.

Excellent point that should be explored in further detail in the next edition. For instance, in Bitcoin there have been multiple CVEs which if exploited (at least one was) could have resulted in changes in the money supply. Is that a feature or a bug?

And the most recent one, found in pre-0.16.3, was partially downplayed and hidden to prevent others from knowing the extent of potential damage that could have been done.

On p. 59 they write:

The dependence on a trusted middleman, some cryptocurrency purists would argue, overly compromises a blockchain’s security function, rending it unreliable. For that reason, some of them say, a blockchain is inappropriate for many non-currency applications. We, however, view it as a trade-off and believe there’s still plenty of value in recording ownership rights and transfers to digitally represented real-world assets in blockchains.

I think this whole section should be reworded to describe:

  1. what types of blockchains they had in mind?
  2. how the legal hooks into certain blockchains behave versus anarchic chains?
  3. being more precise with the term purist… do they mean maximalists or do they mean someone who points out that most proposed use-cases are chainwashing?

On pages 59 and 60 they write:

Permissioned blockchains – those which require some authorized entity to approve the computers that validate the blockchain – by definition more prone to gatekeeping controls, and therefore to the emergence monopoly or oligopoly powers, than the persmissionless ideal that Bitcoin represents. (We say “ideal” because, as we’ll discuss in the next chapter, there are also concerns that aspects of Bitcoin’s software program have encouraged an unwelcome concentration of ownership – flaws that developers are working to overcome.)

It would be beneficial in the next edition to at least walk through two different “permissioned blockchains” so the reader can get an idea of how validators become validators in these chains. By not including them, each platform is painted in the same light.

And because they are still comparing it with Bitcoin (which was designed for a completely different type of use-case than ‘permissioned chains’ are), keep in mind that the way mining (block making) is done in 2018 is very different than when it was first proposed in the 2008 paper. Back then, mining included a machine that did two things: validated blocks and also generate proofs-of-work. Today, those two functions are completely separate and because of the relatively fierce competition at generating hashes, there are real exit and entry costs to the market.

In many cases, this means that both the mining pool operators and hash generators end up connecting their real world government-issued identities with their on-chain activity (e.g., block validation). It may be a stretch to say that there is an outright monopoly in mining today, but there is a definite trend towards oligopoly in manufacturing, block producing, and hash generation the past several years. This is not explored beyond a superficial level in the book.

On p. 60 they write:

Until law changes, banks would face insurmountable legal and regulatory opposition, for example, to using a system like Bitcoin that relies on an algorithm randomly assigning responsibility at different stages of the bookkeeping process to different, unidentifiable computers around the world.

This is another asinine comment because they don’t explicitly say which laws they would like changed. The authors make it sound like the PFMIs are holding the world back when the opposite is completely true. These principals and best practices arose over time because of the systemic impact important financial market infrastructures could have on society as a whole.

Proof-of-work chains, the ones that are continually promoted in this book, have no ability to prevent forks, by design. Anarchic chains like Bitcoin and Ethereum can only provide probabilistic finality. Yet commercial best practices and courts around the world demands definitive settlement finality. Why should commerce be captured by pseudonymous, unaccountable validators maintained in jurisdictions in which legal recourse is difficult if not impossible?

On p. 60 they continue:

But that doesn’t mean that other companies don’t have a clear interest in reviewing how these permissioned networks are set up. Would a distributed ledger system that’s controlled by a consortium of the world’s biggest banking institutions be incentivized to act in the interest of the general public it serves? One can imagine the dangers of a “too-big-to-fail blockchain” massive institutions could once again hold us hostage to bailouts because of failures in the combined accounting system.

This has been one of Michael Casey’s talking points for the past three years. I was even on a panel with him in January 2016 in which he called R3 a “cartelchain,” months before Corda even existed. His justified disdain towards traditional financial institutions — and those involved with technology being developed in the “permissioned” world — pops up throughout this book. I do think there are some valid critiques of consortia and permissioned chains and even Corda, but those aren’t presented in this edition of the book.

He does make two valid observations here as well: regulated commerce should have oversight. That is one of the reasons why many of the organizations developing “permissioned blockchains” have plans to or already have created separate legal entities to be regulated as some type of FMI.

The other point is that we should attempt to move away from recreating TBTF and SIFI scenarios. Unfortunately in some cases, “permissioned chains” are being pitched as re-enabler of that very scenario. In contrast, dFMI is a model that attempts to move away from these highly intermediated infrastructures. See also my new article on SICNs.

On p. 60 they write:

Either way, it’s incumbent upon us to ensure that the control over the blockchains of the future is sufficiently representative of broad-based interests and needs so that they don’t just become vehicles for collusion and oligpolistic power by the old guard of finance.

The ironic part of this statement is — while well-intended — because of economies of scale there is an oligopoly or even monopoly in most PoW-mined coins. It is unclear how or why that would change in the future. In addition, with the entrance of Bakkt, ErisX, Fidelity and other large traditional financial organizations (e.g., the old guard) into the cryptocurrency world, it is hard to see how “permissionless ecosystems” can prevent them from participating.

On p. 61 they write:

As we stated in The Age of Cryptocurrency, Bitcoin was merely the first crack at using a distributed computing and decentralized ledger-keeping system to resolve the age-old problem of trust and achieve this open, low-cost architecture for intermediary-free global transactions.

But as the authors have stated elsewhere: proof-of-work chains are inherently costly. If they were cheap to maintain then they would be cheap to fork and reorg. You cannot simultaneously have a cheap (“efficient”) and secure PoW network… that’s a contradiction.

See:

Chapter 3

On pages 64 and 65 they provide a definition of a blockchain. I think this could be more helpful more earlier on in the book for newer audiences.

A few other citations readers may be interested in:

On p. 66 they write:

That way, no authorizing entity could block, retract, or decide what gest entered into the ledger, making it censorship resistant.

Could be worth referencing Eligius, a pool run by Luke-Jr. that would not allow Satoshi Dice transactions because its owners religious views.14

On p. 67 they write:

These computers are known as “miners,” because in seeking to win the ten-minute payout, they engage in a kind of computational treasure hunt for digital gold.

I understand the need to make simple analogies but the digital gold one isn’t quite right because gold does not have an inflexible supply whereas bitcoin does. I’ve pointed this out in other book reviews and it bears repeating because of how the narrative of e-cash to HODLing has changed over the last few years.1516

Readers may be interested of a few real life examples of perfectly inelastic supplies.

On p. 67 they write:

Proof of work is expensive, because it chews up both electricity and processing power. That means that if a miner wants to seize majority control of the consensus system by adding more computing power, they would have to spend a lot of money doing so.

This is correct. Yet six pages earlier they say it is a “low-cost” infrastructure. Needs to be a little more consistent in this book. Either PoW is resource intensive or it is not, it cannot be both.

On p. 68 they write:

Over time, bitcoin mining has evolved into an industrial undertaking, with gigantic mining “farms” now dominating the network. Might those big players collude and undermine the ledger by combining resources? Perhaps, but there are also overwhelming disincentives for doing so. Among other considerations, a successful attack would significantly undermine the value of all the bitcoins the attacking miner owns. Either way, no one has managed to attack Bitcoin’s ledger in nine years. That unbroken record continues to reinforce belief in Bitcoin’s cost-and-incentive security system.

It’s worth pointing out that there are ways to fork Bitcoin beyond the singular Maginot Line attack. As mentioned above, Bitcoin and many other coins have forked; see this history. Hundreds of coins have died due to lack of interest by miners and developers.

It could also be argued that between 2015-2017, Bitcoin underwent a social, off-chain attack by multiple different groups attempting to exert their own influence and ideology onto the ecosystem. The end result was a permanent fracture, a divorce which the principal participants still lob social media bombs at one another. There isn’t enough room to discuss it here, but the astroturfing actions by specific people and companies in order to influence others is worth looking into as well. And it worked.

On p. 71 they write:

The caveat, of course, is that if bad actors do control more than 50 percent of the computing power they can produce the longest chain and so incorporate fraudulent transactions, which other miners will unwittingly treat as legitimate. Still, as we’ve explained, achieving that level of computing power is prohibitively expensive. It’s this combination of math and money that keeps Bitcoin secure.

I probably would change some of the wording because with proof-of-work chains (and basically any cryptocurrency), there are no terms of service or end user license agreement or SLA. At most there is only de facto governance and certainly not de jure.

What does that mean? It means that we really can’t say who the “bad actors” are since there is no service agreement. Barring an administrator, who is the legitimate authority in the anarchic world of cryptocurrencies? The original pitch was: if miners want to choose to build on another tree or fork, it’s their decision to do so… they don’t need anyone’s permission to validate blocks and attempt to update the chain as they want to. The next edition should explicitly say who or what is an attacker or what a fraudulent transaction is… these are points I’ve raised in other posts and book reviews.

Also, the authors mention that computational resources involved in PoW are “prohibitively expensive” here. So again, to be consistent they likely should remove “low-cost” in other places.

On p. 71 and 72 they write:

In solving the double-spend problem, Bitcoin did something else important: it magically created the concept of a “digital asset.” Previously, anything digital was too easily replicated to be regarded as a distinct piece of property, which is why digital products such as music and movies are typically sold with licensing and access rights rather than ownership. By making it impossible to replicate something of value – in this case bitcoins – Bitcoin broke this conventional wisdom. It created digital scarcity.

No it did not. This whole passage is wrong. As we have seen with forks and clones, there really is no such thing as this DRM-for-money narrative. This should be removed in the next edition.

Scarcity effectively means rivalrous, yet anyone can copy and clone any of these anarchic chains. PoW might make it relatively expensive to do a block reorg on one specific chain, but it does not really prevent someone from doing what they want with an identically cloned chain.

For instance, here is a list of 44 Bitcoin forked tokens that arose between August 2017 and May 2018. In light of the Bitcoin and Bitcoin Cash divorce, lobbying exchanges to recognize ticker symbols is also worth looking into in a future edition.

On p. 73 they write:

Many startups that were trying to build a business on top of Bitcoin, such as wallet providers and exchanges, were frustrated by an inability to process their customers’ transactions in a timely manner. “I’ve become a trusted third party,” complained Wences Casares, CEO of bitcoin wallet and custodial service Xapo. Casares was referring to the fact that too many of his firms’ transactions with its customers had to be processed “off-chain” on faith that Xapo would later settle the transaction on the Bitcoin blockchain.

This is one of the most honest statements in the book. The entire cryptocurrency ecosystem is now dominated by intermediaries.

Interestingly, Xapo moved its main office from Palo Alto to Switzerland days after Ripple was fined by FinCEN for violating the BSA. Was this just a coincidence?

On p. 73 they wrote:

Making blocks bigger would require more memory, which would make it even more expensive to operate a miner, critics pointed out. That could drive other prospective miners away, and leave Bitcoin mining even more concentrated among a few centralized players, raising the existential threat of collusion to undermine the ledger.

This wasn’t really the argument being made by the “small blockers.” Rather, it was disk space (not memory) that was — at the time — perceived as a limitation for retail (home) users in the long run. Yet it has been a moot point for both Bitcoin and Bitcoin Cash as the price per gigabyte for a hard drive continues to decline over time… and because in the past year, on-chain transactions on both chains have fallen from their peak in December 2017.

In practice, the “miners” that that authors refer to are the roughly 15 to 20 or so mining pools that in a given day, create the blocks that others build on. Nearly all of them maintain these nodes at a cloud provider. So there is already a lot of trust that takes place (e.g., AWS and Alibaba are trusted third parties). Because of economies of scale, spinning up a node (computer) in AWS is relatively inexpensive.

It really isn’t discussed much in the book, but the main argument throughout the 2nd half of 2017 was about UASF — a populist message which basically said miners (mining pools) didn’t really matter. Followers of this philosophy emphasized the need to run a node at home. For instance, if a UASF supporter based in rural Florida is attempting to run a node from his home, there could be a stark difference between the uptime and bandwidth capacity he has at home versus what AWS provides.

On p. 74 they write:

Without a tally of who’s who and who owns what, there was no way to gauge what the majority of the Bitcoin community, composed of users, businesses, investors, developers, and miners, wanted. And so, it all devolved into shouting matches on social media.

I wrote about this phenomenon in Appendix A in a paper published in November 2015. And what eventually happened was a series of off-chain Sybil attacks by several different tribes, but especially by promoters of UASF who spun up hundreds — thousands of nodes — and acted as if those mattered.

Future editions should also include a discussion on what took place at the Hong Kong roundtable, New York agreement, and other multilateral governance-related talks prior to the Bitcoin Cash fork.

On p. 74 they write:

A hard-fork-based software change thus poses a do-or-die decision for users on whether to upgrade or not. That’s bad enough for, say, word processing software, but for a currency it’s downright problematic. A bitcoin based on the old version could not be transferred to someone running software that support the new version. Two Bitcoins. Two versions of the truth.

The authors actually accidentally proved my earlier point: that public chains, specifically, proof-of-work chains, cannot prevent duplication or forks. Proof-of-work only makes it resource intensive to do double-spend on one specific chain.

This is one of the reasons why regulated financial organizations likely will continue to not issue long lifecycle instruments directly onto an anarchic chain like Bitcoin: because by design, PoW chains are forkable.

Also, future editions may want to modify this language because there are some counterarguments from folks like Vitalik Buterin that state: because hard forks are opt-in and thus lead to cleaner long-term outcomes (e.g., less technical debt).

On p. 75 they write a lot about Lightning Network, stating:

So, there are no miners’ fees to pay and no limit on how many transaction can be done at any time. The smart contracts prevent users from defrauding each other while the Bitcoin blockchain is used solely as a settlement layer, recording new balance transactions whenever a channel is opened or closed. It persists as the ultimate source of proof, a guarantee that all the “off-chain” Lightning transactions are legitimate.

What is not discussed in this edition is that:

  1. Lightning has been massively hyped with still relatively subdued traction
  2. Lightning is a separate network – it is not Bitcoin – and thus must be protected and secured through other non-mining means
  3. Lightning arguably distorts the potential transition to a fee-based Bitcoin network in much the same way that intermediaries like Coinbase do. That is to say, users are paying intermediaries the fees instead of miners thus prolonging the time that miners rely on block rewards (as a subsidy) instead of user fees.

Also, it bears mentioning that Bitcoin cannot in its current form act as a legal “settlement layer” as it cannot provide definitive settlement finality as outlined in the PFMIs (principle #8).

On p. 75 they write:

The SegWit/Lightning combination was in their minds the responsible way to make changes. They had a duty, they believed, to avoid big, disruptive codebase alterations and instead wanted to encourage innovators to develop applications that would augment the powers of the limited foundational code. It’s a classic, security-minded approach to protocol development: keep the core system at the bottom layer of the system simple, robust, and hard to change – some of the words “deliberately dumb” – and thus force innovation “up the stack” to the “application layer.” When it works you get the best of both worlds: security and innovation.

The authors should revise this because this is just repeating the talking points of specific Core developers, especially the last line.

Empirically it is possible to create a secure and “innovative” platform… and do so with multiple implementations of a specification. We see that in other cryptocurrencies and blockchain-related development efforts including Ethereum. The Bitcoin Core participants do not have a monopoly on what is or is not “security minded” and several of them are vocally opposed to supporting multiple implementations, in part, because of the politics around who controls the BIP process.

In fact, it could be argued that by insisting on the SegWit/Lightning approach, they caused a disruption because in point of fact, the amount of code that needed to be changed to increase the block size is arguably less than what was needed to build, verify, and release SegWit.

It’s not worth wading deep into these waters in this review, but the next edition of this book should be more even handed towards this schism.

On p. 76 they write:

But a group of miners with real clout was having none of it. Led by a Chinese company that both mined bitcoin and produced some of the most widely used mining equipment, this group was adamantly opposed to SegWit and Lightning. It’s not entirely clear what upset Jihan Wu, CEO of Bitmain, but after lining up with early Bitcoin investor and prominent libertarian Roger Ver, he launched a series of lobbying efforts to promote bigger blocks. One theory was that Bitmain worried that an “off-chain” Lightning solution would siphon away transaction fees that should be rightly going to miners; another was that because such payment channel transactions weren’t traceable as on-chain transactions, Chinese miners were worried that their government might shut them down. Bitmain’s reputation suffered a blow when revelations emerged that its popular Ant-miner mining rigs were being shipped to third-party miners with a “backdoor” that allowed the manufacturer-cum-miner to shut its opponents’ equipment down. Conspiracy theories abounded: Bitmain was planning to subvert SegWit. The company denied this and vowed to disable the feature. But trust was destroyed.

There is a lot of revisionism here.

But to start with, in the process of writing this review I reached out and contacted both Roger Ver and separately an advisor at Bitmain. Both told me that neither of the authors of this book had reached out to them for any comment. Why would the authors freely quote Bitcoin Core / SegWit developers to get their side of this debate but not reach out to speak with two prominent individuals from the other side to get their specific views? The next edition should either include these views and/or heavily revise this section of the book.

There are a few other problems with this passage.

Multiple different groups were actively lobbying and petitioning various influential figures (such as exchange operators) during this time period, not just Jihan and Roger. For instance, as mentioned above, the Hong Kong roundtable and New York agreement were two such examples. Conversely, SegWit and UASF was heavily promoted and lobbied by executives and affiliates at Blockstream and a handful of other organizations.

Regarding this “backdoor,” let’s rewind the clock and look at the overt / covert tempest in a teapot.

Last April Bitmain was alleged by Greg Maxwell (and the Antbleed campaign) of having maybe kinda sorta engaged in something called covert mining via Asicboost. Jimmy Song and others looked into it and said that there was no evidence covert was happening. At the time, some of the vocal self-identified “small block” supporters backing UASF, used this as evidence that Bitmain was a malicious Byzantine actor that must be purged from Bitcoinland. At the time, Greg proposed changing the PoW function in Bitcoin in order to prevent covert Asicboost from working.

In its defense, Bitmain stated that while Asicboost had been integrated into the mining equipment, it was never activated… partly because of the uncertain international IP / patent claims surrounding Asicboost. Recently, they announced a firmware upgrade that miners could activate overt Asicboost… a few days after another organization did (called “braiins”).

So why revisit this?

Two months ago Sia released code which specifically blocked mining equipment from Bitmain and Innosilicon. How and why this action is perceived as being fair or non-political is very confusing… they are definitely picking favorites (their own hardware). Certainly can’t claim to be sufficiently decentralized, right?

Yet in this section of the book, they don’t really touch on how key participants within the tribes and factions, represented at the time. Peruse both lists and look at all of the individuals at the roundtable that claim to represent “Bitcoin Core” in the governance process versus (the non-existent) reps from other implementations.

Even though the divorce is considered over, the tribes still fling mud at one another.

For example, one of the signatories of the HK roundtable, Adam Back, is still heckling Bitmain for supposedly not being involved in the BIP process. Wasn’t participation supposed to be “voluntary” and “permissionless”? Adam is also now fine with “overt” Asicboost today but wasn’t okay with it 18 months ago. What changed? Why was it supposedly bad for Bitmain to potentially use it back then but now it’s kosher because “braiins” (Slush) is doing it? That seems like favoritism.

Either way, the book passage above needs to be rewritten to include views from other camps and also to remove the still unproven conspiracy theories.

On p. 76 they write:

Meanwhile, original bitcoin went on a tear, rallying by more than 50 percent to a new high above $4,400 over a two-week period. The comparative performance of the pair suggested that small-block BTC and the SegWit reformers had won.

The next edition should change the wording because this comes across one-sided.

While an imperfect comparison, a more likely explanation is that of a Keynesian beauty contest. Most unsophisticated retail investors had heard of Bitcoin and hadn’t heard of Bitcoin Cash. Bitcoin (BTC) has brand recognition while Bitcoin Cash and the dozens of other Bitcoin-named forks and clones, did not.

Based on anecdotes, most coin speculators do not seem to care about the technical specifications of the coins they buy and typically keep the coins stored on an intermediary (such as an exchange) with the view that they can sell the coins later to someone else (e.g., “a greater fool“).

On p. 77 they write:

Bitcoin had gone through a ridiculous circus, one that many outsiders naturally assumed would hurt its reputation and undermine its support. Who wants such an ungovernable currency? Yet here was the original bitcoin surging to new heights and registering a staggering 650 percent gain in less than twelve months.

The problem with cherry picking price action dates is that, as seen in the passage above, it may not age well.17

For example, during the write-up of this review, the price of bitcoin declined from where it was a year ago (from over $10,000 then down to around $4,000). What does that mean? We can all guess what happened during this most recent bubble, but to act like non-tech savvy retail buyers bought bitcoin (BTC) because of SegWit is a non sequitur. No one but the tribalists in the civil war really cared.

On p. 77 they write:

Why? Well, for one, Bitcoin had proven itself resilient. Despite its civil war, its blockchain ledger remained intact. And, while it’s hard to see how the acrimony and bitterness was an advantage, the fact that it had proven so difficult to alter the code, to introduce a change to its monetary system, was seen by many as an important test of Bitcoin’s immutability.

There are a few issues here.

What do the authors mean by the “blockchain ledger remained intact”? I don’t think it was ever a question over whether or not copies of the Bitcoin blockchain (and/or forks thereof) would somehow be deleted. Might want to reword this in the future.

Segwit2x / Bitcoin Cash proponents were not trying to introduce a change to Bitcoin’s monetary system. The supply schedule of bitcoins would have stayed the same. The main issue was: a permanent block size increase from 1 MB to at least 2 MB. That proposal, if enacted, would not have changed the money supply.

What do the authors mean by “Bitcoin’s immutability”? The digital signatures are not being reversed or changed and that is what provides transactions the characteristic of “immutability.”

It is likely that the authors believe that a “hard fork” means that Bitcoin is not immutable. That seems to conflate “immutability” of a digital signature with finality (meaning irreversibility). By design, no proof-of-work coin can guarantee finality or irreversibility.

Also, Bitcoin had more than a dozen forks prior to the block size civil war.

On p. 77 and 78 they write:

Solid censorship resistance was, after all, a defining selling point for Bitcoin, the reason why some see the digital currency becoming a world reserve asset to replace the outdated, mutable, fiat-currency systems that still run the world. In fact, it could be argued that this failure to compromise and move forward, seen by outsiders as Bitcoin’s biggest flaw, might actually be its biggest feature. Like the simple, unchanging codebase of TCP/IP, the gridlocked politics of the Bitcoin protocol were imposing secure rigidity on the system and forcing innovation up the stack.

This is not what “censorship resistance” means in the context of Bitcoin. Censorship resistance is narrow and specific to what operators of miners could do. Specifically, the game theory behind Nakamoto Consensus is that it would be costly (resource intensive) for a malicious (Byzantine) actor to try and attempt to permanently censor transactions due to the amount of hashrate (proof-of-work) a Byzantine actor would need to control (e.g., more than 50%).

In contrast, what the authors described in this book was off-chain censorship, such as lobbying by various special interest groups at events, flamewars on Twitter, removing alternative views and voices on reddit, and via several other forms.

The “world reserve asset” is a loaded phrase that should be clarified in the next edition because the passage above comes across a bit like an Occupy Wall Street speech. It needs more of an explanation beyond the colorful one sentence it was given. Furthermore, as I predicted last year, cryptocurrencies continue to rely on the unit-of-account of “fiat systems” and shows no signs of letting up in this new era of “stablecoins.”

The authors definitely need to remove the part that says “unchanging codebase of TCP/IP” because this is not true. TCP/IP is a suite of protocol standards and its constituent implementations continue to evolve over time. There is no single monolithic codebase that lies unchanged since 1974 which is basically the takeaway from the passage above.18

In fact, several governing bodies such as IFTF and IAB continue to issue RFCs in order to help improve the quality-of-service of what we call the internet. It is also worth pointing out that their analogy is flawed for other reasons discussed in: Intranets and the Internet. In addition, the next version of HTTP won’t be using TCP.

As far as whether innovation will move “up the stack” remains to be seen but this seems to be an argument that the ends justify the means. If that is the case, that appears to open up a can of worms beyond the space for this review.

On p. 78 there is a typo: “BTH” instead of “BCH”

On p. 78 they write:

That’s what BTC, the original Bitcoin, promises with its depth of talent at Core and elsewhere. BTH can’t access such rich inventiveness because the community of money-focused bitcoin miners can’t attract the same kinds of passionate developers.

Strongly recommend removing this passage because it comes across as a one-sided marketing message rather than a balanced or neutral explanation using metrics. For instance, how active are the various code repositories for Bitcoin Core, Unlimited, and others? The next edition should attempt to measure how to measure “depth.”

For example, Bitmain has invested $50 million into a new fund focused on Bitcoin Cash called “Permissionless Ventures.” 2-3 years from now, what are the outcomes of that portfolio?

On p. 78 they write about permissioned blockchains:

Under these arrangements, some authority, such as a consortium of banks, choose which entities get to participate in the validation process. It is, in many respects, a step backward from Nakamoto’s achievement, since it makes the users of that permissioned system dependent once again, on the say-so of some trusted third party.

This is a common refrain throughout the book: that the true innovation was Bitcoin.

But it’s an apples-to-oranges comparison. Both worlds can and will co-exist because they were designed for different operating environments. Bitcoin cannot provide the same finality guarantees that “permissioned chains” attempt to do… because it was designed to be forkable. That’s not necessarily a flaw because Satoshi wasn’t trying to create a solution to a problem banks had. It’s okay to be different.

On p. 79 they write:

Most importantly, permissioned blockchains are more scalable than Bitcoin’s, at least for now, since their governance doesn’t depend upon the agreement of thousands of unidentified actors around the world; their members can simply agree to increase computing power whenever processing needs rise.

This doesn’t make sense at all. “Permissioned chains” in the broadest sense, do not use proof-of-work. As a result, there is no computational arms race. Not once have I been in a governance-related meeting involving banks in which they thought the solution to a governance-related issue was increasing or decreasing computational power. It is a non sequitur and should be removed in the next edition.

Also, there are plenty of governance issues involving “permissioned chains” — but those are typically tangential to the technical challenges and limitations around scaling a blockchain.

On p. 79 they write:

To us, permissionless systems pose the greatest opportunity. While there may well be great value in developing permissioned blockchains as an interim step toward a more open system, we believe permissionlessness and open access are ideals that we should strive for – notwithstanding the challenges exposed by Bitcoin’s “civil war.”

The authors repeat this statement in a couple other areas in the book and it doesn’t really make sense. Why? Because it is possible for both operating environments to co-exist. It doesn’t have to be us versus them. This is a false dichotomy.

Also, if any of these “permissioned chains” are actually put into production, it could be the case that end users could have “open access” to the platform, with the exception of participating in the validation of blocks. That’s pretty much how most coin users experience a cryptocurrency network today (e.g., via permissioned endpoints on Coinbase).19

On p. 80 they write:

The problem was that Bitcoin’s single-purpose currency design wasn’t ideally suited for these non-currency applications.

A side note maybe worth mentioning in a footnote is that Satoshi did attempt to build a marketplace early on but gave up.

On p. 81 they mention Nick Szabo with respect to smart contracts. Could be worth exploring the work of Martín Abadi which predates Szabo (the idea of distributed programs that perform authorizations predates Szabo’s “smart contracts”).  Mark S Miller has also done work in this area.

On p. 82 they write about Ethereum:

“Android for decentralized apps.” It would be an open platform much like Google’s smartphone operating system, on which people could design any new application they wanted and run it, not on a single company-owned server but in a decentralized manner across Ethereum’s ownerless network of computers.

This is probably not the best analogy because there is a difference between Google Android and Android Open Source Project. One of them includes proprietary tech. Also, Google can and does add and remove applications from the Play store on a regular basis based on its terms and conditions.

Lastly, someone does in fact own each of the computers that constitute the Ethereum blockchain… mining farms are owned by someone, mining pools are owned by someone, validating nodes are owned by someone. And so forth.

On p. 82 they write about Vitalik Buterin:

Now he was building a universally accessible, decentralized global supercomputer.

The next edition should drop the “supercomputer” verbiage because the Ethereum chain is only as powerful as the least powerful mining pool node… which in practice is typically a common computer located in a cloud provider such as AWS. This isn’t something like Summit over at Oak Ridge.

On p. 82 they write:

Now, with more than six hundred decentralized applications, or Dapps, running on Ethereum, he is looking vindicated. In just the first eleven months of 2017, the system’s internal currency, ether, rose from just over $8 to more than $400. By then the entire market cap for ether stood at $39 billion, a quarter that of Bitcoin’s. The success has made the wunderkind Buterin an instant multi-millionaire and turned him into a cultlike figure for the holders of ether and related tokens who’ve become rich.

The next version of the book should explicitly spell out what are the metrics for success. If it is solely price of a coin going up, what happens when the price of the coins goes down like it has in the past year?

For instance, ether (ETH), peaked in mid-January at around $1,400 and has been hovering near $100 the past several weeks. Does that mean Vitalik is no longer vindicated? Also, what is he vindicated from?

Lastly, it would be worth exploring in the next edition what Dapps are currently being used on a regular basis. As of this writing, the most popular Dapps are gambling apps (like proof-of-weak-hands / FOMO3D) and a few “decentralized exchanges” (DEX).

On p. 82 they write:

Ethereum co-founder Joseph Lubin only added to the complexity when he setup ConsenSys, a Brooklyn-based think tank-like business development unit tasked with developing new use cases and applications of the technology.

ConsenSys markets itself as a “venture studio” — a bit like YCombinator which incubates projects and provides some seed financing to get it off the ground. These projects are typically referred to as “spokes” (like a hub-and-spoke model).  As of this writing there are over 1,100 employees spread across several dozen spokes.  There is more to it than that and it would be interesting to see it explored in the next edition.

On p. 83 they write:

For example, the Parity Wallet, which was designed by Ethereum co-founder and lead architect Gavin Wood as a way to seamlessly engage, via a browser, with Ethereum smart contracts, lost $30 million in a hack.

Actually, Parity had a couple issues in 2017 and it is likely that the book may have been sent to publication around the same time the bigger problem occurred on November 13, 2017. The second one involved a Parity-developed multisig wallet… and $150 million in ether that is now locked away and cannot be accessed (barring a hardfork). Most developers — including those at Parity — characterize this instance as a “bug” that was accidentally exploited by a developer.

On p. 84 they write:

These kinds of dynamics, with large amounts of money at stake, can foster concerns that founders’ interests are misaligned with other users. Ethereum’s answer was the not-for-profit Ethereum Foundation, which was tasked with managing the pool of ether and other assets from the pre-mine and pre-sale- a model since used by many of the ICO token sales.

It would be interesting to explore how this foundation was created and how it evolved and who manages it today. For instance, at one point in 2014 there were conversations around creating a commercial, for-profit entity led in part by Charles Hoskinson who later left and founded Cardano.

On p. 85 they write about The DAO:

After a few modest coding changes failed, they settled on a drastic fix: Ethereum’s core developers “hard-forked” the Ethereum blockchain, implementing a backward-incompatible software update that invalidated all of the attacker’s transactions from a certain date forward. It was a radical move. To many in the cryptocurrency community, it threw into question Ethereum’s all-important claim to immutability. If a group of developers can force a change in the ledger to override the actions of a user, however unsavory those actions are, how can you trust that ledger won’t be tampered with or manipulated again in the interest of one group over another? Does that not destroy the whole value proposition?

This passage should probably be revised because of the usage of the word immutable.

Also, it could be argued that Bitcoin Core and other “core” groups act as gate keepers to the BIP process (or its equivalent) could lobby on behalf of special interest groups to push specific code changes and/or favor certain outcomes on behalf of specific stakeholders.

In either case, it is the miners that ultimately install and use the code. While some developers (like Bitcoin Core) are highly influential, without miners installing and running software, the rules on the network cannot be changed.

See Sufficiently Decentralized Howeycoins.

On p. 85 they write:

Well, in many respects, the Ethereum team operated as policymakers do during real-world crises. They made hard decisions that hurt some but were ultimately taken in the interests of the greater good — determined, hopefully, through as democratic a process as possible. The organizers went to great lengths to explain and gain support for the hard fork.

The next edition should strive to be more specific here: what exactly made the decision making around the hard fork democratic. Who participated, who didn’t participate. And so forth.

Continuing on p. 85:

And, much like the Segwit2x and other Bitcoin reform pro-miners didn’t accept it. For all intents and purposes, the fix was democratic – arguably, much more so than non-participatory democratic models through which crisis policymaking is enacted by national governments. And since Ethereum is more of a community of software engineers than of cryptocurrency investors, it was less contentious than Bitcoin’s struggle over hard-fork proposals.

This makes very little sense as it is written because the authors don’t define or specify what exactly made any of the decision making democratic. Who was enfranchised? Who got to vote and make decision? Also, how do the authors know that Ethereum is “more of a community of software engineers than of cryptocurrency investors.” Is there any hard numbers to back that assertion up?

And lastly how do we measure the level of contentiousness? Is there an objective measure out there?

On p. 85 they write about Ethereum Classic:

This created much confusion and some interesting arbitrage opportunities – as well as some lessons for bitcoin traders when their own currency split two years later – but it can also be viewed as the actions of a dissenting group non-violently exercising their right to secede. More than a year later, Ethereum Classic is still around, though it trades at a small fraction of Ethereum’s value, which means The DAO attacker’s funds – whose movements on the public Ethereum blockchain have been closely watched – are of lower value than if they’d been preserved in ETH.

I don’t think we can really say for sure how much the The DAO fund (and child DAO fundss) would be worth since that is an alternative timeline.

Also, there are some vocal maximalists that have created various Ethereum-branded tribes which are okay with The DAO attacker having access to those funds. Will be interesting to see if there are any sociological studies to reference in a new edition.

On p. 86 they write:

These hacks, and the scrambles to fix them, seem nuts, right? But let’s put them in perspective. First, is this monetary chaos anything less unsettling than the financial crisis of 2008? Or the audacity of the subsequent Wall Street trading scandals?

This is a whataboutism. Also, strangely the authors are saying the bar for judgement is as low as the financial engineering and socialized loses of the GFC. Isn’t the narrative that cryptocurrencies are supposed to be held to a higher standard because the coin creators seek to architect a world that doesn’t have arbitrary decision making?

On p. 87 and 88 they write:

When the FBI auctioned the 144,000 bitcoins (worth $1.4 billion as of late November 2017) that it seized from Ross Ulbricht, the convicted mastermind of the Silk Road illicit goods marketplace, those coins fetched a significantly higher price than others in the market. The notion was that hey had now been “whitewashed” by the U.S. government. In comparison, other bitcoins with a potentially shady past should be worth less because of the risk of future seizure. That’s hardly fair: imagine if the dollar notes in your wallet were hit with a 10 percent tax because the merchant knew that five years ago, unbeknownst to you, they had been handled by a drug dealer. To avoid these distortions and create a cryptocurrency that works more like fungible cash, Wilcox’s Zcash uses sophisticated “zero-knowledge proofs” to allow miners to prove that holders of the currency aren’t’ double-spending without being able to trace the addresses.

What the authors likely mean by “whitewashed” is probably “cleansed.” In the US there have been discussions on how this could take place via the existing Uniform Commercial Code (see Section 3.3). To date, there hasn’t been a specific update to the UCC regarding this issue (yet) but it has been discussed in multiple places such as Bitcoin’s lien problem.

As far as the “fairness” claim goes, it could be worth revising the passage to include a discussion around nemo dat quod non habet and bona fide purchasers. Legal tender is explicitly exempt because of the very scenario the authors describe. But cryptocurrencies aren’t legal tender, so that exemption doesn’t exist (yet).

Lastly, only “shielded” transactions in Zcash provide the functionality described in the passage above… not all transactions on Zcash utilize and opt-in to this mode.

On p. 89 they describe EOS. Worth updating this section because to-date, they have not achieved the 50,000 transactions per second on mainnet that is stated in the book. There has also been a bit of churn in the organizations as Ian Grigg (named in the book) is no longer at the organization, nor are employees 2 through 5.

On p. 90 they write about proof-of-stake:

One criticism of the model has been that without the electricity consumption costs of proof of work, attackers in a proof-of-stake system would simply mine multiple blocks to boost their chances of inserting a fraudulent one into the ledger.

This “nothing at stake” scenario is a valid criticism of some early attempts at building a proof-of-stake mechanism but isn’t valid for some other proposals (such as, theoretically, “Slasher“).

Chapter 4

On p. 91 they write:

It was clear that investors bought into Brave’s promise of a token that could fundamentally change the broken online advertising industry.

How do we know this was clear to investors? Anecdotally it appears that at least some investors participated as speculators, with the view that the token price would increase. A future edition should probably change the wording unless there is a reference that breaks down the motivation of the investors.

What about Civil?

On p. 96 they write about StorJ

Other models include that of the decentralized computer storage platform Storj, which allows hard-drive-starved users to access other’s excess space in exchange for storj tokens.

Could be worth pointing out that Storj had two public ICOs and it is still unclear if that will result in legal or regulatory issues. Putting that aside, currently Storj has just under 3,000 users. This stat is worth looking at again in future versions, especially in light of less-than-favorable reviews.

On p. 98 they talk about BAT:

The point is that it’s all on the community – the society of BATs users – not on external investors, to bear the risk of that happening

[…]

Once the 1 billion tokens had sold out in twenty-four seconds, it was revelead that only 130 accounts got them and that the biggest twenty holdings covered more than two-thirds of the total. Those distortions left many investors angry.

There is currently a debate around whether these types of ICOs in 2017 (and earlier) were investment contracts (e.g., securities). In the US, this has led to more than a hundred subpoenas with some quiet (and not so quiet) enforcement action.

The language used in this chapter (and elsewhere in the book) suggests that the participants involved in the ICO were investing with the expectation of profit in a common enterprise managed by the Brave team. Worth revisiting in a future edition.

On p. 102 they write about ERC20 tokens:

But because of the ERC-20 solution, they didn’t need to develop their own blockchain with all the independent computing power that would require. Instead, Ethereum’s existing computing network would do the validation for them.

This piggybacking may be initially helpful to token issuers but:

  1. it is a form of centralization which could have legal and regulatory consequences with respect to being viewed as not sufficiently decentralized
  2. in the long run this could create a top-heavy issue as miners are not being compensated in proportion to the amount of value they are trying to secure (see Section 2.1)

On p. 102 they write:

This low-cost solution to the double-spending challenge launched a factory of ICOs as issuers found an easy way to tap a global investing community. No painful negotiations with venture capitalists over dilution and control of the board. No wining and dining of Wall Street investment banks to get them to put their clients on the order book. No wait for SEC approval. Just straight to the general public: here are more tokens; they’re cool, buy them. It was a simple, low-cost formula and it lowered the barrier to entry for some brilliant innovators to bring potentially world-changing ideas to market. Unfortunately, it was also a magnet for scammers.

Could be worth updating this section to include more details on the scams and fraud that took place throughout 2017. Many of the tokens that raised capital from outside investors during this time not only have not delivered a working product, but in most cases, the token underperformed both ether and bitcoin.

Also bears mentioning that beginning in late 2017 through the time of this writing, there was a clear divergence between public sale ICOs and private sale of tokens… the latter of which basically involves a private placement to accredited investors, including the same type of funds that the passage above eschewed.

On p. 104 they write about Gnosis:

With the other 95 percent controlled by the founders, those prices meant that the implied valuation of the entire enterprise stood at $300 million – a figure that soon rose above $1 billion as the Gnosis token promptly quadrupled in price in the secondary market. By Silicon Valley standards, it meant we had the first ICO “unicorn.”

Actually, Ethereum did an ICO back in 2014 — and as the price of ether (measured in USD) increased, it is likely that ETH could be seen as the first ICO “unicorn.” But that’s not really an apples-to-apples comparison though because ETH (or Gnosis) holders do not have say, voting rights, which equity holders of a traditional company would.  Plus, “marketcap” is a poorly defined metric in the coin world (see Section 6).

On p. 104 and 105 they write:

One day, Paul received a call from a businessman who’d read one of his stories in The Wall Street Journal and wanted more information about how to get started and where to get legal advice. The man said he’d tried to reach the lawyer Marco Santori, a partner at the law firm Cooley who’d been quoted in the story, but couldn’t get through. Santori later told us that he was getting so many calls about ICOs, he simply couldn’t answer them all.

In January 2018, the SEC Chairman gave a public speech in which he singled out the “gatekeepers” (legal professionals) regarding the advice they gave clients. Could be worth revisiting who the main ICO-focused lawyers and lawfirms were during this time period and where they are now and if there were any enforcement actions undertaken.

On p. 105 they write:

“Most of these will fail,” said Olaf Carlson-Wee, the CEO of Polychain Capital, citing poorly conceived ideas and a lack of coding development. “Most of these are bad ideas from the beginning.” That said, Polychain is an investment firm that Carlson-Wee founded expressly to invest in these new projects. In fact, most of the people investing seemed to be taking a very VC-like approach to it. They understood that most of the projects would fail. They just hoped to have a few chips down on the one winner.

Carlson-Wee’s comments seem accurate insofar as the inability of many projects to execute and deliver based on the narratives each pitched investors. However, it could be worth digging into Polychain itself, which among other drama, may have “flipped” tokens due to a lack of lock-up periods.20 21

On p. 108 and 109 they compare Blue Apron and block.one (EOS). Even though it’s not an apples-to-apples comparison could be worth revisiting this in the future because of the churn and drama with both organizations.

Pages 110 and 111 aged quickly as most of the ICO rating websites and newsletters have fallen to the wayside due to payola scandals and inability to trust the motivations behind the ratings.

Similarly, the authors describe accredited investors and SAFTs. There is a typo here as the authors likely mean that an individual needs to have an income of $200,000 not $200 million. The SAFT model has fallen out of favor for several reasons that could be explored in a future version.22

On p. 112 they write about ASICs:

But developers of Vertcoin have shown that it’s also possible to create a permanent commitment to ASIC-resistance by introducing something from the real, non-digital world of social organizations: a pact. If the platform’s governing principles include a re-existing commitment from all users of the coin to accept a fork – a change to the code – that would add new, ASIC-resistant elements as soon as someone develops such a chip, the coin’s community can protect the distributed, democratic structure of a GPU-led mining network.

Putting aside the fanciful ASIC-resistance utopia that is peddled by some coin issuers, the passage above raises a couple flags.

Who gets to decide what the governing principles are? Do these principles get to change overtime? If the answer is yes to either, who are those decision makers and how are they chosen? So far, there has not really been any “democratic” way of participating in that decision making process for any cryptocurrency. How can that change in the future?

Why is a GPU-led mining network considered more democratic? In practice, most of these farms are located in basically the same type of structure and geography as ASIC-based equipment… in some cases they are swapped out over time. In light of the Sia coin fork… which clearly shows favoritism at play, a future edition of the book could include a chart or spectrum explaining how the mining of one coin more or less democratic versus another.

On p. 113 there is more discussion of ICOs and token sales as it relates to “open protocols” but in practice it has largely been reinventing the same intermediated system we have to do, but with fewer check and balances or even recourse for retail investors.

On p. 114 they speculate that:

This speaks to our broader notion that tokens, by incentivizing the preservation of public goods, might help humanity solve the Tragedy of the Commons, a centuries-in-the-making shift in economic reality.

That’s a big claim that requires evidence to back it. Let’s revisit next time.

On p. 115 they write:

Much like Wall Street bond traders, these will “make markets” to bring financial liquidity to every countervailing pair of tokens – buying some here and selling other there – so that if anyone wants to trade 100 BATs for a third of a Jackson Pollock, they can be assured of a reasonable market price.

But how does a blockchain actually do this? They mention Lykke as an startup that could help match tokens at a fair price… but to-date there is nothing listed on Lykke that really stands out as different than what you could fine at other cryptocurrency exchanges. Perhaps a future version of the book could walk the reader step-by-step through how a blockchain can enable this type of “fairness” whereas previous technology could not.

On p. 116 they discuss several projects they label as “interoperability” initiatives including Interledger, Cosmos, sidechains, and Lightning. It may be helpful for the reader to see a definition for what “interoperability” means because each of these projects — and its supporters — may be using the term in a different way. Perhaps a comparison chart showing the similarities and differences?

On p. 117 they write:

In an age where U.S. presidents peddle “alternative facts” and pundits talk openly about our “post-truth society,” using the truth machine to put a value on honesty sounds appealing.

On the face of it, that end goal seems like more than a stretch because it’s unclear how a blockchain (today) controls off-chain behavior. The example they go on to use is Augur. But Augur is a futures market and there are many of those already in existence. How would Augur or a futures market “with a blockchain” prevent politicians from lying? Walking through this process could be helpful to the reader.

On p. 118 they mention Erick Miller’s investment fund called CoinCircle… and a couple of “special value tokens” called Ocean Health Coin and Climate Coin.

Maybe worth following up in the next edition because neither has launched and each of the pitches sounds very handwavy, lacking in substance. Also, one of the ICOs CoinCircle advised – Unikrn – is part of a class action lawsuit.

Most of p. 119 and 120 come across as more political discourse, which is fine… but unclear how a blockchain in some form or fashion could directly impact the various issues raised. Perhaps the next edition could include a chart with a roadmap in how they see various projects achieving different milestones?

Chapter 5

If the reader is unfamiliar with IoT then the first 1/3 of chapter five is pretty helpful and informative.

Then there are some speedbumps.

On p. 130 they write about authenticating and verifying transactions involving self-driving cars:

The question, though, is: would this transaction be easily processed if it were based on a private blockchain? What are the chances, in a country of more than 230 million cars, that both vehicles would belong to the same closed network run by a group of permissioned validating computers? If they weren’t part of the same network, the payment couldn’t go through as the respective software would not be interoperable.

This is a red herring. Both “permissioned” and “permissionless” blockchains have similar (though not identical) scaling challenges. And interoperability is a separate issue which has been a known hurdle for years.

In fact, recently the Hyperledger Fabric team announced that it now supports the EVM. This comes a couple weeks after Hyperledger joined EEA as a member and vice-versa. Maybe none of these immediate efforts and experiments amount to many tangible outputs in the short-run but it does show that several ecosystems are attempting to be less tribal and more collaborative.

Also, the issue of payments is also separate from a blockchain-related infrastructure. Payments is a broad term and can include, for instance, a proposed central bank digital currency (e.g., “cash on ledger”)… or it can involve plugging into existing external payment systems (like Visa or ACH). It would be helpful if the next edition was more specific.

Continuing on p. 130 they write:

Other car manufacturers might not want to use a permissioned verification system for which, say GM, or Ford, is the gatekeeper. And if they instead formed a consortium of carmakers to run the system, would their collective control over this all-important data network create a barrier to entry for newer, startup carmakers? Would it effectively become a competition-killing oligopoly?

These are possible scenarios and good questions but this is kind of an unfair characterization of consortia. Let’s flip it around: why shouldn’t carmakers be allowed to build their own blockchains or collaborate with others who do? Do they need someones permission to do so? Depending on local regulations, maybe they do need permission or oversight in a specific jurisdiction. That could be worth exploring in another version.

On this topic they conclude that:

A truly decentralized, permissionless system could be a way around this “walled-garden” problem of siloed technology. A decentralized, permissionless system means any device can participate in the network yet still give everyone confidence in the integrity of the data, of the devices, and of the value being transacted. A permissionless system would create a much more fluid, expansive Internet of Things that’s not beholden to the say-so and fees of powerful gatekeepers.

That sounds well and good and a bit repetitive from earlier passages which said something similar. The passage aboves seems to be redefining what make something “permissioned” and “permissionless.” What does it mean for every device participate on a ‘decentralized, permissionless system’? Does that mean that each device is capable of building and/or creating a new block? If so, how do they choose which chain to build on?

And why is it so hard to imagine a world in which open-sourced platforms are also permissioned (e.g., validation is run by known, identifiable participants)… and these platforms are interoperable. Could be worth exploring because that scenario may be just as likely as the ones presented in this chapter.

Lastly, how does a “permissionless system” create a more fluid IoT world? These claims should be explored in more detail next time.

On p. 131 and 132 they write about IOTA, a specific project that markets itself as a purpose-built blockchain for IoT devices. But that project is beset by all kinds of drama that is beyond the scope of this review. Suffice to say that the February software build of IOTA cannot be run on most resource constrained IoT devices.

On p. 138 they mention in passing:

Exergy is a vital concept for measuring energy efficiency and containing wasteful practices; it doesn’t just measure the amount of energy generated but also the amount of useful work produced per each given amount of energy produced.

Fun fact: back in May 2014 I wrote an in-depth paper on Bitcoin mining that utilized the concept of “exergy.”

On pages 139-145 they talk about a number of vendors, use-cases, and platforms typically centered around the supply chain management world. Would be interesting to see which of these gained traction.

On p. 147 they write:

Blockchain-proven digital tokens point to what blockchain consultant and entrepreneurs Pindar Wong calls the “packetization of risk.” This radical idea introduces a negotiable structure to different phases of the chain. Intermediate goods that would otherwise be encumbered by a pre-established chain of unsettled commitments can instead be put out to bid to see if other buyers want to take on the rights and obligations associated with them.

It would be useful in this explanation to have a diagram or two to explain what Pindar proposes because it is a bit hard to follow.

On p. 147 they write:

This is why many people believe that the concept of a “circular economy” – where there is as much recycling as possible of the energy sources and materials in production – will hinge on the transparency and information flows that blockchain systems allow.

Does this mean that other “non-blockchain” systems do not allow transparency and information flows?

On p. 147 they write:

The principal challenge remains scaling. Open-to-all, permissionless blockcahins such as Bitcoin’s and Ethereum’s simply aren’t ready for the prime time of global trade. If all of the world’s supply chains were to pass their transactions through a permissionless blockchain, there would need to be a gargantuan increase in scalability, either off-chain or on-chain. Solutions may come from innovations such as the Lightning Network, discussed in chapter three, but they are far from ready at this stage.

Can we propose a moratorium on additional usages of “Lightning” in the next edition unless there is significant adoption and usage of it? Also, it is unclear why the worlds supply chains should for some reason be connected onto an anarchic chain: what is the benefit of putting this information onto a chain whose operators are unaccountable if a fork occurs?

On p. 148 they write:

Instead, companies are looking at permissioned blockchains, which we’ll discuss in more detail in chapter six. That makes sense because many big manufacturers think of their supply chains as static concepts, with defined members who have been certified to supply this or that component to a finished product. But in the rapidly changing world of the Fourth Industrial Revolution, this might not be the most competitive option. Emerging technologies such as additive manufacturing, where production can be called up anywhere and delivered by anyone with access to the right software files and a sufficiently configured 3D printer, are pointing to a much more fluid, dynamic supply-chain world, where suppliers come and go more easily. In that environment, a permissionless system would seem necessary. Once scaling challenges are resolved, and with robust encryption and reliable monitoring systems for proving the quality of suppliers work, permissionless blockchain-based supply chains could end up being a big leveler of the playing field for global manufacturing.

There are way too many assumptions in this paragraph to not have somewhere written that there are many assumptions.

Is a blockchain really needed in this environment? If so, a future edition should explain how a 3D printer would be more useful connected to a blockchain than some other network. Also, this seems to be a misuse of the term “permissionless” — why does the network need to be anarchic? How would the supply chain benefit from validators who are unknown?

On p. 148 they write:

It will be difficult to marry that old-world body of law, and the human-led institutions that manage it, with the digital, dematerailized, automated, and de-nationalized nature of blockchains and smart contracts.

How are blockchains “de-nationalized”? As of this writing there are probably a couple dozen publicly announced state-sponsored blockchain platforms of some kind (including various cryptocurrency-related initiatives). This phrase should probably be removed.

On p. 150 they write about the Belt and Road Blockchain Consortium:

Hence the opportunity for blockchain technologies to function as an international governance system. Hong Kong’s role will be important: the territory’s British legal traditions and reputation for respecting property rights have made it a respected safehouse for managing intellectual property and other contractual obligations within international trade. If the blockchain is to be inserted into global trade flows, the region’s bridging function may offer the fastest and most impactful route. For Hong Kong residents who want the territory to retain its British legal traditions, that role could be a vital protection against Beijing undermining them.

From publicly available information it is unclear if the Belt and Road Blockchain Consortium has seen much traction. In contrast, the Ping An-led HKMA trade finance group has turned on its “blockchain” platform.

Chapter 6

On p. 151 they wrote about a public event held on August 5, 2015:

As far as bankers were concerned, Bitcoin had no role to play in the existing financial system. Banking institutions thrive on a system of opacity in which our inability to trust each other leaves us dependent on their intermediation of our transactions. Bankers might give lip service to reforming the inner workings of their system, but the thought of turning it over to something as uncontrollable as Bitcoin was beyond heresy. It wasn’t even conceivable.

This is a bit of a red herring. I’ve been in dozens of meetings with banks and financial institutions over the past four years and in general there is consensus that Bitcoin – the network – is not fit for purpose as financial market infrastructure to handle regulated financial instruments. Why should banks process, say payments, on a network in which the validators are neither accountable if a problem occurs nor directly reachable in case users want to change or upgrade the software? Satoshi wasn’t trying to solve interbank-related issues between known participants so this description shouldn’t be seen as a slight against Bitcoin.

Now, bitcoin, the coin, may become more widespread in its usage and/or ownership at banks. In fact, as of this writing, nearly every large commercial bank owns at least a handful of cryptocurrencies in order to pay off ransomware issues. But the passage above seems to conflate the two.

See also: Systemically important cryptocurrency networks

On p. 151 they write:

At the same time, committed Bitcoin fans weren’t much interested in Wall Street, either. Bitcoin, after all, was designed as an alternative to the existing banking system. An improvement.

This is a bit revisionist. For instance, the original whitepaper uses the term “payment” twelve times. It doesn’t discuss banking or specific product lines at banks. Banks do a lot more than just handle payments too. Satoshi attempted to create an alternative payment system… the “be your own bank” narrative is something that other Bitcoin promoters later added.

On p. 152 they discuss the August 2015 event:

In essence, Symbiont was promising “blockchain without bitcoin” – it would maintain the fast, secure, and cheap distributed network model, and a truth machine at its center that validated transactions, but it was not leaderless, permissionless, and open to all. It was a blockchain that Wall Street could control.

This has some hyperbole in it (does “Wall Street” really control it?) but there is a kernel that the authors could expand on in the next version: vendor-dependence and implementation monopoly. In the example above, the authors could have pointed out that the same market structure still exists, so what benefit does a blockchain provide that couldn’t already be used? In addition to, what do the authors mean by “cheap distributed network model” when they have (rightly) mentioned that proof-of-work is resource intensive? As of this writing, Symbiont uses BFT-SMaRt and doesn’t use PoW.

Also, the authors seem to conflate “open to all” with blockchains that they prefer. Yet nearly all of the blockchains they seem to favor (like Bitcoin) involve relatively centralized gatekeeping (BIP process) and permissioned edges via exchanges.

Again, when I wrote the paper that created this distinction in 2015, the “permissionless’ness” is solely an attribute of mining not on sending or receiving coins.

On p. 153 they write:

But these permissioned systems are less open to experiments by computer engineers, and access rights to the data and software are subject to the whim of the official gatekeeper. That inherently constrains innovation. A private blockchain, some say, is an oxymoron. The whole point of this technology is to build a system that is open, accessible, and public. Many describe them with the generic phrase “distributed ledger technology” instead of “blockchain.”

This is why it would be important for the authors to explicitly mention what “blockchain” they are referring to. In many cases their point is valid: what is the point of using a blockchain if a single entity runs the network and/or monopolizes the implementation?

Yet their argument is diminished by insisting on using loaded phrases like “open” and “public.” What does it mean to be open or public here? For instance, in order to use Bitcoin today, you need to acquire it or mine it. There can be substantial entry and exit costs to mining so most individuals typically acquire bitcoins via a trusted, permissioned gateway (an exchange). How is that open?

Lastly, the euphemism of using the term “blockchain” instead of using the term “bitcoin” dates back to late 2015 with investors like Adam Draper explicitly stating that was his agenda. See: The great pivot?

On p. 156 they write:

Though Bitcoin fans frowned upon permissioned blockchains, Wall Street continued to build them. These tweaked versions of Bitcoin shared various elements of the cryptocurrency’s powerful cryptography and network rules. However, instead of its electricity-hungry “proof-of-work” consensus model, they drew upon older, pre-Bitcoin protocols that were more efficient but which couldn’t achieve the same level of security without putting a centralized entity in charge of identifying and authorizing participants.

There is a few issues with this:

  1. Which Bitcoin fans are the authors referring to, the maximalists?
  2. Proof-of-work is not an actual consensus model
  3. There are newer Byzantine fault tolerant protocols such as HoneybadgerBFT which are also being used by different platforms

Their last sentence uses a false dichotomy because there are different security assumptions based on the targeted operating environment that result in tradeoffs. To say that Bitcoin is more or less secure versus say, an instance of Fabric is a bit meaningless because the users have different expectations that the system is built around.

On p. 157 they write about R3:

The biggest winner in this hiring spree was the research and development company R3 CEV, which focused on the financial industry. It sought to build a distributed ledger that could, on the one hand, reap the benefits of real-time securities settlement and cross-industry harmonization but, on the other, would comply with a vast array of banking regulations and meet its members’ proprietary interest in keeping their books private.

This seems like a dated pitch from a couple use cases from mid-2015 because by the time I departed in September 2017, real-time securities settlement wasn’t the primary use (for Corda) being discussed externally.

Also, the “CEV” was formally removed from the name about two years ago. See: A brief history of R3 – the Distributed Ledger Group

By the spring of 2017, R3 CEV had grown its membership to more than one hundred. Each member firm paid annual dues of $250,000 in return for access to the insights being developed inside the R3 lab. Its founders also raised $107 million in venture funding in 2017, mostly from financial institutions.

I don’t think the full details are public but the description of the funding – and what was exchanged for it – is not quite correct. The original DLG members got equity stakes as part of their initial investment. Also, as far as the Series A that was announced in May 2017, all but one of the investors was a financial institution of some kind.

On p. 157 they write:

Some of that money went to hire people like Mike Hearn, a once prominent Bitcoin developer who dramatically turned his back on the cryptocurrency community with an “I quit” blog post complaining about the bitter in fighting. R3 also hired Ian Grigg – who later left to join EOS – another prominent onetime rebel from the cryptocurrency space.

To be clear on the timing: Mike Hearn began working at R3 in October 2015 (along with James Carlyle).23 Several months later he published a widely discussed post about Bitcoin itself. Based on his public talks since January 2016, he still seems to have some passing interest in cryptocurrencies; he did a reddit AMA on /r/btc this past spring.

Also, Ian Grigg has since left EOS and launched a new startup, Chamapesa.

On p. 157 they write about me:

Before their arrival, R3 had also signed on Tim Swanson as research director. Swanson was a distributed ledger/blockchain analyst who was briefly enthused by Bitcoin but who later became disillusioned with the cryptocurrency’s ideologues. He became a vocal, anti-Bitcoin gadfly who seemed to delight in mocking its travails.

This is also revisionist history.

Not to dive too much into the weeds here – and ignoring everything pre-2014 – a quick chronology that could be added if the authors are looking to be balanced is the following:

Over the course of under four months, after doing market research covering a few dozen projects, I published Great Chain of Numbers in March 2014… which was a brief report that quickly became outdated.

Some of the feedback I received – including from Bob, an expert at a data analytics startup – was that I was too charitable towards the claims of cryptocurrency promoters at payment processors and exchanges.24 That is to say, Bob thought that based on analytics, the actual usage of a payment processor was a lot lower than what the executives from that processor told me. In retrospect, Bob was absolutely correct.

A couple months later I ended up – by accident – doing an interview on Let’s Talk Bitcoin. The original guest did not show up and while we (the co-hosts) were waiting, I ended up getting into a small debate with another co-host about the adoption and usage of cryptocurrencies like Bitcoin. You can listen to it here and read the corresponding long-read that provides more citations and supporting links to back up the comments I made in the podcast.

From this moment forward (June 2014) – because I fact-checked the claims and did not blindly promote cryptocurrencies – I quickly became labeled as a pariah by several of the vocal cryptotwitter personalities. Or as the authors of this book unfairly label me: “anti-Bitcoin gadfly.” To call this order of events “disillusionment” is also unfair.

Lastly, a quick fix to the passage in the book: I technically became a formal advisor to R3 at the end of 2014 (after their second roundtable in Palo Alto)… and then later in August 2015 came on full-time as director of market research (although I subsequently wore several different hats).

On p. 158 they write:

Of a similar breed was Preston Byrne, the general counsel of Eris Ltd., later called Monax which designed private blockchains for banks and a variety of other companies. When Byrne’s Twitter feed wasn’t conveying his eclectic mix of political positions – pro-Trump, anti-Brexit, pro-Second Amendment, pro-encryption, anti-software utopianism – or constant references to marmots (the Eris brand’s mascot), it poured scorn on Bitcoin’s fanatic followers. For guys like Swanson and Byrne, Bitcoin’s dysfunctional governance was a godsend.

Again, chronologically I met Preston online in early 2014. He helped edit and contributed to Great Chain of Numbers. Note: he left Eris last year and recently joined a US law firm.

This is an unfair description: “For guys like Swanson and Byrne, Bitcoin’s dysfunctional governance was a godsend.”

This is unfair for several reasons:

  • We were hardly the first people to spend time writing about the governance problems and frictions involved in cryptocurrencies. For instance this includes: Ray Dillinger, Ben Laurie, and likely dozens of others. Nor were we the only ones discussing it in 2014 and 2015.
  • Preston and I have also – separately – written and discussed issues with other cryptocurrencies and blockchains during that time frame… not just Bitcoin.

Thus to single us out and simultaneously not mention others who had similar views, paints us as some type of cartoonish villains in this narrative. Plus, the authors could have reached out to us for comment. Either way, the next version should attempt to fix the word choices and chronology.

I reached out to Preston Byrne and he provided a response that he asked to have included in a footnote.25

On p. 159 they write more about R3:

On the one hand, regulators were comfortable with the familiar membership of R3’s consortium: they were more accustomed to working with bankers than with T-shirt-and-jeans-wearing crypto-investors. But on the other, the idea of a consortium of the world’s biggest banks having say-so over who and what gets included within the financial system’s single and only distributed ledger conjured up fears of excessive banking power and of the politically unpopular bailouts that happened after the crisis. Might Wall Street be building a “too-big-to-fail” blockchain?

This is some strange criticism because many of the developers of Corda (and other pieces of software) wore casual and business casual attire while working in the offices.

Corda is not the “single and only distributed ledger” being used by enterprises. Nearly all of the banks that invested in R3 also invested in other competing entities and organizations including Axoni and Digital Asset. Thus the statement in the middle should be updated to reflect that R3 does not have some kind of exclusivity over banking or enterprise relationships.

Michael Casey has said multiple times in public (even prior to the existence of Corda) that R3 was a “cartel coin” or “cartel chain” — including on at least one panel I was on with him in January 2016.  This is during a time in which R3 did not have or sell any type of product, it was strictly a services-focused company.  Maybe the organization evolves in the future – there may even be some valid criticism of a mono-implementation or a centrally run notary – but even as of this writing there is no Corda Enterprise network up and running.26

Lastly, all of these banks are members of many different types of consortia and multilateral bodies. Simply belonging to or participating in organizations such as IOSCO does not mean something nefarious is afoot.

On p. 160 they write:

The settlement time is also a factor in a financial crisis, and it contributed to the global panic of 2008.

This is a good point and it would be great to go into further details and examples in the next edition.

On p. 160 they write:

This systemic risk problem is what drew Blythe Masters, one of the key figures behind blockchain innovation on Wall Street, into digital ledger technology; she joined Digital Asset Holdings, a blockchain service provider for the financial system’s back-office processing tasks, as CEO in 2014.

Two small quibbles:

  1. Pretty sure the authors meant to say “distributed” not “digital”
  2. Blythe Masters joined as CEO in March 2015, not in 2014

On p. 162 they write:

It’s just that to address such breakdowns, this new wave of distributed ledger system designers have cherry-picked the features of Nakamoto’s invention that are least threatening to the players in the banking system, such as its cryptographic integrity, and left aside its more radical, and arguably more powerful, features, especially the decentralized, permissionless consensus system.

This is revisionist history. Satoshi bundled together existing ideas and libraries to create a blockchain. He or she did not invent cryptography from the ground up. For more details, readers are encouraged to read “Bitcoin is worse is better” from Gwern Branwen. IT systems at financial institutions were (and are) already using various bits of cryptography, encryption, permissioning, data lakes, and distributed storage methods.

Furthermore, because the participants in the financial system are known, there is no reason to use proof-of-work, which is used in Bitcoin because the participants (miners) are unknown.

Lastly, the authors touch on it and do have a valid point about market structure being changed (or unchanged) and should try to expand that in the next edition.

On p. 162 they write:

The DTCC, which settles and clears the vast majority of US stock and bond trades, handles 10,000 transactions per second; Bitcoin, at the time of this writing, could process just seven. And as strong as Bitcoin’s value – and incentive-based security model has proven to be, it’s not at all clear that a few hundred million dollars in bitcoin mining costs would deter rogue traders in New York or London when government bond markets offer billion dollar fraud opportunities.

Firstly, at the time of this writing, on-chain capacity for Bitcoin (even with Segwit activated) is still less than seven transaction per second.

Second, it is not clear how “rogue traders” in New York or London would be able to directly subvert the mining process of Bitcoin. Are the authors thinking about the potential security delta caused by watermarked tokens and colored coins?27

On p. 162 they write:

Either way, for the firms that R3 and Digital Asset serve – managers of the world’s retirement funds, corporate payrolls, government bond issuances, and so forth -these are not security risks they can afford. For now – at least until solutions as Lightning provide large-scale transaction abilities – Bitcoin isn’t anywhere near ready to service Wall Street’s back-office needs.

But Bitcoin is not fit for purpose for regulated financial institutions. Satoshi wasn’t trying to solve back-office problems that enterprises had, why are the authors intent on fitting a round peg in a square hole?

Also, Lightning isn’t being designed with institutions in mind either. Even if one or more of its implementations becomes widely adopted and used by Bitcoin users, it still doesn’t (currently) meet the functional and non-functional requirements that regulated institutions have. Why market it as if it does?

On p. 162 they write:

There are also legal concerns. R3’s Swanson has argued that the mere possibility of a 51 percent attack – that scenario in which a minder gains majority control of a cryptocurrency network’s computing power and fraudulently changes transactions – means that there can never be “settlement finality” in a cryptocurrency transaction. That of perpetual limbo is a scenario that Wall Street lawyers can’t live with, he said. We might retort that the bailouts and various other deals which banks reversed their losses during the crisis make a mockery of “finality,” and that Bitcoin’s track record of irreversibility is many magnitudes better than Wall Street’s. Nonetheless, Swanson’s catchy critique caught on among bankers. After all, he was preaching to the choir.

So there are a few issues with this statement.

I did not invent the concept of “settlement finality” nor did ‘Wall Street lawyers.’  The term dates back decades if not centuries and in its most recent incarnation is the product of international regulatory bodies such as BIS and IOSCO. Regulated financial institutions – starting with financial market infrastructures – are tasked with reducing risk by making sure the payment systems, for instance, are irreversible. Readers should peruse the PFMIs published in 2012.

The next issue is, they make it sound like I lobbied banks using some ‘gotcha’ loophole to scare banks from using Bitcoin. Nowhere in my presentations or speeches have I justified or handwaved away the (criminally?) negligent behavior of individuals at banks that may have benefited from bailouts. This is another unfair characterization that they have painted me as.

To that point, they need to be more specific about what banks got specific transactions reversed. Name and shame the organizations and explain how it would not be possible in a blockchain-based world. Comparing Bitcoin with ‘Wall Street’ doesn’t make much sense because Bitcoin just handles transfers of bitcoin, nothing else. ‘Wall Street’ encompasses many different product lines and processes many other types of transactions beyond payments.

All in all, painting me as a villain is weak criticism and they should remove it in their next edition.

On p. 163 they write about permissioned ledgers:

They’re not racing each other to win currency rewards, which also means they’re not constantly building a wasteful computing infrastructure a la Bitcoin.

They say that as if it is a good thing. Encourage readers to look through the energy costs of maintaining several different proof-of-work networks that handle almost no commerce.

On p. 163 they write:

That’s why we argue that individuals, businesses, and governments really need to support the various hard-core technical solutions that developers are pursuing to help permissionless ledgers like Bitcoin and Ethereum overcome their scaling, security, and political challenges.

This agenda has been pretty clear throughout the book, though it may be more transparent to the reader if it comes earlier in chapter 1 or 2.

From a historical perspective this argument doesn’t make much sense. If Karl Benz had said the same thing in the 19th century about getting engineers to build around his car and not others. Or the Wright Brothers had been ‘more successful’ at suing aerospace competitors. Why not let the market – and its participants – chose to work on platforms they find of interest?

On p. 165 they write about the MIT Digital Currency Inititative but do not disclose that they solicit financial support from organizations such as central banks, some of whom pay up to $1 million a year to collaborate on research projects. Ironically, the details of this program are not public.

On p. 167 they write:

A broad corporate consortium dedicated to a mostly open-source collaborative approach, Hyperledger is seeking to develop nothing less than a common blockchain / distributed ledger infrastructure for the global economy, one that’s targeted not only at finance and banking but also at the Internet of Things, supply chains, and manufacturing.

The next edition should update that passage. All of the projects incubated by the Hyperledger Project are open sourced, there is no “mostly.” And not all of these projects involve a blockchain, some involve identity-related efforts.28

On p. 169 and again on p. 172 the authors quote Joi Ito who compares TCP/IP with “walled gardens” such as AOL and Prodigy.

That is comparing apples-and-oranges. TCP/IP is a suite of protocols, not a business. AOL and Prodigy are businesses, not protocols. AOL used a proprietary protocol and you could use TCP/IP via a gateway. Today, there are thousands of ‘walled gardens’ called ISPs that allow packets to jump across boundaries via handshake agreements. There is no singular ‘Internet’ but instead there are thousands of intranets tied together using common standards.

Readers may be interested in: Intranets and the Internet

On p. 173 they write:

Permissionless systems like those of Bitcoin and Ethereum inherently facilitate more creativity and innovation, because it’s just understood that no authorizing company or group of companies can ever say this or that thing cannot be built.

How are they measuring this? Also, while each platform has its own terms of service, it cannot be said that you need explicit permission to build an application on top of a specific permissioned platform. The permissioning has to do with how validation is handled.

On p. 173 they write:

It’s the guarantee of open access that fosters enthusiasm and passion for “permissionlessness” networks That’s already evident in the caliber and rapid expansion in the number of developers working on public blockchain applications. Permissioned systems will have their place, if nothing else because they can be more easily programmed at this early stage of the technology’s life to handle heavier transaction loads. But the overarching objective for all of us should be to encourage the evolution of an open, interoperable permissionless network.

This is just word salad that lacks supporting evidence. For the next edition the authors should tabulate or provide a source for how many developers are working on public blockchain applications.

The passage above also continues to repeat a false dichotomy of “us versus them.” Why can’t both of these types of ‘platforms’ live in co-existence? Why does it have to be just one since neither platform can fulfill the requirements of the other?

It’s like saying only helicopters provide the freedom to navigate and that folks working on airplanes are only doing so because they are less restricted with distances. Specialization is a real.

On p. 173 they conclude with:

There’s a reason we want a world of open, public blockchains and distributed trust models that gives everybody a seat at the table. Let’s keep our eyes on that ball.

This whole chapter and this specific statement alone comes across as preachy and a bit paternalistic. If the message is ‘permissionlessness’ then we should be allowed to pursue our own goals and paths on this topic.

Also, there are real entry and exit costs to be a miner on these public chains so from an infrastructure point of view, it is not really accurate to say everybody gets a seat at the table.

Chapter 7

This is probably their strongest chapter. They do a good job story telling here. Though there were few areas that were not clear.

On p. 179 they write:

But as Bitcoin and the blockchain have shown, the peer-to-peer system of digital exchange, which avoids the cumbersome, expensive, and inherently exclusionary banking system, may offer a better way.

The authors have said 5-6 times already that proof-of-work networks like Bitcoin can be very costly and wasteful to maintain. It would be helpful to the reader for the authors to expand on what areas the banking system is expensive.

And if a bank or group of banks used a permissioned blockchain, would that reduce their expenses?

On p. 181 they write about time stamps:

The stamp, though, is incredibly powerful. And that, essentially, is the service that blockchains provide to people. This public, recognizable open ledger, which can be checked by any time by anybody, acts in much the same way as the notary stamp: it codified that certain action took place at a certain time, with certain particulars attached to it, and it does this in a way that the record of that transaction cannot be altered by private parties, whether they be individuals or governments.

In the next edition the authors should differentiate time stamps and all the functions a notary does. Time stamps may empower notaries but simply stamping something doesn’t necessarily make it notarized. We see this with electronic signatures from Hello Sign and Docusign.

Also, these blockchains have to be funded or subsidized in some manner otherwise they could join the graveyard of hundreds of dead coins.

On p. 181 they write about Factom and Stampery. It would be good to get an update on these types of companies because the founder of Stampery who they single out – Luis Ivan Cuende – has moved on to join and found Aragon.

On p. 183 they discuss data anchoring: taking a hash of data (hash of a document) and placing that into a blockchain so that it can be witnessed. This goes back to the proof-of-existence discussion earlier on. Its function has probably been overstated and is discussed in Anchor’s Aweigh.

On p. 184 they discuss Chromaway. This section should be updated because they have come out with their own private blockchain, Chromapolis funded via a SAFT.

On p. 185 they write:

The easier thing to do, then, for a reform-minded government, is to hire a startup that’s willing to go through the process of converting all of an existing registry, if one exists, into a digital format that can be recorded in a blockchain.

Why? Why does this information have to be put onto a blockchain? And why is a startup the right entity to do this?

On p. 186 they mention several companies such as Bitfury, BitLand, and Ubiquity. It would be good to update these in the next edition to see if any traction occurred.

On p. 187 they write:

They key reason for that is the “garbage-in/garbage-out” conundrum: when beginning records are unreliable, there’s a risk of creating an indisputable permanence to information that enshrines some abuse of a person’s property rights.

This GIGO conundrum doesn’t stop and isn’t limited to just the beginning of record keeping. It is an ongoing challenge, potentially in every country.

On p. 188-192 they describe several other use cases and projects but it is unclear why they can’t just use a database.

On p. 193 they write:

Part of the problem is that cryptocurrencies continue to sustain a reptutation among the general public for criminality. This was intensified by the massive “WannaCry” ransomware attacks of 2017 in which attackers broke into hospitals’ and other institutions’ databases, encrypted their vital files and then extorted payments in bitcoin to have the data decrypted. (In response to the calls to ban bitcoin that inevitably arose in the wake of this episode, we like to point that far more illegal activity and money laundering occurs in dollar notes, which are much harder to trace than bitcoin transactions. Still, when it comes to perception, that’s beside the point – none of these incidents help Bitcoin’s reputation.)

This is a whataboutism. Both actions can be unethical and criminal, there is no need to downplay one versus the other. And the reason why bitcoin and other cryptocurrencies are used by ransomware authors is because they are genuinely useful in their operating environment. Data kidnapping is a good use case for anarchic networks… and cryptocurrencies, by design, continue to enable this activity. The authors can attempt to downplay the criminal element, but it hasn’t gone away and in fact, has been aided by additional liquidity to coins that provide additional privacy and confidentiality (like Monero).

On p. 193 they write about volatility:

This is a massive barrier to Bitcoin achieving its great promise as a tool to achieve financial inclusion. A Jamaican immigrant in Miami might find the near-zero fees on a bitcoin transaction more appealing than the 9 percent it costs to use a Western Union agent to send money home to his mother.

This financial inclusion narrative is something that Bitcoin promoters created after Satoshi disappeared. The goal of Bitcoin — according to the whitepaper and announcement threads – wasn’t to be a new rail for remittance corridors. Maybe it becomes used that way, but the wording in the passage above as a “great promise” is misleading.

Also, the remittance costs above should be fact-checked at the very handy Save On Send site.

On p. 194 they write about BitPesa. Until we see real numbers in Companies House filings, it means their revenue is tiny. Yet the authors make it sound like they have “succeeded”:

The approach is paying dividends as evident in the recent success of BitPesa, which was established in 2013 and was profiled in The Age of Cryptocurrency. The company, which offers cross-border payments and foreign-exchange transactions in and out of Kenya, Nigeria, Tanzania, and Uganda, reported 25 percent month-on-month growth, taking its transaction volume midway through 2017, up from $1 million in 2016.

They also cited some remittance figures from South Korea to the Philippines which were never independently verified and are old.

On p. 194 they dive into Abra a company they described as a remittance company but earlier this year they pivoted into the investment app category as a Robinhood-wannabe, with a coin index.

On p. 196 they discuss the “Somalia dilemma” in which the entire country is effectively unable to access external financial systems and somehow a blockhain would solve their KYC woes. The authors then describe young companies such as Chainalysis and Elliptic which work with law enforcement to identify suspicious transactions. Yet they do not close the loop on the narrative as to how the companies would help the average person in Somalia.

On p. 198 they discuss a startup called WeTrust and mention that one of the authors – Michael – is an advisor. But don’t disclose if he received any compensation for being an advisor. WeTrust did an ICO last year. This is important because the SEC just announced it has fined and settled with Floyd Mayweather and DJ Khaled for violating anti-touting regulations.

Chapter 8

Chapter 8 dives into self-sovereign identity which is genuinely an interesting topic. It is probably the shortest chapter and perhaps in the next edition can be updated to reflect any adoption that took place.

On p. 209 they write about physical identification cards:

Already, in the age of powerful big data and network analytics – now enhanced with blockchain-based distributed trust systems to assure data integrity – our digital records are more reliable indicators of the behavior that defines who we are than are the error-prone attestations that go into easily forged passports and laminated cards.

How common and how easily forged are passports? Would be interesting to see that reference and specifically how a blockchain would actually stop that from happening.

On p. 212 they write about single-sign ons:

A group of banks including BBVA, CIBC, ING, Societe Generale, and UBS has already developed such a proof of concept in conjunction with blockchain research outfit R3 CEV.

Earlier they described R3 differently. Would be good to see more consistency and also an update on this project (did it go anywhere?).

On p. 213 they describe ConsenSys as a “think tank” but it is actually a ‘venture studio’ similar to an incubator (like 500 Startups). Later on p. 233 they describe ConsenSys as an “Ethereum-based lab”.

On p. 216 they write about Andreas Antonopoulos:

What we should be doing, instead of acting as judge and executioner and making assumptions “that past behavior will give me some insight into future behavior,” Antonpolous argues, is building systems that better manage default risk within lenders’ portfolios. Bitcoin, he sustains, has the tolls to do so. There’s a lot of power in this technology to protect against risk: smart contracts, multi-signature controls that ensure that neither of the two parties can run off with the funds without the other also signing a transaction, automated escrow arrangements, and more broadly, the superior transparency and granularity of information on the public ledger.

There are at least two issues with this:

Nowhere in this section do the authors – or Antonopolous – provide specific details for how someone could build a system that manages default risk on top of Bitcoin. It would be helpful if this was added in the next edition.
And recently, Antonopoulos claims to have been simply educating people about “blockchain technology” and not promoting financial products.

If you have followed his affinity marketing over the past 4-5 years he has clearly promoted Bitcoin usage as a type of ‘self-sovereign bank‘ — and you can’t use Bitcoin without bitcoins.29 He seems to be trying to have his cake and eat it too and as a result got called out by both Nouriel and Buttcoin.

On p. 219 they write:

If an attestation of identifying information is locked into an immutable blockchain environment, it can’t be revoked, not without both parties agreeing ot the reversal of the transaction. That’s how we get to self-sovereignty. It’s why, for example, the folks at Learning Machine are developing a product to prove people’s educational bona fides on Blockcerts, an MIT Media Lab-initiated open-source code for notarizing university transcripts that hashes those documents to the bitcoin blockchain. Note the deliberate choice of the most secure, permissionless blockchain, Bitcoin’s. A permissioned blockchain would fall short of the ideal because there, too, the central authority controlling the network could always override the private keys of the individual and could revoke their educational certificates. A permissionless blockchain is the only way to give real control/ownership of the document to the graduate, so that he/she can disclose this particularly important attribute at will to anyone who demands it.

This disdain for ‘permissioned blockchains’ is a red herring and another example of the “us versus them” language that is used throughout the book. If a blockchain has a central authority that can do what the authors describe, it would be rightly described as a single point of failure and trust. And this is why it is important to ask what ‘permissioned’ chain they had in mind, because they are not all the same.

They also need to explain how they measure ‘most secure’ because Bitcoin – as described throughout this review – has several areas of centralization include mining and those who control the BIP process.

On p. 219 they quote Chris Allen. Could be worth updating this because he left Blockstream last year.

Chapter 9

This chapter seemed light on details and a bit polemical.

For instance, on p. 223 they write:

Many of our politicians seem to have no ideas this is coming. In the United States, Donald Trump pushes a “Buy America First” campaign (complete with that slogan’s echoes of past fascism), backed by threats to raise tariffs, tear up trade deals, boot undocumented immigrants out of the country, and “do good deals for America.” None of this addresses the looming juggernaut of decentralized software systems. IoT systems and 3D printing, all connected via blockchains and smart-contract-triggered, on-demand service agreements, will render each presidential attempt to strong-arm a company into retaining a few hundred jobs in this or that factory town even more meaningless.

Putting the politics aside for a moment, this book does not provide a detailed blue print for how any of the technology listed will prevent a US president from strong-arming a company to do any specific task. How does a 3D printer connected to a blockchain prevent a president from executing on their agenda?

On p. 224 they write about universal basic income:

This idea, first floated by Thomas Paine in the eighteenth century, has enjoyed a resurgence on the left as people have contemplated how robotics, artificial intelligence, and other technologies would hit working-class jobs such as truck driving. But it may gain wider traction as decentralizing force based on blockchain models start destroying middle-class jobs.

This speculation seems like a non sequitur. Nowhere in the chapter do they detail how a “blockchain-based model” will destroy middle class jobs. What is an example?

On p. 227 they write:

In case you’re a little snobbish about such lowbrow art, we should also point out that a similar mind-set of collaborative creation now drives the world of science and innovation. Most prominently, this occurs within the world of open-source software development; Bitcoin and Ethereum are the most important examples of that.

If readers were unfamiliar with the long history of the free open source software movement, they might believe that. But this ignores the contributions of BSD, Linux, Apache, and many other projects that are regularly used each and every day by enterprises of all shapes and sizes.

Also, during the writing of this review, an open source library was compromised — potentially impacting the Copay wallet from Bitpay — and no one noticed (at first). Eric Diehl, a security expert at Sony, has a succinct post up on the topic:

In other words, this is an example of a software supply chain attack. One element in the supply chain (here a library) has been compromised. Such an attack is not a surprise. Nevertheless, it raises a question about the security of open source components.

Many years ago, the motto was “Open source is more secure than proprietary solutions.” The primary rationale was that many eyes reviewed the code and we all know that code review is key for secure software. In the early days of open source, this motto may have been mostly true, under some specific trust models ( see https://eric-diehl.com/is-open-source-more-secure/, Chapter 12 of Securing Digital Video…). Is it still true in our days?

How often do these types of compromises take place in open-source software?

On p. 232 they write:

Undaunted, an unofficial alliance of technologists, entrepreneurs, artists, musicians, lawyers, and disruption-wary music executives is now exploring a blockchain-led approach to the entire enterprise of human expression.

What does that even mean?

On p. 232 they write about taking a hash of their first book and inserting it into a block on the Bitcoin blockchain. They then quote Dan Ardle from the Digital Currency Council who says:

“This hash is unique to the book, and therefore could not have been generated before the book existed. By embedding this hash in a bitcoin transaction, the existence of the book on that transaction date is logged in the most secure and irrefutable recordkeeping system humanity has ever devised.”

These plattitudes are everywhere in the book and should be toned down in the next edition especially since Ardle – at least in the quote – doesn’t explain how he measures secure or irrefutable. Especially in light of hundreds of dead coins that were not sustainable.

On p. 233 they write:

The hope now is that blockchains could fulfill the same function that photographers carry out when they put a limited number of tags and signatures on reproduced photo prints: it turns an otherwise replicable piece of content into a unique asset, in this case a digital asset.

This seems to be solutionism because blockchains are not some new form of DRM.

Continuing on this topic, they write:

Copying a digital file of text, music, or vidoe has always been trivial. Now, with blockchain-based models, Koonce says, “we are seeing systems develop that can unequivocally ensure that a particular digital ‘edition’ of a creative work is the only one that can be legitimately transferred or sold.” Recall that the blockchain, as we explained in chapter three, made the concept of a digital asset possible for the first time.

This is empirically untrue. It is still trivially possible to download and clone a blockchain, nothing currently prevents that from happening. It’s why there are more than 2,000 cryptocurrencies at the time of this writing and why there are dozens of forks of Bitcoin: blockchains did not make the concept of a digital asset possible. Digital assets existed prior to the creation of Bitcoin and attempting to build a DRM system to prevent unauthorized copies does not necessarily require a blockchain to do.

On p. 238 they write:

Yet, given the amssive, multitudinous, and hetergeneous state of the world’s content, with hundreds of millions of would-be creators spread all over the world and no way to organize themselves as a common interest, there’s likely a need for a permissionless, decentralized system in which the data can’t be restricted and manipulated by a centralized institution such as a recording studio.

Maybe, but who maintains the decentralized system? They don’t run themselves and are often quite expensive (as even the authors have mentioned multiple times). How does a decentralized system fix this issue? And don’t some artists already coordinate via different interest groups like the RIAA and MPAA?

On p. 240 they discuss Mediachain’s acquisition by Spotify:

On the other hand, this could result in a private company taking a technology that could have been used publicly, broadly for the general good, and hiding it, along with its innovative ideas for tokens and other solutions, behind a for-profit wall. Let’s hope it’s not the latter.

This chapter would have been a bit more interesting if the authors weren’t as heavy handed and opinionated about how economic activities (like M&A) should or should not occur. To improve their argument, they could include links or citations for why this type of acquisition has historically harmed the general public.

Chapter 10

On p. 243 they write:

Bitcoin, with its new model of decentralized governance for the digital economy, did not spring out of nowhere, either. Some of the elements – cryptography, for instance – are thousands of years old. Others, like the idea of electronic money, are decades old. And, as should be evident in Bitcoin’s block-size debate, Bitcoin is still very much a work in progress.

This statement is strange because it is inconsistent with what they wrote on p. 162 regarding permissioned chains: “… cherry-picked the features of Nakamoto’s invention that are least threatening to the players in the banking system, such as its cryptographic integrity…”

In this section they are saying that the ideas are old, but in the passage above in chapter 6, they make it sound like it was all from Nakamoto. The authors should edit it to be one way or the other.

Also, Bitcoin’s governance now basically consists of off-chain shouting matches on social media. Massive influence and lobbying campaigns on reddit and Twitter is effectively how the UASF / no2x movement took control of the direction of the BIP process last year.

On p. 245 they write:

That can be found in the individual freedom principles that guide the best elements of Europe’s new General Data Protection Regulation, or GDPR.

All blockchains that involve cross-jurisdictional movement of data will likely face challenges regarding compliance with data privacy laws such as GDPR. Michele Finck published a relevant paper on this topic a year ago.

See also: Clouds and Chains

On p. 247 they write about if you need to use a blockchain:

Since a community must spend significant resources to prove transactions on a blockchain, that type of record-keeping system is most valuable when a high degree of mutual mistrust means that managing agreements comes at a prohibitively high price. (That price can be measured in various ways: in fees paid to middlemen, for instance, in the time it takes to reconcile and settle transactions, or in the fact that it’s impossible to conduct certain business processes, such as sharing information across a supply chain.) When a bank won’t issue a mortgage to a perfectly legitimate and creditworthy homeowner, except at some usurious rate, because it doesn’t trust the registry of deeds and liens, we can argue that the price of trust is too high and that a blockchain might be a good solution.

Not all blockchains utilize proof-of-work as an anti-Sybil attack mechanism, so it cannot be said that “a community must spend significant resources”.

In the next edition it would be interesting to see a cost / benefit analysis for when someone should use a blockchain as it relates the mortgage use case they describe above.

On p. 248 they talk about voting:

Every centralized system should be open for evaluation – even those of government and the political process. Already, startups such as Procivis are working on e-voting systems that would hand the business of vote-counting to a blockchain-based backend. And some adventurous governments are open to the idea. By piloting a shareholder voting program on top of Nasdaq’s Linq blockchain service, Estonia is leading the way. The idea is that the blockchain, by ensuring that no vote can be double-counted – just as no bitcoin can be double-spent – could for the first time enable reliable mobile voting via smartphones. Arguably it would both reduce discrimination against those who can’t make it to the ballot box on time and create a more transparent, accountable electoral system that can be independently audited and which engenders the public’s trust.

A month ago Alex Tapscott made a similar argument.

He managed to temporarily unite some of the warring blockchain tribes because he penned a NYT op-ed about how the future is online voting… powered by blockchains. Below is a short selection of some Twitter threads:

  • Arvind Narayanan, a CS professor at Princeton said this is a bad idea
  • Angela Walch, a law professor at St. Mary’s said this is a bad idea
  • Philip Daian, a grad student at Cornell said this is a bad idea.
  • Luis Saiz, a security researcher at BBVA said this is a bad idea
  • Joseph Hall, the Chief Technologist at the Center for Democracy & Technology said this a bad idea
  • Preston Byrne, a transatlantic attorney and father of marmotology said this is a bad idea
  • Matt Blaze, a CS professor at UPenn, said this is a bad idea

NBC News covered the reaction to Tapscott’s op-ed.  Suffice to say, the next edition should either remove this proposal or provide more citations and references detailing why this is a good idea.

Throughout this chapter projects like BitNation and the Economic Space Agency are used as examples of projects that are “doing something” — but none of these have gotten much traction likely because it’s doing-something-theater.

On p. 252 – 255 they uncritically mention various special interest groups that are attempting to influence decision makers via lobbying. It would be good to see some balance added to this section because many of the vocal promoters at lobbying organizations do not disclose their vested interests (e.g., coin positions).

On p. 255 they talk about “Crypto Valley” in Switzerland:

One reason they’ve done so is because Swiss law makes it easier to set up the foundations needed to launch coin offerings and issue digital tokens.

MME – the Swiss law firm that arguably popularized the approach described in this section – set up more than a dozen of these foundations (Stiftung) before stopping. And its creator, Luke Mueller, now says that:

“The Swiss foundation actually is a very old, inflexible, stupid model,” he said. “The foundation is not designed for operations.”

Could be worth updating this section to reflect what happened over the past year with lawsuits as well.

On p. 255 they write:

The next question is: what will it take for U.S. policymakers to worry that America’s financial and IT hubs are losing out to these foreign competitors in this vital new field.

This is FOMO. The authors should tabulate all of the companies that have left the US – or claim to leave – and look at how many jobs they actually set up overseas because of these laws. Based on many anecdotes it appears what happens in practice is that a company will register or hold an ICO overseas in say, Singapore or Panama, but then open up a development arm in San Francisco and New York. They effectively practice regulatory arbitrage whereby they bypass securities laws in one country (e.g., the US) and then turn around and remit the proceeds to the same country (the US).

On p. 263 they conclude the chapter with:

No state or corporation can put bricks around the Bitcoin blockchain or whitewash its record. They can’t shut down the truth machine, which is exactly why it’s a valuable place to record the voices of human experience, whether it’s our love poems or our cries for help. This, at its core, is why the blockchain matters.

Their description basically anthropromorphizes a data structure. It also comes across as polemical as well as favoritism towards one specific chain, Bitcoin. Furthermore, as discussed throughout this review, there are clear special interest groups – including VC-backed Bitcoin companies — that have successfully pushes Bitcoin and other cyrptocurrencies – into roadmaps that benefit their organizations.

Conclusion

Like their previous book (AoC), The Truth Machine touches on many topics but only superficially.  It makes a lot of broad sweeping claims but curious readers – even after looking at the references – are left wanting specifics: how to get from point A to point B.

There also seems to be an anti-private enterprise streak within the book wherein the authors condescendingly talk down efforts to build chains that are not anarchic. That becomes tiring because – as discussed on this blog many times – it is not a “us versus them” proposition.  Both types of blockchains can and do exist because they are built around different expectations, requirements, and operating environments.

In terms of one-sided narratives: they also did not reach out to several of the people they villify, such as both myself and Preston Byrne as well as coin proponents such as Roger Ver and Jihan Wu.  The next edition should rectify this by either dropping the passages cited above, or in which the authors reach out to get an on-the-record comment from.

Lastly, while some churn is expect, many of the phrases throughout the book did not age well because it relied on price bubbles and legal interpretations that went a different direction (e.g., SAFTs are no longer popular).  If you are still looking for other books to read on the topic, here are several other reviews.

Endnotes

  1. See A brief history of R3 — the Distributed Ledger Group []
  2. Developers of various coins will include “check points” which do make it virtually impossible to roll back to a specific state. Both Bitcoin and Bitcoin Cash have done this. []
  3. See Why the payment card system works the way it does – and why Bitcoin isn’t going to replace it any time soon by Richard Brown []
  4. See Learning from the past to build an improved future of fintech and Distributed Oversight: Custodians and Intermediaries []
  5. Unsurprisingly users want to be able to hold someone accountable for their lack of care and/or difficulty in safely and securely backing up their keys. []
  6. Ibid []
  7. Technically every orphaned block alters the blockchain, because you thought one thing and now you are asked to think another. []
  8. Readers may be interested in The Path of the Blockchain Lexicon by Angela Walch []
  9. Recall that generating hashes is a means to an end: to make Sybil attacks costly on a network with no “real” identities. []
  10. For instance, Selfish Mining []
  11. Albumatic -> Koala -> Chain.com the Bitcoin API company -> Chain.com the enterprise company, etc. []
  12. This is slightly reminiscent of Dr. Strangelove in which General Turgidson says, “I admit the human element seems to have failed us here.” []
  13. See The Revolving Door Comes to Cryptocurrency by Lee Reiners and Is Bitcoin Secretly Messing with the Midterms? from Politico []
  14. See also his role in attacks on CoiledCoin and BBQcoin []
  15. David Andolfatto, from the St. Louis Fed, also pointed this out back in May 2015, skip to the 28 min mark []
  16. See the “no” side of the debate: Can Bitcoin Become a Dominant Currency? []
  17. Ironically in his most recent op-ed published today, he asks people to “quit this ugly obsession with price.”  There are at least 3-4 instances of the co-authors using price as a metric for “strength” in this book. []
  18. See also this related thread from Don Bailey []
  19. Some exchanges, such as Gemini, want proof of mining activity. See also: What is Permissioned-on-Permissionless []
  20. See also the Polly Pocket Investor Day []
  21. Ryan Zurrer, second-in-command at Polychain, was recently fired from Polychain amid weak performance this year. []
  22. The whole public sale thing is problematic from a MSB perspective. The colorability of the position taken by Cooley in that section was questionable at the time and possibly indefensible now. []
  23. Mike wrote the first line of code for Corda over three years ago. []
  24. The initial conversation with Bob took place in San Francisco during Coin Summit. Bob later became a key person at Chainalysis. []
  25. According to Preston:

    Eris, now Monax, was the first company to look at the combination of cryptographic primitives that make up Bitcoin and attempt to use them to make business processes more efficient. In shorthand, the company invented “blockchains without coins” or “permissioned blockchains.”

    Bitcoin’s dysfunctional governance wasn’t a “godsend” for our business, as we weren’t competing with Bitcoin. Rather we were trying to dramatically expand the usecases for database software that had peer to peer networking and elliptic curve cryptography at its core, in recognition of the fact that business counterparties reconcile shared data extremely inefficiently and their information security could benefit from a little more cryptography.

    In exchange for our efforts, Bitcoiners of all shapes and sizes heaped scorn on the idea that any successor technology could utilize their technology’s components more efficiently. We responded with pictures of marmots to defuse some of the really quite vitriolic attacks on our company and because I like marmots; these little critters became the company’s mascot through that process.

    Subsequent developments vindicated my approach. Cryptographically-secure digital cash being trialled by Circle, Gemini, and Paxos utilizes permissioning, a concept that Circle’s Jeremy Allaire said was impossible in 2015 – “they’re not possible separately” – and I predict that as those USD coins seek to add throughput capacity and functionality they will migrate off of the Ethereum chain and onto their own public, permissioned chains which are direct conceptual descendants of Eris’ work.

    They will compete with Bitcoin in some respects, much as a AAA-rated bond or USD compete with Bitcoin now, but they will not compete with Bitcoin in others, as they will cater to different users who don’t use Bitcoin today and are unlikely to use it in the future.

    Ultimately, whether Eris’ original vision was right is a question of how many permissioned chains there are, operating as secure open financial services APIs as Circle and Gemini are using them now. I predict there will be rather a lot of those in production sooner rather than later. []

  26. Oddly the authors of the book do not name “Corda” in this book… they use the phrase: “R3’s distributed ledger” instead. []
  27. Readers may also be interested in reading the 2016 whitepaper from the DTCC []
  28. At the time of this writing there are: 5 incubated “Frameworks” and 6 incubated “Tools.” []
  29. Antonopolous recently gave a talk in Seattle where he promoted the usage of cryptocurrencies to exit the banking system.  Again, a user cannot use a cryptocurrency without absorbing the exposure and risks attached to the underlying coins of those anarchic networks. []
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A panel on smart contracts with industry developers and educators

Earlier today I participated in a virtual panel covering smart contracts called, “Let’s Talk Smart Contracts.”

The panel included: Adam Krellenstein (Counterparty), Oleg Andreev (CoreBitcoin), Pamela Morgan (Empowered Law), Stefan Thomas (Codius, Ripple Labs), Stephan Tual (Ethereum), Tim Swanson (Of Numbers), Yurii Rashkovskii (Trustatom) and it was moderated by Roman Snitko with Straight.

Below are some transcribed notes of my own statements.

Introduction starting at 09:06:

Hey guys, great to be here.  Thanks for the invite, thanks for organizing this.  So I’m here because you guys needed another white guy from Europe or something like that (that’s a joke).  So the definition I have of smart contracts, I have written a couple books in this space, and the definition I use is a smart contract is “a proposed tool to automate human interactions: it is a computer protocol – an algorithm – that can self-execute, self-enforce, self-verify, and self-constrain the performance of a contract.”  I think I got most of that definition from Nick Szabo’s work.  For those of you who are familiar with him, look up some of his past writings.  I think that the primary work he is known for is the paper, “Formalizing and Securing Relationships on Public Networks.”  And he is basically considered the [intellectual] grandfather of this space.  I’m here basically to provide education and maybe some trolling.

From 22:02 -> 24:15

I think I see eye-to-eye with Adam here.  Basically the idea of how we have a system that is open to interpretation, you do have reversibility, you do have nebulousness.   These are things that Nick Szabo actually discussed in an article of his called “Wet code and dry” back in 2008.  If you look back at some of the earlier works of these “cypherpunks” back in the ’90s, they talked about some of these core issues that Oleg talked about in terms of being able to mitigate these trusted parties.  In fact, if you look at the Bitcoin whitepaper alone, the first section has the word “reverse” or “reversibility” around 5 times and the word “trust” or “trusted” appears 11 times in the body of the work.  This was something that whoever created Bitcoin was really interested in trying to mitigate the need for any kind of centralized or third party involved in the process of transactions to reduce the mediation costs and so forth.

But I suppose my biggest criticism in this space, it is not pointed to anyone here in particular, is how we have a lot of “cryptocurrency cosplay.”  Like Mary Sue Bitcoin.  I’m not sure if you guys are familiar with who Mary Sue is: she is this archetype who is this kind of idealized type of super hero in a sense.  So what happens with Bitcoin and smart contracts is that you have this “Golden Age” [of Comics] where you had the limited ideas of what it could do.  Like Superman for example, when he first came out he could only jump over a building and later he was pushed to be able to fly because it looks better in a cartoon.  You have only a limited amount of space [time] and it takes too long to jump across the map.  So that’s kind of what I see with Bitcoin and smart contracts.  We can talk about that a little bit later, just how they have evolved to encompass these attributes that they’re probably not particularly good at.  Not because of lack of trying but just because of the mechanisms of how they work in terms of incentives for running mining equipment and so on.  So, again we can talk about that later but I think Adam and Oleg have already mentioned the things that are pretty important at this point.

40:18 -> 41:43

I’m the token cynic, huh?  So actually before I say anything, I would like to mention to the audience other projects that you might be interested in looking at: BitHalo; NotaryChains is a new project that encompasses some of these ideas of Proof of Existence created by Manuel Araoz, he is the one who did POE.  NotaryChains is a new project I think that sits on top of Mastercoin.  The issue that people should consider is that proof of existence/proof of signature: these are just really hi-tech forms of certification.  Whether or not they’re smart contracts I guess is a matter of debate.

There is another project: Pebble, Hyperledger, Tezos, Tendermint, Nimblecoin.  With Dogethereum their project is called Eris which apparently is the first DAO ever.  A DAO for the audience is a decentralized autonomous organization, it’s a thing apparently. SKUChain is a start-up in Palo Alto, I talk about them in chapter 16.  They have this interesting idea of what they call a PurchaseChain which is a real use-case for kind of updating the process from getting a Letter of Credit to a Bill of Lading and trying to cut out time and mediation costs in that process.  There are a few others in stealth mode.  So I really don’t have a whole lot to add with cynicism at this point, we can go on and come back to me in a little bit.

59:41 -> 1:02:35

The go to deficiency guy, huh?  They’re not really saying anything particularly controversial, these things are fundamentally — at least from an engineering perspective — could be done.  The problem though I think runs into is what Richard Boase discussed in — if listeners are interested — he went to Kenya and he did a podcast a few weeks ago on Let’s Talk Bitcoin #133.  I really recommend people listen to it.  In it he basically talks about all of these real world issues that run into this idealized system that the developers are building.  And as a result, he ended up seeing all of these adoption hurdles, whether it was education or for example tablets: people were taking these tablets with bitcoin, and they could just simply resell it on a market, the tablet itself was worth more than they make in a year basically; significant more money.  He talked about a few issues like P2P giving, lending and charity and how that doesn’t probably work like we think it does.

I guess the biggest issue that is facing this space, if you want issues, is just the cost benefit analysis of running these systems.  There is a cost somewhere to run this stuff on many different servers, there is different ways to come up with consensus for this: for example, Ripple, Stellar, Hyperledger, they’re all using consensus ledgers which require a lot less capital expenditures.  But when you end up building something that requires some kind of mining process itself, that costs money.  So I think fundamentally in the long-run it won’t be so much what it can do but what can it economically do.

So when you hear this mantra of let’s decentralize everything, sure that’s fine and dandy but that’s kind of like Solutionism: a solution looking for a problem.  Let’s decentralize my hair — proof of follicle — there is a certain reductio ad absurdum which you come to with this decentralization.  Do you want to actually make something that people are actually going to use in a way that is cheaper than an existing system or we just going to make it and throw it out there and think they’re going to use it because we designed [wanted] it that way.  So I think education is going to be an issue and there are some people doing that right now: Primavera De Fiillipi, she’s over at Harvard’s Berkman Center — she’s got something called the Common Accord program.  And also Mike Hearn; listeners if you’re interested he’s made about 7 or 8 use-cases using the existing Bitcoin blockchain including assurance contracts — not insurance contracts — assurance contracts.  And he’s got a program called Lighthouse which hopes to build this onto the actual chain itself.  So there are things to keep in mind, I’m sure I’ll get yelled at in a minute here.

1:23:58 -> 1:28:10

Anyone listening to this wanting to get involved with smart contracts: hire a lawyer, that’s my immediate advice.  I will preface by saying I don’t necessarily agree with policies that exist and so on; I don’t personally like the status quo but there is no reason to be a martyr for some crusade led by guys in IRC, in their little caves and stuff like that.  That’s not towards anyone here in this particular chat but you see this a lot with “we’re going to destroy The Fed” or “destroy the state” and the reality is that’s probably not going to happen.  But not because of lack of trying but because that’s not how reality works.

Cases right now are for example: DPR, Shavers with the SEC, Shrem now with the federal government, Karpeles [Mt. Gox] went bankrupt.  What’s ended up happening is in 2009, with Bitcoin for example, you started with a system that obviated the need of having trusted third parties but as users started adopting it you ended up having scams, stolen coins, people losing coins so you ended up having an organic growth of people wanting to have insurance or some way to mediate these transactions or some way to make these things more efficient.  And I think that it will probably happen — since we’re guessing, this is speculative — I think that this will kind of happen with smart contracts too.  That’s not to say smart contracts will fail or anything like that.  I’m just saying that there will probably just be a few niche cases initially especially since we don’t have much today, aside I guess from Bitcoin — if you want to call it a smart contract.

What has ironically happened, is that we have created — in order to get rid of the middlemen it looks like you’ve got to reintroduce middlemen.  I’m not saying it will always be the case.  In empirical counter-factual it looks like that’s where things are heading and again obviously not everyone will agree with me on that and they’ll call me a shill and so on.  But that’s kind of where I see things heading.

I have a whole chapter in a book, chapter 17.  I interviewed 4 or 5 lawyers including Pamela [Morgan] of different reasons why this could take place.  For example, accredited investor — for those who are unfamiliar just look up ‘accredited investor.’  If you’re in the US, in order to buy certain securities that are public, you need to have gone through certain procedure to be considered a ‘sophisticated investor.’  This is one of the reasons why people do crowdsales outside of the US — Ethereum — because you don’t want to have to interact with the current legal system in the US.  The reason I mention that is because you end up opening yourselves to lawsuit because chains — like SWARM — cannot necessarily indemnify users.  That’s legal terminology for being able to protect your users from lawsuits from third parties; they just do not have the money, the revenue to support that kind of legal defense.  Unlicensed practice of law (UPL) is another issue.  If you end up putting up contracts on a network one of the issues could be, at least in the US, are bar associations.  Bar associations want to protect their monopoly so they go after people who practice law without a license.  I’m not saying it will happen but it could happen.

My point with this is, users, anyone listening to this should definitely do your due diligence, do your education.  If you plan to get involved with this space either as an investor or developer or so on, definitely at least talk to a lawyer that has some inkling of of an idea [on this].  The ones I recommend, in addition to Pamela here are: Ryan Straus, he is a Seattle-based attorney with Riddell Williams; Austin Brister and James Duchenne they’re with a program called Satoshi Legal; and then Preston Byrne, who’s out in London and he’s with Norton Rose Fulbright.

1:52:20 -> 1:54:43

Guys look, I understand that sounds cool in theory and it’s great to have everything in the background, but the reason you have to see these “shrink wrapped” EULAs [end user license agreements] and TOSs [terms of service] is because people were hiding stuff inside those agreements.  So if you hide what’s actually taking place in the contract you end up making someone liable for something they might not actually agree to.  So I’m not sure, I think it’s completely debatable at this point.  If we’re trying to be transparent, then you’re going to have to be transparent with the terms of agreement.

I should point out by the way, check out Mintchalk.com, it’s run by guys named James and Aaron in Palo Alto, they’re doing contract building.  ACTUS is a program from the Stevens Institute, they’re trying to come with codified language for contracts.  Mark S. Miller, he’s got a program over at Google, he does something with e-rights.

I mention all of this because, we already have a form of “polycentric law” if you will in terms of internationally with 200 different jurisdictions vying for basically jurisdiction arbitrage.  Ireland and the Netherlands have a tax agreement that Facebook, Google, Pfizer they take advantage of.  It’s this Double Irish With a Dutch Sandwich.  In fact my own corporation is incorporated in Delaware because of the legal arbitrage [opportunities].  Obviously smart contracts might add some sort of new wrinkle to that, but people who are listening to this, don’t expect to be living in some Galt’s Gulch tomorrow or something like that.

For example, when you have something that is stolen, there is something called Coinprism which is a colored coin project.  They can issue dividends on stock.  The cool thing with that is, “hey, you get to decentralize that.”  The double-edged side of that is if that when that get’s stolen: people steal stuff like bitcoins and so forth, what happens to the performance of that dividend?  If the company continues paying that dividend in knowing that the person had been stolen from: if somebody stole from me and I tell the company, “hey, it was stolen” and they continue paying, then I can sue them for continuing to pay a thief.  If they stop paying then it defeats the purpose of decentralization because anonymity is given up, identity has taken place.  Obviously this moves into another area called “nemo dat” it’s another legal term talking about what can be returned to the rightful owner, that’s where the term “bona fide” comes from.  Anyways, I wanted to get that out there.  Be wary of disappearing EULAs, those have a purpose because people were being sued for hiding stuff in there.

2:10:05 -> 2:12:23

So I think everybody and all these projects are well-intentioned and have noble goals but they’re probably over-hyped in the short-run, just like the Segway was.  It eventually leads to some kind of burnout, or over-promise and under-delivering.  I’m not saying this will happen, I’m just saying it could happen.  I actually think the immediate future will be relatively mundane, such as wills and trusts kind of like Pamela was talking about.

One particular program is in Kenya there is something called Wagenitech which is run by Robin Nyaosi and he is wanting to help farmers move, manage and track produce to market to bypass the middleman.  That doesn’t seem like something really “sexy,” that doesn’t seem like the “Singularity” kind of thing that everyone likes to talk about.  But that is needed for maybe that particular area and I think we might see more of that along with PurchaseChain, NotaryChains, some of these things that we already do with a lot of the paperwork.

Again, blockchains and distributed ledgers are pretty good at certain things, but not everything.  It has real limitations that vocal adopters on the subreddit of Bitcoin like to project their own philosophical views onto it and I think that it does it a very big disservice to this technology long-term.  For example, LEGO’s can be used to make a car but you wouldn’t want to go driving around in one.  A laptop could be used as a paper weight but it’s not particularly cost effective to do that.  And so what I think we’ll end up running into a tautology with smart contracts, it’s going to be used by people who need to use them.  Just like bitcoin is.  So what we’re going to have is a divergence between what can happen, this “Superman” version of Bitcoin and smart contracts, versus the actual reality.

So for example, people say it’s [Bitcoin] going to end war.  You had the War of Spanish Succession, there was a Battle of Denain, a quarter million people fought that in 1712 and it was gold-based [financed by specie].  Everyone that says bitcoin is going to destroy fiat, if the state exists as it does today there’s always going to be these institutions and types of aggression.  I do think smart contracts do add collateral and arbitration competition and it does take away the problem of having trust in the system itself, but the edges are the kryptonite.  And always will be.  So we need to focus on education and creating solutions to real actual problems today with the actual technology and not just some hypothetical “Type 2” civilization where we are using [harvesting] the Sun for all of our energy.

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Email use-cases for ‘colored coins’ and DACs

Earlier this week, version 0.0.5 of Chromawallet was released (here’s is Alex’s official announcement) and users have begun testing the creation and sending of colored assets (first on testnet, soon on mainnet).  A few adventurous people have sent 0.0008 BTC in fees related to Colored assets (you can look at Blockchain.info for a few here and there).

I received two interesting emails this week, the first is a use-case for Colored Coins from Mark:

I think a good use case is for stocks: so long as it’s for Class A common stock, no dividends, it’s a very uniform asset, already digitally-issued. If Google treasury (the issuer of Google stock) colored a coin, they are the final arbiter of whether a share is a share is a share, and I would trust them as the issuer of the coin. But what about proxies, splits, ugh…

Best, best use case is for foreign stocks to be registered this way: it’s still really cumbersome for a non-Brazilian investor, for example, to buy Petrobras on Brazil’s Bovespa market.

Good question, the potential is there, the technical side works.  Whether or not that these kind of companies are willing to try and adopt this method is another matter entirely — as are the legal issues of exchanging a security to different qualified investors (foreign, accredited, etc.).  JoinMyIPO, LTBcoin and BankToTheFuture are trying different approaches to this crowdequity opportunity.

DACs

I received an email from Gary who initially talked about alts, but is looking for he sees as long-term opportunities through DACs:

I don’t think its really about the currency, its the underlying technology and how it can be applied to Decentralised Autonomous Corporation, the project that O like that will be the front runner is the Ethereum project, the only problem with me is that how do O create a DAC? I could put it this way, you take a normal business process and convert that process into a DAC, is it possible, I think so. I did post a sort of DAC on the Ethereum forum, in regards to the production of electricity and had some good constructive comments, have a look when you have the time and let me know what you think. I don’t know if you have seen this new development in the US regarding Benefit Corporation:

In April 2010, Maryland became the first U.S. state to pass benefit corporation legislation

Typical major provisions of a benefit corporation are:

Purpose

  • Shall create general public benefit
  • Shall have right to name specific public benefit purposes (e.g. 50% profits back to community)
  • The creation of public benefit is in the best interests of the benefit corporation

Unfortunately I am not a lawyer, so I’m not sure how DACs will be recognized in each jurisdiction.  Furthermore, just so that everyone is on the same page: no team has actually unveiled a working DAC/DAO — in fact, there is no real consensus of how to define a DAO/DAC/DACP.

That said, conceivably it is likely a matter of time (months, years?) before someone designs a DAO that can create the functionality that Gary is looking for.  If I hear anything about releases, I will definitely write about it.  However word of warning: a CAO may actually be more efficient and effective for internal uses (see Subledger.com discussed in Chapter 5), thus I suspect a DAO will not necessarily be the only player in town.

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Footnotes and agnostic ledgers are not for everyone

Judge Richard Posner does not care for footnotes (pdf).

On the other hand, I use them copiously because they allow me to continue the conversation and provide additional references that would otherwise distract the reader from the main body.

Other examples are, Ken Shirriff, who has some excellent info nuggets he places in these articles:

Similarly, “gwern” does a great job using footnotes.  In fact one particular piece (which my friend Taariq Lewis recently rehighlighted) stands out in particular: Bitcoin is Worse is Better.

While gwern’s piece is great in-and-of itself, one of the footnotes that I have pondered over the past few months (I’ve probably read the piece 3 times) is footnote #4 which links to one of Satoshi’s first known public emails, stating in November 2008 that he had been working on this project for about the previous 18 months.  That he actually built the software first and then wrote the whitepaper to describe it.12

The reason this is important in my mind is that I think (and will likely be stoned for saying this) is that Bitcoin itself has probably been misrepresented by various special interest groups.  Specifically, individuals that keep pointing to Satoshi’s purported motivation for this — to defuse future financial crisis’ — are likely incorrect.  Again, he/she/they built the software first before writing the white paper which describes what was built (hence the reason why the code was in working order when he/she/they released it in January ’09).   Thus he did so prior to any of the key events of the financial crisis.  Sure he did sign the genesis block with “The Times 03/Jan/2009 Chancellor on brink of second bailout for banks” however it would be a stretch to conclude his exact motivations without him specifically stating them.3  Furthermore, Satoshi only mentions the word “libertarian” once in all of his writings (on the mailing list [here] just a few days after releasing the whitepaper; and not on the forum) and none of his posts were particularly geared towards politics, in fact he seemed to have a desire not to have Bitcoin put in the political hotseat (he specifically asked Wikileaks not to accept bitcoin).4 5 And while he did post one comment about economic scarcity, utility and value, it was unrelated to politics.6

I briefly touched on this in my own footnote in chapter 5, stating that while the protocol could conceivably track other assets and token values, that it was not initially intended as such from day 1, rather it was intended as a way to create a trustless form of payments, “One of the primary reasons this was the case is because Satoshi Nakamoto intentionally created Bitcoin for that purpose, hence the full name of the paper “A peer-to-peer electronic cash system” – the first section of the whitepaper discusses the problems people have with paying for things online; it was not a manifesto.”7

His political and philosophical inclinations are neither here nor there.  He could have been a member of any political organization yet Bitcoin itself is just a tool.  It would be akin to saying that all databases and accounting ledgers should conform to Republican ideals or Democrat ideals or Socialist ideals.  Databases are tools, Bitcoin is a tool.  The code is open-sourced and will likely be adopted and used in numerous environments and circumstances that could very well be, non-ideological (e.g., backoffice for financial institutions, medical records for hospitals & HMOs, property title tracking in developing countries). 8

Just as very little of Linus’ original codebase still exists in in Linux, 75% of the Bitcoin code is now non-Satoshi based.  While the first application of this trustless system that ended up correlated with the protocol, fiat value, there likely will be any number of uses for both a decentralized and centralized cryptoledger and may in fact, end up used inside the very institutions that politically motivated individuals would rather have them not.

It is impossible to say either way, perhaps Darkwallet, Zerocoin and Darkcoin will be the killer-apps that bring in billions of users or maybe nationally mined cryptocurrencies (like proto examples such as Auroracoin or Mazacoin) will become more widely used.9 Either way, early adopters in this new segment are incredibly creative, innovative and passionate — I have been very fortunate to correspond with many of them over the past several months.  Yet my doubts as to whether these projects will succeed are unimportant because the wallets of market participants collectively will decide what will succeed and what will be purged.  Thus, don’t rule out anything, including the footnotes.

  1. He mentions the 2007 timeframe also in the forum, see these three posts: Re: Questions about Bitcoin, Transactions and Scripts: DUP HASH160 … EQUALVERIFY CHECKSIG and Re: MSVC build & SHA-256 []
  2. He states early in the mailing list that he did it backwards, writing code first then writing the white paper, see the last comment on November 9th, Re: Bitcoin P2P e-cash paper []
  3. This is based on a real article from The Times, Chancellor Alistair Darling on brink of second bailout for banks []
  4. He specifically stated that “I make this appeal to WikiLeaks not to try to use Bitcoin.  Bitcoin is a small beta community in its infancy.  You would not stand to get more than pocket change, and the heat you would bring would likely destroy us at this stage.”  See Re: Wikileaks contact info? and Re: PC World Article on Bitcoin []
  5. He did have one semi-political statement regarding censorship on November 9th, Re: Bitcoin P2P e-cash paper []
  6. See Re: Bitcoin does NOT violate Mises’ Regression Theorem []
  7. This is in footnote 57 in chapter 5.  Be sure to also read Mike Hearn’s germane comment at github. []
  8. Satoshi did prefer public domain works over other proprietary licenses.  He designed and released the original logo/icons to the public domain.  He also posted several comments about releasing code under either an MIT license or public domain, see for example: Re: Switch to GPL []
  9. See As Auroracoin “Airdrop” Approaches, What Does It Mean When A Nation Adopts A Cryptocurrency? from TechCrunch and Lakota Indian Promotes New Digital Currency, Mazacoin from The Wall Street Journal []
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Let a thousand agnostic cryptoledgers blossom?

While it may be controversial to suggest in some circles, but cryptoledgers are agnostic tools.  And due to their open-source availability, they can likely be used internally by an assortment of organizations, companies and institutions — big or small, for-profit and not-for-profit.

London-based Preston Byrne, a securitization attorney that helped me extensively in Chapter 2 of GCON, has an upcoming article discussing the use of distributed and decentralized blockchains — and cryptoledgers in general — in governments and corporations.  This is something he previously discussed in the book and while it could be controversial to some, if history is a guide, just like the internet itself and operating systems before it, there were many early adopters who had differing ideological goals.

Yet how the Bitcoin ledger operates mechanically is for all intents and purposes ideologically agnostic.  There are many productive business and organizational use-cases that could adopt and utilize one, but not necessarily need all of the functionality.  Put another way, it would be like saying that for the theory of database or journaling file system design to survive, each design has to include features that further a specific ideology such as anonymizing transactions.  Perhaps Zerocoin or Darkcoin will fill certain niches for specific groups, but there are many other uses for a cryptoledger that do not necessarily need to have certain anonymizing or decentralization features.  In fact, these particular functions may add a lot of computational and capital overhead and will likely be stripped out by an IT team trying to adopt a cryptoledger at a financial institution trying to automate the backoffice or an HMO trying to adopt a ledger for a medical records database.

Again, some of these ideas are discussed by a few different sources in the book, with scenarios using “pre-mined” proof-of-stake or Ripple-like systems (that require a bare minimum of computational resources to maintain).  Proof-of-work would not likely be as energy efficient, plus the block times of the original Bitcoin protocol could be too slow for internal applications.

Since the source code is released for many of these platforms, time will tell; in the meantime I point you to Byrne’s latest post: Bitcoin and the English legal system, part I

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Proof-of-Gox and Recoverycoins

Yesterday I had the pleasure to moderate a panel discussing Goxcoin on LTB episode #89.  Participants included Adam B. Levine who is the editor-in-chief of Let’s Talk Bitcoin! as well the chief visionary officer to the Humint project (and who wrote the foreword to GCON).  David Johnston is the managing director of BitAngels, the first angel investment network focused on digital-currency startups, and a board member at the Mastercoin Foundation (I also interviewed him for GCON and included his insights in Chapter 3).  And the final panelist was Pete Earle, who is a multi-decade veteran of the financial trading sector as well as an economics writer (the article that sticks out most to me was incidentally his piece on mudflation).

It’s a very thought provoking conversation as it raises real-world use-cases for using cryptoprotocols (such as Bitcoin and Mastercoin) in a more effective, efficient, secure and transparent manner than existing models and frameworks.

Developers can find out more information about the Master protocol white paper.

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The troubles of book categorization

Earlier today a friend of mine asked how self-publishing works with Kindle.  Again, because the community provided the training and information to me freely, my goal is (and was) to simply reproduce the “trustless” meme in the widest, freest ways possible (hence an open Creative Commons license plus epub, PDF, Scribd, HTML); and the Kindle platform is the largest ebook retailer around so it would make sense to put it on there too.

The lowest price an author can price a book at is $0.99, though if you use the “Select” program you can temporarily reduce it to as low as $0 for like a once-a-month weekend gimmick.  But to be part of the “Select” program you have to opt-in to their exclusive system that allows them to kick you off the entire bookstore if they find you placed the ebook on another platform (like iTunes or Scribd).

In addition, the current platform for Kindle-only publications limits authors to placing a book in just 2 categories. So what are the broadest categories something like GCON could be placed in?

I chose ecommerce/online trading for one and the other was… computer & technology/algorithms primarily because of the amount of technical language used throughout.

I am not sure what the other sales volume for the other 8 listed below are, but I am curious to know if Amazon uses a weighted metric to temporarily boost a new release up to the top spot easier than say, a book that has been published for 2-3 months.

Here’s an image that shows a reason why I think that may be the case:

I’m flattered and thankful but which of these is not like the other…

[Note: I hope that others can take the manuscript, purge its weaknesses and improve on it over the coming months and years.]

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Another long, strange trip

By day, I work in a segment unrelated to the ever-growing cryptocurrency industry.  I was fortunate that several dozen people took the time to simplify these ideas to me and after roughly seven weeks of research, writing and distillation I have published a guide on trustless asset management.

  • Adam B. Levine (host of LTB) is not only a deep thinker on these issues but also a very thoughtful writer, providing me with a great foreword and — fortunately for him — at least most people will read the foreword before quitting on the rest of the book!
  • I’m especially grateful to Alan Safahi (ZipZapInc) who not only let me visit him at his office but also provided written feedback.
  • Similarly Ryan Orr not only provided numerous quotes but also constructive feedback on the qualitative measurements (matrices).
  • Taariq Lewis spent several hours both in-person and over Skype explaining how several different protocols worked including Counterparty and Mastercoin which are essentially new to everyone.
  • Pierre Rochard, Daniel Krawisz and Michael Goldstein (the Mises Circle trio) all exchanged lively feedback via email involving this space and appreciate their wit and insights.
  • Derek Au provided insights on venture trends and showed my gf and I around Fisherman’s Wharf a couple months ago.
  • Steve Bennet met with me, Ryan Orr, Jack Wang and Rui Ma for coffee and it was a delightful conversation.
  • I really enjoyed the 500 Startups group of Rui and Sean Percival, very open, witty and inviting.  Celso was very articulate as well.
  • Ethereum team (Vitalik, Charles, Joel, Stephan Tual) was very open and definitely want to change the world (like everyone else)
  • Ron Gross spoke to me into the wee hours of the morning (or was it evening) out in Israel.  Not only is he spearheading Mastercoin development, but leading a noble cause with Bit-cause.
  • If you’re looking for info on Asia (which is what I’m primarily focused on) be sure to chat with Zennon Kapron, Eddy Travia, Rui Ma and Jack Wang.  Probably have the best perspective of what is going on there.
  • Speaking of which, Jack Wang is a rising star, be sure to keep your eye out for him.
  • The Ripple Team was very helpful in providing constructive data.  I had a chance to meet with Stefan and he’s a brilliant guy.  Monica also provided some useful feedback as well.
  • Matthew Wilson is an old college friend who provided lots of good soundboarding (mainly because he is a bear on cryptoledgers)
  • Andrew White is well-informed and very friendly.  Has helped introduce me to numerous people and provided lots of good feedback in many areas of the guide (especially related to Ripple.
  • The NXT team of Graviton and Uniqueorn were also very friendly and accessible; it’s curious that their proof-of-stake network isn’t reported on more.
  • Counterparty.co guys (PhantomPhreak and cityglut) are super busy, they ship tons of code right now and have to if they want not only their ecosystem to grow but the underlying token.
  • Colored Coins (Alex, Amos, Meni) were the first outside dev team I spoke with and they were very helpful at providing feedback and corrections.  Chromawallet looks pretty neat, wait another month or two to hear more about Amos’ latest project.
  • Preston Byrne, hire him asap.  This lawyer not only understands cryptocurrencies but also how legal frameworks intersect with smart contracts.  He not only provided knowledge but lots of well-written prose.
  • Petri Kajander probably read more of the manuscript and provided more feedback than anyone besides Preston and my gf.  He is well-versed in both economics and technology and very giving of his time.
  • Daniel Larimer was also giving of his written feedback, providing lots of good corrections for what I had previously written
  • David Veksler and Scott Freeman are friends I have back in Shanghai that helped bridge the cryptoscene there with the industries I had previously worked in.
  • The Argentine team of Wences, Sebastian and Diego Zaldivar were quite informative, I didn’t know how bad of economic conditions Argentina was 10 years ago.
  • Nikos Bentenitis (Coinsimple) and Hakim Mamoni (Seedcoin) were colorful and very passionate guys who have their finger on the pulse of the industry.
  • Robert McMillan (Wired) actually ended up helping me indirectly becoming introduced to Rui Ma which led to getting to meet Jack Wang who I had previously read articles from.  Robert has been following this segment for awhile.
  • Jared Mimms (Peercover) is probably the most passionate person I spoke to on the phone, very articulate too.
  • Justin Simcock and Raffael Danielli both provided lots of encouragement and a couple of good anecdotes/references that I managed to interject in the manuscript.  Hire these guys, super gurus.
  • Zachary Caceres has a very interesting project going on with SCI and had lots of good written feedback for me.
  • Mark DeWeaver (who wrote the foreword to my previous book) did a good job playing the devil’s advocate about policies in China.  He provided realism among the hype.
  • Stephan Kinsella and Sean Zoltek legal experts extraordinaire.  I’ve known both for over a decade and always enjoy listening to their comments.
  • Chris Odom (OT) and Stephan Pair (BitPay) are both quite busy but provided me with really good information to work with.
  • Jesse Powell has had one of the most colorful experiences within this community (see his post from a few days ago) and Salvatore is very accessible (his artcoin idea is also intriguing).
  • Alex Tabarrok provided me with some excellent material for the assurance contract section, I screwed up and forgot to add him to the acknowledgements (did the same thing with Tuur Demeester and Robert Sams too).
  • Nick Szabo is brilliant, if you have just 5 minutes read through his paper Formalizing and Securing Relationships on Public Networks
  • Mike Reid provided editing and the cover art with his firm: Invisible Order (with Natalie and Matt Thomas).
  • Kyle Torpey is actually one of the guys who inspired me to write this in the first place.  He wrote a very interesting overview of several of these projects 2 months ago.  We have spoken several times since then and his vision of decentralized applications is quite unique.
  • I met Tom Mornini at a Ripple demo day event a couple weeks ago and his service (Subledger) sounded pretty unique.  We kept in touch and his written correction on my manuscript were quite helpful as well.
  • Jeremy Kandah was an enjoyable and even funny guy to speak with, all the BitAngel’s guys were very enthusiastic and supportive with their feedback.
  • Many thanks to Mike Youssefmir, Koen Swinkels, Ben Davenport and Vijay Boyapati for their comments, criticism and feedback which I hope to build and grow from.
  • Dan Roseman has one of the first pay-by-crypto job sites (Coinality) and was very accessible in corresponding with.
  • Jeremy Liew was kind enough to respond to me even while on vacation.
  • Jon Holmquist squeezed me in between his commute between SF and LA, is working on multiple projects and was quite diplomatic about other projects in this space.
  • Scott Robinson was the manager at the SF bay accelerator in chapter 6, he was really sick and I didn’t hear back from him about using his specific quotes until after it was published, but he was quite helpful (gave me the analogy about the cruiselines/airlines too).
  • And Mike Hearn was likewise giving of his time, despite being under the weather and busy with several other projects.

Altogether this project took just under seven weeks and it could not have been done without the help of everyone I spoke with.  In fact, I’m sure if you took away all of their quotes and insights, the rest of the book would just be footnotes!

While I will likely continue working outside of the industry in the short-run, I plan to continue paying attention to this exciting space.  And despite a few bumps in the road, this community is very innovative, resilient and here for the long-run.  Nerds for the win.

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Glossary

[Note: below is the glossary to Great Chain of Numbers]

Because of the dynamic nature of this new ecosystem, the data and statistics cited here will quickly become outdated.  This is not making excuses for the manuscript but rather illustrates to you the rapid pace of change relating to innovations and opportunities in this new space.

Before embarking on reading this book, below are commonly used definitions for several important terms used throughout the guide:

Smart contracts1 are computer protocols that facilitate, verify, execute and enforce the terms of a commercial agreement.2 Current proto-examples include some digital financial instruments used on electronic securities exchanges.

Smart property is property whose ownership is controlled via smart contracts that may or may not reside on a cryptoledger.

Cryptocurrency3 is a virtual token (e.g., a bitcoin, a litecoin) having at least one moneyness attribute, such as serving as a medium of exchange.4 It is transported and tracked on an encrypted, decentralized ledger called a cryptoledger.5

Trustless asset management refers to the ability to manage an asset such as a virtual token in a trustless manner – relying on mathematics, rather than a trusted 3rd party like a payment processor or a bank through the use of a cryptoledger.

Decentralized autonomous organization (DAO), also known as a decentralized autonomous consensus platform (DACP), is a virtual entity that interfaces with a cryptoledger and performs a specific, preprogrammed task.  In its simplest form it is merely an agent programmed to do a specific task like acting as a multisignature wallet that sits on the ledger waiting for outside instructions.   In order to modify or fulfill its task, it must receive a certain threshold of digital signatures from keyholders (e.g., voters, shareholders) and perhaps with a 67% majority, have the right to release the entity’s funds and modify its code.6 It can fulfill the functions of an organization, corporation, or agent by conducting operations such as payroll management, issuance of dividends, stock, or debt, or otherwise executing repetitive, mechanical, quantifiable actions from a cryptoledger.7

When spelled with an uppercase “B” Bitcoin (or uppercase “L” Litecoin) refers to a peer-to-peer network, open-source software, decentralized accounting ledger, software development platform, computing infrastructure, transaction platform and financial services marketplace.8 When spelled with a lowercase “b” bitcoin (or “l” for litecoin) is a digital cryptocurrency and unit of account.  As of this writing one bitcoin is equivalent to $600 USD and one litecoin is worth approximately $15 USD.  In addition, the acronym “BTC” is often used to represent a bitcoin (and “LTC” for a litecoin).

  1. Contracts in legal terminology are required to have ‘offer,’ ‘acceptance’ and ‘mutual acceptance’ – this is called ‘meeting of the minds.’  Whether the ‘smart contracts ‘used in cryptoledgers will be recognized or stand legal scrutiny is an on-going area of discussion and speculation. []
  2. The task of trying to encode all the possible legal subtleties that underlie even the most basic contract could potentially be difficult from a designing perspective and will likely run into hurdles with mainstream commerce. []
  3. While several state legislatures (California, Washington) recognize cryptocurrencies as alternative currencies and it may technically be used as a ‘currency’ in the economic sense, as of this writing, no United States court has categorized ‘bitcoin’ as a currency yet; rather in legal terminology it could be treated like a commodity.  Furthermore, in the United States it is currently not categorized as a stock or bond or an investment contract (a security).  These issues are being debated by policy makers and it may be some time before a consensus builds within each jurisdiction.  One source I spoke with used the analogy that trying to pigeon-hole cryptocurrencies under existing laws is equivalent to how regulators at the turn of the 20th century applied cruiseline laws to the nascent airline industry.  Similarly, it took a decade to build up regulatory framework surrounding credit cards – which are essentially, preapproved electronic loans (e.g., a line of credit).   Perhaps a ‘BitLicense’ will become integrated with the New York Uniform Commercial Code Article 4-A: Funds Transfers.  See New York considers creating a ‘BitLicense’ for Bitcoin businesses from The Verge []
  4. All assets have at least one form of ‘moneyness’ including: medium of exchange, store of value or unit of account.  The question over whether or not a virtual asset can have all three is an ongoing debate.  See Bitcoin now ‘unit of account’ in Germany from The Guardian, Bitcoin More Speculative Than Real Currency, Study Finds from Bloomberg, Economics of Bitcoin: Is Bitcoin an Alternative to Fiat Currencies and Gold? by Peter Šurda as well as the writings of JP Koning []
  5. Stylistically many other writers use hyphenated words (e.g., crypto-currency, crypto-ledger).  I use a hyphenless style throughout strictly for aesthetic purposes. []
  6. There are multiple different ways to describe a Decentralized Autonomous Organization.   Some call it an Agency, an Application, a Corporation or even Consensus.  A thorough explanation can be found in “Application Specific, Autonomous, Self Boot-Strapping Consensus Platforms (And the DACs that live on them)” forthcoming by Adam Levine. []
  7. There is also no standard, consistent definition for what a DAO is and is not.  Mike Hearn describes it differently than Vitalik Buterin (see chapter 3).   Perhaps, speculatively, as time goes on, developers can build more complicated features creating more robust functionality beyond that of what a contract can execute. []
  8. The 8 identities of Bitcoin by William Mouyagar []
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Chapter 9: Conclusions

[Note: below is chapter 9 to Great Chain of Numbers]

Even with some froth that has arisen, greater functionality is coming, with a clear consensus emerging that this technology will reduce friction – and overheads – for business if thoughtfully designed for financial applications.  Some platforms may succeed, others may fail – it is entirely possible that the platform which will introduce this technology into the mainstream has not even been coded yet.  As Yogi Berra purportedly said, “it’s tough to make predictions, especially about the future.”1 Perhaps these matrices can help, at least for now, to prevent paralysis by analysis:

Platform Matrix

Table 1

Table 2

 Table 3

 

Synthesis

If you, the reader, are now asking yourself: “which platform is the best?”  “Which platform should your team or business adopt and integrate into?”  The only honest answer is that no one can say.

The goal in writing this guide is to provide readers an overview look into an often-hyped, but nonetheless dynamic and rapidly-moving area in technology, law, and commerce, and in writing this guide I have tried to be as unbiased and diplomatic as I can, giving equal time to different viewpoints, approaches and platforms.  What they all share is enthusiasm, which can be found in abundance on the part of developers, entrepreneurs, investors, and thinkers alike.

My suspicion, on overview, is that as the technology evolves over the next two years, there will be a considerable amount of energy devoted to the sector – though there will not necessarily be a clear set of ‘winners’ and ‘losers’ in terms of platform market share and ledger-rot.

Where existing protocols all pursue ambitious goals, they remain subject to significant – and known – technical limitations and, at least to date, a lack of funding and manpower to address them.  Additionally, while it would appear that there is some profitable low-hanging fruit with immediate applications, such as betting and gambling, gearing app development towards these market sectors will involve significant legal overheads and diminishing returns as there are already a number of active participants in this ‘math-tax’ segment.

If the goal of cryptoprotocols is to provide frictionless mechanisms to foster real economic growth, then creating applications that provide genuine increases in productivity to end-users that replace expensive existing infrastructure is likely an area for ripe business development (e.g., if gambling actually created real growth, then Las Vegas and Macau would replace New York City and Shanghai as economic centers for growth).  The United States casino industry generates roughly $125 billion in revenue a year, yet most people do not gamble in part to the ‘math-tax.’2 Simultaneously there are more than 1 billion bank-issued cards in the US – most of which are replaced on a semiannual basis.3

How, then, can firms tap into the wider consumer ecosystem – where cryptoprotocols have not yet seen widespread adoption?  Some veterans in the sector suggest entrepreneurs who are new to the space initially work on projects that do not have high compliance overheads – such as exchanges or money transmitting business – or to look at different geographical corridors to address the needs of the unbanked and underbanked in the developing world.4 One of the reasons why WordPress began accepting bitcoin, for example, was because not everyone in the world has a Visa card and PayPal blocks user access in over 60 countries; WordPress wants to reach places where these services are not.5 Other experts have suggested keeping the idea and execution simple: before trying to obtain a million customers, try to provide a high-quality service to a few hundred, and learn from the experience.

Alternatively, others suggest focusing on purely commercial applications, in high finance or in business-to-business platforms, due to the complexity of money laundering and consumer protection laws which apply when dealing directly with the general public.  Perhaps being a software provider that does not hold the tokens, or exchange tokens for fiat, could be a safe middle ground or creating easier point-of-sale merchant accessibility with QR codes. Or as Sean Percival suggested, redesigning interfaces for consumers so that cryptocurrency becomes more accessible.

There is also a growing impetus to build bridges between existing financial infrastructure and cryptoprotocols.  While enormous amounts of capital (human and financial) have been invested in this space, some projects are likely redundant – reinventing the wheel as it were – and others may be based in political, rather than commercial, motivations.  Anyone wanting to get involved in his space should therefore ask: what profitable business application can be built on top of these systems?  Is building another proof-of-work-based blockchain an effective use of resources or can your team sync your features to an existing ledger?  Is it possible to provide new value to larger customer bases without having a Turing-complete protocol?  Do you necessarily need to use a decentralized processing framework instead of a distributed or even centralized (in the case of intranets) systems?  Can your development team work remotely, reducing overheads, or do they need to be located in a specific office or housing complex?  Can formal partnerships with existing market participants be forged to secure more funding and better cater to their needs?

There will likely be $100 million in formal start-up funding this year however even if they can answer all of these question some of these projects may no longer be relevant once they ship code.

Instead of having to stand in one location to call another fixed location – as the landline-era has conditioned us to think of commerce – decentralization brought about by mobile phones enabled users to call and connect with specific individuals from anywhere.  Smartphones and tablets subsequently opened up the ability to perform and use productivity apps, empowering new demographics to utilize virtual offices, leapfrogging the need to use traditional brick-and-mortar office parks.  Cryptocurrency is similarly disrupting the way we use money and, more generally, asset management.  It is one of the few areas over the past twenty years that has not been radically transformed by new digital technology – but this will likely change, as both Naval Ravikant and Eli Dourado recently analogized, Bitcoin is not money – it is the internet of money.6 While there may be banking apps on phones, at the end of the day it is still essentially a virtual bank teller or ATM. On the other hand, Bitcoin and its progeny empower individuals to be their own financial institution – much like how Linux platforms enabled ordinary users to potentially utilize more powerful use-cases than Windows.

The interviewees for this book – and indeed all of us – are participants in an unprecedented, cryptographic, mathematically constrained experiment that is likely to impact nearly every industry.  Yet it is clear that decentralization is not necessarily the answer, the silver-bullet or panacea to every economic problem; it is merely a tool, a solution for some things, but not for all, and corporations, organizations, firms and institutions can still benefit from the technology while employing centralized management systems (e.g., IT support).  Furthermore, skepticism is warranted for bold claims about specific future events such as the need to reinvent the ledger-based wheel with a flavor of the month. For every project listed here there are two or three more that could have been surveyed and analyzed. As Carl Sagan once said, extraordinary claims require extraordinary evidence. And based on my interactions with the teams detailed above, I believe that many if not all of them are capable of achieving the milestones and goals they have set.

Community views on cryptocurrency’s future are varied and heterogeneous; it seems likely that entry into constructive, and technical, dialogue with global policymakers is a necessary prerequisite of wider adoption for virtual currencies in some countries – but that is a topic for books others will inevitably write.  While decentralized apps geared towards illicit markets may be popular and profitable with certain segments and niches, the key to mass adoption will likely be providing real value by addressing real needs (e.g., why would your mother want to use it; why would a bank use it; how do we empower the unbanked?).

Each of these platforms, even the 1.0 generation, has the potential to provide a trustless storage and transportation mechanism for asset management.  Yet, despite the hype and promise, it remains nonetheless entirely plausible that the technology may not meet the expectations of its most zealous advocates, and the only decentralized app that is still popular a decade from now is still relegated to the world of peer-to-peer torrents.  It is my view that cryptoledgers have the potential to make smart contracts, smart property and trustless asset management a reality for all.

Exciting days lie ahead in the unfolding “mathematical industrial revolution.”

And you can be a part of it.

  1. The perils of prediction, June 2nd from The Economist []
  2. Casino Industry Accounts For Significant Slice Of U.S. Economy: Study from The Huffington Post []
  3. Point-of-Sale Terminals Should Revolutionize Credit Card Payments by Dave Wilkes and Hack-resistant credit cards come at a price from San Francisco Gate []
  4. As mentioned in Chapter 6, the Philippines is the 3rd largest remittance-receiving country.  Nearly 10% of the population works abroad and most of these workers send money home, yet are faced with fees each month.  Reducing and eliminating these fees could be a way cryptocurrencies can provide value and increase adoption.  See Hong Kong money senders battle for Philippine trade from BBC []
  5. Pay Another Way: Bitcoin from WordPress []
  6. See Bitcoin – The Internet of Money by Naval Ravikant and Bitcoin isn’t Money—It’s the Internet of Money by Eli Dourado []
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Chapter 8: Jack-of-All-Trades?

[Note: below is chapter 8 to Great Chain of Numbers]

Can Bitcoin do everything?  I spoke with Adam Levine, editor-in-chief of Let’s Talk Bitcoin about the future of altcoins and DACP.1 According to Levine, “unfortunately many crypto proponents are conflating cryptocurrencies (an ecosystem of protocols) with Bitcoin (the protocol) and bitcoin (the token) – yes, bitcoin is a cryptocurrency but not all cryptocurrencies will necessarily be (a) bitcoin. They are not mutually exclusive and are all part of the larger cryptocurrency ecosystem.  Another way to think of it is Bitcoin is a specific reference implementation of Cryptocurrency but not the definitive technology as it does not solve all the problems, otherwise nobody would care about Ethereum, Mastercoin or Counterparty.  Thus it would be imprecise to just say Bitcoin is the only real cryptocurrency because the altprotocols and “2.0” projects all learned from limitations of Bitcoin; borrowing lessons and ideas but not necessarily the code. And as a consequence, immutable algorithms employed by these improved DACPs and cryptoprotocols empower users to choose their own parameters, boundaries and even create voluntary associations.”

Levine also sees Bitcoin as a type of highway and the other platforms and protocols as off-ramps.  Yet, in time other protocols could also become highways and thus an interconnected series of decentralized, encrypted highways would transmit and track value globally in a frictionless manner.  As he says, “it is an open source ecosystem filled with numerous competitive platforms.  There will probably be a marketshare ‘winner’ in a few years that is bigger than everybody else and at that point, all the other participants will retarget their DAC development at the new platform.  Perhaps they will fork the winner and start from there.”

While not everyone agreed with method or path, the one common theme from everyone who provided insights to this guide was: do not be afraid to take risks. Nearly each person I spoke with had started a company in the past and experienced failure first hand.  Do not let that stop you from trying a different approach. Learn from your mistakes and be open to changes.  This might sound cliché but the world has never seen anything like a cryptoledger before and incumbent institutions are now paying attention.  In fact, in its latest 10-K filing with the Securities and Exchange Commission (SEC), eBay named both BitPay and Coinbase as potential competitors to PayPal.2 Similarly in January 2014 Wells Fargo held a meeting on how to assess and ascertain the legal and competitive issues that cryptocurrencies create.3

While the Bitcoin protocol has grown immensely in the past five years, it is still quite young in terms of market penetration.  At the time of this writing, the market cap for bitcoins (all 12.4 million that have been mined) is roughly $7 billion.  For comparison, according to the World Gold Council, as of December 2n 2013, there is roughly $6.8 trillion in above ground gold.4 And global e-commerce sales topped a collective $1 trillion in 2012.5 While there has been a concerted focus on the token value of bitcoins this misses the forest for the trees.  The potential market cap for all trustless asset management is the same sum total of known assets which is several orders in magnitude larger; the key difference is how they are managed and transferred.  Some assets, such as deeds and collateralized loans, are easier to encode as a smart contract; others may be more difficult.  Similarly, existing blockchains are limited in terms of what secondary attributes they can store (e.g., hashes of contracts) and, due to their confirmation periods, are not ideal for transmitting securities in an HFT manner.6 Thus cryptoprotocols today, should be seen as works in progress with enormous potential.

With the knowledge of the previous chapters, the question that decision makers, executives and business development managers should ask is, what can cryptoledgers or smart contracts solve for large organizations with established networks, retail operations, or mobile assets?   Time-stamping and HR automation have already been discussed, as have customer-reward programs like frequent-flier miles, so what about monitoring car fleets?  Or perhaps Bitcoin is not needed to perform every function; perhaps it will serve as a bridge for some, but not all virtual exchanges.

Niche payment processing platform

At this time, while it is very good for remittances, Bitcoin is not a competitive payment system for many parts of the world.  It can be used, but it is not ideal.  This is because the confirmation rate of its currency (bitcoin) is too slow and relatively expensive – the transactions per second has lagged behind the price.  Similarly the protocol is less than optimal in most transactional settings because it is cumbersome, not Turing-complete, and not intended for this specific purpose, preventing developers from building transactional and contract systems, services and applications on top of it.  As a consequence, its usability is still extremely limited for most mainstream payments such as point-of-sale; and software and infrastructure must be deployed to take it to a network capacity of 100s or 1000s of transactions per second instead of the current 7 per second.

This situation may be temporary and could take a few years to resolve – and at that point perhaps we will see payment adoption take off but this would require substantial changes to the protocol.  For example, perhaps by that time blockchain pruning (SPV) will be implemented to eliminate all spent outputs from the blockchain (shrinking it substantially).7

David Evans, a law professor at the University of Chicago, recently published a payment platform comparison between M-PESA (in red) and Bitcoin (in blue).8 Below is one figure reprinted with permission: mobile payments comparison

As Evans points out in his article, M-PESA was first introduced in Kenya in mid-2007 whereas Bitcoin was launched in January 2009.  Yet as I mentioned above in chapter 6, M-PESA is so widely used in Kenya that roughly 43% of its annual GDP is handled through this mobile payment system, the same obviously has not occurred with Bitcoin yet (perhaps it could with other systems such as NXT or Ripple).910

It should be noted that the direct comparison is not entirely apples-to-apples either as the Bitcoin transactions in this chart only include on-chain transactions.11 Coinbase and Circle use off-chain wallets which permit users to buy, sell and trade bitcoins (including micropayments) instantly that would otherwise take tens of minutes to confirm via an on-block chain implementation.  An off-blockchain solution also allows users to trade below the dust limit (roughly 5460 satoshis) which is an artificial limit implemented by the developers several years ago to prevent spam from propagating the network (e.g., a malicious user could send out millions of 1 satoshi, each of which needs to be added to a block, thus taking up time and resources).  BTC-e takes this off-chain approach a step further by allowing users to build bots that interact with its API, enabling high-frequency trading.  None of this is possible on-chain and thus these types of transactions are not represented in the image above.

But Evans is right to bring this criticism up and it is an issue that has motivated other developers to build these ‘next generation’ platforms described in chapter 3.  For example, Bitcoin currently has a hardcoded block size of 1 MB, or 7 transactions per second.  In contrast, Visa’s payment processing centers handle on average of 2,500 transactions per second and are built to process a surge of up to 10,000 to 20,000 per second.12 Other platforms such as Ripple have a purposefully more robust payments system, in the case of Ripple its current setup, while security conscious, can handle 100 transactions per second but it is designed to handle at least 1,000 transactions per second as well.

Again, this may not be an issue in developed countries, where users have easy-access to Bitcoin wallets (both web and mobile based).  And because of the relatively large fees described in Chapter 6, cross-border remittances has been one of the ‘killer’ apps for Bitcoin and will remain so into the future.  In fact, despite the fact that it takes 10 minutes for one confirmation, it is still quicker than other existing remittance processes such as ACH which can take three days to clear.13

But as an RTGS, a real time gross settlement service, where transactions clear near instantaneously, it cannot compete at the same level as credit cards or M-PESA.14 This is an issue that potential entrepreneurs should keep in mind.  In fact, while there are certain days that $50-$100 million worth of bitcoins are processed along the network, that is about as much as MasterCard and Visa process in a few minutes.15 For comparison, in 2013, MasterCard and Visa processed a combined $7.4 trillion in purchases.  Together with American Express and Discover, these four companies generated $61.3 billion in revenue during the same period.  While credit card companies like Visa can make the clearance of payments even offline (they download the blacklist on terminals) and M-PESA is quick and easy via SMS, the slower confirmations are a challenge for Bitcoin as it makes its way into the mobile payments space.

Usage rates

Readers may be wondering just how many users actually use Bitcoin or other cryptocurrencies.  Because of the decentralized nature, it is a difficult answer to actually provide.   In addition, it is difficult to differentiate between those who have exchanged a fraction of a bitcoin at any time and those who are actively using bitcoins today.  For instance, according to Bitcoin Pulse, the number of cumulative individual wallet downloads hosted at Sourceforge is 5 million; yet as shown below, this is not the only type of wallet users have access to.16 Other metrics, such as looking at popular social media sites like reddit or Bitcointalk are also inconclusive because while there may be 110,000 redditors subscribed to the Bitcoin channel, many of those are likely sock puppets.   In addition, readers should keep in mind that a user of bitcoin can be defined as a user even if the amount they transmitted is a little as 1 satoshi (0.00000001 bitcoin) or as large as 1 million bitcoins.

While roughly 1.1 million Bitcoin addresses hold 99.99% of all bitcoins (as of block 285,000), this is not the equivalent to saying only 1.1 million people hold all the mined bitcoins.17 As of this writing, 107 addresses hold 21.76% of all mined bitcoins.  Again, this does not necessarily mean that only 107 individuals own roughly one-fifth of all bitcoins.  For example, some of these addresses belong to large exchanges and web-based wallet services such as Coinbase and BitStamp.  Because these customer wallets are off-chain it is impossible as an outsider to know exactly how many people actually own and use bitcoins behind this wall.  Coinbase now has over 1 million customer wallets and it is unknown how many of these users actively trade and use bitcoins with other internal services.

Yet, there is likely a liberal upper bound estimate of roughly 10 million users on all platforms in the ecosystem today.  There are two ways to derive this number, the first is from the fact that there are roughly 10 large web-based exchanges.  If each of these has one million users, which they likely do not, then that is approximately 10 million users.

Another way to derive the 10 million is through the limitations of using microtransactions directly through the blockchain.  Because of anti-spam provisions know as the dust limit, users currently cannot send less than 5460 satoshis on the blockchain directly, otherwise that transaction is not incorporated into a block.  For users in developing countries looking to conduct in commerce and or even remit with bitcoins, there are few formal exchanges based in these regions.  Thus they will likely use on-chain wallets and if they use on-chain wallets their transactions will be limited to sending bitcoin values above this dust limit.  As of this writing 26.39 million addresses (95.27% of all on-chain addresses) hold bitcoin balances between 0.0 and 0.001 bitcoins.  However, it is unknown how many of these addresses are actual active users or how these are abandoned addresses (e.g., forgotten about, lost private key, used as a temporary go-between address, mining transaction fees, unclaimed reddit tips, etc.).   Usage rates of many other cryptocurrencies follows similar patterns.  This dearth of fiat-to-cryptocurrency exchange in emerging markets presents a business and educational opportunity for entrepreneurs such as bitcoin ATM providers as discussed later in this chapter.

Decentralization for decentralization’s sake

In conducting the research for this manuscript, I spoke with several investors who explained that using crypto for crypto’s sake or decentralization for decentralization’s sake is not a particularly efficient or effective business or even developmental model.  In fact, centralization of information and assets can and is oftentimes easier to manage in most industries.  Just because Bob stores data in a centrally managed Amazon cloud server, does not make his enterprise any less effective.  In fact, the code probably runs much quicker due to how AWS can scale (e.g., less distance and therefore less lag between computing nodes).18 Furthermore, just because some system can be decentralized, does not mean a business owner should do so.  In fact, irrespective of cryptocurrencies’ long-term potential, a total-cost-of-ownership (TCO) analysis should always be done by anyone wanting to move from one infrastructure to another.  Perhaps the opportunity costs of keeping the existing system are less than switching and managing another.

Similarly, others have explained to me that making a product easy-to-use should not be the penultimate goal either; rather, developers and entrepreneurs should instead answer these questions: What problem does this solve?  What need does this satiate?  Why should others use it?   Bob could extol the virtues of cryptocurrencies to his relatives and convince them to purchase bitcoins or dogecoin as a speculative investment, but what would they use it for in their daily life?  How does it make their life any better or easier?  Just because you can decentralize, should you?  These are the kind of questions that start-ups in this space need to answer.

This insight could save many people a lot of headaches in the future.  Instead of forking code and reinventing the wheel, several sources I spoke with think developers should learn from the mistakes of the open-source community fifteen years ago.  Where there were endless Linux distributions being rolled out and semi-funded, each had technical advantages, yet few could convincingly provide a solution to specific problems and garner mass market appeal.  And ultimately after years of consolidation and market purges, the most popular Linux-based end-user package was not Ubuntu or Fedora, but Android – which simultaneously satiated customer demand and solved needs in an easy-to-access manner.19 Thus, when looking upon potential investments, this investor will often ask startups in this space why do you need a decentralized system running in the first place.  What is the burning need?  In cases such as maintaining IT infrastructure they could in fact create higher costs or produce negligible gains.20

One investor explained to me that while critics are right to point out that there has thus far been a limited buy-in of mindshare of these new technologies, they should also acknowledge that existing system today replaced other systems and so on.  Whereas previously brokers traded on the exchange floor, electronic traders were viewed as outsiders and the floor traders were the insiders.  That role has reversed in a matter of decades.  Like the horse-and-buggy before it, any new disruptive technology will seriously impact the landscape creating winners and losers.  What entrepreneurs need to try and figure out is how they can position their firm to get on the winning side.  Maybe it is blockchains, maybe it is consensus ledgers, maybe it is something else entirely.21

Cost benefit analysis of decentralizing

Too much of a good thing, however, can be problematic.  While a lightweight proof-of-stake or Ripple-based cryptoledger could be used internally by corporates to replace auditors and accountants (e.g., reducing administrative overhead, electrical and equipment costs), an intranet-based proof-of-work cryptoledger – while possibly being able to achieve that objective – may be a solution looking for a problem.

Unlike the Internet, intranets are based on centralized network controls where all actors are known and all actors are already constantly monitored and there is trust.  Because trust is enforced by administrative oversight, the problem of tracking financial and other assets is suitably addressed for normal commerce by existing technology.

Our example begins in the future, where cryptoledgers and smart contracts provide accounting and auditing but also utilize tokens to track and manage inventory and logistics internally.  With this technology, inventory systems that could be compromised and abused might instead be replaced with cryptoledgers.  If Bob owns a large media store, he could manage and track all of the books with embedded RFID tags; instead of building and trying to maintain a relatively costly proof-of-work infrastructure (e.g. hardware expenditures, electricity), because it could conceivably run on a smartphone, a proof-of-stake ledger could easily be maintained, powered and integrated within cash registers, point-of-sale terminals and nearly any intranet-connected devices.  The cryptoledger could itself be managed by a DAO which then connects it to a larger corporate VPN to franchise locations and vendors in the supply chain, each of which have their own ledger and so forth.

Again, the token itself is unimportant from the perspective of human agents; it is not used for some value-based exchanges but for internal bookkeeping and rationing.  In all likelihood, if a cryptoledger is used internally, the tokens would all be premined.  Another example of where the technology might be applied would be automobile dealerships and car rental facilities.  If Alice runs a Hertz franchise she could install a proplet (a MEMS device that can interact with smart contracts and cryptotokens), with which she could control the operation of a vehicle based on the lease agreements – including reverting control of the vehicle to a new owner all via a cryptoledger. This kind of functionality extends beyond automating the movement of information – individuals can already buy, sell and rent vehicles over their mobile, but must use trusted 3rd parties and payment sites.

A cryptoledger, on the other hand, removes the necessity for 3rd party involvement.  For example, Hertz could implement an internal proof-of-stake ledger at each location, and a DAO would connect the ledger via a VPN to the parent company. Each car ignition would be fitted with a proplet that can communicate with the ledger via a cryptographic handoff (a token of some kind), and therefore any customer or owner could use smart contracts to pass ownership off to other approved individuals. Or, if it is a self-driving vehicle, it could start and drive to Alice’s home and drop her off at the office.  The ‘minting’ of tokens within the POS (or POW) ledger is not important as a store of value but again, is used to track and manage inventory in an unforgeable manner.

Consequently, neither Alice nor Bob are locked in within any specific vendor of cryptoledgers, as these systems are currently open-source.  Furthermore, because a DAO manages the edge of the network, they can work with decentralized exchanges that enable customers from any part of the globe to transfer one type of cryptocurrency for a cornucopia of tokens representing thousands of assets, thereby creating a frictionless environment for decentralized commerce.

But would the cost and unfamiliarity of adoption of cryptoledgers over existing technology which serves the same purpose be worth it? It is probable that for smaller businesses the opportunity cost – the new skill sets which employees would need to learn – might be prohibitively high, particularly given the dearth of software tools available for the technology. Some, however, see that businesses with sufficient scale might be employ cryptoledgers – sooner rather than later – for strategic applications of a capital-intensive nature, such as obtaining funding from the capital markets, as Preston Byrne suggests in chapter 2.  “A smart contract could be written which permits vehicle immobilisation as part of security enforcement, as Nick Szabo proposed,” Byrne says. “Depending on applicable local laws this could be provided as a security package for issuer SPVs. The example of Hertz is particularly instructive – while the company has embarked on whole-business securitisations in the past, this technology might improve the quality of the company’s collateral to a sufficient extent that future transactions could be asset-backed instead of being backed by all of the firm’s receivables, lowering its funding costs. In a broader automobile lending context such a system could be used by any lender to dramatically reduce servicing costs while providing considerably better loan-level data to prospective investors.”

Thus the opportunity costs, the seen and unseen of implementing and maintaining a decentralized cryptoledger should be taken into account.  Similarly, at some point traditional players could enter the market when cryptocurrency has enough traction and either build something themselves or try to buy the new established players.22 For example, if Coinbase continues to increase in popularity, perhaps Wells Fargo would absorb it.  While speculative, perhaps the upcoming launch of SecondMarket’s exchange, a New York-based platform, could be acquired down the road by JP Morgan or Chase.23

NGO use-cases

In an exchange with Petri Kajander, an entrepreneur and a senior fellow at The Cobden Centre, an economic think tank, he sees “a lot of parallels with the dotcom boom and also with the mobile boom.  They also started with basic protocol and infrastructure levels and built up from there to the more sophisticated services once the basic layers were settled and established.  It is sort of a similar story here.  You cannot aim too high at the beginning since the basic building blocks are still not in place.  Also, even though you might be anticipating the right services and needs – your timing might be off.  The end users are just not there yet.  The sweet spot might be still years away – even though the technical capabilities could be in place.  There is going to be a lot of trials-and-error, and huge amount of luck involved, for some.  The trick is to try and monetize throughout the journey.  For instance, the most boring applications may be the most profitable in the beginning; like a financial back office and corporate administrative solutions providing the biggest savings in the first phase.  Market participants should also be aware and cognizant of regulatory bodies and policies – they do play a role in the development and deployment zigzag.  And different governments have different incentives and approaches to the matter. This may have interesting tipping points and “good enough” technology selection and market approval choices, even by pure chance.”

Mundane applications such as tracking inventory or coupons as described in chapter 5.  Perhaps integrating a CRM API with a ledger could allow companies to track customer sales, or as mentioned in chapter 4, figuring out ways to integrate EDI with a ledger could likewise enable robust and secure supply chain management with all vendors.  Kajander also sees some of the current crypto-based solutions hammer-like, or in his words, “everybody in the field is excited and has a proverbial hammer in their hands.   And there seems to be so many nails all over the place, or at least that what they seem to see.”   Not every solution needs a new ledger or needs to be decentralized.

One comparison that Kajander used involves the disintermediation of the entertainment industry, “if you look at Napster and BitTorrent, both created disruptions to the marketplace and after the dust settled, it was iTunes and Netflix that became the platforms adopted by mainstream consumers.  Similarly Orkut was incredibly popular with specific countries like Brazil and India but was completely passed over by the larger social networking consumer-base.  In many ways, these platforms being built today could start as a Napster but end up as iTunes.  In fact, while there was a lot of idealism in the ‘90s about what the internet could do or should do, the actual long-term use-cases involved a balancing act between capabilities and policy making.”  Netflix and Youtube combined now account for roughly half of the bandwidth consumed during peak-hours in the United States.24

Kajander and several others I spoke with, see an intersection between cryptoledgers and non-profit organizations as well.  As noted in chapter 5, there was a notable example of fund mismanagement in China related to the 2008 Sichuan earthquake.  According to Kajander, “in the future non-profits such as the William and Melinda Gates Foundation could utilize cryptoledgers to track their donations projects or even funds throughout the globe, providing a transparent and real-time auditable framework to their initiatives.  Perhaps even a Kiva and Bitcoin-like mashup could emerge for similar emerging markets.”  Kiva is a non-profit organization that allows people to send and receive money via the internet to entrepreneurs and students in underserved countries.   Other charities could benefit from this transparency as it also reduces administrative overhead by removing the need for several functionaries.

Continuing, “the blockchain is virtually incorruptible, it cannot be changed or reversed.  So in the future, having elections could be as easy as each user submitting their digital signature for a particular policy or candidate and the election could be both quickly verified and difficult, if not impossible to cheat.  Voting is not limited to national elections either, as villages, classrooms, any organization could use a token-based cryptoledger system to provide a transparent mechanism for the electioneering process.  All someone needs is access to a mobile phone or laptop.”

Specific examples could be community organizations that hold votes to release funds to improve hospitals, schools and libraries.  Coupled with the assurance contracts discussed in chapter 2, voters or voiceholders as Adam Levine describes them, could review the votes and act on the consensus.  Thus as Kajander and Hakim Mamoni have explained, you can remove middlemen, bureaucracies and allow direct involvement between two or more parties (e.g., reduce the hierarchy between the borrowers and lenders; recipients and donors).

Another way that for-profit companies can utilize this token system is through a matching campaign.  For instance, if you purchase $50 of Nike products online, a cryptocurrency could be issued and sent to your wallet.  In an offline situation, the product could have a scanable QR code that serves the same function.  They can then be sent to a charity or NGO of your choice and Nike will redeem and donate a certain amount of prearranged money to the recipient.  In Kajander’s words, “these initiatives could be for a particular purpose (e.g., infrastructure for clean water, new trees planted) and could scale into the hundreds of thousands, even millions through the use of smartphones.”  Again, as described in chapter 2, these tokens do not necessarily have to have some kind of fiat value attached to them, but rather serve as a virtual representation of a vote.

China

At a basic level there appears to be a lack of clear property rights and contractual rights in China.  While some jurisdictions like Shanghai are more transparent and modern than others, no one actually owns property for more than 70 years, after which it is automatically reverted back to the state.25  In many cases, the actual property may only have a 40 or 50 year lease left because of the different staggered stages of post-Mao liberalization.  Furthermore, at any given time some of these titles can be revoked or modified by a 3rd party without due recourse.26

As a consequence, despite reforms over the years, land confiscation is still common.   For example, each year approximately four million rural Chinese are evicted from their land.27 Why?  Because, according to an HSBC report, local governments generate 70% of their income from land sales much of which are ill-gotten gains for one or more party (e.g., state-owned firm’s pressure local leaders to evict farmers from land).28 Through the adoption of cryptoledgers, each level of government could benefit, not only by being able to track and manage the funds of its associates, but by being able to track these land titles in a transparent, unforgeable manner.

Additionally, a 2004 report from the OECD found that roughly half of all urban Chinese workers primarily migrant workers from the inner provinces participated in the “informal” sector.2930 They might benefit if their payroll and compensation was managed by a decentralized autonomous organization (DAO), a cryptographically controlled AI agent, rather than a human boss (laoban) who could arbitrarily change his or her mind or otherwise abuse the relationship (e.g., change the contract ex post).3132 For instance, without an urban household registration (hukou), most of these migrant workers are left without any legal recourse in the event that their contracts are tampered or ignored.33 Yet with an independently run DAO these same individual could potentially still be automatically paid based on previously agreed to condition or at least bring the issue to an arbiter; and if they are recognized, a government court.

While it remains to be see how policy makers will react to these new innovations, these cryptoprotocols could provide new tools for everyone to reduce costs and secure value.

Startup Cities Institute

Zachary Caceres is the executive director of Startup Cities Institute (SCI), a non-profit research center at Universidad Francisco Marroquín located in Guatemala.34 In an email exchange I asked him why an NGO and specifically his project would find cryptocurrencies of use.  In his words, “at SCI, we are most excited by the humanitarian possibilities of cryptocurrencies.  Many of the world’s poorest face high inflation and instability in their national currency.  Despite all its volatility right now, cryptocurrencies may actually prove to be a better choice than politicized money in some developing nations. In countries like Guatemala, where we’re based, security is also a constant problem.  Robbery is common, especially in poorer neighborhoods.  Cryptocurrencies could be a safe alternative to store your savings.”

As noted earlier by Alan Safahi as well as Wences Casares and Sebastian Serrano, one of the areas that cryptocurrencies can already disrupt is the remittance marketplace.   In 2012, approximately 1.5 million Guatemalans (roughly 10% of the population) worked abroad and remitted $4.8 billion back home, making Guatemala one of the largest receivers globally; and remitting through Bitcoin or Ripple could reduce the fees substantially.35 As Caceres notes, “With Bitcoin or another digital currency on both ends of the transaction, you could have instantaneous transfers at a much cheaper rate.  Perhaps something like a debit card could be loaded from the U.S. and then cashed out in a developing nation. There is a huge market opportunity here.”

One challenge that his team is facing with their new incubator, SCI Ventures, is developing an ATM.  Their goal is to bring cryptocurrencies to developing countries and thus because most people do not always have a computer or reliable internet access, in their view “people will need an easy interface, either by phone or ATMs.”  So how could they make a secure Bitcoin ATM ubiquitous in the streets of cities like Mumbai or Nairobi?  “It’s still too expensive. There’s a long way to go. But we’re working with some entrepreneurs and designers to try to push this along.”

Other projects and vendors in the Bitcoin ATM space include Lamassu, Skyhook, Genesis and Robocoin.36

And how does this tie in with the rest of the guide?  According to him, “this interest in cryptocurrencies ties in to our broader project, Startup Cities.  What if law and governance is just a technology like any other?  Smart property and smart contracts raise this question clearly. If law and governance is just a technology, then perhaps it could be open to disruptive innovation.  What we are developing at SCI is the idea of using small zones to pilot comprehensive reforms in the legal, political, and economic systems of nations. Instead of trying to fix the whole country, just make several small, competing zones with different institutions and let people vote with their feet.  Some may fail and others may be spectacular successes, just like in any other startup environment.  The startup municipalities that work can grow by attracting money, talent, and capital.  Nations can then bring good reforms to the national level.  This is a low-cost, low-risk way to bring major improvements to the developing world. It does not force anything on anyone, and respects human rights each step of the way.”

Startup Cities has a unique entrepreneurial approach to public policy that is being pursued by other independent groups including Blueseed and the Urbanization Project (e.g., Charter Cities).37

Another issue he brought up was one that Preston Byrne, Hakim Mamoni and Petri Kajander have also discussed: using cryptoledgers to provide transparency for organizations including governments.  In his view, “we have the broad outlines of a transparency platform we call MuniBit. It seems possible that with public Bitcoin wallets or another transparent cryptoledger, you could bring near-total transparency to a government’s finances.”

Another obvious application of transparent internal accounting would be for NGOs themselves because, “the governance structure of Startup Cities could also be enhanced by cryptographic technologies.  At least in principle, municipal governments could be held as something like a DAO.  Citizens could actually become shareholders in their local government.  Citizens could make political decisions through transparent digital processes and interfaces set up around a DAO.”

While it remains to be seen whether or not a DAO could provide such functionality, multisignature addresses and oracle based wallets, or Hierarchical Deterministic Multi-signature (HDM) wallets, such as CryptoCorp already exist, providing small organizations the ability to perform some of these functions such as securely voting and releasing funds.38

  1. Let’s Talk Bitcoin []
  2. eBay Views BitPay and Coinbase as Potential PayPal Competitors from CoinDesk []
  3. Wells Fargo calls Bitcoin summit on ‘rules of engagement’ from Financial Times []
  4. See Demand and supply statistics from World Gold Council []
  5. 3 Infographics on the Future of Digital Retail from JCK and Ecommerce Sales Topped $1 Trillion for First Time in 2012 from eMarketer []
  6. It should also be noted that while the low-hanging fruit of smart contracts is securities trading, it is highly unlikely that a professional trader would use a blockchain directly for an HFT.  For example, in most markets, especially the very liquid ones, where latencies are counted by increasingly smaller segments of time, the pace of 1 block per 10 minutes (or even 2.5 minutes) is limiting.  Open-Transactions (OT) has the ability to create safe ‘centralization’ through federation and ‘voting pools.’   Essentially there would be off-chain exit nodes that transfer to HFT clusters.  See Voting Pools: How to Stop the Plague of Bitcoin Heists, Thefts, Hacks, Scams, and Losses from Bitcoinism and How can Open Transactions benefit Bitcoin? from StackExchange []
  7. See also Chapter 3 on the discussion of Simplified payment verification (SPV) and How explicitly can the blockchain be pruned? from StackExchange []
  8. Professor Evans uses a different title “Chart 1” than what is in this manuscript.  See Bitcoin Payments: Igniting Or Not? by David Evans []
  9. From oil painter to the C-suite from Financial Times and M-Pesa helps world’s poorest go to the bank using mobile phones from The Christian Science Monitor []
  10. NXT currently has a maximum rate of 255 transactions per block and 1 block is processed every minute, so roughly 4 transactions per second.  However, ‘transparent mining’ is a new feature that is being developed by NXT which will enable it to compete with Ripple and other payment platforms.  See Transactions per block and maximum transactions per second from Nextcoin.org and Transparent mining, or What makes Nxt a 2nd generation currency from Bitcointalk []
  11. Another reviewer suggested that this was not an apples-to-apples comparison because SMS functionality is built into the feature-phones that Kenyans have.  Thus a Bitcoin app would have to be on every phone and there would need to be people willing to accept Bitcoin in order for this to be a fair comparison.  While this may be the technical case, the larger issue is that media coverage of Bitcoin dwarfs similar M-PESA coverage in nearly every market, yet despite this, there has been very little adoption due to the reasons discussed in this manuscript (e.g., cumbersome wallets, security vulnerabilities on the edges, no ‘smart fine print’). []
  12. Visa’s system has an uptime near 100% during peak times of up to 20,000 transactions per second and encrypts every transaction separately; key hashes expire roughly three seconds later reducing exploits to zero (e.g., zero money stolen off the wire, or out of merchant accounts).  According to Visa, it spent $425 million on IT expenses for the year ending on September 30, 2010.  While decentralized systems have some advantages, in computer science, they cannot currently simultaneously fulfill the following guarantees: consistency, availability, partition tolerance (called the CAP theorem).  They can provide two-of-three but usually not all three simultaneously.   In addition, while it may be reduced later, the infrastructure costs of maintaining this proof-of-work system is significantly higher than Visa’s.  See Comparing VISA and DoD I.T. by Paul Strassmann []
  13. ACH stands for Automated Clearing House, which is an electronic financial network in the US.  In 2012 it processed 21 billion transactions worth a total of $36.9 trillion.  See ACH Payment Volume Exceeds 21 Billion in 2012 from NACHA []
  14. This issue was recently highlighted in a very articulate article, Bitcoin – A Jack of All Trades is the Master of None by Ken Griffith.  There are other financial startups in the payments space including Coin (a swipeable card) and Ricardo.  In addition, Apple is including functionality with new iPhone hardware and software that allows Bob to scan barcodes at stores and instantly pay with his phone instead of going to the checkout.   Bob can also pay with a photo of the item.  See Bitcoin vs. Coin: Which will have the most success in 2014? From The Next Web, Ricardo – An Executive Summary and Apple Pushes Deeper Into Mobile Payments from The Wall Street Journal []
  15. See Bitcoin Seen as Little Threat to Payment Firms from Bloomberg.  MasterCard recently launched a new location-based service called Syniverse.  See MasterCard Creates New Payment Product With A Company Most Have Never Heard Of. by Brian Roemmele []
  16. Bitcoin Client Num Downloads from Bitcoin Pulse []
  17. The actual number as of this writing is 1,307,387 addresses that hold 99.99% of all bitcoins.  Again, these are addresses not users.  These addresses can be managed by exchanges which have thousands or even millions of users.  See Bitcoin Distribution by Address at Block 285,000 from BitcoinRichList []
  18. AWS is both centralized and decentralized depending on your perspective.  The datacenters themselves are distributed globally in specific geographic locations.  Yet a user can split databases and computation into decentralized nodes/instances within these datacenters.  See Amazon Architecture from High Scalability Customer Centricity at Amazon Web Services from All Things Distributed []
  19. While Mint, Ubuntu and Fedora are more popular on desktops, in terms of overall usage and penetration, Android is far and away the leader in Linux-based adoption.  See The most popular end-user Linux distributions are… from ZDNet []
  20. Centralized versus decentralized information systems : A historical flashback by Mats-Åke Hugoson, Centralization Versus Decentralization: A Closer Look at How to Blend Both by Shelly Heiden, Decentralized Information Technology Requires Central Coordination! By Sarah Michalak, Julio Facelli and Clifford Drew, Mae Gets A New Job from Library and Information Center Management and Gartner Identifies 10 Key Actions to Reduce IT Infrastructure and Operations Costs by as Much as 25 Percent from Gartner []
  21. The disruptive potential of smart contract for the entire financial industry, not just fiat credit facilities, is enormous. Charles Stross, the British sci-fi author, recently criticized Bitcoin and the cryptocurrency endeavor, wishing that it die a quick death (in fire no less).  While his contentions were fallacious on a number of counts (especially regarding the environmental impact), ironically, he previously predicted seven years ago that near-future sci-fi authors are still probably missing something disruptively as large as the Internet 20 years ago or the smartphone was this past decade.  In other words, just as rewatching older sci-fi films that failed to foresee drones and self-driving automobiles seems dated, the portrayal of centrally managed financial products may one day be viewed as an anachronism of our not-so-quaint analog past.  Thus, Stross’ prediction of another unforeseen invention could very well be these smart property applications and digital financial instruments that are managed and transported by the very same cryptoledgers he dreamt of burning.  See Shaping the future and Why I want Bitcoin to die in a fire by Charlie Stross and Charles Stross takes on the Bitcoin community by Tim Swanson []
  22. While it may be contentious to claim, the cryptocurrency industry may end up following the banking industry development, perhaps meeting with the current system somewhere in between.  For example, there will likely be whole liquidity providers (market makers) and clearing houses.  Arguably the easiest and perhaps quickest that can happen is incumbents entering the market. []
  23. SecondMarket jumps to give legitimacy to Bitcoin from USA Today []
  24. Netflix and YouTube are the Internet’s bandwidth consumption kings from BGR []
  25. See Chinese Land-Use Rights: What Happens After 70 Years? from China Smack, China’s Real Estate Riddle from Patrick Chovanec, You May Own your Apartment, but who Owns the Land Underneath Your Feet? by Thomas Rippel, If Beijing is your landlord, what happens when the lease is up? from China Economic Review and Chinese fear homes are castles in the air by Stephen Wong []
  26. See China’s Land Grab Epidemic Is Causing More Wukan-Style Protests from The Atlantic, China Tackles Land Grabs, Key Source of Rural Anger from The Wall Street Journal, China land price fall threatens local finances from Financial Times and China’s land-seizure problem from Chicago Tribune []
  27. See China’s Land Grab Epidemic Is Causing More Wukan-Style Protests from The Atlantic and China Tackles Land Grabs, Key Source of Rural Anger from The Wall Street Journal []
  28. See China land price fall threatens local finances from Financial Times and China’s land-seizure problem from Chicago Tribune []
  29. This is between 120-150 million workers, see Internal Migration in China and the Effects on Sending Regions from OECD []
  30. It should be noted that the term ‘formal’ versus ‘informal’ economy boils down to whether or not economic activities are tracked and taxed by a government agency.  The majority of global economic trade and exchange has and is conducted informally, that is to say “untaxed.”  For example, transactional exchanges that are not monetized – consulting with friends, families and even strangers – are not taxed.  In many cases ‘informal’ activity is just as transparent and efficient as ‘formal’ sectors, yet for many migrant workers, a lack of property rights and contractual structure creates abusive situations.  Most social capital activities would fall under this definition yet the actual activities can be both productive and economically rewarding for the participants.  System D is another name for it.  See The Shadow Superpower by Robert Neuwirth and Could Bitcoin Become the Currency of System D? by Jon Matonis []
  31. See Computer corporations: DAC attack from The Economist, Bootstrapping A Decentralized Autonomous Corporation: Part I by Vitalik Buterin and Bitcoin and the Three Laws of Robotics by Stan Larimer []
  32. DAX is another term for the overall idea, decentralized autonomous ‘x’ where the ‘x’ can stand for corporation, organization, application, etc.  For a spirited conversation regarding this topic involving Charles Hoskinson (Ethereum), David Johnston (Mastercoin) and Daniel Larimer (Invictus/Bitshares) see episode 80 – Beyond Bitcoin Uncut from Let’s Talk Bitcoin. []
  33. Hukou system and China: Urbanization and Hukou Reform from The Diplomat []
  34. See Startup Cities Institute and Hacking Law and Governance with Startup Cities by Zachary Caceres.  Interested parties can contact Mr. Caceres at: startupcities@ufm.edu []
  35. Remittances flows to Latin America and the Caribbean remain stable at $61bn from Inter-American Development Bank and Remittances to Guatemala increased by 14.5 percent in January from The Tico Times []
  36. Lamassu, Skyhook, Genesis and Robocoin []
  37. See Blueseed, Urbanization Project, Software Is Reorganizing the World and Silicon Valley’s Ultimate Exit (slides) by Balaji Srinivasan []
  38. Securing wallets by integrating a third-party Oracle from CryptoCorp []
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Chapter 7: How to Get Involved with the Crypto Ecosystem

[Note: below is chapter 7 to Great Chain of Numbers]

No matter how you might have heard or learned about cryptocurrency, there are different ways to obtain your first tokens.  You can mine them, you can buy them through an exchange (e.g., BitStamp, Kraken, BTC-e), or if you are a merchant, you can receive tokens for your wares.

Mining

Unfortunately mining Bitcoin profitably currently requires a significant capital investment in single-use ASIC hardware.  While you could use a cloud-based hashing service such as Ghash.io or ASICMiner, you will learn very little of how the network actually works.  In fact, even with an ASIC, most mining systems currently lack power to select or validate bitcoin transactions themselves; you are merely selling a computing service (hashing) to the mining pools.1 Another lower-cost option is that you could purchase a small USB ASIC miner (e.g., Bi•Fury); however, the problem is that you would need to rely on whatever token amount you generate to appreciate in value in order to pay for the electricity you expend in mining (e.g., if you generate 0.1 BTC that is worth $80 but it cost you $85 in electricity to generate, then you would need to wait for the bitcoin to appreciate; otherwise you are at a net loss).2

Over the past several years, one business model has emerged in the Bitcoin mining industry: preorders.  Typically what this entails is sending X amount of bitcoin to an ASIC manufacture who will then use that bitcoin to invest, design, build and ultimately ship an ASIC to you.  To maximize inventory, manufacturers create batch orders with wait lists.  The farther you are down the list, the longer it takes to receive the machine and hence recoup your initial investment.  While you can try your luck in getting the first batch of a new ASIC prior to its release, you are probably more exposed to risks with fewer potential upsides than downsides.  Your capital is tied up in a depreciating asset – a machine that unlike a GPU that can be resold to gamers and 3D designers – has progressively lower resale value and has a singular use that may or may not be delivered on time with unknown hashrate performance deltas.3

Or you could be thinking, just like the first people who managed to get an Avalon batch last winter or a new terahash-level CoinTerra machine in January, perhaps you might be lucky enough to get placed high on the list for the upcoming KnC Neptune; but the odds are you will not, especially if you are reading this and have not pre-ordered it.4 One illustration of the risks is the time lapses and project delays involved in Butterfly Labs (BFL) ASIC orders last year.  BFL originally announced a variety of different desktop ASIC machines in July 2012 and hundreds of customers subsequently preordered them with bitcoin.5  Yet due to a number of developmental and testing problems shipments were continually delayed over the course of the following year.6 For instance in March 2013, a close friend of mine who is a Bitcoin investor paid 50 bitcoins for four ASIC machines from BFL, each capable of mining at 25 gigahashes/second.7 He received them more than six months later at the end of November.  If instead, he had held that 50 bitcoins, he would have been able to sell the tokens for $40,000 – $50,000 on many exchanges.8 Consequently, if you plug that 100 GH/s mining rate into a mining calculator, he will not even be able to mine 1 bitcoin for the next year at the current difficulty rating let alone ever be able to mine the 50 bitcoins it cost to buy them.9 Caveat emptor.

If history is any guide, looking back at the California gold rush (the ‘49ers), the firms that ended up financially solvent were merchants and service companies such as Samuel Brannan, Philip Armour, John Studebaker, Levi Strauss and Wells Fargo.10 Those who also made and sold mining equipment (picks, axes, shovels, sluices) had mixed results.  Yet the group of people that typically fared the worst financially was the miners themselves, as they were nearly all exposed to various types of risks (upfront capital costs, land title lawsuits, inclement weather, sickness, landslides and cave-ins) and as a consequence, most ended up bankrupt.11 Yet, if you feel the urge to mine – to better understand the blockchain verification and network – another alternative is to mine an altcoin such as Litecoin or Dogecoin, both of which are Scrypt-based.  Scrypt is a different proof-of-work (Bitcoin uses SHA256d) and requires a larger memory pool to utilize which in turn makes it more resistant to the rapid performance increases spurred by ASIC development.12 Thus you can still use a GPU that has resale value and utility beyond mining.

Merchant Ecosystem

Chapter 2 briefly discussed a milestone in the Bitcoin ecosystem, the exchange of ten thousand bitcoins for a pizza in 2011.13 This is considered the first publicly known transfer of value and thus became the original foundation for fiat exchange.14

Since then, the merchant ecosystem has grown to encompass an estimated 50,000 online vendors.  BitPay is one of the largest startups in this segment, providing an electronic payment processing system with bitcoins for online merchants.15 In 2013 it processed more than $100 million in bitcoin transactions and has signed-up more than 20,000 merchants.16 Gyft, a digital and mobile gift-card wallet (who is partnered with BitPay) that accepts bitcoin as a form of payment, allows customers to buy, send, receive, manage and redeem digital gift cards via mobile devices and works at more than 100,000 retail stores.17 On November 27, 2013, Shopify, a large ecommerce platform, announced that its 75,000 merchants now accept bitcoin as payment.18 On January 9, 2014, Overstock.com began accepting bitcoin for payments.  On the first day it processed $126,000 in sales with bitcoin and less than two weeks later that amount climbed to more than $500,000.19 Subsequently, on January 23, 2014, TigerDirect announced it would begin accepting bitcoin as a form of payment and within one week processed $500,000 in bitcoin payments.20 On February 27, 2014, Coinbase announced that it not only has over one million consumer wallets – up from a mere 13,000 at the beginning of 2013 – but that more than 25,000 merchants use the Coinbase platform.21

On a nearly daily basis other vendors and merchants independently add bitcoin payments as well.  Zynga, the developer behind social games such as Farmville, announced on January 4, 2014, that it would begin accepting bitcoin as payment (via BitPay).22 Previously, on May 9, 2013 HumbleBundle (in partnership with Coinbase) announced that it would begin accepting bitcoin as payment for its game bundles (later expanded to the entire store).23 Another example, during CES 2014, Formlabs, the maker of 3D printers announced that it will now accept Bitcoin payments in its online store.24 And on February 4, 2014 CheapAir.com announced that it would begin accepting bitcoins as payment for hotel stays (it had earlier accepted bitcoins for flight bookings).25

In chapter 3 I introduced, Jon Holmquist who works with Ripple as the Community Liaison, he is also the founder of Bitcoin Black Friday (BBF), the largest e-commerce day for Bitcoin-related purchases, which takes place the day after Thanksgiving filtered through one site.  One of the reasons he was motivated to start BBF in the fall of 2012, “I was working with a Bitcoin merchant and we started doing various sales promotions to drum up support from the Bitcoin community yet there was – ironically – no central avenue, nowhere to funnel them to.  I also noticed a lot of merchants individually conducting sales promotion campaigns and thought a central launching pad would be a great experiment to show a real empirical case-study of Bitcoin ecommerce in action.”

Holmquist built and the consumers came.  In 2012, the first year BBF worked with 60 merchants, 600 in 2013 and they hope to work with 6,000 this year.  BitPay alone processed 6,926 bitcoin-based transactions on November 29th last year up from 99 transactions on the same day the year before.26 Yet to Holmquist the big number that often is overlooked is the fact that BBF customers donated over $1 million worth of bitcoins to charity.  If this had been done with normal credit card transactions, fees of 5% would have been assessed.  Instead that $50,000 in surcharges went to a charity instead of a credit card company.  While this event may be an outlier for the ecosystem, for Holmquist “this is just the beginning to enable easier transfer of value to consumers.  And this is also an area where entrepreneurs and developers can continue to simplify the process for merchants wanting to support cryptocurrencies by providing turnkey services such as plugins.”27

Perhaps this specific incarnation of virtual money (bitcoin) is a fad and merchants will drop all support for it.  If that is the case, switching to another ledger would be relatively simple, as both the front end and back end of existing merchant systems could use other altcoins or altprotocols.   Yet these case-studies referenced above serve as empirical examples of how value can be transferred globally, to anyone, safely, reliably and nearly instantaneously without any middlemen or institutions.

Developer, Developers, Developers

One key theme that all the investors and software architects that I spoke with has been that the ecosystem is in continuous need of competent, creative programmers.  And because the space is so new, so fast and quickly evolving, the barriers to entry are very low.  Thus novice coders with business acumen could potentially find entrepreneurial opportunities in the ever-growing ecosystem.

BTCJam

I spoke with Celso Pitta, the founder of BTCJam.28 Founded in 2013, BTCJam has expanded into 131 countries, with 12,000 users who have provided $5 million in bitcoin-based loans to one another.  It has done this by fusing a global P2P payment protocol with a credit score system, matching loaned bitcoins to borrowers.  Pitta is originally from Brazil and previously worked with statistical models for the credit card division of Citi.  He was motivated to create a P2P lending platform primarily because of the increasingly high interest rates on credit cards in Brazil, some as high as 200% a year.29 In contrast to developed countries where credit is relatively cheap because there is a dearth of credit options in emerging markets such as Brazil, consumers are left with few alternatives.30

According to Pitta, “unless you have access to the FICO credit rating system, it is very difficult to receive a credit line.31 And due to their developing status with a lack of financial institutions and infrastructure, most emerging markets do not have a credit rating system capable of accurately gauging the creditworthiness of borrowers.  In contrast, by using an open registration, where a user can submit any pertinent details they want, we have built a statistical engine that can sort through the quality of their data and provide an increasingly accurate rating.  Bitcoin is a perfect microlending platform in that its 8 decimalization units provide flexibility for fractionalization and the transmission is both secure and relatively fast.  In contrast, with fiat, merchants and lenders not only risk fraudulent chargebacks but expensive fixed costs irrespective of amount lent (e.g., 10% fee on $1 lent).  With bitcoin, there is no way for someone to game the system with chargebacks – once the token is sent, it is sent – transactions are irreversible.  And while there have been cases of a borrower who is unable to pay back a loan in our system, our fulfillment rate is now at 98% compared to the global average in 92% for P2P lending.”

According to its 2013 report, LexisNexis found that online merchants pay $3.10 for each dollar of fraud losses incurred via the internet (e.g., on top of fraudulent charge-backs, fraud monitoring, and bank fees, the merchant must replace the item(s) that are lost).32 Cryptocurrencies are a solution to this problem as they cannot be recalled once sent or double-spent.  Pitta thinks there are other opportunities in this segment for entrepreneurs who want to help enable the unbanked and underbanked.  In fact, he has found that borrowers are very motivated to obtain a credit line and as a consequence learn and educate themselves as to what Bitcoin and cryptocurrencies are in order to use them.  Yet there are still challenges as well: “The friction between obtaining fiat such as Real (R$) and the regulatory framework which is still a grey area in most countries still create barriers to entry for both parties.”

For comparison US-based peer-to-peer lenders such as Prosper and Lending Club issued $2.4 billion in loans in 2013.33 Why is this important?  According to the International Payments Framework Association, through 2010 the average cash flow margin on global transaction services (GTS) was 38%, making it a steady stream of revenue for banks.34 Attractive margins like this makes it an opportune segment for technological disruption and innovation.

Evergreen

In February 2014 I spoke with Joel Dietz, CEO and founder of Evergreen.35  Evergreen is a protocol layer that can connect off-ledger with Bitcoin and was designed with ease of use in mind.  The protocol enables developers to build an infrastructure on top to create mobile web apps that natively accept micropayments.  With this experience Dietz subsequently sees smart contracts and DAOs as having a big impact in the future.  According to him, “I think many of the functions that contract designers (such as attorneys) do today can and will be automated – and that their current jobs will likely be coded away.  Contracts are ultimately just code and are the new innovations and apps to this space.  In fact, I think a variety of smart contracts will be available for use by the end of the year – easy to use smart contracts with escrow and verification ability.  Of course, they will have to build the platform first.  But I think they’ll be relatively easy to create because prototype code already exists.”

In his view, decentralized autonomous organizations have “many benefits from a funding standpoint as they enable organizers to simply check off the boxes.  Cryptoledgers and multisignature functions provide the auditing and logistical abilities.  This is a transparent, straightforward method and is quantifiably better than other crowdfunding techniques.  For instance, because of the way the current system is designed, there is no way to engage and reward userbases directly, especially early adopters who contribute content.  In the case of Twitter, those who tweeted and convinced their friends and families to use it were not rewarded – rather only the equity holders (the founders and investors) were able to receive compensation.  In contrast, crowdequity can engage and incentivize adoption creating an early userbase with rewards for content and marketing.  And the easiest, most transparent method to finance crowdequity is with cryptocurrencies managed by a DAO.”

BankToTheFuture is one the first crowdequity platforms in this space and has 10 startups working on Bitcoin-related projects.36

Adam Levine has been working on a project involving Kickstarter coins that provides similar crowdequity functionality rewarding early adopters and users for their support.37 In fact, Levine proposed not only a new cryptographically controlled manner by which companies and organizations can raise funds (via an initial float of brand-specific cryptocoins), but also how in the event that a company falters or fails, a reverse merger can take place utilizing these tokens:

Even after a company has exhausted their potential ideas and abandoned such a coin, the very fact that it is so inexpensive could be its resurrection. Another company could opportunistically buy those very cheap and abandoned shares, then announce they’ll be honoring them for their service or product with the rate of exchange being the characteristic that defines the intrinsic value since they are one and the same.38

On February 17, 2014 a new project in the crowdequity space was unveiled called, Join My IPO (JMI).39 It was developed by Amos Meiri, a Colored Coins team member, and will issue its first coin in the coming months.  The core idea is that individuals (backers) can invest in specific people before launching his or her own venture, campaign or career is launched.  So for example, entertainers, entrepreneurs and artists can directly raise money through coin issuance to backers (e.g., friends, family, fans).  In fact, anyone with an account can issue their own customizable cryptocurrency, offering it to anyone else who has downloaded a Chromawallet (the same wallet used for tracking Colored Coins).  Through the JMI website, ‘talent’ can customize what kind of award to give to backers such as quarterly dividends or percentage of income, which can then provide access to wares that the talent creates (e.g., books, CDs, schwag, concert tickets).40  And by doing so, it is expected that celebrities issuing such coins could strengthen the bond with fans.  Simultaneously, these tokens can be traded on an exchange, producing real-time signals to investors and backers as to the relative strength and health of a particular talent.

While, Max Keiser, a TV host and Kim Dotcom, an internet entrepreneur have both issued ‘coins’ – MaxCoin and Megacoin respectively, these tokens do not offer much new functionality compared with existing altcoins.41 Yet projects like LTBCoin and Join My IPO will enable users to not only launch a custom token through existing infrastructure, but to redeem these tokens for actual value (e.g., concert tickets, books, dividends).

Credit score

In terms of credit scores, Nick Szabo has previously described several use-cases for leases and creditor liens whereby after a set of conditions is met (or not met); control is reverted back to the original owner.42 While cryptoledgers and cryptoprotocols currently have the ability to provide pseudonymity (and potentially anonymity through Dark Wallet and ZeroCoin), there may actually be incentives for some users to reveal their public address.  That is to say, for credit score purposes (e.g., lending), the more open you are about your transaction history, the more data a potential creditor has to gauge and quantify risk with.  Thus, in practice Bob may actually have a publicly traded account that he publicly lists (on business cards, websites) but then he may have several other digital wallets in which he actually stores all transactions, savings and revenue. Szabo observes a similar dichotomy, stating “there’s a big trade-off between privacy and developing a reputation. Long-lived pseudonyms could also be used to develop reputations, but current regulations strongly favor ‘true name’ identity.”43 Thus, while it has become standard operating procedures to use a new random address for each transaction today, in the long-run the incentives to identify at least one of your accounts may outweigh privacy concerns.

Ease of use and simplification was another common theme that investors and developers reiterated.  While those with enough technical acumen and computer savvy have become early adopters to cryptocurrencies, the vast majority of the population has difficulties in fully understanding not only how the virtual tokens work but also how to use, secure and store them.

Ease of use and discovery

Sean Percival, a tech-industry veteran who is now a venture partner at 500 Startups, explained to me that “when evaluating new startups in this space, I look at a number of criteria including the novelty of the service as well as the ease-of-use for consumers who will be able to interact with it.44 To both the developer and myself, it may be easy to download and backup digital wallets, but the vast majority of consumers do not have the time or inclination to devote to learning how this new type of bank account should work.”

In particular, Percival is interested in taking away complexity – moving the technical processes into the background making them invisible to users.  Because he works hands-on with developers on how to make UX and UI flow easier for consumers, he sees numerous opportunities for businesses to simplify processes such as the sign-up process for a particular service (e.g., online wallets).45 Or in his words, “providing a frictionless funnel that enables consumers to conduct commerce without needing a technical background.  When you swipe a credit card at a retail store a consumer does not have to pay attention to all the intermediary steps and that’s the way it should be with cryptocurrencies.”  Nick Szabo calls this point-of-sale invisibility, “smart fine print.”46

While neither he nor most of the investors I spoke with are interested in fiat-token exchanges, he is increasingly interested in business solutions to concepts like proof-of-existence (i.e., whether or not a document is in a particular file) or proof-of-storage (i.e., whether or not a computer system has a certain amount of storage available).  In his view, “building a team with the right combination of talent, leadership and marketing to build a profitable product that can be shipped in this space is the exception to the rule.  New ideas like proof-of-storage motivates everyone to rush to the door, but only a few can get in and accelerate to consumer adoption.  As a consequence, an important part of their marketing effort should be focused on user on-boarding and education that builds both trust and a “coolness” factor.  You cannot force trust and coolness, once you lose it, it is almost impossible to get back.”

I spoke with Dan Roseman who is the founder of Coinality, a job board where employers and job seekers can connect for job opportunities that pay in cryptocurrencies.47 According to Roseman, “While I was familiar with cryptocurrencies in general, it was not until about April last year that I began to look for actual business development opportunities.   I created the platform in September 2013 because I saw an unmet need in the community that other job boards did not have; receiving bitcoin as compensation. Since launching the platform, there are now over 1,600 registered members, with over 1,000 job applications received from job-seekers, and roughly 600 job submissions (openings).  While all submitted jobs are vetted by humans, approximately 95% get published and the remaining 5% are usually spam or are irrelevant.  Our team also works to find other openings on a variety of other job boards and make sure they are opened on Coinality as well.”

“While I work part-time with Coinbase in customer service, I currently work full-time on building out Coinality to be a real player in this segment.  As a consequence I have first-hand experience and direct knowledge of the kind of jobs that businesses and entrepreneurs are looking for.  Currently the single biggest demand are for C++ and Python.  C++ was the language that Satoshi originally wrote the first Bitcoin wallet in and Python is frequently used by fiat-bitcoin exchanges.  There is also a lot of demand for graphic design (logos and website layout) as well as marketing experts to help drive traffic to a site.  Thus if you have those skillsets you will likely be able to find a job in this quickly evolving marketplace.”

Roseman pointed out why employers would want to find programmers listed on Coinality.  On February 10, 2014, Mt. Gox announced that there was a bug affecting its wallet-system which could potentially enable attackers to double-spend.48 Mt. Gox was one of the largest fiat-exchanges and its announcement caused volatility in the marketplace.  Yet the bug it announced (transaction malleability) was not only a known issue, but it had been on Gox’s radar for several years (e.g., its own internal wiki had an entry for it and several core developers had pointed out this issue before).49 The problem was not with Bitcoin itself, but rather Gox’s specific (error-prone) implementation of a wallet.  Gox was originally created to handle the trading of a collectible card game called Magic: The Gathering and while the site served its original purpose, as it moved into the cryptocurrency arena its developers were unfamiliar with the needed security toolset to protect against this vulnerability.50 Thus, in Roseman’s view, “companies looking to hire developers with the necessary skillset and awareness of such exploits can be found on our job board, which hopefully will prevent such volatility-induced events in the future.”  With outstanding debt of 6.5 billion yen ($63.6 million), on February 28, 2014, Mt. Gox filed for bankruptcy in Japan due in part to its internal accounting mismanagement as well as other technical issues; its creditor’s fate is uncertain.51

Bitcloud

I spoke with Kyle Torpey, editor in chief at Cryptocoinsnews and member of the Bitcloud development team.52 Originally announced in January 2014, Bitcloud is an underlying protocol for decentralized applications that require bandwidth and storage.  According to Torpey, “the initial idea was to have a ‘cloudcoin’ through a ‘proof-of-bandwidth’ but after some investigation and internal development the economics of trying to use a coin to back a decentralized application rather than a cryptoasset would not work the way it was envisioned.  I believe Adam Levine came to the same conclusion for his own internal project LTBCoin at Let’s Talk Bitcoin.53 For instance, as you build more applications, the coin would likely appreciate in value and thus make services on the cloud more expensive due to fixed supply.  Similarly it would be hard to balance because early adopters would be rewarded for sitting on tokens instead of using them, causing a “free-rider” problem that exists in Bitcoin and other cryptocurrencies.  We have since switched frameworks and will now be an escrow service for bitcoin transactions.  That is to say, Bitcloud will be 3rd party, an escrow service for sharing storage space.  The way this will be done is through multisig transaction where you have multiple parties (Bob the storage provider, Alice the storage user) and Bitcloud is the 3rd participant, the mediator in multisig transactions.”

As discussed in Chapter 4, multisignature transactions involve two or more parties who must submit their digital keys to a certain address within a certain time frame for an action (e.g., releasing funds) to be executed.54

Torpey’s team is simultaneously building the first app that can utilize Bitcloud, “We want to build WeTube, a decentralized Youtube, which lives on top of the protocol and will launch simultaneously with it.  I should note though that WeTube is a working title.  We need to build Bitcloud first, so what we call WeTube will probably look completely different than what we have right now.  The new funding model will work through a concept called Cloudshares, where with each bitcoin transaction a user would get a share in the entire Bitcloud decentralized app (an open API).  Again, while the original idea was to use Cloudshares to monetize the entire Bitcloud network, we have decided to move the monetization process to the decentralized applications on top of Bitcloud.  So the shares that someone receives for hosting content for WeTube would be shares of WeTube, not shares of Bitcloud.  So it is really WeTubeshares, SocialDAshares, etc.  For instance, if Bob purchased storage space from Alice he would use bitcoins as the intermediary token.  In exchange he would receive a share of Cloudshares which then solves the early adopter “free-rider” problem because many adopters do not provide or generate new value as speculators.   Another way to think of is, Cloudshares is like a share in decentralized app which continuously builds the entire network.  In our view it is not a good idea to monetize the underlying protocol, because if you had shares in protocol layer then you would have to have dividends.  Or in other words, one cannot invest in Bitcloud, only in the decentralized applications built on top of it.  Thus Bitcloud is a free protocol, and we are not monetizing that aspect of it.  Because that would mean the transactions between those hosting would be more expensive.  Now, instead, we are putting the shares into the layer above Bitcloud, which will be divided by specific applications – including possibly a Facebook-like social networking service.  As a consequence, apps themselves are not centralized in one system but rather will interact with a protocol, Bitcloud.”

Coinsimple

In February 2014 I spoke with Nikos Bentenitis.  Bentenitis is the co-founder of CoinSimple, vice-chair of the education committee of the Bitcoin Foundation and also creator of the MasterProtocolEducation.org project that aims to inform the community about the Master Protocol and Mastercoin.  CoinSimple was briefly mentioned by Eddy Travia in chapter 6 and in Bentenitis’ words, “CoinSimple makes it extremely easy for e-commerce merchants to accept Bitcoin. With CoinSimple you can use any of the existing payment processors (BitPay, Coinbase, BIPS, GoCoin) and you won’t need any developer to integrate them to your e-commerce store. We have done the development for you and added customer analytics in a simple user interface.”

In terms of what may be the first use-cases of smart contracts working on next-generation platforms, he thinks that it may be, “the issuance of asset-backed cryptocurrencies that can be used to fund projects. For instance, a solar energy park can be funded with the issuance of a user-defined cryptocurrency that guarantees the delivery of a certain amount of electrical power after the park is operational.”  Similarly, he thinks the adoption rate of cryptocurrency-related apps will vary from region largely due to existing infrastructure (or lack thereof), “For people who live in the US and the rest of the developed world, there is maybe not much that crypto-currencies can do to become killer apps. But for the rest of the world, simple payments, the ones already supported by the Bitcoin protocol, when introduced in existing devices (cellphones, bank cards) would be the killer app.”

Consequently he also thinks there are untapped areas that have been overlooked, including in education, “There is so much going on in the space and even a motivated investor cannot follow the amazing opportunities that arise daily. I am certainly playing catch-up every day. Educational and research groups in the space, like the ones I am working towards with the University of Texas, the University of Nicosia and the University of Hong Kong might provide a way for investors and entrepreneurs to identify business opportunities faster.”

Bentenitis raises an interesting point regarding educational opportunities in this segment.  Just as programming languages and network engineering spawned numerous training programs (CNA, CCNE, MCSE, A+), there will likely be a similar market demand for trainers to provide developers and entrepreneurs with the skills needed to effectively utilize these new platforms.  Perhaps your firm can create a certification process for cryptocurrency or smart contract design competency.  Similarly, authors and writers may find new audiences through manuscripts published through O’Reilly Media or even ‘Bitcoin 2.0 Platforms for Dummies.’  In addition, Bentenitis noted during our conversation that MOOCs (massive open online courses) such as Udacity and Coursera could be utilized to provide knowledge and training of cryptoprotocols to a global audience.55 As of June 2012 there were approximately 2.4 billion global internet users some of whom may be interested and capable in learning more about this space.

BitPay

In February I also spoke with Stephen Pair, cofounder and CTO of BitPay and board member of the BitGive Foundation.  As noted earlier in this chapter, BitPay is a large merchant payment processor and it recently released an open-source fork of bitcoinJS called bitcore.56  According to Pair, “the idea behind bitcore is to reengerize and simplify the process of developing applications that utilize the Bitcoin protocol without having to deal with C++.  By using a virtual machine through JavaScript and node.js, it makes it easier for developers to run their code on any OS and platform, creating a very flexible process that fulfills our initial goal: to make it open and immediately usable by people. We now have 6 people working on it full-time and the goal there is not necessarily to create a specific app but to create a library for the entire community to build from.”  Node.js is a platform built on Chrome’s javascript runtime enabling developers to build and scale applications.

“In some ways this is similar to the Colored Coins project because bitcore works in conjunction with bitcoind [daemon] meaning there is no need to recreate an independent blockchain or validation process yet it enables and gives developers more functionality that does not exist today.   Insight57 is a good project to that illustrates how it has real functionality and provides real value to end-users.”

Just as web browsers were organically adopted for solving real needs, according to Pair “I think cryptocurrencies in general provide a better accounting system and level of security relative to existing financial systems that could be abused.  As a consequence, I think it is just a matter of time before mainstream adoption occurs and that there is not necessarily a “right idea” that will catalyze this.  If you look at the direction that cryptography and cryptographic accounting are heading, it will just be a matter of time before something like Bitcoin is adopted industry-wide, it just makes sense.  For instance, there is a need for secure international payment systems, especially for Africa and South America and Bitcoin provides this today.”

In terms of next-generation platform, Pair thinks that, “while there are several ambitious projects currently being developed to remove the perceived ‘ugliness’ in the current protocol, I see this endeavor as Betamax versus VHS.  VHS won out in the format war despite lower fidelity and it is possible that the new innovations which arise from the ‘2.0’ projects will be adopted and integrated back into Bitcoin.  In the past, I’ve worked on several software projects that required a team to simultaneously solve 10 to 12 hard problems, without which the underlying functionality could not be capitalized off on.  Thus, unless these teams make substantial progress on all fronts, they may be taking on too many things at one time.   In our perspective, “the perfect is the enemy of the good,” that is to say, HTTP is not as elegant as a lot of other projects that were being developed at the same time, but it is now widely used because it worked good enough – and because the other competing teams suffered from trying to make the most elegant, perfect solutions.”

Betamax was a proprietary recording tape standard created by Sony that competed with VHS, a similar yet license-free technology developed by JVC.58 Despite technically superior fidelity specifications, Betamax lost that ‘format war’ as consumer adoption was relegated to small niches.  Similarly there are multiple versions and forks of HTTP, some providing better technical specs, but the one that was adopted was considered ‘good enough.’59

Part of BitPay’s long-term focus, according to Pair is, “We ultimately would like to make it easier to create and integrate multi-signature technology.  This alone will make wallets more secure, easier to manage and ultimately user-friendly because right now for the average person it is virtually impossible to secure a wallet.  As a consequence, I think companies such as Apple and Microsoft will end up integrating wallets built into their browsers because of the current support for nodeJS and V8 within existing browsers such as Chrome.”  V8 is an open-source javascript engine developed by Google for Chrome.

Kraken

In February I spoke with Jesse Powell, founder and CEO of Payward, the parent company of Kraken.60 Kraken is a virtual currency exchange in which users can trade several different cryptocurrencies as well as fiat.61 According to Powell, “projects like Ethereum have some interesting claims and ideas that you cannot do today with other platforms.  We have also looked at others like Colored Coins and Mastercoin as well, these are all interesting concepts.  However, one of the main advantages of having a central server to trade with is that it enables high-frequency trading (HFT).  In addition, one of the reasons that Kraken currently enables trading pairs with Ripple (XRP) is that, it is easier and more robust to issue an asset because the network was built for it.”

While one of the low-hanging fruits of smart contracts is securities trading, it is highly unlikely that a professional trader would use a blockchain directly for an HFT.  For example, in most markets, especially the very liquid ones, where latencies are counted by increasingly smaller segments of time, the pace of 1 block per 10 minutes (or even 2.5 minutes) is limiting.  Currently the only way to enable this functionality is via an off-chain solution, such as Kraken, which allows users to build functionality around an internal API.62

In February 2014 I spoke with Salvatore Delle Palme, digital strategist at Kraken and founder of Ripple Federation.  In terms of immediate business opportunities in this space, in his view, “anything that connects disparate systems is a good idea. There will be a lot of opportunity in improving the interoperability between existing digital currency systems, legacy financial systems, and cryptocurrency 2.0 protocols.  Merchant integration will also take on a whole new meaning as the industry progresses.  In addition, I wrote an article a while back for Let’s Talk Bitcoin called The Archetypes of Virtual Currencies, where I said something about how popular culture would play a role in the success of some future alternative digital currencies.63 I was actually ridiculed slightly in the comments for that.  Fast forward six months and we’ve arrived at Dogecoin.  A coin based on a silly Internet meme has the third highest trading volume and the fifth highest market capitalization of the entire ecosystem!  Dogecoin proves that popular culture matters, and that there’s room for more proof-of-work coins like Bitcoin or Litecoin.  Part of the success of Dogecoin can certainly be attributed to its role as a ‘tipping currency’ with exponentially more units than Bitcoin.  It’s more fun than Bitcoin, and fun has value.”

Dogecoin is based on the same codebase as Litecoin, yet its developers took a different approach to marketing – basing it solely around an internet meme – and as a consequence, its popularity measured by a variety of metrics (network hashrate, daily transactions, reddit followers) has surpassed Litecoin.

One of the common themes of the investors, developers and entrepreneurs I spoke with is that of ‘rebooting’ the financial system, plugging it into modern technologies.  According to Delle Palme, “it’s taking a while to get the financial system rebooted on the web, but I think things will start accelerating more quickly once this trend is further along. The cryptocurrency layer is being built up nicely, but the social layer is feeble.  For example, we appear to be nowhere near being able to send money to a friend or a merchant over Facebook, let alone all of the other social platforms (although PikaPay is doing some interesting things with Bitcoin and Twitter). Eventually, a much higher level of cohesion will be achieved.”

Another area that some investors have mentioned is that a trading platform akin to e-Trade or Scottrade is currently lacking in the cryptocurrency space.  Delle Palme sees that, “Kraken’s service is optimized to be a FOREX platform for digital currencies.  Although, because we offer sophisticated security options, such as two-factor authentication and master passwords, Kraken is a great place to store digital currency.   Furthermore, I believe Kraken was built from the ground up to be immune to issues like transaction malleability.  Our developers have been aware of the issue for a long time.”  As mentioned previously in Chapter 3, in mid-February, several exchanges – most notably Mt. Gox – were impacted by a known bug called transaction malleability.  For balance, Coinbase and Blockchain.info, the two largest web-based wallets were not affected as well.

As noted above, Kraken operates as an exchange of multiple different cryptocurrencies, including XRP, the token unique to the Ripple network.  Long-term Delle Palme thinks that, “Ripple has a lot of advantages. The biggest one for me has simply been that they actually have a robust product that works. This is why I worked to bolster their community. I knew that Ripple would be successful at achieving some important things the rest of the Bitcoin community was unlikely to easily achieve, such as a distributed exchange (e.g. the Ripple system has a distributed exchange built-in) and smart contracts.   XRP is fueling the growth of a great company, and Ripple offers liquidity and innovation.  I suspect they will continue to gain support from open source communities and entrepreneurs around the world and eventually do amazing things.”  He is also looking into the potential of Ethereum as way to “marry a cryptographic asset to an original work of art, and support the value of this asset via social consensus.  In general, altcoins allow for experimentation within the crypto-mining community.  I think Ethereum will become the standard for altchain experimentation and provide many new uses-cases, such as an ‘artcoin.’”64 In addition to Namecoin, Bitcoin, Ripple (XRP), Litecoin, and Ven (XVN), Kraken recently added support for Dogecoin.

  1. This is a paraphrase from Jeff Garzik, a Bitcoin developer.   Furthermore, decentralized pools like P2Pool would help alleviate some of that concern, yet there are financial incentives for “hashers” to use larger pools that create imbalances that are discussed in Hashers are not miners, and Bitcoin network doesn’t need them. []
  2. An example is Bi•Fury from Crypto Store.  In terms of electricity, this has always been an issue even as far back as 2011, see Bitcoin Mining Update: Power Usage Costs Across the United States from PC Perspective []
  3. Other questions that need to be answered about new ASIC announcements: Has it passed verification process?  Has it been taped out?  What about maskmaking?  See: Automate and Control the Functional-Verification Process from Chip Design, Interview: Adnan Hamid Addresses Trends In Chip Verification from Electronic Design and Chip verification made easy by Laurent Fournier []
  4. See Engineering the Bitcoin Gold Rush: An Interview with Yifu Guo, Creator of the First Purpose-Built Miner from Motherboard, That Swedish Bitcoin Mining Company Has Sold $28 Million-Worth Of Its New Mining Hardware from Business Insider and CoinTerra Ships First Terahash Bitcoin Mining Rig from CoinDesk []
  5. Butterfly Labs Announces Next Generation ASIC Lineup from PRWeb []
  6. BFL ASIC Status from Butterfly Labs and Butterfly Labs Shipping Still A Year Behind, Broken Promises from igotbitcoin []
  7. Personal correspondence, November 30, 2013 []
  8. Martin Meissner recently brought a lawsuit against BFL over a similar issue, for failure to deliver on two 1,500 GH/s miners he paid $62,598 for which he allegedly never received.  See Butterfly Labs Faces $5m Lawsuit Over Unfulfilled Order from Coindesk []
  9. Difficulty rating for Bitcoin adjusts every 2016 blocks or roughly every 2 weeks. See Bitcoin mining profitability calculator []
  10. Contrary to popular myth Sears & Roebucks did not exist at this time and in fact was founded much later in its modern form in 1893.  It was Richard Sears’ father, James who went to California during the gold rush and failed to “strike it rich.” []
  11. Or ‘fragile’ as Nassim Taleb would likely classify their predicament (as opposed to anti-fragile); (video). []
  12. I have written several articles on how to build and use Scrypt-based mining systems, see: 12 Step Guide: Easiest and fastest way to start mining Scrypt-based tokens for Litecoin and Dogecoin and Should you buy an Alpha Technology ASIC for Litecoin mining? []
  13. This Pizza Cost $750,000 from Motherboard []
  14. Shelling Out — The Origins of Money by Nick Szabo []
  15. BitPay also includes functionality that allows users to synch and import bitcoin sales into Quickbooks.  Another example of integration and adoption was in March 2013, Expensify added support for Bitcoin payment which allows companies to reimburse international workers with bitcoin.  See Import your Bitcoin Sales into Quickbooks from BitPay and Expensify Now Offers Support For Bitcoin, An Alternative To PayPal For International Contractors from TechCrunch []
  16. BitPay Exceeds $100,000,000 in Bitcoin Transactions Processed from BitPay and BitPay Announces Bitcoin Payroll API from BusinessWire []
  17. Gyft doubled its accepted locations in six months during 2013.  See Gyft Launches Rewards Platform to Give Consumers Up to 3% Back on Gift Card Purchases from PRNewswire and  Gyft Opens Bitcoin Acceptance to 50,000 Merchant Locations from PaymentsSource []
  18. Shopify Merchants Can Now Accept Bitcoin from Shopify from Shopify []
  19. In First Day With Bitcoin, Overstock Does $126,000 in Sales from Wired and Here Is What Bitcoin Users Are Buying On Overstock.com from Forbes []
  20. Tiger Direct Processes $500,000 in Bitcoin Payments from Josic []
  21. A Major Coinbase Milestone: 1 Million Consumer Wallets from Coinbase []
  22. Games Giant Zynga Starts Playing With Bitcoin from CoinDesk []
  23. See Humble Bundle now accepting Bitcoin using Coinbase bitcoin merchant tools from Coinbase []
  24. Formlabs releases PreForm 1.0 and begins accepting Bitcoin payments from The Verge. I f you would prefer someone else print your 3D wares, individuals can patronize CryptoPrinting. []
  25. 200,000 Hotels Now Accept Bitcoin Through Online Travel Agency CheapAir from CoinDesk []
  26. BitPay Drives Explosive Growth in Bitcoin Commerce from BusinessWire []
  27. Even if a company is not necessarily interested in becoming involved within the cryptocurrency community, it is relatively easy and straightforward for a merchant to accept bitcoin as a payment option.  In less than 15 minutes a merchant could download a plugin from Coinbase or BitPay and the transactions will move seamlessly through the store. []
  28. BTCJam []
  29. Credit-card debt may threaten Brazil’s boom from Bloomberg Businessweek []
  30. While credit would likely still be cheaper in developed countries, because interest rates are centrally planned by various institutions, this creates distortions in time-preferences for market participants (e.g., zero-interest rate policies encourage the usage of capital instead of the accumulation of capital; risk is subsidized by one or more parties).  See The Theory of Money and Credit by Ludwig von Mises []
  31. FICO is an acronym for Fair, Isaac and Company.  In 1989 this firm created a rating system that is used by the largest credit reporting bureaus (e.g., Experian, Equifax and TransUnion). []
  32. 2013 LexisNexis True Cost of Fraud Study []
  33. US P2P Lenders Issue $2.4 Billion in Loans in 2013 from Lean Academy []
  34. Bitcoin is far more than a currency for speculators from Financial Times and Riding the wave of global transaction services and payment systems from IPFA pgs. 11-12 []
  35. Evr.gr []
  36. See BankToTheFuture.com and Equity Crowdfunding – Building The Bitcoin Infrastructure from IamSatoshi []
  37. See Kickstarter Coins and LTBCoin by Adam Levine.  In some ways, this is also a cryptographically controlled process to subsume penny-stocks and over-the-counter instruments.  Other hypothesized tokens include ‘couch surfing coins’ and tokens representing digital assets in games such as EVE Online and World of Warcraft. []
  38. Ibid []
  39. Join My IPO []
  40. FrostWire, a company that makes BitTorrent software, recently integrated Bitcoin, Litecoin and Dogecoin into their software.  Users can directly donate and support content creators.  See Bitcoin Donations Now Integrated into BitTorrent Client from TorrentFreak []
  41. MaxCoin and Megacoin []
  42. The Idea of Smart Contracts by Nick Szabo []
  43. Personal correspondence, January 24, 2014 []
  44. I interviewed him on February 6, 2014.  See also ‘500 Startups’ Recruits Ex-MySpace VP to Mentor Bitcoin Businesses from CoinDesk []
  45. UX means ‘user experience’ and UI means ‘user interface.’ []
  46. Smart Contracts by Nick Szabo []
  47. Coinality and 12 Days of Bitcoin: Get Paid in Bitcoin from Bloomberg []
  48. Is this “transaction malleability” really an issue? from StackExchange []
  49. Contrary to Mt. Gox’s Statement, Bitcoin is not at fault by Gavin Andresen and Mt. Gox Blames Bitcoin – Core Developer Greg Maxwell Responds from Cryptocoinsnews []
  50. Bitcoin Exchanges Under ‘Massive and Concerted Attack’ from CoinDesk []
  51. The story is likely more complex and details are still forthcoming.  See Unilateral Statement Regarding Mt. Gox from an Insider by Jesse Powell, Inside Japan’s Bitcoin Heist from The Daily Beast, Mt. Gox Exchange Files for Bankruptcy from Bloomberg, Mt. Gox files for bankruptcy, blames hackers for losses from Reuters and The programming error that cost Mt Gox 2609 bitcoins by Ken Shirriff []
  52. The development team has published a public wiki describing the specifications and functionality.  See Bitcloud Project []
  53. Adam Levine has been working on an interesting side project involving reputational callable tokens.  See Kickstarter Coins and LTBCoin []
  54. A recent public example of multisignature transaction is from the Bitcause initiative to provide humanitarian aid to Ukrainians.  The three key holders are Edan Yago, Ron Gross and Elizabeth Ploshay.  See Bitcause and Only Bitcoin can reach them! []
  55. In addition to Udacity and Coursera, readers may be interested in projects like Khan Academy, CodeAcademy and Duolingo. []
  56. Introducing Bitcore from BitPay []
  57. Insight.bitcore.io []
  58. The Betamax vs VHS Format War from Media College []
  59. HTTP 2.0 is currently in the standardization phase at this time. []
  60. Kraken []
  61. Once a user has been authorized, one of the unique features of Kraken is that they can eventually conduct leveraged and margin trading. []
  62. While the latency and logistical issues are being discussed, the Open-Transactions (OT) project attempting a different approach to HFT through the ability to create ‘centralization’ via federated servers and ‘voting pools’ – essentially there would be off-chain exit nodes that transfer to HFT clusters. []
  63. The Archetypes of Virtual Currency by Salvatore Delle Palme []
  64. The Ephemeral Artcoin by Salvatore Delle Palme []
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Chapter 6: Fundraising Landscape

[Note: below is chapter 6 to Great Chain of Numbers]

According to CB Insights, venture capital (VC) firms spent $74 million across 40 Bitcoin-related deals in 2013; the two largest rounds were Coinbase ($25m) and Circle ($9m).1 Similarly, Garrick Hileman recently published data and found that roughly $97.5 million in VC funding went towards 36 Bitcoin-related startups during the same time frame and his findings are discussed below.23

Despite the increased media attention, even if these numbers are repeated again this year this may not help boost the performance for some VC funds.4 Even with the optimistic outlook many of the VC firms apparently now have their actual results at roughly 6.2% per annum over the past decade they have underperformed the Russell 2000.56 Why?  This is not to disparage the VC segment, rather like all industries some VCs are not as nimble at feeling and filtering out business models with revenue generating capabilities as many angel investors are.

Changes over Four Decades

Consistent with the theme of ubiquitous adoption of open-source software as well as cloud computing that has lowered the cost of developing software and (more importantly) the costs associated with launching new companies, so too has this trend lowered the threshold for technology for startups and investments.  Where previously the funding of start-ups was limited to deep-pocketed professional investors, namely VCs, the deflationary landscape has increasingly enabled greater numbers of individual investors – angels – to compete in the funding environment.

The new class of angel investors is more astute than the passive and non-tech-savvy high-net-worth investor of yesteryear.  Increasingly, angel investors today have deep domain experience.  Many have worked in the sector that they are funding, are entrepreneurs and experienced operators themselves and visionary at feeling out new business and innovative trends.  The historical barrier to entry for angel investing is one of risk quantification (followed by knowledge and coordination) given the magnitude of investment commitment.  With lower costs of starting businesses, this hurdle is largely gone.  Having angels with deep operational domain expertise is disruptive to the traditional VC universe.  They may be better attuned and friendlier with terms that are less predatory than the historical VC norm.

This is not to say that VCs will not flourish once again, however, as it stands, most angels began as entrepreneurs and learned how to generate sales and revenue firsthand.  Furthermore, as noted above, over the past decade technological costs have driven down expenses.  For example, relatively cheap cloud services like github and Compute Engine provide services (CaaS, SaaS and IaaS) that allow many tech start-ups to be leaner than before in terms of what funding they require to cover operating costs.7 On top of this are better organized angels who now have an entire ecosystem of choices to fund through such as AngelList, 500 Startups, Plug and Play, Y Combinator, SVAngel, Bitcoin Opportunity Fund and Boost.8 In fact, over the past six months, BitAngels.co have invested $7 million in 12 crypto-related projects globally and Plug and Play is providing both mentoring and seed funds of $25,000 to bitcoin-related ventures.9

Another way that cryptocurrency-related startups are being funded is crowdfunded IPOs.  This includes Mastercoin, which raised (at the time) $5 million in part by 4,700 bitcoins from “investors.”10 NXT and the upcoming Ethereum IPO have also included raising funds through bitcoin transfers.11 While I am not necessarily endorsing any of these particular fundraising models, this illustrates how small (and perhaps large) development teams can financially cover costs without seed funding by VCs.  And, in addition to crowdfunding sites like Kickstarter and Indiegogo, there are also sites that allow individuals to receive Bitcoin funding directly for their ideas, such as BitcoinStarter and CoinFunder.12

Consequently, it is premature to write off VCs or claim that angels are the only source to pool funds from.  In fact, a substantial amount of series funding over the course of the last two years in the Bitcoin realm has been from VC firms.  For example, Andreessen Horowitz has invested nearly $50 million in Bitcoin-related startups, including leading the $25 million round for Coinbase last fall.13 In February 2014, Marc Andreessen – the firms founding partner – explained to CNBC that,

“[Bitcoin] is mostly new opportunity.  For example, there is a lot of ecommerce today that just doesn’t happen because a lot of people around the world literally aren’t in modern payment systems where they can’t pay for anything.  There are a lot of merchants that can’t be profitable in a lot of categories because transaction fees are too high.  It’s a huge opportunity and everybody has the opportunity.  Bitcoin is an open technology, it’s open source, it’s freely available – anybody can participate.  So every established business that wants to take advantage of it, including people like Western Union, can do so.”14

While it is too early to predict how these investments will exit, VCs are still a potent market force.

Venture Capital Charts

In addition to the findings of CB Insights above, below are four charts reprinted with permission from Garrick Hileman which were originally published on February 24, 2014:15 charts 1

 

As Chart 1 (or rather Table 1) notes, this is the total of the known venture capital funded Bitcoin-related companies globally since 2012.

Chart 2 illustrates the division of what specific segments those companies are categorized under.  In his analysis, Hileman noted that mining hardware companies have generated over $200 million in revenue to date.  The unknown segment is for undisclosed projects that received VC funding.

charts 2

Chart 3 illustrates that as a percentage of the total VC funds, what geographical location they are located.16 Silicon Valley (i.e., the San Francisco Bay Area) based firms have received the lion’s share, at 51%.

To produce Chart 4, Hileman looked at the total value of the VC-funded projects ($97.5 million) and the chart shows the geographical dispersion of these funds; US firms received 70% of those funds.  While these numbers will likely continue to increase over the next year, it is unclear if the geographical trends will continue.17

Straight to the Source

Jeremy Liew is managing director at Lightspeed Venture Partners, which has invested in several startups in this space, including Ripple and BTCChina, and anchored the Boost BitCoin Fund.18 According to him, “I think that there are three use cases that will lead math based currencies to mass adoption. 1) Microtransactions (perhaps for online content, perhaps for digital goods in games) which are impractical using credit cards; 2) Cross border transactions (both C2C as in remittance, and B2B for import/export and ecommerce) where transaction fees are high; 3) Leapfrogging credit cards for ecommerce and m-commerce purchases in the developing world.  The developing world leapfrogged fixed line telephony to go straight to mobile telephony and that is the model that I would anticipate for math based currencies leapfrogging credit cards. Today a common form of payments for ecommerce in Russia, China and India is “cash on delivery” and that likely is the first payment method to be replaced by a math based currency.”

In terms of what specific segment of this space LSVP is interested in, “We are still in the infrastructure phase, making math based currencies easier to buy (exchanges), hold (wallets) and spend (payments). And of course to speculate on. The infrastructure will need to mature a little more before applications can be built on top of them to be able to drive mass adoption. Then it would be the three themes from earlier.”  Yet as to trying to predict which platform or what technology like smart contracts will spring forth, “I don’t know, all I know is that it will be exciting and transformative. Just as no one could predict the explosion of uses that got sparked by VoIP when we were still on POTS, so too it is impossible to predict what the “programmable” part of math based currencies will bring.  But it will be awesome.”

He raises a visceral point about unexpected innovations and their knock-on effects; Skype calls alone are now equivalent to one-third of all global phone traffic, providing new tools and lower transaction costs to every demographic group.19  Similarly, digital goods such as music, movies, games and books – a market that barely existed a decade ago – is expected to reach $80 billion in turnover by 2015 in the United States alone.20 In fact, according to Ofcom, 11% of American internet users regularly pay for digital online content.21 During my exchange with Mike Hearn, he expressed similar sentiment in terms of the untapped business opportunities in this space, noting that “right now it seems there are a billion startups exploring every possible angle on these ideas – most of the work that needs to get done though is fairly boring infrastructure type stuff.”  Laying the foundations for these platforms could be a business opportunity for the next several years.

As mentioned in chapter 2, Ryan Orr is a professor at Stanford University and chairman at Zanbato that is a partner in a new crypto-based incubator called CrossCoin Ventures.  He noted that, “with the recent wave of regulatory actions, I am personally feeling quite excited about how the “smart property” projects evolve in 2014.   It is starting to feel like smart property could be a much lower path of resistance for the bitcoin protocol as it establishes a “non-monetary” form of use that fulfills a valuable social purpose.  And thus it should not be viewed as a direct threat by regulators who are afraid of losing monopoly control of money. It is the “duality” of purpose of gold, where people can hold it under the auspices of non-monetary purposes, but also hold it for monetary purposes (eg. a hedge against inflation), that makes it so difficult for the governments to totally eliminate it as a form of money (even though the US government did try to do so in 20th century).  If bitcoin can develop a similar duality, where the ‘smart property’ use makes it legitimate, and then people also can secretly hold it as an uncorrelated hedge against government dysfunction, then that could be pretty interesting.  In sum, it feels like the ‘smart property’ could become the ‘formal, legal, legitimate’ face to the project that can develop independent of how the regulators rule on the use of Bitcoin for monetary purposes.”

What Angels Are Looking For

Jeremy Kandah, Managing Partner at BitAngels, is now leading a fund focused on decentralized applications that utilize cryptoledgers.  He argues that, “the new “2.0” protocols and projects like Mastercoin and Counterparty are the equivalent of computing languages such as Java and C++.  Today there are hundreds of computing languages but only about a dozen that serve as platforms for large billion dollar ecosystems.  If you are platform dependent you are selling yourself short and risk long-term vendor lock-in.  Nearly all of the projects in this space are open-source for a reason, as it allows portability to other cryptoledgers and decentralized platforms.  Open-Transaction (OT) is a good example of this as their toolkit and codebases are entirely open-source and as a consequence even if a fork were to happen with the Bitcoin protocol, which I am not saying there would be, but both the developers and users of that OT application could quickly migrate to another cryptoledger.”

Kandah explained that while there is a debate over whether or not Bitcoin itself is the TCP/IP foundation for the cryptocurrency world, there will still need to be a lot of infrastructure extensions built to enable the decentralized applications that these “2.0” projects propose to build.  This means that there is a continuous need for both developers and entrepreneurs to build start-ups and business models to bring value to the marketplace.  As he notes, “while I am ledger agnostic, there may be even a profitable way to utilize Namecoin’s functionality, especially since it uses merged-mining with Bitcoin and thus the transaction and confirmation network already takes care of itself.”

Ultimately he sees significantly greater decentralization and uses for user-defined virtual tokens and that entrepreneurs providing value in this way will increase utilization rates for the entire ecosystem as a whole.  According to him, “during our due diligence phase, when we look for value-added business models we look for teams that address a current market need and provide new solutions that are easy for the average consumer to interface with.  For example, there is likely a way to ‘gamify’ – to streamline how mesh networks can operate and interact with mobile devices connected to a cryptoledger, allowing a decentralized internet infrastructure to be built ad hoc across nearly any city.  Similarly, just as Uber and Lyft have decentralized the taxi industry, perhaps there is a way to utilize cryptoledgers and trustless asset management to provide package delivery services in a profitable manner yet competes with the level service from FedEx.”

Another analogy both Kandah and David Johnston mentioned was to keep in mind that while there have been newer versions of HTTP, the perfect is the enemy of the good, that mind share and the network effect behind a protocol is difficult to reproduce and ultimately funds like BitAngels are looking for teams that understand the value proposition (e.g. promise to deliver and create value) for customers.22 Customers who are more interested in security, safety and reliability of the applications that utilize a token exchange system and not necessarily the nuts-and-bolts of how a cryptoledger platform works.

In addition, I also spoke with Ben Davenport, an angel investor and a member of the monetization team at Instagram.  While he does not necessarily endorse one specific project, in his view, “colored coin technology allows such centralized assets to be traded in a completely decentralized way.  Every single equity in the world has a central issuer — the company itself. But imagine the power of being able to make a trustless trade of stock for bitcoin with a stranger, at a distance, with no 3rd party involved. With colored coins, I can construct a single atomic transaction which encodes such an exchange. That, to me, is the most important basic thing that colored coins can enable.”

Hakim Mamoni, co-founder of Seedco.in and founder of DealCoin, an in-person Bitcoin exchange platform, takes a similar view, arguing that “the true story of Bitcoin is that it is part of a larger decentralization movement that illustrates how humans are better at organizing themselves than previous systems.23 While ‘civilization’ has existed since the founding of Sumeria in 4500 BCE, generally speaking we have had the same type of top-down pyramidal structure reproduced year after year.  Even after the American and French revolutions, the communities adopted previously existing centralization methods because they had pigeons and horses and not the technology we have today.  Now we finally have the technological capability to reboot centralized systems and voluntarily self-organize.”

One specific problem he describes that could be mitigated and changed is the role of central banks.  “If you look at a person’s resume and you see a poor track record of past performance you would likely not want to continue with that member on your team.  And in looking back since the early 1900s, given the goal of creating stability, none of the central banks have done very well.  Thus for me, Bitcoin is the current killer app – Bitcoin wallets enable anyone to send money to anyone around the world enabling people to be their own bank.  Eventually other projects will create some featureset and functionality on top of that and we are currently moving towards exciting developments with projects like Ethereum, not just in changing traditional banking but in other ways to decentralize other systems such as telecommunication networks, food production and even energy production.”

Wireless mesh networking is a method for decentralizing telecommunications by enabling each node to relay data for the network.  Projects like Commotion and XORP are working towards providing end-users with decentralized wireless functionality.24

Mamoni also finds projects like Open-Transactions exciting, “I really like the ideas behind OT because users do not have to trust the server as contracts can move from one server to another in an encrypted manner.  Governments were designed and set up to help protect against bad actors cheating the system.  Yet if you merge governance with the new paradigm of these technologies, there is no need for these legacy regulations because everything is out in the open, everything is done by algorithm and mathematics.  Thus eventually I think regulators will likely embrace these types of technologies because it prevents fraud.  Consequently, Seedco.in is looking for a diverse array of startups that not only helps strengthen and grow the cryptocurrency ecosystem in general but provides bridges to the existing financial structure.  It cannot be done overnight and we believe there is a lot of value during this transition period.”

Another example that Mamoni sees as a use-case for a blockchain is for financial institutions that create the daily London Interbank Offered Rate (LIBOR).25 LIBOR is an interest rate average that leading banks in London estimate they would be charged if they borrowed from other banks and is published daily at 11:30am.  In 2012, a scandal arose in which it was discovered that member banks were manipulating the rate behind closed doors.  Yet according to Mamoni, if each of these trades were placed on a blockchain, the rate would be impossible – or at least more difficult – to game or rig as the blockchain is both secure and transparent for everyone to see.

Non-profit organizations and NGOs could also adopt cryptoledgers for similar transparent asset tracking.26 According to the Tampa Bay Times, of the $1.4 billion in donations received over the past decade, the 50 worst charities in the US spent roughly $970.6 million on solicitors.27 A public cryptoledger would give donors the ability to audit the charity in near-real time.  Coupled with a DAO, much of the administrative overhead at non-profit organizations (e.g., payroll) could be replaced entirely by AI.

This transparency could be utilized in other countries as well.  For example, on May 12, 2008, approximately 69,000 people were killed during the deadliest earthquake in China for the past 30 years.  Subsequently, aid and donations (totaling $11.2 billion) from around China and the world poured into Sichuan, the epicenter of the disaster zone.28 Yet after the dust settled, several investigations discovered that various organizations and institutions had siphoned off tens of millions of dollars due to a lack of transparency and accountability.29 The Red Cross Society of China (RCSC) itself failed to collect the funds donated to drop boxes placed throughout several hundred locations around China – four years after the quake.30 Cryptoledgers could be used to track donations and assets of a non-profit organization, reducing fraud and providing real-time transparency and auditing.  In fact, as noted in chapter 5, much if not all of the administrative overhead (e.g., paying bills, receiving donations) in such organization could potentially be replaced by a DAO.  This is discussed further in chapter 8.

In January I also spoke with a marketing manager for a San Francisco bay area accelerator that is looking for early stage startups that use the Bitcoin protocol within the verticals of software-as-a-service enabled tax and accounting solutions as well as smart contracts (SaaS enabled Wills, parameter-based or DACs-like business-to-business partnerships).  Or in other words, solutions that focus on small-to-medium businesses as well as consumers.

What was unique about the conversation was that they were interested in accounting solutions that involve the full cycle of automatic transfers to tax filing, which only one other group specifically mentioned and thus may be an undervalued niche.  Altogether this would involve project management compensation via cryptocurrencies which is a topic discussed in chapter 7 related to Coinality.

The manager also had confidence in decentralized autonomous corporations (DACs) seeing them as the wave of the future.  His teams thinks that the ecosystem will eventually outsource a majority of tasks normally allotted to many job types but specifically: accounts payable, accounts receivable, tax, other accounting processes, remittance (varying roles), emergency response (fund distribution), community investment (i.e., local school measures), REITs (community-based real estate investment), and community property management (lease interpretation for automatic service calls).  Thus building a company that focuses on designing DACs in those spaces will likely attract the attention of both outside investors as well as potential clients.

Asia

I had an email exchange with Zennon Kapron, founder and managing director of Kapronasia, a large independent research consultancy focusing on the Asian financial services industry.31 Based in Shanghai, Kapron has continual first-hand experience of the mainland marketplace.  According to him, acceptance applications are and will remain very important especially in Asia.  Right now, acceptance of any cyrptocurriences is still low outside of a few niche geographic areas. Why do more people have a Visa than an American Express?  Largely acceptance – Visa is just accepted in more places. Especially in Asia, the point-of-sale and merchant solutions similar to BitPay are very thin on the ground.  In addition, even with the myriad of exchanges out there, there are only a few that I would consider user friendly. Most require wiring money, which the average consumer might not feel comfortable with. Coinbase is an interesting example of an exchange that might have it right: you can link your bank account and make ACH transfers very easily.  That comfort is very important for at least the initial adoption of cryptocurrencies, however once the larger population has a balance of cryptocurrencies and acceptance is higher, the need to move into fiat currencies will of course be lower, so exchanges are not as important.”

While BitPay, BitPagos and BIPS have come to dominate large portions of the Bitcoin-based merchant ecosystem, aside from YesBTC.co, a Chinese or even Asian-based equivalent has not yet arisen to the same level.  Part of this has to deal with language and cultural barriers as Kapron noted and because not many websites use or accept cryptocurrencies in Asia, specifically in China due to legal issues.  In fact, after the People’s Bank of China statement on December 5, 2013 regarding the banning of payment processors for cryptocurrency exchanges (and categorizing cryptocurrencies as commodities instead of as a currency), ecommerce giant, Taobao, announced that it would no longer allow stores on its platform to buy, sell or trade in wares related to cryptocurrencies.32 Despite these hurdles it is likely that there are still opportunities on the edges in this segment.33 Furthermore, ACH is an electronic financial network in the US – even though it processed 21 billion transactions in 2012 worth a total of $36.9 trillion – according to entrepreneurs there is still scope to compete on the margins, and among the underbanked.

Continuing, Kapron notes that, “Asia is behind the West in terms of cryptocurrency applications and solutions so startups focused on ‘big’ solutions like exchanges, point-of-sale merchant solutions still have viability in Asia as, outside of exchanges in mainland China, the market for these applications is far from saturated.  There may be a number of start-ups running in stealth-mode that are developing these solutions, however, besides exchanges, there have been few if any public launches or investments in cyrptocurrency start-ups.  Of course some of the smaller solutions (e.g., tax-auditing plugins, bitmessage, twister, syncnet) also will have a market, but the larger solutions like exchanges and merchant acceptance solutions still have a big opportunity.”

Bitmessage and Twister were briefly mentioned in chapter 3; while technically feasible, it is unclear how policy makers will react to domestic businesses that develop anonymous and pseudonymous communication tools.

In terms of smart contract and next-generation platforms, “the technology ideas and algorithms behind the current batch of cryptocurrencies are ideal for potential smart contracts and other ledger applications. These would likely also be easier to implement as they would not necessarily need to be global, but could be limited to a smaller geographical area.  For example, you might have a real-estate focused ledger just for London or just for Paris.  Because of the limited geographical area, these would have fewer government and regulatory approvals and governments could also be involved in the creation and maintenance of the smart contracts without weakening the appeal of the system.  In other words, one of the primary goals of Bitcoin and other cryptocurrencies is that they can operate without government influence which many people believe has caused some of the current economic issues (e.g. quantitative easing in the US artificially supporting US exports through a cheaper dollar).  That would not be such a concern with smart contracts as long as there was a trust that the government would act in the best interest of the people.”

As noted by Preston Byrne in chapter 2, it is possible that institutions and organizations including governmental departments could build and maintain cryptoledgers to replace redundant functionaries.  A speculative way a central bank could utilize one is through a ‘proof-of-burn’ (POB) method described in chapter 3.  Just as the East German Mark (Mark der DDR) was converted and exchanged into the West German Deutsche Mark prior to reunification, the Banco Central de la República Argentina (central bank of Argentina) could one day declare that it was “issuing cryptotokens” to prevent the debasement of the peso.34 The BCRA could ask peso holders to convert their holdings into cryptopesos.   During the conversion process the physical pesos are recycled or destroyed and subsequently the virtual tokens are then tracked on a public ledger preventing double-spending and inflation as described by Wences Casares and Sebastian Serrano in chapter 2.  The likelihood of this type of adoption is of course debatable.35

While the People’s Bank of China is currently reviewing its policies involving cryptocurrencies, according to Kapron, “regulation will still drive the integration of and opportunities in cryptocurrency throughout the region.  Hong Kong and Singapore are typically known as some of the more entrepreneurial hubs in the region in terms of payments and financial technology in general.  If we draw generalizations from Bitcoin, the indications from regulators in both countries are very positive for cryptocurrencies and so it is likely that we will continue to see both innovative solutions for and acceptance of cryptocurrencies in both Hong Kong and Singapore.  In many respects this is great for the region as although both countries have large economies, they are still relatively small, both from a geographical and economic perspective, so almost similar to a free trade zone in China, Hong Kong and Singapore could end up being test-beds for cryptocurrencies. China already does this with Hong Kong for the financial industry in general, by the allowing the Hong Kong financial sector to innovate and change even though the mainland remains somewhat constrained. In addition, both Hong Kong and Singapore have a long history of country-wide payment innovations like EZ-link and Octopus which have largely thrived for many of the same reasons why cryptocurrencies also could.  The larger economies from both a population and economic size perspective like China and India will likely follow what happens in Hong Kong and Singapore as the risks for the larger economies are much higher, especially as both economies have capital controlled currencies. Smaller economies, especially those in Southeast Asia, have enough economic and political challenges and less influence in Asia’s overall economy, so will not likely influence integration.”

Over the past three decades, China has created 15 “special economic zones” (经济特区) that are allowed to set their own import regulations and duties and as a consequence are relatively popular for establishing joint-ventures and foreign trade operations.  Beginning last year, several other municipalities including Shanghai began laying the groundwork for ‘free trade zones’ which will create testing grounds for new economic reforms that are expected to further liberalize the financial sector.36

In January 2014 I interviewed Rui Ma, a Beijing-based angel investor with 500 Startups, a business accelerator which has invested in a number of Bitcoin-related startups including Bitdazzle and BTCJam.37 In her opinion, “cryptocurrencies are a solution to crossborder microtransactions as they provide business opportunities in segments that have been completely overlooked by the traditional banking sector.  I think mobile payments in particular are interesting for everyone – especially emerging markets – because internet finance has made large gains over the past year in China due to a lack of consumer (and small-medium enterprise) financial products in general across the board.  Though, this is not a business one or two angels can probably scale alone due to capital expenditures for traditional payment mechanisms but I am certainly interested in services based on top of infrastructure, and Bitcoin is pretty ideal for that.”38

Due to strict capital controls it can be difficult for high-net worth individuals in China to diversify abroad.  This issue is compounded with a dearth of domestic financial instruments in part because the country is still developing and because its financial sector is essentially oligopolistic (e.g., dominated by large state-owned banks).39 As a consequence it has been technology companies such as Alibaba and Tencent leading the way, creating innovations in the consumer market such as providing mobile-based mutual funds and 3rd party payment processing services.  For example, last year Alipay began offering a low-cost mutual fund (called Yu’E Bao) through a partnership with Tianhong (a Chinese asset management company).  With $42.6 billion in its fund and 49 million customers, Yu’E Bao has grown to become the 2nd largest mutual fund on the mainland.40  In January 2014, Tencent, the largest internet company in China unveiled a partnership with China Asset Management, the largest mutual fund manager in China to provide a similar service called Licaitong.41 Tencent has simultaneously integrated Licaitong with WeChat, the fastest growing social networking service globally, (with more than 600 million registered users).42 Tencent is also the parent company of QQ, which develops the biggest social media platform in China, with 816 million monthly users.43

Ma recognizes these market trends and changes and how cryptocurrencies like Bitcoin can play a role in.  Noting that “another issue in the mobile segment globally (not just in China) is payment infrastructure, which current protocols do not match up to the development and proliferation of devices and content and goods for consumption. Now that we can manufacture and distribute smart devices relatively cheaply and the data infrastructure is expanding rapidly, it is time for payments to catch up.  And this is where I think there is a lot of friction (e.g., institutions, old infrastructure, policy) that can be decreased, removed and even erased with cryptocurrencies, which are more secure, speedier, cheaper; and due to these three main benefits, much more scalable.”

I also spoke with Jack Wang.  Wang is a cofounder of a Bitcoin startup called Dearcoin that is developing consumer Bitcoin applications, including Bitpass, a Bitcoin-based authentication protocol.  He previously developed a Bitcoin exchange and merchant tool and has taught a Bitcoin class for General Assembly.44 He says that he likes “the concepts embodied in applications such as ‘colored coins.’ The biggest innovation that Bitcoin represents is a distributed, verifiable ledger system, and its use as a currency is just the first application.  In thinking through some ways in which Bitcoin develops, I believe there are multiple potential killer applications for this kind of system, especially as we move into an age in which 1) digital property becomes increasingly valuable and 2) verification of rights to all kinds of property becomes digitized.  If Bitcoin becomes the de facto system for digital property rights verification and management, the value extends way beyond just as a currency.”

Wang explained this by analogizing Bitcoin to the frequency spectrum in the wireless industry.  Where the ability to propagate and record digital rights onto the blockchain will depend on ownership of bitcoins, bitcoin owners can be thought of as owning these rights.  And according to him, “the applications can include anything that involves rights verification – contracts, stocks, titles to houses and cars, actual keys to houses and cars, digital files (music, art, etc.).  Longer term I see the fungibility, transferability, and divisibility features of cryptocurrencies replacing the use of fiat money in a lot of ways.  People cannot barter today because it is infeasible to trade a car for 5,000 sandwiches, but you can do that with cryptocurrencies even if they are not just just as a currency but as a colored coin or something similar.  Maybe we should start calling it cryptobarter.  This opens up a cornucopia of business opportunities and consequently, once cryptocurrencies are used for things besides fiat exchange, older institutions and business models are really in a bind.”

The problem, of course, is getting enough people to adopt the technology so that it can serve as a useful medium for these transactions.  Eddy Travia, based in Hong Kong, is the founder of the Bitcoin Institute and co-founder of Seedcoin which is the world’s first seed-stage Bitcoin startup virtual incubator.45 And he has some ideas about how this could be done; the areas he and other angels at Seedcoin are looking for are “any application that makes exchange clear and simple to end-users, like Hive which is a bitcoin wallet with built-in applications.46 Another area is for development teams to find out what people know and use regularly in their daily lives, for example CoinSimple will make it easier for merchants to switch among various payment processors, from BitPay to GoCoin to BIPS to BitPagos and other market players.47 So it means more merchants can accept bitcoin and thus more clients can use their services and seamlessly use any bitcoin payment processors chosen by the merchant.”

Travia adds, “we are also still busy helping basic infrastructure in certain countries, like a solid bitcoin exchange in Mexico (MEXBT) so once that part is done (exchanges and payment gateways available around the globe) the potential user base will grow significantly larger.48 It still needs to expand so that more and more entrepreneurs have a market large enough to support the investment into their applications and also have locally customised apps (language, regulations, etc.).”

He continues, “Bitcoin is also at the intersection between finance and technology so it will not be as easy as “email” or Android; local regulations and laws have to be considered.  When it comes to mass adoption, there are always laws taken into consideration.  Consumers are used to it with banks, mobile operators, credit companies because we do not bother reading the fine print anymore on all the contracts and thus there will likely be fine print with bitcoin services as well – people will have to get used to it.  Armed with this knowledge and understanding, Seedcoin is a channel for angel investors in a way, but also enables small players to become angels and invest into these companies.”

Potential business opportunities

While many users and commentators have been relatively fixated on one data point, one use-case, arguably, where the long-term Christensen-disruption and Schumpeter’s “creative destruction” will come from is trustless asset management.

The question for entrepreneurs and businesses is, as everywhere else, what are the unique value opportunities you can provide?  Business analysts experienced with requirements gathering may find opportunities designing and creating specifications for a smart contract for specific needs.  Similarly, programmers will be needed to take the design and implement and translate it into code in accordance with applicable regulation.  Commercial lawyers will be drafted in as advisers to draft and negotiate the contracts and review the code, perhaps even following through the steps originally synthesized by Nick Szabo fifteen years ago.49 Yet be aware that long-term, if history is a guide, it is likely that some of these smart contracts could eventually become open-source – and standardized – and thus alternate revenue streams will need to be found.50 When I put this question to Nick Szabo, he said that “traditional contracts are already typically treated by the legal community as open source rather than as copyrighted. The vast majority of contract clauses are boilerplate and I hope the same will be true for smart contracts code.  And in the cryptocurrency community (or more broadly speaking, the block chain community) we should not trust code that is not open source.”51

In fact, there is already an initiative called Algorithmic Contract Types Unified Standards (ACTUS) that is attempting to create a standard language and contract-centric framework to represent all known financial contracts in a reference database.52

For perspective I also spoke with Sean Zoltek, a New York-based corporate lawyer specializing in securitization and collateralization.  In terms of designing and encoding a contract into computational algorithms, “we can easily make a set of programmatic rules that have a variety of default replies based on historical track records and know with roughly 99% certainty how it would turn out.   In fact, we use standardized forms all the time.  Both the linguistic construct and existing legal framework have been built up over decades to support these types of contracts.  For example, I could draft a contract for a small business loan to include check-boxes that provide default conditions.  The user interface for such instruments already exist and have been simplified to where a party only needs to answer criteria such as type of existing loans, assets and length of maturity dates.  In fact, many of the contracts at law firms are much more sophisticated than a commercial bank due to the level of detail and case knowledge that we have.”

In his view this could be done today in a three or four page document or a few dozen lines of code, would be completely automatable and would not require an attorney to fill out.53  Furthermore because of its robustness built on previous case law, a judge could look at a smart contract and it would likely be enforceable.54 Zoltek believes that “smart contracts already can encompass this functionality.  For instance, based on the context of what kind of loan it would be, the next 1,000 transactions from the same bank service segment could literally be identical.  A small business loan is a good example because it typically involves $20 million in assets, $100,000 of inventory in the store or office and some kind of standard insurance policy.  We would not even need to worry about electronic chattel paper or letters of credit.  In addition, such a contract could accommodate would likely be fair for both parties involved because they could both provide input.  This is in contrast to the relatively one-sided terms of service that most banks provide borrowers today that are non-negotiable.”

According to him, since it is in the firm’s interest to help small businesses succeed, with simplified interfaces and default conditions (e.g., trust, escrow), “it could absolutely be done in computer code and would definitely make certain lawyers sweat.  This is in turn would mean our industry would move towards increased sophistication and specialization.  Yet on occasion there are nuances that are not entirely straightforward or streamlined.  There is the law and then there is how it is applied to circumstances hence the reason some party has to make judgment calls.  As time goes on and case-law is built, you eventually end up with cookie-cutter deals and which are automatable.  This situation is amplified with cryptocurrencies like Bitcoin through its low or no cost transactions, clearly defined allocation of value, transport of value and open algorithmic rules that everyone trusts.  You can potentially build on top of that mechanism providing more complicated transactions and instruments that are beyond what the Bitcoin protocol can currently do.  Thus once you assume how a typical contract works you build above it, and I see it as beneficial to all parties involved.”

In terms of open-source smart contracts, Zoltek notes, “There is an old saying in the legal profession, if you have language that works, use it.  Aside from litigation cases (which involve some original creativity), there is little creativity in a contract prose themselves.55 In fact, many briefs may reuse entire passages, citations and analysis of a previous case, this is a common practice as that material stood legal challenges.  In other words, once you have a good argument, you continue reusing it.56 Furthermore, once we produce the contract, it becomes public because it is filed with the SEC or some other institution.  In fact, no contract says “copyright GE” – it is just a contract.  As a consequence, if you can make our lives easier by automating things, we will have to branch off into more creative-based niches which is generally the trend the industry has been heading since 2007.”

In the meantime however, there is potential for experienced financial-instrument programmers and designers to work in this segment.  For instance, Sean Percival, a venture partner at 500 Startups recently explained that “[i]n the New York tech scene, a lot of engineers want to move over to startups, but their skill set is not a match.  This may be a case where their financial programming skill set is going to be a great match for bitcoin companies.”57

As noted by Szabo and others, the easy low-hanging fruit are financial instruments and other contracts executed by code, including crypto-based financial instruments that exist today.  For example, using open-source Cryptotrader software, programmers have been able to build and execute arbitrage bots used on fiat-cryptocoin exchanges such as BTC-e.58 The next logical step is to build a smart contract that interfaces with various cryptoledgers such as Bitcoin to Ripple or Bitcoin to Counterparty (or any ledger).  Another smart contract could be a simple invoice – repayable in a cryptocoin –  to bill clients for services rendered.59) Another is an assurance contract, which is how crowdfunding sites operate (e.g., I will deliver this product if I get X amount of pledges made by day Y).6061

During his Turing 2013 presentation, Mike Hearn mentioned that just about any repetitive work (filling out spreadsheets, opening bank accounts), anything that can be mathematically quantified and formalized can and will be replaced by automated agents.  It is the creative roles that will be difficult to automate.  Looking forward in time (by decades), Hearn sees other automatable segments powered by DAOs such as taxi providers, commodity deliveries (such as fruits and vegetables), units of computational time (cloud services), and even “smart roads.”62

In a sense a DAO is an autonomous agent, a computer that owns itself as an economic actor.  It earns money and pays for itself with money it generates and thus could alternatively be described as the first form of artificial life (though it is not intelligent).  If a DAO is profitable and successful it can self-replicate its codebase and thereby create a “child,” ceding its assets in the form of a “birth loan.”  If it operates at a loss, it could then “die” (i.e., purged from market).  This long-term perspective is important if you are looking to make any sizable investment in the segment.

Remittances, Value-Added Services, and Legal Considerations

In the United States there are multiple state and federal agencies currently assessing the impact of cryptocurrencies.  The exact policy implications are unclear at this time.  However over the course of the past year the US Senate, Securities and Exchange Commission (SEC), Commodities Futures Trading Commission (CFTC), New York Department of Financial Services and FinCEN (among others) have held hearings to gather information and occasionally provide regulatory guidance.63 For example, in a hearing held across two days, January 28th and 29th, the New York Department of Financial Services interviewed over a dozen witnesses regarding possible regulatory policies and witness testimony ranged across the entire spectrum.6465 The following day, on January 30, 2014, FinCEN independently issued two new rules that stating that both miners and investors are not money transmitters and thus did not need licenses.66

On February 19, 2014, California Assembly Bill “AB-129 Lawful money: alternative currency” which clarifies the possession and acceptance of bitcoin and other virtual currencies as money, passed unanimously.67 The State of Washington recently updated its statutes to state that, “Virtual currency, also known as digital currency or crypto-currency, is a medium of exchange not authorized or adopted by a government. There are many different digital currencies being used over the internet, the most commonly known being Bitcoin. In Washington, digital currency is included in the definition of “Money” in the Uniform Money Services Act (UMSA), chapter 19.230 RCW.”68 Other countries such as China and the United Kingdom have differing laws.69 On December 5, 2013, the People’s Bank of China issued a notice that banned 3rd party processors (such as Alipay and Tenpay) from providing renminbi (RMB) transactions with cryptocurrency exchanges.70 In contrast, on March 2, 2014, Britain’s tax authority announced that it was scrap its tax on Bitcoin trading.71

While these issues are being sorted out, there may be other areas in which regulatory uncertainty could be mitigated.  One way around logistical issues is to put transportation clauses that must be met otherwise various counterparty stipulations take effect.  That is to say, what if your state DMV does not recognize a particular smart contract or token transfer as an official legitimate means for exchanging your vehicle?  While you may find a legal work around, this could recreate a barter economy.  For example, in the event that a fiat-exchange system is shut down and price discovery in relation to that particular token is affected, users could trade other assets worth roughly the same value instead.

Another area where cryptoledgers and policy intersect is the transmission of the token.  Since tokens are transmitted on a peer-to-peer basis, they can be sent anywhere around the world near-instantaneously.  Thus if Alice had friends or family working overseas and in need of money, instead of using costly remittance services such as Eurogiro or Western Union which charge high fees for no value-added, Alice could send Bob any amount of Bitcoin for almost no cost (or other crypto-based token).7273  In fact, in 2012 Western Union generated $4.6 billion in transaction fees and had a net profit margin of 16%.74 A recent report from the World Bank found that the 232 million international migrants working abroad remitted an estimated $550 billion in 2013 – the top three countries for incoming remittances reached $71 billion in India, $60 billion in China and $26 billion for the Philippines.7576 Fees charged by various levels of middlemen providers, exchangers and compliance offices collectively add another $74 billion from this process, with no value added.  For example, the average African migrant is charged 12.4% in remittance fees, thus reducing that fee to even 5% would save Africans from the continent $4 billion.77 Globally the average fee on remittances is 9% and many banks charge an additional “lifting” fee that adds another 5% to remit it into local currency.78

In February 2014 I spoke with Alan Safahi, the CEO of ZipZapInc.79 Founded in 2010, ZipZap is the largest global cash transaction network enabling consumers to use cash to buy digital currencies.  In this manner it acts as a software-based intermediary between Payment Centers who collect fiat and exchanges that provide bitcoin liquidity.  According to Safahi, ZipZap is building both on-ramp and soon off ramp connections from physical cash to digital currencies around the world which they hope will someday provide a free remittance network, “I want the cost for remittance to go down to 0%.  Currently we have to charge fees for fiat on both ends however as time goes by eventually, we will only have to charge for fiat conversation out.  Ultimately we will go to a freemium model in which basic services like remittances are free through the use of cryptocurrencies like bitcoin.”

“We as an industry will have to provide value-added services on top of free remittance services to the edges that consumers would want to buy,” added Safahi. “It would be similar to the online gaming community which has successfully adopted a freemium model to provide additional product or enhancements the gamers gladly pay for.”

Safahi would like to turn the status quo upside down.  Whereas currently a customer has to meet certain rigid standards and then pay relatively high fees if he or she remits from developing countries (and in some cases gets rejected), he wants to make it easier for customers to transmit value that they own.  Accordingly, “it is my mission to make life easier for consumers, change it in a manner in which the customer comes first for any new financial services products not the service providers.”  ZipZap launched its global cash payment network in 2012 and has grown to 700,000 payment center locations.80 ZipZap also recently expanded into 28,000 new UK locations and continues to partner with more Bitcoin exchanges (such as Bittylicious, ANX, Kraken, CoinMKT, and BIPS Market) to allow customers to convert local currencies into bitcoins at any of the locations.81

I also spoke with Charles Hoskinson, creator of the Bitcoin Education Project and member of the Ethereum core development team.82 In terms of the impact DAOs and trustless asset management will have, he sees that, “the simplest way of looking at it is 3.5 billion people in emerging markets are faced with two configurations of property and contracts.  The first is that because of how institutions are organized and incentivized, those who are well-connected or whom are willing and able to bribe government officials are able to protect their property.  This is not a very stable structure as it is subject to any change in government (e.g., removal of politicians).  The other configuration is a grey system, a type of informal economy based on handshakes and under-the-table dealings.”

As a consequence he sees that “it is risky and difficult for residents overseas in developed countries to make educated investments because of a lack of clear rules and property rights.  When you have a stronger rule of law, such as codified contracts and arbitration mechanisms, then investing is not only more transparent but also safer and more efficient.  Projects like Ethereum that utilize a DAO, they present a strong 3rd option: they do not have to ask a government or institution for bribe.  Users also do not have to worry about a nebulous grey area.  Instead, you can put your trust on a ledger – in math – which then creates transparency.  Consequently, due its peer-to-peer nature it also transcends any jurisdiction and thus can be used by anyone to track and manage any asset.  This will change how business is conducted in both developing and developed markets.”

Because these are autonomous systems it will also change banking and the way capital is transferred, acquired, stored and managed.  Smart property tied to existing jurisdictions could likely be affected as well.  According to Hoskinson, “we have begun to see this already over the past 5 years in terms of fiat exchanges interfaced with bitcoin, but a DAO will only amplify both the uses and the impact on society.  For example, since at least 1991 there has been a variety of methods for building reputation systems – webs of trust – that incentivizes users to pay back creditors.83 With a blockchain you can now have a safe place to put an instrument or contract and people can digitally sign it.  Since it is publicly audited, other users can see its history and if it is reliable thus building credit scores.  In turn, business transactions based on clearly defined terms and services can be conducted on an exchange through a form of identity management.  This will completely transform how the flow of capital and investment work and will be a godsend to the 3rd world.  For instance, a person with a reliable DAO (or smart contract) could create a monetary instrument (a cryptocoin) and lend it to anyone on the globe in the form of a loan with specific terms and conditions.  This is done in an external, tamperproof system, a cryptoledger that is not controlled by an institution capable of abuse.  As a consequence, for developing countries, just as they leapfrogged copper wiring choosing to use wireless telephony, some may forgo building replicas of existing financial infrastructure and instead choose to use this virtual-based system through their mobile devices.”

The most successful mobile payment system currently is M-PESA, operated by Safaricom and Vodacom and serving 30 million users in East Africa (Kenya and Tanzania), the Middle East and India.84 It is a mobile-phone based money transfer and microfinancing platform; last summer, Kipochi integrated a lightweight Bitcoin wallet with M-PESA which enables Kenyans to bypass costly remittance fees charged by middlemen such as MoneyGram and Western Union.85 While some may ignore the possibilities of mobile banking, preferring desktops or even physical visits to bank branches, 43% of Kenya’s GDP is spent through mobile phones.86 In fact, according to a recent Reuters report, “M-Pesa has enabled 67 percent of Kenyan adults to access banking. Its transactions total about $1 billion per month.”8788 There are roughly 253 million unique mobile phone subscribers in Africa (many have two SIM cards) and an estimated 70% of the population on the continent are underbanked or have no access to a bank.89 Therefore cryptocurrencies and trustless asset management tools built on cryptoledgers that interface with mobile phones will enable and empower an entirely new demographic and consumer base to emerge from subsistence.  In fact, according to a 2009 report from Financial Access Initiative, half of the world is unbanked which leads to new opportunities for entrepreneurs.90

  1. See Bitcoin Startup Investing Snapshot: VCs Deploy $74M Across 40 Deals in 2013 from CB Insights, Bitcoin startup Coinbase receives $25m investment from a16z from ZDNet and Circle Raises $9M Series A From Accel And General Catalyst To Make Bitcoins Mainstream from TechCrunch []
  2. Following the Money: Trends in Bitcoin Venture Capital Investment by Garrick Hileman.  Note: Hileman used different chart numbering in his original publication. []
  3. Despite the enthusiasm, competence and funding, the likelihood of success is not a given for any startup.  And based on years of experience there are ways to try and mitigate and plan around known issues of founding a new company.  See Death and startups: Most startups croak 20 months after their last funding round from Venture Beat, The Venture Capital Secret: 3 Out of 4 Start-Ups Fail from The Wall Street Journal, Fighting co-founders doom startups from CNN|Money, Why Small Businesses Fail: SBA from About.com and How Many New Businesses Fail in the First Year? from eHow []
  4. Kauffman Foundation Bashes VCs For Poor Performance, Urges LPs To Take Charge from The Wall Street Journal and Most venture capital funds lose money from CNN|Fortune []
  5. See Venture Survey Finds Big Jump in Investor Optimism for 2014 from The Wall Street Journal, Venture Capital’s Sluggish Performance from DealBook and Venture capital kingpin Kleiner Perkins acknowledges weak results from Reuters []
  6. See the annual MoneyTree Report from PricewaterhouseCoopers and the ever-growing list of funded Bitcoin companies listed on CrunchBase []
  7. Compute Engine, github and Urbit []
  8. AngelList, 500 Startups, Plug and Play, Y Combinator, SVAngel, Bitcoin Opportunity Fund and Boost.  Each of these organizations provide different types of services, some are networking tools others are accelerators and incubators for entire development teams.  For example, see Seven bitcoin startups pitch for funding at Boost VC demo day from CoinDesk []
  9. See BitAngels Goes Global, Closing $7 Million (7,000 BTC) in Funding for Bitcoin Startups from MarketWired,Plug and Play Unveils Bitcoin Startup Incubator With Expert Mentors from CoinDesk and Currency Kings by Entrepreneur []
  10. Backed by $5 Million in Funding (4,700 BTC), Mastercoin Is Building a Flexible, New Layer of Money on Bitcoin from MarketWired []
  11. See What is Nxt? and Ethereum []
  12. See BitcoinStarter and CoinFunder []
  13. Why Bitcoin Matters by Marc Andreessen and Coinbase Raises $25M Led By Andreessen Horowitz To Build Its Bitcoin Wallet And Merchant Services from TechCrunch []
  14. Marc Andreessen sings Bitcoin’s praises from CNBC []
  15. Following the Money: Trends in Bitcoin Venture Capital Investment by Garrick Hileman.  Note: Hileman used different chart numbering in his original publication. []
  16. Following the Money: Geographic Dispersion of VC Bitcoin Investment by Garrick Hileman.  This is part 2 of his analysis, he uses different chart numbering. []
  17. In addition to Garrick Hileman’s data for Bitcoin Venture Investments, another open database of investment information can be found with The Bitcoin Database.  See also: Exclusive: State of Bitcoin 2014 Report Analyses Emerging Trends from CoinDesk []
  18. Lightspeed Venture Partners, Lightspeed Anchors Bitcoin Startups in Adam Draper’s Incubator from The Wall Street Journal and Why Lightspeed Venture Partners Sees Bitcoin as a Good Investment from CoinDesk []
  19. Skype calls now equivalent to one-third of global phone traffic from ArsTechnica []
  20. Global Digital Goods Opportunities by Sam Kwong []
  21. The Communications Market Report: International from Ofcom []
  22. Shakil Khan, founder of CoinDesk uses the analogy that Bitcoin has the potential to be an IP address for money.  See Shakil Khan: Bitcoin can be “money over IP”, but services must get more intuitive from CoinDesk []
  23. DealCoin []
  24. Commotion, XORP, 802.11s, Wireless Mesh Networking []
  25. My thwarted attempt to tell of Libor shenanigans by Douglas Keenan []
  26. BitGive Foundation, Bitcoin Not Bombs and Sean’s Outpost are probably the three most well-known charities that accept cryptocurrency donations.  See Bitcoin Helps Homeless Charity Sean’s Outpost go from Strength to Strength from CoinDesk and Jason King of Sean’s Outpost on Bitcoin and Charity interview by Jeffrey Tucker []
  27. The 50 worst, ranked by money blown on soliciting costs from Tampa Bay Times []
  28. China gets 76 bln yuan in donations for Sichuan quake from People’s Daily []
  29. County vows to correct misuse of post-disaster relief money from China Daily and Quake zone hit by yet another relief scandal from South China Morning Post []
  30. For more on this issue related to China, see Chapter 18 in Great Wall of Numbers.  See also, Red Cross donations not collected for 4 years from China Daily []
  31. Kapronasia and Bitcoin Singapore 2013 with Zennon Kapron []
  32. The December 5th notice does not really say that merchant services are forbidden.  It says that financial companies and 3rd party payment processors cannot deal with Bitcoin, and also says that bitcoin is not a currency.  The prevailing thought at the moment is that exchanging goods and services for bitcoin is like bartering, so merchant services should be fine.  The industry will only really know once something like BitPay actually takes off in China.   China Bans Payment Companies From Clearing Bitcoin, News Says from Bloomberg and淘宝新增比特币等虚拟币等禁售规则公示通知 from Taobao.  It may also be instructive to read虚拟货币本质上不是货币 from Sheng Songcheng, the head official of investigation and statistics at the PBOC. []
  33. A type of chicken and egg problem – the important point is whether domestic users can pay for wares in a cryptocurrency.  Since the majority of ecommerce in China is managed through Alibaba and Tencent, who in turn have backed out of supporting this crypto space, in the short run may only work for Chinese residents buying products abroad but in China itself there are several hurdles to adoption. []
  34. The German Monetary Unification (Gmu): Converting Marks to D-Marks by Peter Bofinger []
  35. Outside of academia, over the past years various people have discussed the role a cryptocurrency can play with respect to integration with central banks, including using to fulfill the bancor concept (international reserve system).   One recent example is the Bitnote thought-experiment from Wolfgang Münchau.  For more on bancor, see Reserve Accumulation and Intern ational Monetary Stability from the IMF, The Global Currency Conundrum and the “Babel Fish” of Money by Chris Larsen and Our flawed financial system is reflected in Bitcoin from Financial Times []
  36. Shanghai liberalises offshore yuan borrowing in free-trade zone from South China Morning Post, Shanghai Free Trade Zone: The next Shenzhen? from The Economist, China approves 12 more free trade zones from Xinhua []
  37. 500 Startups, BitDazzle, BTCJam []
  38. Interview on January 12, 2014 []
  39. Both citizens and expats are limited to international transfers of $50,000 denominated in foreign currencies per year.  For more details see Chapter 5 – Financial services in Great Wall of Numbers and Animal Spirits with Chinese Characteristics by Mark DeWeaver. []
  40. Tianhong’s Alibaba mutual fund grows to second largest in China from South China Morning Post []
  41. Text, Chat, Profit: Tencent Launches Investing on WeChat from The Wall Street Journal []
  42. And at least 272 million monthly users.  See China’s WeChat App Targets U.S. Users from The Wall Street Journal,China banking war heats up with launch of online investment app from Financial Times and How WeChat’s 600 Million Users Spell Out Big Profits For Brands from Jing Daily []
  43. See Tencent: China’s hottest tech company from CNN|Money and Chapter 12 – Social Media and marketing your brand from Great Wall of Numbers []
  44. Dearcoin, General Assembly and Bitpass []
  45. Bitcoin Institute and Seedco.in []
  46. Hivewallet []
  47. CoinSimple []
  48. MEXBT and  The bitcoin industry embraces what it was built to avoid—rules and regulation from Quartz []
  49. ‘Trustless attorney’ is probably a marketing term lawyers will avoid using; instead, digital currency attorneys may become the nomenclature. []
  50. With the advent of ‘zero-knowledge’ proof, there may be techniques like ‘obfuscation’ cryptography and homomorphic encryption that could enable proprietary contracts (e.g., obscuring information and applications in such a way that discerning the code would be impossible, thus the complete opposite of open source).  See Cryptography Breakthrough Could Make Software Unhackable from Wired, IBM’s homomorphic encryption could revolutionize security from InfoWorld and Cryptographic Code Obfuscation: Decentralized Autonomous Organizations Are About to Take a Huge Leap Forward by Vitalik Buterin []
  51. Personal correspondence, February 4, 2014 []
  52. Smart contracts will need data standards and the first six Contract Types are (PAM, ANN, SWAP, STOCK, OPTION, FUTURE).  See Project ACTUS, The Importance of ACTUS from Stevens Institute of Technology and Improving Systemic Risk Monitoring and Financial M arket Transparency: Standardizing the Representation of Financial Instruments by Mendelowitz et. al. []
  53. Designing financial instruments could become straightforward with ACTUS standardizations.  In contrast, a disproportionate allocation of resources is currently spent on arbitration, compliance and fraud protection associated with the contracts and instruments. []
  54. For example, the New York Uniform Commercial Code already has a body of precedents covering payment systems, electronic bank deposits, debit cards and a default set of laws involving electronic transactions within Article 4-A: Funds Transfers. []
  55. If you plagiarize a litigation brief, this is considered verboten.  Similarly, while using Westlaw and LexisNexis, the search results are copyrighted, but the actual content is not (i.e., how you got there is copyrighted).  In contrast, once a judge uses wording from a contract, it is in the public domain and others can use it. []
  56. In a termsheet the precedents remain the same as the only thing that is usually different are the items explicitly listed.  Other areas of law that are considered off-limits for copying are covenant analysis or collateral analysis.  According to Sean Zoltek and several other lawyers consulted on this manuscript, attorneys in general look for methods to reduce repetition and reduce the amount of drafting done on a set of documents.  Thus they may build a document 70% and then reuse or recycle portions of previous document which has a great set of covenants for the other 30%. []
  57. ‘500 Startups’ Recruits Ex-MySpace VP to Mentor Bitcoin Businesses from CoinDesk []
  58. Cryptrade is the open-source repository on github, Cryptotrader is a community of programmers and architects creating bots used on exchanges (e.g., for HFT arbitrage).  Be aware that anyone claiming to sell you a turnkey bot capable of arbitrage is likely scamming you, if it worked as stated, they would be using it instead. []
  59. Andreas Antonopolous used this as an example of smart contract he would build if and when Ethereum is launched.  See What is ethereum? (video []
  60. Mike Hearn uses this in his presentation (video) as an example of how a DAO and smart contracts can be used to replace taxation for public goods. []
  61. The private provision of public goods via dominant assurance contracts by Alexander Tabarrok []
  62. Mike Hearn (video) calls the initial phase of this DAO infrastructure the “TradeNet.”  He later uses hardware examples, yet it is the software that controls the smart property functionality within the hardware.  By “dying” he means that an inefficient taxi service-based DAO could sell itself as salvage material (to pay off debts) and/or restart and turn back on during potentially different market conditions.  Eventually there could be a “MatterNet” in which quadcopters can transport goods (e.g., like the Amazon air delivery) or urban infrastructure that rearranges itself based on real-time demand (e.g., automated vending machines being lifted by quadcopters to new locations based on market demand).  All of this again, is controlled by DAOs that may or may not reside virtually on a cryptoledger. []
  63. See Regulating Bitcoins: CFTC vs. SEC? from Mondaq, CFTC’s Chilton on Possible Regulation of Bitcoin from Bloomberg, Here’s how Bitcoin charmed Washington from The Washington Post []
  64. One of the topics discussed at the hearing was KYC which is ‘Know Your Customer,’ a banking regulation enacted to collect customer information for statutory compliance.  See Community Debates What’s Next After New York Hearings from CoinDesk and Understanding global KYC differences from PricewaterhouseCoopers []
  65. In February 2014, The Law Library of Congress published a detailed look into 40 jurisdictions with respect to the regulation of Bitcoin, “Regulation of Bitcoin in Selected Jurisdictions.”  See also Bitcoin’s Legality Around The World from Forbes and BitLegal which provides a color-coded map of each jurisdiction with relevant regulatory information.  KPMG recently published a thorough article regarding tax implications surrounding Bitcoin, Chomping at the Bit: U.S. Federal Income Taxation of Bitcoin Transactions. In addition, several of the 2.0 platforms have created an industry association called Consortium of Decentralized Applications (CoDA) to discuss and navigate the legal framework of various jurisdictions.  Similarly, the Digital Asset Transfer Authority (DATA) is a new self-regulatory organization focused on creating regulatory proposals and interaction with policy makers. []
  66. FinCEN Publishes Two Rulings on Virtual Currency Miners and Investors from Financial Crimes Enforcement Network []
  67. AB-129 Lawful money: alternative currency from the California Legislature.   Perhaps a ‘BitLicense’ will become integrated with the New York Uniform Commercial Code Article 4-A: Funds Transfers.   See California House Passes Bill Declaring Cryptocurrency Legal Tender from AltCoin|Press []
  68. Money Transmitters and Currency Exchangers from Washington State Department of Financial Institutions []
  69. Singapore’s government is currently taking a hands off approach towards cryptocurrency right now whereas Denmark plans to regulate and oversee its use.   At the end of February, Vietnam’s central bank issued a statement warning banks and credit institutions from using it.  See Singapore government decides not to interfere with Bitcoin from Tech In Asia, Bitcoins Spark Regulatory Crackdown as Denmark Drafts Rules from Bloomberg, Vietnam Warns Against Bitcoin, Invokes the Ghost of Gox from CoinDesk []
  70. China Bans Payment Companies From Clearing Bitcoin, News Says from Bloomberg []
  71. Britain to scrap Bitcoin tax from Financial Times []
  72. The Bitcoin network does charge a small nominal fee for some transactions, although most are processed without any fee.  A transaction drawing bitcoins from multiple addresses and larger than 1,000 bytes may be assessed 0.0002 BTC as a fee.  Furthermore there is a hardcoded block size of 1 MB, or 7 transactions per second.  For comparison, VISA’s payment processing centers handle on average of 2,500 transactions per second and are built to process a surge of up to 10,000 to 20,000 per second.  In order to change this, a hard fork must be implemented.  Long-term this creates a problem dubbed a “crypto tragedy of the commons.”  Ken Griffith recently pointed this out, noting that “Bitcoin transactions cost above $50 per transaction, which is very high, but it feels low because this cost is paid for through the creation of new bitcoins that equally dilute everyone’s bitcoins.  The person making the transaction doesn’t pay the fee, all holders of Bitcoins pay what amounts to an inflation tax out of dilution of their Bitcoin value. From the user’s perspective of sending money with Bitcoin, it feels practically free!”  While the actual transaction cost fluctuates (has been in the range of $40-$90 over the past 3 months), he does have a valid point that is usually glossed over.  See Transaction fees, On Transaction Fees, And The Fallacy of Market-Based Solutions, Bitcoin – A Jack of All Trades is the Master of None by Ken Griffith, Bitcoin needs to scale by a factor of 1000 to compete with Visa. Here’s how to do it. by Timothy Lee and Top secret Visa data center banks on security, even has moat from USA Today []
  73. The way the current system is setup, remittances and funds sent abroad go through multiple institutions via ‘correspondent accounts’ or ‘correspondent banking.’ []
  74. Will Migrant Workers Drive Bitcoin’s Mundane Future? from Bloomberg []
  75. Is Bitcoin the future of remittances? from CCTV and Remittance Prices Worldwide from World Bank []
  76. Migrants from developing countries to send home $414 billion in earnings in 2013 from World Bank []
  77. African Migrants Could Save US$4 Billion Annually On Remittance Fees, Finds World Bank from World Bank []
  78. Will Migrant Workers Drive Bitcoin’s Mundane Future? from Bloomberg []
  79. ZipZap []
  80. MoneyGram Joins ZipZap’s U.S. Payment Center Network from PRWeb []
  81. You Can Now Pay Cash For Bitcoin at 28,000 UK Stores from CoinDesk []
  82. Bitcoin Education Project and Bitcoin or How I Learned to Stop Worrying and Love Crypto at Udemy []
  83. PGP (Pretty Good Privacy) was released in 1991 by Phil Zimmermann, see: Cypher Wars from Wired []
  84. M-PESA and Enabling financial transactions for consumers and businesses: Safaricom’s M-PESA mobile money service by Filippo Veglio []
  85. Kipochi launches first Bitcoin wallet in Africa with M-Pesa integration from Kipochi []
  86. From oil painter to the C-suite from Financial Times and M-Pesa helps world’s poorest go to the bank using mobile phones from The Christian Science Monitor []
  87. Insight: African tech startups aim to power growing economies from Reuters []
  88. According to an email exchange with Michael Youssefmir, an engineer at Google who has previously published mobile data pricing on Ghana, “MPESA was successful because Safaricom had a monopoly and regulators failed to regulate before the system took hold. Successful mobile money systems in the class of MPESA must become defacto standards. The fragmentation and regulation that occurred in other African countries is exactly why we keep having to talk about Kenya and only Kenya. As a defacto standard that is resistant to regulation, bitcoin is an ideal currency and system to serve as mobile money in the developing world.” []
  89. Fewer than one in three Africans has a mobile phone from Reuters and The Sleeping Giants Of African Mobile Payments from TechCrunch []
  90. Half the World is Unbanked from Financial Access Initiative []
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Chapter 5: How smart contracts could work

[Note: below is chapter 5 to Great Chain of Numbers]

Theory is grey

While they do sound neat in theory, as Dr. Faustus discovered, “theory is grey, life is green.”1 One problem with institutions is not that they do not follow rules but rather that there is no conceivable set of rules that could unambiguously cover all of their activities.  Thus, to minimize nebulous outcomes, it is imperative for a programmer or businessman to conduct the necessary research and gather all of the requirements needed within the design phase of a smart contract.  This will be challenging one of the reasons that few known decentralized autonomous organizations exist today is that they could likely face various vulnerabilities and exploits that prevent them from carrying out their duties.  In fact, in his presentation to the 2013 Turing Conference, Mike Hearn (a core Bitcoin developer) noted this point: implementing the theory is much more difficult than creating it.2 Thus while science fiction novels and movies tease our imaginations with seemingly intelligent AI agents, creating even simple forms of non-creative bots will be a tall order.

Time Clock and Log-in

Over the past century there have been multiple mechanisms used by employees to verify that they worked a particular shift at a particular location.  Depending on trust levels, an employee may only need to say hello to their boss, others may need to sign their name on a particular line in a notebook.  Others might need to use a “card” that is punched with a timestamp throughout the day (e.g., when an employee first walks into the office, at lunch, after lunch and to clock out at the end of the day).  And there are even other employers in the past decade that have installed tracking software on computers.  While it is easy to verify that an employee is logged into the network or that an employee is indeed sitting at their desk and superficially looking at the monitor, some employers want to know exactly what is happening on each machine.3 Thus after an employee logs into the system, the software can siphon all of the input metrics (e.g., website visits, keystrokes, files) that they create during the day or other programs that randomly takes snapshots of the screen to verify that an employee is not watching videos when they are supposed to be filling out TPS reports.4 There are ways that each of the older “analog” systems can be abused.  In the case of time sheet or even time card, a friend or colleague could be asked to stamp your card even if you do not go to work.  Yet with the advent of software or even network-based tracking, it is much more difficult, if not impossible to abuse an on-site computer without making the company aware that the software has been removed or the network has been hacked.

Again, the goal of smart contracts and smart property is not to intentionally build some kind of totalitarian panopticon, but rather to enable all parties to clearly codify their responsibilities, obligations and compensation.  As I described earlier in the chapter, marginalized individuals such as migrant workers in China have little recourse during contract disputes due to the household registration system (hukou).  And they have a lot to gain if their contracts are not only tamperproof but that they can also prove in some manner if they fulfilled the contractual obligations such as on-site time.

While some requirements will be more difficult to codify into a smart contract, one area of low-hanging fruit could be the time-honored clock “punch.”  There are several ways to do this with existing systems: by using an RFID badge or NFC chip inside a phone, the “clock” would just have to be connected to whatever mechanism and network is ultimately responsible for sending the affirmation signal to the smart contract or DAO that automatically pays them.  Another example would be to use biometric fingerprints or eye scanners to verify the employee is “clocking in” (or out) and then connect that system to the same mechanism mentioned in the previous example.  There are limitations however: for instance, if an employee or contractor gets a piece rate or must frequently switch sites throughout the day to different neighborhoods, campuses, or even cities.  Creating a tamper resistant mobile check-in device that replaces the immobile clock to keep track of the number of pieces could be a business opportunity in the future.5 In fact, through the microtransaction abilities of Bitcoin, users can send micropayments, signed with their digital key, to prove that they were in a particular hotspot for a particular amount of time.

Decentralized Autonomous Organization

As I described in the introduction, a DAO is a virtual AI agent capable of performing, fulfilling, and executing the tasks, actions, and functions normally conducted by managers and executives, such as paying bills, issuing dividends and even crowdfunding an IPO.678 This would be done in a trustless or quasi-trustless environment, the “balance of trustlessness” determined by the intention of the parties and the capabilities of the code.  By using a Turing-complete language integrated with a cryptoledger, a DAO is essentially a tamper-resistant or tamperproof entity, immune to many of the abuses and vulnerabilities that have been happening to brick-and-mortar organizations are today (e.g., burglaries, arson, unintentional exposure to proprietary documents).  Currently no real decentralized autonomous organization (also known as a decentralized autonomous corporation or autonomous agent) is known to actually exist on a cryptoledger, although there are payroll bots and various software-based HR tools out on the market that integrate at the edges (BitPay).9

Some analysts claim that Bitcoin itself is a DAO because all of the users technically must submit a digital key which counts as some kind of voting mechanism, shareholders (miners) receive direct compensation for their work (seigniorage) – and there is no administrative overhead per se.1011 Yet, since development and direction of the Bitcoin protocol itself is not handled by direct ”votes” it is thus more akin to a proto-DAO.12

But voting and separate personality does not a company make.  Just like the cargo cult on Vanuatu dressed up like soldiers with the belief that air cargo planes would return with wartime goods, implementing voting into a cryptoprotocol and assuming this will create a company is a fairly superficial understanding of a corporation.13 Because of how development has come under the purview of the Bitcoin Foundation, the current Bitcoin ecosystem is a blend between “shareholder” and “stakeholder” system.14 This has potentially destabilizing issues in the long-term: fiduciary responsibility boundaries are fuzzy due in part to how it is funded (sponsorships) and how the organization wants to be perceived from the outside.  Furthermore, like any initiative there is the possibility that the network could be abandoned by users; a company cannot function without shareholder input.  This is not to say that there should not be a foundation (or many foundations) or even that a foundation could not receive money from outside sources or that users will abandon the project and network – rather, that because there is no direct voting process by bitcoin holders (like in a real corporation), the decision making process of the actual direction of the protocol itself is not an example of a DAO.

Last fall privacy advocates objected to a new “Coin Validation” project (whitelisting of bitcoins) and subsequently started the Dark Wallet and Zerocoin projects in an effort to move development one direction.15 While core developers have differing views, there have been no direct votes with digital signatures by bitcoin holders in this process.16 In fact, in the face of the new Coin Validation route that foundation members discussed, Roger Ver’s Blockchain.info promoted Shared Coin (developed by Gregory Maxwell, a Bitcoin developer) as a way to work around potential white and blacklisting.171819 This is not an endorsement of any proposal, but rather serves as an example of how a DAO could be used to mollify a set of actions.

Putting the DAC into DACP

Vertical institutions traditionally have created hierarchies in which intelligence and decision making is conducted at the top and automation functions based on guidance from human inputs.  An illustration of this phenomenon is legacy companies that arbitrarily trim divisions to meet certain metrics and consequently often cut at the edges of the network.  The lower echelons of departments in this case are sometimes viewed as replaceable or some simply lack the political capital (guanxi) that other departments may have had.  However, this dynamic all changed when Bitcoin introduced the idea of autonomous distributed consensus, automation at the center of the network and intelligence on the edges.

Unlike in a legacy company where decision-making authority is concentrated at the executive level, in a Decentralized Autonomous Consensus Platform (DACP), the decision-making authority is part automated, in that it has specific rules that are followed without possibility of deviation from expected form, and conversely human interaction and bias is limited to the edges.20 In such a model, power and authority, rather than being collected at the top, is spread to the edges of the network by allowing key holders (or VoiceHolders) to influence the decision-making and priorities of the DACP proportionally with their preapproved voting rights (e.g., when setting up a firm, a voting structure is put in place usually based on the amount of equity or shares an individual has).21

The legal liability and responsibility of a DACP or DAC still trace back to the key holders who sign their digital keys with a DACP which then calculates results based upon the prearranged voting proportionality.  For example, Bob’s Boutique requires that the allocation of special funds used by the DACP to hire contractors must be approved by a threshold of digital signatures.  If the threshold is unmet then the DACP does not release the funds to hire the contractors.

Software-based solutions used to calculate, authenticate and verify shareholder votes for many corporations and organizations already exist yet most still rely on a trusted 3rd parties and are susceptible to social engineering and man-in-the-middle attacks.  Thus, one opportunity for e-voting enterprises is to build consoles and virtual applications that utilize a cryptoledger, allowing members of organizations and institutions of all sizes to securely sign policy decisions.  To prevent internal takeovers and allow for quick dissolution (e.g., to manually reallocate assets), a self-termination clause could be programmatically designed within a DACP that could be triggered if enough shareholders submit signatures (or Voice) to a specific internal address within a specific timeframe (nLockTime).

In another real-world example: a DACP can be created as articulation of an assurance contract based upon a predesigned outcome, those who agree with the sentiment send funds to the DACP (the fundraising) and after a value-threshold is met, the DACP acts to bring about the desired result. Funds that are raised during this process are not releasable until a threshold (e.g., 51%) of those who put the value there in the first place, or those who purchased extra shares (e.g., giving larger voting pools) agree to both the need for the expenditure, and the final product being submitted for reimbursement.

Again, as mentioned in chapter 4, although this may sound futuristic, these autonomous platforms have no “artificial intelligence” at the top of the pyramid.  Where the capstone used to be the ultimate centralization of power, in the words of Adam Levine, “now it is only the nexus point for consensus from those participating further down the structure.”   It has the ability to spend funds, but only at the direction and authorization of the majority of shareholders.  Just like Bitcoin, DACs and DACPs are consensus driven, rules-based systems.  To be part of the system, according to Levine “is to follow the rules, so there can be no pre-mining, no individuals with privileged status at all.  Privilege is the antithesis of efficiency, and these structures seek efficiency above all things.”

Below is a rubric designed by Levine in his forthcoming paper to describe a hypothetical DACP assurance contract:

  1. DACP specification is proposed with Kickstarter Address collecting Ethereum/Bitcoin
  2. Received funds comprise development funds and initial DACP monetary base
  3. Kickstarter Address hits funding threshold and DACP Proposal Hub bounty is issued and rewarded by DACP consensus
  4. Proposals to develop DACP are created, and one or multiple are accepted
  5. Completed bounties are reviewed, and bounties are released by prearranged consensus.  DACs cannot integrate submitted bounty solutions until the winner has been paid.
  6. Once the platform is created and operational, DACP token holders can sell their tokens for Ethereum/Bitcoin at current market rate, hold it to speculate on the platform becoming more popular relative to the fixed number of DACP tokens, or exchange their DACP token with the DACP itself for DAC token as described above.

Experimental Cases

What a DAO could do is actually execute the contract based on pre-agreed to conditions.  If a digital signature counts as a vote, the only way to modify what a DAO would do is to get X amount of votes to approve some kind of execution process.  The specific amounts are hardcoded into the program beforehand and perhaps some are weighted differently.  To a limited extent, multisignature transactions, also known as m-of-n transactions (e.g., “joint bank account” “multisignature lotteries”), already work with Bitcoin itself, although again, you are limited to around 10,000 bytes, which would not be enough to fit hundreds of “votes.”22

Multisignature authorization of transactions is not a new concept as it has existed for hundreds of years in every corner of the globe.  This is done, as Szabo pointed out in chapter 3, to force conspiracy to take place in order for abuse to be undertaken.  That is to say, no single individual has the unilateral ability to abuse the treasury of an organization (or launch a ballistic missile).23 For example, using the Bitcoin protocol today as established by the built-in rules of Script (the name of the internal language), three parties could sign a contract which is programmed to release funds so as long as it receives the digital key of at least two of the parties.  As a consequence, this makes the Bitcoin protocol the legal system as it is impossible to use the tokens without the signatures.  Or in other words, if Bob operates a small company he may need to have 2-out-of-3 executives sign a document in order to release funds to pay for warehouse expansions.  With cryptocurrencies, the same idea applies wherein to move a ledger value (a bitcoin) to a different address, a smart contract or DAO that holds and controls “locked” tokens needs a predetermined amount (threshold) of digital signatures to release them.24 While it is not a DAO, Bits of Proof has developed software that provides this type of 2-out-of-3 reconciliation with a company, Bullion Bitcoin.25

In the future, a small auto-body company could create a DAO on the Ethereum ledger (or Litecoin, Bitcoin, etc.).  The company has five executives, each with a digital key needed to utilize and modify the cryptoledger.  Based on the company charter (and as specified in the smart contract or DAO), at least three of the five are required to use their keys in order for the tokens within a DAO to be used.  After a company meeting, an agreement is made to use the funds and three executives – Alice, Bob, and Carol – are asked to use their digital signatures (keys) to tell the DAO to release a certain amount of tokens.  Utilizing their smartphones (or any network connected device with an app tied into the ledger), they then submit their key and the funds are released.

This can scale up in the case of shareholders of a company.  Unfortunately as noted above, the current Bitcoin protocol has technical limitations that prohibit hundreds of digital signatures being sent to a specific address.  Yet other projects like Ethereum could potentially enable hundreds or thousands of signatures to be sent to a DAO.  This then could enable shareholders to vote on specific policies.  For example, if the board of a shoe manufacturer wants to expand production of a new running shoe that requires the use of tokens managed by a DAO, based upon pre-approved programmatic rules, they would need to bring this up for a shareholder vote.  A DAO could be preprogrammed to fulfill specific functions based on voter thresholds, like a majority or supermajority of votes (51%, 67%, etc.).  In this example, if there are 1,000 shareholders altogether, the DAO which was programmed with a 50.1% threshold, would only release the tokens if it received 501 digital signatures from all shareholders.

Peercover

In January I spoke with Jared Mimms who is working on Peercover, a startup that allows anyone to become their own decentralized insurance company.26  After months of work, they created one the first known smart contracts using a cryptoledger, interfacing with Ripple.27 According to him, “Peercover’s goal is to allow for a sandbox where people can chain smart contracts together and produce profit bearing assets (companies) without having to code. This mean the companies provide valuable services and are simple for people to use and join once companies are founded.  Peercover has developed a series of what they call “company types.” Each of these is really just an “algorithmic framework” for a company, including an “offer system” that allows founders to invest in companies by chaining 3rd party services to them to make them more attractive to join. Finally, a built-in trading system and soon to launch Simple Stock market allows founders to sell portions of their assets and investors to easily trade equity and reap automated or manual dividends.”  Mimms claims that Peercover is “the first true contract client in the space” which likely will increase competitive attitudes from other projects.28

With respect to smart contracts more broadly, Mimms says, “these types of instruments could provide a real opportunity for decentralized innovation.  Specifically, I saw how cryptocurrencies can allow for the automation of superfluous corporate functions.  And to accomplish this I began working with Peercover, where we can provide customers and entrepreneurs the ability to trade through gateways (via Ripple) without having to build and manage an entire backend.  Ripple has an open API that we use because currently it is the most efficient and robust at enabling  truly decentralized merchanting with low confirmation times compared with competing APIs that can take an hour per confirmation.”

Ripple Labs open-sourced the Ripple protocol last fall; the Ripple network has confirmation times between 5-15 seconds versus several minutes for blockchain-based ledgers.29

“For our first “smart contracts” we initially focused on peer-to-peer insurance companies – contracts – because of the new Obamacare mandates.  That is to say, there is a noticeable absence of insurance startups in healthcare and our platform makes it easy for companies to build their own custom solutions.  While we call them “companies” they are essentially a simple decentralized autonomous corporation (DAC).    Furthermore, one of our current plans is to integrate social networking functionality within Peercover to allow people (developers, customers, merchants) to talk to one another.  As a consequence, part of this process will require taking necessary steps to prevent fraud, thus we will verify people’s identities.  This may sound easy but as we have learned with working on various altcoin projects, if there is money involved some people will go to great lengths to commit fraud by forging and doctoring “official” photographs.”

The DAC claim is quite bold as no other team besides Invictus has announced any such development in a production environment.  And while legal compliance issues such as Know Your Customer (KYC) compliance have briefly been mentioned in passing; authentication has been a hurdle for other parts of the ecosystem, especially involving exchanges.30 According to several investors I spoke, maintaining KYC databases will likely become outsourced to firms that solely focus on this area of law.

Altcoins such as Dogecoin and altprotocols such as NXT surprised Mimms and his team this past year and he credits these two specifically for introducing a new marketing mechanism and potentially new platforms.  It is through these experiences that “we have learned to become adaptive and open to new cryptocoins and cryptoprotocols.  Because of our trial-by-fire experience, we can integrate with a new altcoin or altprotocol within a few nights whereupon we then provide users with a very flexible sandbox and drag-and-drop functionality to all users.  For example, if you own a bicycle repair shop you can create a customized contract that enables funding options, stock issuance, dividends and even discount management (e.g., 20% coupons to all users).   We are also the first company to actually create contracts that allow for accredited investors to create crowdfunding in compliance with SEC laws.  That is to say, instead of paying an investment bank like Goldman Sachs or J.P. Morgan to IPO your stock, you can do it yourself through a $200 kickstarter on our platform.  You can issue dividends and allow other people to hold shares.”

This crowdequity meme is also discussed in chapter 7 with examples from BankToTheFuture, JoinMyIPO and LTBcoin.  How the legal issues will be resolved in countries such as the United States is also an aspect to look into if your company is interested in this competitive space (e.g., allowing non-accredited investors to invest).31

Looking toward the future, Mimms says that Peercover has “also begun development towards using Watson-like functionality to provide fully autonomous customer service.  As a part of this effort, we have begun implementing tools such as a “tax” tab that will automate the amount of taxes to be withheld (e.g., a percent based on regional sales taxes that can be sent to specific cryptocurrency address).   While Ripple Charts users themselves are creating and executing contracts – which we build from, we have also partnered with BIPS, a large European-based payment solution provider in this space.”32)

Watson is a natural-language processing system developed by IBM and was popularized in a 2011 series of competitions on Jeopardy in which it beat two championship level human opponents.  IBM has subsequently improved on its abilities and plans to integrate the system in the healthcare industry.33 In addition, automated tax tools are another relatively “simple” area that several developers and investors mentioned that could be relatively easy for development and production.

Continuing, “While other platforms have noble goals, we think a decentralized 3rd party tools creates too much unnecessary complexity for end-users.”

Thus the takeaway message from Peercover’s experience seems to be, “in contrast, what we think is going to win is to have a sandbox-based platform that integrates fees where anyone can create and manage – with advanced interfaces – blindingly simple contracts.  For instance, we had one customer who raised $30,000 in two days with just $200 in kickstarter fees.  The technical backend, how it is done is not necessarily relevant to the minds of users who do not have time or the knowledge to fine tune the infrastructure.  And in the end, if your goal is to decentralize banking, keeping it simple is probably the number one issue developers and entrepreneurs should continually pay attention to.”

Subledger

The ability for a centralized platform to tap into decentralized processes is also being capitalized on with another project called Subledger.34 Subledger is an in-application accounting API that enables developers and businesses to integrate financial databases, including those based on cryptoprotocols into a double-entry real-time ledger analytics engine.

In February I spoke with Tom Mornini, co-founder at Subledger and according to him, “Applications make entries into Subledger for every transaction, in real-time if possible.  It’s then easy to share account records with the parties they represent, such as customers and vendors. That builds trust by eliminating the need for it, just like the blockchain does in cryptocurrencies.”  They have also refined segmentation so that customers have individual accounts for anything that needs to be tracked; we only aggregate during reporting.  Furthermore, the system never updates old entries and completely documents each transaction to maintain an audit trail.”

Continuing, “most people think accounting is about money.  While it is nearly universally used to track money but it’s really about tracking state changes of units of account which are not necessarily money.”

Furthermore, ignoring the time to close (e.g., the lag time between the close of a quarter and the close of the books) is a huge problem with currently deployed software. “The time to actionable information is critical for all companies.  The effort to audit is also greatly reduced, which also means less expensive, and auditing can now take place in real-time.  Auditors could verify a percentage of transactions every day, hour or minute and, essentially, continually attest to the accuracy of the information.”

He also sees at least one competitive advantage between Subledger (a trusted 3rd party) and DAOs, in his view, “the distributed autonomous organizations will be more expensive per-transaction because of the consensus overhead.  If there’s no counter party, there’s no reason to pay that overhead, which also requires the information therein to be public knowledge.  I’m not clear that a DAO would want its internal cost accounting to be shared publicly.  In some cases, yes, in other cases, perhaps not.”

Perhaps developers in this space can leverage a service like Subledger to provide a SaaS-based automatable system that integrates with an intranet-based cryptoledger as described later in chapter 8.  In the wake of Mt. Gox’s bankruptcy in February, which appears to have occurred in part due to a lack of internal accounts reconciliation practices and metrics, perhaps future exchanges could utilize a DAO or a CAO to provided quicker information to decision makers.

Where the Rubber Meets the Road

Currently it is difficult to foresee how the arbitration mechanism in a DAO would initially help anyone in China or other jurisdictions.  After all, who or what would enforce its decisions?  Or, if you used a DAO, what clauses could you include that hedge against the uncertainty of a potentially untrustworthy party?35 In terms of payment, fool proof clauses must be written into a contract that specify what exact channels or addresses the funds will go through and at what specific times.  While direct deposits are common on the mainland, it is not unheard of for unscrupulous employers to change bank accounts in an attempt to not pay debts.  Yet, cryptoledger-based escrow and bank providers may find new opportunities in this segment.36 And there are other options such as atomic-based transactions or atomicity in database parlance.

Michael Goldstein, founder of the Satoshi Nakamoto Institute, wrote a concise explanation of what an atomic transaction means:

Two parties agree to exchange one cryptocurrency for another, and the transaction is done in such a way that neither side can execute their portion of the trade without releasing funds to the other party. The trade either happens in its entirety, or not at all, which means nobody can walk away empty-handed. The worse possible outcome is that no trade occurs at all and everybody keeps what they had.37

You can substitute “cryptocurrency” with any kind of token (metacoin, colored coin or even a smart contract) that is capable of performing the same function.  Previous such atomic transactions have taken place in other systems such as with airline bookings.  A potential passenger must both pay for and reserve a seat or neither pay for nor reserve a seat.  A booking system will allow one option to occur and not a mix.

Using existing technology plus atomic transactions, there are several ways an employee and employer could resolve payment disputes.  In a small business between friends, family and other trusted parties, the formalized contract steps could be minimized.  A simple contract might look like this: working from home (it could be any arbitrary location) Bob builds a website for Alice and thereafter uses 0.0001 bitcoin (or litecoin, etc.) to generate a temporary token of arbitrary color, size or type but which represents a predetermined, pre-agreed amount of value – a temporary “labor” coin – and sends it along a cryptoledger to Alice.  Later that day, Alice looks at and approves of the website quality and subsequently sends Bob a token of predetermined value worth $500 (the exact amount is based upon a previously agreed to amount) and utilizes the same cryptoledger (although it does not necessarily have to).  Both tokens have a function called nLockTime built into them for twelve hours (these time values are arbitrary).  If both tokens are sent and received during that twelve hour time period, then the atomic-transfer takes place and both receive the other token.  Alice scraps the token she receives because it was a mere abstraction of the labor Bob provided (she can keep it for accounting purposes if she wants).  Bob on the other hand can then exchange his token to any fiat exchange, token exchange (Cryptsy, Bter), or perhaps even a merchant.

Again, this was simplified to illustrate how the atomic transaction works.  In this case, if one or both parties did not send their token in the allotted time – none of the tokens would be received by the intended parties.  Instead, the ledger would send it back to the originating wallet address.  For example, if Alice did not send a token, the next day Bob would wake up and see that he has not been paid and his “labor” token was sent back.  He can then talk to Alice to find out what the issue might be; after all, he would like to be paid for his labor.  In reality, as well as this example, it is possible for both Alice and Bob to use different cryptoledgers so long as there is some mechanism like a web exchange that has the ability to process both types of tokens.38

And so long as there are decimal units in a particular token, the logistics of sending value can be scaled up, for all practical purposes, near infinitely and potentially infinitely (assuming scalability issues can be overcome).  Even if all seven billion humans (plus DAOs) immediately began using one particular cryptochain that used just one specific base token (a bitcoin, ether, etc.), they could send fractional token sizes (e.g., 0.00001) to other parties.  Each individual (and DAO) could also include a secondary attribute in a “hash” or code snippet to identify what asset this token actually is meant to represent, such as cars, commodities, “labor,” and fiat (e.g., using metadata to turn 0.0001 BTC into a “blue” token or some other random attribute that acts as an abstraction to an specific asset).

Abstractions and Decimalization

Consequently because of this decimalization, the virtual economy should never run out of base tokens in the money supply.39 This is not inflationary, as no new base token is created that is not tied to some particular asset.  The underlying foundational token is still tied to the scarcity of the original money supply.  Furthermore, there are built-in anti-spam functions in existing cryptoledgers that require minimum transmission values, below which a transaction is not permitted along the network – this is known as the dust limit.40 And again, with Bitcoin, every 10 minutes 25 bitcoins are “created,” in Litecoin, every 2.5 minutes the same amount is created.  Other cryptochains have their own known, invariable money supply creation rates, but this is not important as the fundamental ideas are the same in that these tokens can be further subdivided into increasingly smaller decimal spaces and also given a second attribute to represent a different asset.  Similarly, additional DAO-based banks and escrow services could provide functions if atomic transactions are not agreed upon beforehand.

At a large enterprise for instance, Bob, a graphic artist, arrives at Adobe (his employer) and logs in with an RFID badge at the front door of the office.  The clock sends an encrypted signature to an HR DAO run by Carol’s independent escrow that creates a timestamped ledger entry on the Bitcoin network (or Dogecoin, etc.).  Bob’s computer is also fitted with software that can monitor his inputs, which are stored on Adobe’s SAN (while this verification role is redundant, Bob could also later point to the information gleaned as proof that he worked).  After completing his assignments Bob again, clocks out with his RFID badge which sends another encrypted signature that generates a token that represents one day worked.  The color or type or size of token is irrelevant as it is merely a representation of an agreed upon completed condition.  Alice, his supervisor can later send her own signature of approval (or disapproval), which is then sent to Carol’s DAO.  If approved, the token could be released and sent to another independent DAO, Dan’s bank, which stores tokens held in escrow on behalf of Adobe (e.g., n-of-m).  Once both tokens are received, the transaction triggers a time-based predetermined, pre-agreed settlement clause between Carol’s escrow services and Dan’s bank whereupon Carol sends Dan’s bank the “labor” token (which could be discarded or held for accounting purposes) and Dan’s bank sends a pre-agreed token (e.g., a bitcoin worth $500) to a prearranged wallet address that Bob controls with his private key (e.g., his bank account).  Dan’s bank could also send the token through other DAOs, this was just one illustration.

As you can tell, this type of system could be used with any amount of time lock, including years – hence the long-term potential uses of managing trust funds and the execution of wills.  For example, Bob has $1,000 and would like to give it to Alice, his 1-year-old baby daughter, when she turns 21.  Bob has several choices.  He can immediately exchange the $1,000 in fiat for a token (e.g., bitcoin) and place it in escrow.  He could deposit the fiat into a bank and fill out a smart contract with the bank that provides a time-based disbursement condition (e.g. in 20 years, spend the $1,000 and purchase an equivalent amount of bitcoin and send it to Alice).  He can deposit the fiat into a bank but then create a smart contract-based financial instrument with a fraction of a bitcoin (0.0001) which may cost him a few dollars now and send the smart contract to a DAO bank where it sits until a specific date is triggered.  He could also simply exchange $1,000 fiat for a bitcoin token today and leave it on the cryptoledger using an “external state contract” because the nLockTime function is already built into the protocol and the token will automatically go to a prespecified address at a specified time (e.g., in 20 years it will be moved to an address controlled by Alice or Bob).41 However, Bob should also be aware that if he signs and broadcasts the transaction far into the future there is a chance that some nodes may choose to drop the transaction in the memory pool.  If he uses an escrow, he can also create a smart contract that lays out the specific conditions, the terms to which a token is allowed to be sent to a pre-specified address (perhaps Alice has her own address, or maybe she is given access to his in the event he dies).

Another way to handle an inheritance with the existing blockchain is through an entity called an “oracle;” an autonomous 3rd party agent.  In his 2012 presentation Mike Hearn described an independent, trusted oracle system that is set up to monitor the obituaries section of a government agency or newspaper, whereupon it can relay identities and information to a contract on a cryptoledger.  Or in other words, the oracle listens and uses that data to sign a multi-signature contract and in order for the contract to release funds to the beneficiaries, it needs a signature from the oracle.  The contract had previously been signed by the original trustees who require a signature from the oracle to release funds to predetermined beneficiaries.42 Last year Michael Goldstein described another oracle involving a sports bet: Bob bet that team A would win and Alice bet the other team would win.43 An oracle holds the deciding key to a contract that says if team A wins, Bob receives the funds (bitcoins) and if team B wins, Alice receives the funds.  The parties write the contract noting how the transaction should proceed in the event of disputes or potential ties.  Then after the event is over an oracle signs it removing the middleman.  Unlike ordinary legal disputes involving nuances and grey areas, sports betting is an objective, idealized scenario because there is no grey area as all that an oracle would have to do is have access to an ESPN data feed.

Mitigating Abuse

Other near-term uses within a cryptoledger are loyalty programs, merchant reward programs and “Frequentfliertokens” from Alice Airlines which could help prevent and mitigate the risks involved in travel hacking (e.g., getting frequent-flier miles without flying).44 For example, United Airlines frequent-flier miles were downgraded effective February 1, 2014, due to rampant inflation caused by a combination of website vulnerability exploits and quick scheduling changes by users.45

Instead, Alice Airlines could offload the auditing, storage and transportation of rewards and utilize the “contract” system of a cryptoledger by using an arbitrary amount of a token (0.01 BTC), creating a “contract” that defines a set amount of mileage (which itself will likely have some predefined expatriation dates).  Assuming that flyers are using cryptocurrency wallets and provide the airline with their wallet addresses, the users will be able to receive the mileage amount in their wallets.46 In turn the users can sell and trade the reward tokens by sending a specified amount to Alice Airlines.

Other institutions can use a smart contract to issue and track its own customer loyalty program rewards.47 For instance, in 2005, Subway ended its sub club stamp program whereby a customer would receive a couple of stamps (stickers) for certain purchases.  When a customer collected a certain threshold of stamps, he or she was eligible to receive free food (chips, drinks, sandwiches).  Yet, a number of customers found a way to game the system by buying and selling entire reams of stamps on eBay, creating massive stamp inflation costing the parent company an unspecified amount in losses.48

Thus, coupons are another ripe area for development.  According to NCH Marketing, “Consumer Packaged Goods (CPG) manufacturers distributed 305 billion coupons in 2012, the same quantity as the year prior. […] total redemption for 2012 fell 17% to 2.9 billion coupons, saving CPG companies a substantial $800 million in face value discounts.”49  While this may seem like a mundane area, consider that by 2016 Juniper Research predicts that “the total redemption value of mobile coupons will exceed $43 billion globally” because coupons are increasingly delivered by mobile apps.50 For perspective, 48% of adult internet users in the United States redeemed a digital coupon for shopping in 2012.51 A company providing coupons or discounts could create a DAO to manage these redemption contracts (e.g., a type of time-locked token), which will not only reduce the logistical overhead but also prevent coupon abuse and fraud (e.g., double-spending).  According to the US postal inspector Roberta Williams, “for every coupon successfully counterfeited, it costs the manufacturer $1 million.”52 Initially these fake coupons are scanable but the coupon inflation ultimately forces manufacturers to redeem more than they had intended.  Furthermore, the Coupon Information Corporation (CIC) estimates that coupon scams create losses of $300 million to $600 million a year – and that these costs end up getting passed onto consumers.53 Yet, if there is one function that the algorithms governing Bitcoin money supply have proven adept at, it is preventing inflation.

While not directly related to fraud prevention, one real world case-study within this overall segment began in February 2014.  PointsHound, a site that rewards travel reservations with frequent flier miles and hotel points, announced that it had begun using bitcoins in its payout system.  If a user selects the bitcoin payout option, PointsHound calculates the reward based on the market price listed on Coinbase and then sends the amount to the user’s wallet.  According to cofounder Pete Van Dorn, “We carve out a portion of the commission to give back to the customer in the currency of your choice. It might be 5,000 miles, it might be Bitcoin.”54

The Tao of DAO

In developed regions, market participants are familiar with computer software that uses, runs, manages, and executes nearly all of the financial instruments on electronic stock exchanges – and how there are various clauses written into them to hedge against (or prevent, or in case of) some type of counterparty risk.  Below we will look at how that functionality can be designed into a smart contract with a normal contract at a normal job or even one that a Chinese migrant worker may do.

One way this might work:  Bob, an employee, would use a digital key to sign a smart contract with his boss Alice, who also uses a digital key to sign it.55 Within the contract will be a number of provisions and stipulations regarding payment time periods and clauses that hedge against the possibility that one party does not fulfill his or her end of the bargain.  Perhaps there will be a clause that says how payment will actually take place: through an escrow service (BTCrow), through bank X, through address Y, or a mix of different options.  This contract could be stored on a public decentralized cryptoledger (e.g., Bitcoin, Ripple).56 If stored on a cryptoledger it is tamper proof and forge proof as it sits there immune from 3rd party interference.  Again, while most people think of Bitcoin as a currency tracking tool, in arithmetic terms it is more akin to a database that can be used to track any particular dataset (e.g., a bitcoin) as long as it fits within the technical limitations.  It just so happens that the sole data this past four years has been for one particular “token” as represented by an integer on the ledger (i.e., bitcoin).57

While there is a way to change the way the DAO could operate by convincing the rest of those with votes to modify it with their private keys, the original contract would still be left in public view and untampered with.  What could happen is that contract itself would have an nLockTime (time-based) clause or condition that after X amount of time, if certain conditions are not met (for example, payment) then it would follow some predefined termination clauses.  Perhaps it would send itself to a predefined arbiter or escrow DAO.  While it is doubtful that smart contracts will solve all of the problems on the edges of a network (e.g. brick-and-mortar infrastructure), it will prevent tampering with the actual contract itself thereby protecting employees (and employers) from trusted 3rd party risks such as fraud.

So in a nutshell, ignoring other aspects of asset management, the following scenario could take place:

Bob digitally signs a smart contract with Alice stipulating various expectations, terms of compensation, etc.  This contract stipulates that payment will go through various channels each month, however if there is a breach of contract it will end up with Cathy’s escrow service (which itself could be an independent DAO).  In fact, there will very likely be several virtual escrow services that need to maintain a good, honest reputation to do business (just as they do today).  Furthermore, there will likely be a dispute-mediation clause regarding independent arbitration if all else fails (just like today).58 By “all else fails,” I mean there will be a time-based trigger: if neither Bob nor Alice re-sign clause B, C or D by a specific time in the contract located on the ledger, the contract is sent to Dan the arbiter or Eve at the public court.  Dan could, like an independent escrow service, be chosen from a list of known reputable arbiters who face similar market conditions to provide unbiased service (net-ARB is a type of service like this).59

These types of default-based relationships and contractual stipulations take place today.  While it may be difficult to initially “codify” them into software, it is likely just a matter of time: last year Coinsigner became the first cryptocurrency-focused dispute resolution service using multi-signature transactions.60 In fact, the barriers to entry are low enough that individuals can create independent mediation resolution practice to provide objective, unbiased fair decisions and any three people can employ it, across borders.  Whether these systems will be commercially viable for enterprises of significant scale is, however, as mentioned several times in this manuscript, very much an open question.

If stricter capital controls and regulations on cryptocurrencies are enacted in China (or elsewhere), by using a couple different “colored” coin chains (or other ledger contracts), Bob from Beijing could potentially transfer assets worth X amount of money to Alice from Anhui instead of X amount of money itself.61 This could create a sort of advanced barter system which may not be as efficient in terms of actually using a cryptocurrency as a medium of exchange but it could help those in an informal economy qualify and quantify asset value and clear up some of the confusion around contracts and property ownership.62 Yet how those contracts will be enforced is also an issue that will likely fill volumes, as any institution providing such service will be a target policy oversight, just like the exchanges are now.

At the same time, there are some uncertainties and legal risks which will vary from one jurisdiction to the next.  In China, it is hard to speculate how the various townships, counties, municipalities, provinces and the central government itself will recognize this type of ledger-based asset management.  Twenty years ago, most Western commentators believed that the internet would empower the average Chinese resident to maneuver around censorship, but the Great Firewall has proven very capable of stemming the flow of all information.63 While it would be difficult for them to block such decentralized peer-to-peer activity perhaps each government layer will instead want a small piece of the transaction and only recognize smart contracts that go through specific government-run DAOs or corporate custodial escrow and arbitration services with a contractual nexus to real assets and a national system of law and enforcement, as suggested by Preston Byrne in chapter 2.

  1. This is from Goethe’s Faust.  The actual quote is, “grey, dear friend, is all theory, and green the golden tree of life.” []
  2. See Mike Hearn, Bitcoin Developer – Turing Festival 2013 video and Bitcoin Developer Mike Hearn and Amex VP Michael Barrett Join Circle Team from CoinDesk []
  3. There is a keyboard shortcut and browser extensions called a ‘boss button’ which quickly switches the screen to hide certain programs (like a computer game or video). []
  4. Companies can receive analytics that provide reports on all file and network.  Some examples of such software are Ultra VNC, eBlaster and Screenshot Monitor.  See Are You Being Monitored At Work? by Becky Worley []
  5. Teaming up with “check-in” providers such as FourSquare could be a method. []
  6. Gregory Maxwell uses the term ‘agent’ in his StorJ proposal; see StorJ, and Bitcoin autonomous agents []
  7. BitcoinStarter and CoinFunder are two current services in the crypto crowdfunding space. []
  8. It is currently unclear what the arbitrary distinction between an “advanced” smart contract and a barebones DAO lies.  Both use a blockchain to conduct and manage their organizational operations.  Furthermore, to use the TCP/IP and SMTP analogy it is unclear at this time whether Bitcoin is merely one type of crypto app (like SMTP) or if it is more general purpose – a foundation – like TCP/IP is.  The ’2.0’ projects in the broadest sense (like Mastercoin, Colored Coins, Invictus, Ethereum, etc.) are an attempt to create a more general platform more akin to TCP/IP that other services are built on top of. []
  9. See BitPay, Coinbase and Bootstrapping A Decentralized Autonomous Corporation: Part I by Vitalik Buterin []
  10. Bitcoin and the Three Laws of Robotics by Stan Larimer:

    Bitcoins can be viewed as a small “share” of the total market cap of the Bitcoin “corporation”.   The “mining” services that validate transactions and secure the network are paid for in new bitcoins that slowly dilute the “stock” as the corporation’s market cap ebbs and flows.  You can generally trade your shares for other currencies, goods, and services.  Operating rules for the corporation cannot be changed unless a majority of stakeholders vote for them by switching to another version of the software.  Interestingly, it is not the holders of existing shares that get to make this decision, but only those “employees” who are contributing their computer resources (mining bots) to run the company.

    Nothing says a corporation can’t be structured to distribute voting rights this way, and that’s exactly what Bitcoin has done.  Shareholders get equity growth.  Employees get voting rights.  All “revenue” is paid to the employees as compensation for their work.  There are no profits. []

  11. An early concept of a larger voting-based system built on a DAO is the Bitcongress Foundation.  Furthermore, David Johnston of the Mastercoin Foundation articulated this same software development centralization problem in a January 24, 2014 interview, episode 80 – Beyond Bitcoin Uncut from Let’s Talk Bitcoin. See also DAC Index []
  12. Vitalik Buterin labels it a prototype, stating:

    As Let’s Talk Bitcoin’s Daniel Larmier pointed out in his own exploration on this concept, in a sense Bitcoin itself can be thought of as a very early prototype of exactly such a thing. Bitcoin has 21 million shares, and these shares are owned by what can be considered Bitcoin’s shareholders. It has employees, and it has a protocol for paying them: 25 BTC to one random member of the workforce roughly every ten minutes. It even has its own marketing department, to a large extent made up of the shareholders themselves. However, it is also very limited. It knows almost nothing about the world except for the current time, it has no way of changing any aspect of its function aside from the difficulty, and it does not actually do anything per se; it simply exists, and leaves it up to the world to recognize it. The question is: can we do better? []

  13. Richard Feynman first popularized this superficial hand-waving phrase 40-years ago through his memorable lecture, Cargo Cult Science.  The name is derived from the actions of a South Pacific tribe located on the island of Tanna in Vanuatu.  See In John They Trust from Smithsonian. []
  14. See The Shareholder vs. Stakeholder Debate reconsidered by Rüdiger W. Waldkirch and How to Bureaucratize the Corporate World by Ben O’Neill []
  15. See Sanitizing Bitcoin: This Company Wants To Track ‘Clean’ Bitcoin Accounts from Forbes and Coin Validation misunderstands fungibility and could destroy bitcoin by Adam Back.  Technically Zerocoin was already in development months before the Coin Validation announcement; at the end of the year Dark Wallet held a successful crowdfunding campaign. []
  16. While the miners could collectively fork and begin hashing a modified Bitcoin that integrated with Zerocoin, they have yet to do so for a variety of reasons, namely the $1 billion in capital investment (hardware) that would have to be written down because Zerocoin uses a new ledger and proof-of-work.  See Anti-Theft Bitcoin Tracking Proposals Divide Bitcoin Community from CoinDesk, Bitcoin Anonymity Upgrade Zerocoin To Become An Independent Cryptocurrency from Forbes  and Hopkins researchers are creating an alternative to Bitcoin from The Baltimore Sun []
  17. Shared Coin was originally called CoinJoin, see this tweet from Blockchain.info.  In addition there is a difference between on-chain (e.g., Blockchain.info) and off-chain wallets (CoinBase and Circle).  See Roger Ver on Blockchain’s Past, Present and Future from CoinDesk []
  18. While the project is still in its early stages, the Ethereum blockchain will unlikely include the anonymity features of Zerocoin.  Rather, there may be ways to create smart contracts and DAOs which can provide some level of anonymity (e.g., shell companies). []
  19. While these decisions provoke strong opinions and feelings, forks are also a potential as well.  Several “next generation” platforms may be compelling to some niches because of potential DAO functionality that could in turn use a contract or DAO to create ‘holding firms’ or even ‘shell companies’ (though obviously it is still on paper and has not been made).  Yet, even if something like Ethereum worked as stated and the Bitcoin development team coded in significant protocol and proof-of-work (PoW) changes, it is unlikely you would get even a plurality of Bitcoin ASIC miners, let alone 90% to agree with moving to a new PoW algorithm because that would make their capital investments worth exactly zero (because a Bitcoin ASIC is tuned to one particular PoW, SHA256d).  One recent estimate suggests that there is roughly $1 billion invested in existing hardware for mining globally including ASIC R&D.  See The Bitcoin-Mining Arms Race Heats Up from Bloomberg Businessweek.  Again, while “forking” comes up in conversations, ultimately the value is not necessarily the software code itself, but the infrastructure and mind-share behind it (the ecosystem). []
  20. Adam Levine coined this acronym for descriptive purposes.  Portions of his upcoming essay “Application Specific, Autonomous, Self Boot-Strapping Consensus Platforms (And the DACs that live on them)” are rephrased and reprinted with his permission. []
  21. This term is used to describe anyone controlling more than a certain amount of tokens that interface with a DAC(P).  The concepts of “exit” and “voice” were described in Exit, Voice, and Loyalty: Responses to Decline in Firms, Organizations, and States by Albert Hirschman.  These ideas have gained new prominence due in part to the decentralizing abilities and functions created by the software community.  See Software Is Reorganizing the World and Silicon Valley’s Ultimate Exit (slides) by Balaji Srinivasan []
  22. See Why are m-of-n transactions not used today? from StackExchange, What are multi-signature transactions? from StackExchange, Bootstrapping A Decentralized Autonomous Corporation: Part I by Vitalik Buterin and the Ethereum whitepaper. []
  23. This is called two-factor authentication (2FA) or two-man rule.  See also Shamir’s Secret Sharing. []
  24. For a technical overview of how multisig works, I recommend watching a video explanation by Andreas Antonopolous (Taariq Lewis put together this slide deck of Andreas’ notes). []
  25. Bits of Proof and Bullion Bitcoin to Launch Gold-Bitcoin Exchange from CoinDesk []
  26. Peercover []
  27. The team is also involved in a new broadcast marketing initiative at OpenXRPTalk []
  28. Personal correspondence, January 31, 2014 []
  29. Ripple is officially open-source! []
  30. Compliance Program Design Presentation at First Virtual Currencies Compliance Conference in NYC by Juan Llanos []
  31. See Accredited investor and the JOBS Act []
  32. BIPS (Bitcoin Internet Payment System []
  33. Doctors seek help on cancer treatment from IBM supercomputer from Reuters []
  34. Subledger []
  35. If the “clawbacks” over the past decade are any indication, local townships and provinces will likely be a hurdle until they see the utility such ledgers could provide their own administrations.  See China’s Turn Against Law by Carl F. Minzner []
  36. See Example 2: Escrow and dispute mediation []
  37. Lex Cryptographia and Satoshi Nakamoto Institute []
  38. These sites already exist: BTC-e, OKCoin, Cryptsy and Bter are among the largest multi-token processors. []
  39. Bitcoin has 8 decimal places, the last of which is called a satoshi.  In Ethereum, the last digit is called a wei.  Note: in all examples, each user uses a cryptoledger as the mechanism for transport and audit. []
  40. The dust limit has changed over the years and was implemented to prevent transaction spam (e.g., tens of thousands of transactions each amounting to 0.00000001 BTC).  The current limit is around 5460 satoshi.  See DustTransactions and What’s the minimum transaction with bitcoin? from StackExchange []
  41. Using external state []
  42. The trustees do not necessarily need to be humans, as a DAO or Digital Oracle could technically act as a party and signatory authority.  For example, see the whitepaper Securing wallets by integrating a third-party Oracle from CryptoCorp []
  43. Michael Goldstein Explains How The Bitcoin Block Chain Enables Smart Property from Newfination []
  44. The Ultimate Travel Hacking Guide from Lifehacker and How to Be a Travel Hacker by Nomadic Matt []
  45. Recap of United’s Downgrades: Award Charts, ExpertFlyer and Meals from Frequently Flying []
  46. It could simply be a hash of an embedded URL that sends you to a screen on Airline Alice with the actual amounts along with the Terms of Service.  Colored Coins have this potential capability as do other projects like Ethereum. []
  47. This is not to say that a company needs to build and maintain its own cryptoledger for a rewards program.  For example, assuming that Cocacolacoin is not using the Ethereum blockchain (or Bitcoin) but rather uses its own independent PoW blockchain, it may be hard to incentivize network hashrate which creates network security (which prevents a 51% attack).  That is to say, instead of trying to incentivize Bob the Miner to exchange hashrate for Coca-cola swag only, Coca-cola could simply use a common, independent cryptoledger (like Bitcoin). []
  48. Fraud Sinks Subway’s Sub Club from Wired []
  49. CPG Coupons: U.S. Market Analysis from NCH Marketing []
  50. Mobile Coupon Redemption Values to Exceed $43bn globally by 2016, Driven by Better Targeting and Mobile Apps by Juniper Research []
  51. Leader In Fast-Growing Digital Coupon Industry Sets Debut from Investors Business Daily []
  52. New coupon scam is costing U.S. companies millions of dollars from Fox6 []
  53. Start Your Own Online Coupon Or Daily Deal Business by Richard Mintzer []
  54. Rewards Program Tries Bitcoin from The New York Times []
  55. Public/private digital key []
  56. BTCrow []
  57. One of the primary reasons this was the case is because Satoshi Nakamoto intentionally created Bitcoin for that purpose, hence the full name of the paper “A peer-to-peer electronic cash system” – the first section of the whitepaper discusses the problems people have with paying for things online; it was not a manifesto. []
  58. See Example 2: Escrow and dispute mediation []
  59. internet-ARBitration []
  60. A Decentralized Bitcoin Exchange Process Dreamed up and Executed from Coinsigner []
  61. See Colored Coins project and Colored Coins: NYDFS Reviews Ways To Transfer Ownership With Bitcoins from International Business Times []
  62. Many of these “crypto exchange” ideas trace themselves back more than 20 years both in academic literature (Nick Szabo) and in science-fiction (Neal Stephenson).  In fact, Stephenson wrote three novels in the 1990s which include crypto-based themes as an integral part of their plots (not cryptoledgers or cryptocurrencies, neither of which were foreseen).  These are Cryptonomicon, Snow Crash and The Diamond Age.  Prior to these publications, one non-fiction document that is historically seen as significant in the development of anonymous digital currencies and electronic privacy is The Cyphernomicon by Timothy May. []
  63. The Great Firewall (防火长城) is an ongoing multi-decade project by several Chinese governmental institutions to filter and block undesired information from the mainland.  The GFW is very effective for the most part; without a VPN, I was directly impacted every day for 5 years.  I discuss this in Chapter 20 in Great Wall of Numbers.  See also The Master Switch by Tim Wu []
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Chapter 4: Smart Property

[Note: below is chapter 2 to Great Chain of Numbers]

Since the release of the original genesis block in 2009, hobbyists and professional traders alike have been practicing trustless asset management – except there has been only one asset: bitcoin, and it has been traded on what until recently was essentially an unregulated securities exchange.  The next evolutionary step is to begin using cryptographic ledgers to track, manage and exchange smart contracts and even smart property.

According to Nick Szabo, the lowest-hanging fruit in this segment is contracts that are 99.9% “dry” code – which is to say, those already formalized which can then be executed automatically via software code with extremely few manual exceptions.1 This would immediately encapsulate nearly all of the securities and financial instruments currently traded on electronic exchanges such as NASDAQ and Euronext (of which the NYSE is a component).2 This has a number of Christensen-disruptive qualities affecting middle management and potentially entire departments of individuals at financial institutions who neither write the code nor provide additional interpretive value to such contracts, and whose jobs (e.g., auditing, accounts reconciliation) could conceivably be  made redundant by a decentralized cryptoledger.

Virtual, digitized assets and financial instruments may be easier to visualize since many people reading this already have experience receiving salaries via direct deposit, using 3rd party payment processors (e.g., PayPal, Alipay) and even online brokerages (e.g., E-Trade, Scottrade); but how could smart contracts interact and control physical property?

Through a modification appropriately called smart property.

Szabo was one of the first to describe a solution to this interaction conundrum, with what he called a “proplet.”3 He stated in the paper, “the goal of proplet design is to control physical objects with digital protocols.”  In his view, the functionality of a proplet could be fulfilled with a microelectromechanical system (MEMS), a device that has microsensors with several capabilities including the ability to track ownership, determine precise location and provide robust security.  Most modern-day smartphones and tablets, as well as some automobiles, include some type of MEMS (such as an accelerometer).

While ten or fifteen years ago it may have been a tall order to convince manufacturers to add “proplets” to their wares, the unintentional spread of MEMS-like devices has taken place through an organic push called the “Internet of Things” (IoT) (e.g., home automation).  This is a term coined by Kevin Ashton in 2009 to refer to the ability to uniquely identify and tag any kind of object through an Internet-like structure.4 This can be done with existing technology such as RFID, NFC, barcodes, QR codes, and digital watermarking.  As a consequence, many modern appliances such as refrigerators, thermostats, smoke detectors, doors, vacuums and even light-bulbs could be manufactured with IoT features built-in.5 According to BI Intelligence, by 2018 there will be 9 billion IoT-enabled devices; more than all smartphones, smart TVs, tablets, PCs and wearable computers combined.6 Yet keep in mind, just because something is automated such as WiFi enabled light bulbs or even doors, that this is not smart property.  It may be automated or even autonomous but it is not “smart” in the sense that ownership and control can be reverted automatically to a different party via a smart contract.

If an object has not only IoT functionality, but also proplet-functionality, it can be managed by digital protocols which in turn can be managed by smart contracts.7 In fact, Szabo used a similar insight in an exchange: “Equipment and appliances that are not already titled, but have enough resale value to use as collateral, are good candidates to use the new peer-to-peer title registries and for building in proplets or something similar.”8

The question of logistics – how to control a physical object remotely through a contract – is a common one that Szabo and others have considered.  In one of his first publications on this topic, Szabo uses an example of a car lease and a smart lien protocol.9 A smart contract for a car lease may include a clause, such as a lien that revolves around a “time lock” (nTimeLock is the technical term used in Bitcoin).  In such a contract, if a lessee fails to make a payment, the smart lien protocol is invoked, preventing the use of the vehicle and enabling a creditor (and repo firm) to retake control of the vehicle.  Obviously there could be grace periods coded into such clauses and even operational exceptions, such as not revoking operation while a car is driving down a freeway.

Another example recently explained by Vitalik Buterin could be a museum pass.10 Using your phone’s NFC capability plus a feature like a “colored” coin or even bitcoin itself, assuming you own that token unit, you can sign a message attached to it with a private key.  You can purchase a museum pass and then you can digitally sign the pass that allows admission into a museum.  If you want to sell the museum pass you can transfer the virtual coin to someone else, they can sign the pass with their key (which is on their phone), and ownership is passed to them.  Or, if Bob managed a rent-to-own store, he could include some kind of “proplet” to electronic merchandise that would facilitate the creditor-borrower ownership (e.g., failure to pay for a television, refrigerator, or even arcade machine results in service termination).

Despite this marginal progression through automation of pharmaceutical dispensaries, automation of factory work, self-driving vehicles, and voice recognition, there is a gulf between what can be done and whether or not it will be legally allowed.

However, according to Szabo,

“There isn’t any big technological barrier to this. It’s largely a matter of learning about the technology and being persuaded enough of its utility to make the relatively large capital investment for such hardware (as opposed to cryptocurrencies and the title registry itself which is just software). The biggest barrier will probably be synchronizing with or replacing existing titling systems.  There’s no terribly difficult new technology required, but when it comes to property that is already registered (for example in the U.S. states register car titles), there has to be synchronization between the two registries, or else the states (in the case of cars) has to switch to using a block chain as the registry of record for their title systems. Alas there will probably be a lot of slow-moving bureaucracy and politics involved.  Since title registries are already pretty good in the developed world there is probably an earlier market for these kinds of systems in less developed countries when it comes to existing kinds of property. In the developed world block chain titles will at first primarily be used for financial instruments or contracts (and of course, the first use of all has been to store and transfer titles to money itself).  Also, equipment and appliances that aren’t already titled, but have enough resale value to use as collateral, are good candidates to use the new peer-to-peer title registries and for building in proplets or something similar.”11

Let us explore the car example.  What this would mean is that a state department of motor vehicles (DMV) would need to be convinced to use a computer system that is connected with the same cryptoledger or database that is being used to transfer automobile ownership.  This could conceivably be done with existing technology.  However, if the past five years of regulatory uncertainty and risks with cryptocurrency is any indication (e.g., anti-money laundering laws, Know Your Customer, Money Transmitter License, Money Service Business), it would seem unlikely that all departments like the DMV will quickly adopt this method and allow assets such as vehicles (or houses or securities) to simply trade hands without some kind of tax or oversight.1213

What happens to smart contracts if a cryptoledger one is using is abandoned by miners?14 For example, maintaining a single-use proof-of-work cryptoledger is not necessarily an optimal use of resources (discussed later in chapter 8).  As noted above, you could potentially use the consensus-mining power of the Bitcoin network (or alts) to actually track and manage nearly every type of asset.  The fact that it only tracks one is non-optimal in terms of assets per hash.  But hypothetically, if Bob created a new cryptoledger for the DMV that is then solely used to allocate and track vehicles from a DMV registry, what happens if the underlying ledger loses all of its miners in a year or two?15 The ledger then no longer is usable for its purpose.16 And the vehicle titles are potentially forgeable and untrackable if miners abandon the network.  The solution to this is that in all likelihood, the codebase for the smart contracts and DAO that utilize a cryptoledger will be portable due to its open-source nature.  Thus you could create and encode additional copies of the smart contracts and place them on multiple ledgers for redundancy.  That is to say, the developmental costs of duplicating and triplicating the smart contracts onto other ledgers are minimal.   Either that or the ledger would be mined by the state, and electricity costs would be passed on to the general public as taxes.17

There may be other opportunities for entrepreneurs to build tamper-proof and tamper-resistant containers with embedded smart property elements (NFC, MEMS), allowing users to track packages in near-real time.18 Or perhaps industrial design consultants can find new opportunities to assist companies wanting to affix proplets to their wares – a process which incidentally fulfills what Richard Brown jokingly stated last fall: on the blockchain, nobody knows you are a fridge.19

Paper Meets Electricity

Smart contracts are coming of age in a period of paper-based controls designed to prevent error, fraud and abuse by delegating tasks to different, imperfect agents.  For example, an auditor may split up functions in a warehouse in which delivery, sales, receipt of payment and accounting are assigned to different parties.  According to Szabo, this segregation-style method is done as to require conspiracy by each party in order to accomplish fraud and abuse.  Yet in a paper-less, digital era many of these functions are now redundant as they are provided by a decentralized cryptoledger that is immune to abuse (without a corresponding digital key); thus there is a need for smarter controls, not more stringent ones.  Such controls would explicitly outline, by way of smart contract, the exact relationships, duties and responsibilities of each party to a transaction.   This will transform traditional hierarchy and organizational structure within companies (both small and large), allowing the possibility for more horizontal, flatter firms.  And typically, the flatter the organization, the fewer the transactional layers and delays between decision makers and information (e.g., removal of some information asymmetries).20

With the advent of CRM, ERP and other advanced accounting, auditing and HR software that condense administrative overhead, these hierarchical and organizational changes have been taking place with increasing rapidity over the past 20 years.  Yet they create new challenges in terms of trust.  For example, mergers between accounting, investment, and consulting firms can create blurred lines of fiduciary responsibility and accountability.  Szabo suggests that trust “will erode still further as accounting firms start taking advantage of the vast amount inside and marketing information.”21 Like clockwork, throughout each year there are numerous investigative reports detailing these types of insider cases, of people being allowed access to privileged information or to execute trade orders without authorization.

General Turdgison’s memorable quote regarding “Plan R” which (un)intentionally was used to bypass authorization protocols and the chain-of-command to unilaterally drop nuclear bombs against the Soviets sums up this conundrum: “the human element appears to have failed here, but we’d hate to condemn an entire program based on a single slip up.”22 Jokes aside, even if there is no intentional abuse by insiders, outside parties can still gain access to sensitive documents and information through social engineering as outfits like Lulz Security have demonstrated in a very public fashion.23 Perhaps in an era of Bitcoin or Ripple-based cryptoledger turnkey solutions, large enterprises could not only manage access to key documents (away from the prying eyes of Alice and Bob) but easily manage physical plants, campuses and even fleets of cars through the use of proplets.  There will likely even be various profitable business opportunities for (attempted) key recovery consulting.

Slowly Evolving

More than twenty years ago, automobile manufactures created the precursors to the modern electronic data interchange (EDI) standard.24 EDI is a document standard that essentially turns paper-based business forms into electronic forms and thus acts as a common interface between two or more computer applications that enables them to understand what the documents mean.  By using standardized markup, syntax and terminology (e.g., XML), organizations can quickly and cheaply send structured information to other compliant systems which allows closer integration.  For example, a manufacturer can seamlessly send documents to vendors in its supply chain.  Automobile and aerospace companies were some of the first firms to implement this technology as it allowed computer systems to automate what had otherwise been a manually intensive, error-prone, and sometimes – abused network of systems.

Over the years EDI has grown to digitally absorb dozens of forms such as: product and price catalogs, purchasing orders, inventory status updates, shipping orders, customs declarations and receipts.   Consulting, accounting and law firms have followed suit, automating  administration, billing and cost recovery systems into one standardized documentation and file format used by ECRS and LEDES software packages that have become industry standard in any enterprise of meaningful size.  The supply chain industry and shipping industry are further fusing with technology through the power of cloud-based services.  For example, in October 2013, Ingram Micro acquired Shipwire, a cloud logistics and supply chain management provider.25 That same month, Pacejet Logistics raised $4.5 million in an effort to connect logistics services with carriers like UPS via the cloud.26

As a testament to Nick Szabo’s groundbreaking work, rather than rephrasing what he has written, I recommend that all readers interested in smart contracts read his seminal piece, Formalizing and Securing Relationships on Public Networks, which deals with many of these matters in considerable detail.27

Though Szabo presents a holistic view of a trustless system, we should keep in mind that his view is a proposal – a visionary one, but one which will be tested by many hypothetical and real-world scenarios that will challenge the idea of trustless asset management in the coming years (and which will likely fill many volumes of writing).  The influence of hackers – not of the blockchain itself, but of more vulnerable systems authorized to interact with it – is particularly illustrative.  When Alice’s digital key on her smartphone or laptop is hacked by Bob and her smart contract-enabled car is sold and then fraudulently resold to numerous individuals, what recourse could she have?  In an ideal scenario, the security of the car and her key would remain out of the reach of hackers, but as has been illustrated over the past five years, digital keys can be lost, stolen and extorted (e.g., the CryptoLocker virus, or unencrypted wallets being stolen from cloud storage).

In all likelihood, as Preston Byrne and another legal professional consulted on this manuscript think, market demand for consumer protection might discourage and even reverse decentralization, rather than promote it.  As Byrne speculates, “there would likely be several centralised repositories tasked with verifying legal title and reversing fraud – whether those be corporate or government entities.  Alice might, in this case, specify in advance which agency or court would have authority to make that decision (by possession and cold storage of the relevant private key) when title first lawfully passed to her; she might also have to pay a small one-off fee (assuming a competitive market for custodial services).  Likewise, purchasers would want to be able to verify that any digital title they possessed was validly transferred and not subject to equities in favour of any third person.  The blockchain would therefore need to be paired with other methods of title verification – which would likely be less expensive than the current title transfer systems in place in many jurisdictions (e.g. a state DMV).  In the event Alice does not want to pay a small fee for a 3rd party, however, she could use an unregulated blockchain, but that ancient rule would apply – caveat emptor.”

  1. Personal correspondence, January 24, 2014 []
  2. The Euronext merger with the NYSE was completed on April 4, 2007.  In turn, Intercontinental Exchange completed the acquisition of NYSE Euronext on November 13, 2013. []
  3. Proplets — Devices for Controlling Property by Nick Szabo []
  4. That ‘Internet of Things’ Thing by Kevin Ashton and Open Source Solution for the Internet of Things into the Cloud []
  5. See Your Door Is About to Get Clever: 5 Smart Locks Compared from Wired, Smart Refrigerator from Mashable, Nest Thermostat, Nest Protect, LG Hom-Bot Square review from C|net and Spotlight on LIFX LED bulbs from C|net []
  6. The ‘Internet Of Things’ Will Be Bigger Than The Smartphone, Tablet, And PC Markets Combined from Business Insider []
  7. In one notable example used by Mike Hearn, he describes how a Bitcoin user could use the microtransaction capability of Bitcoin to open and close doors equipped with such devices.  See his Bitcoin 2012 London video.  The new OpenLibernet is a project that is trying to make this a reality, by fusing bitcoin microtransactions with decentralized mesh networking. []
  8. Personal correspondence, January 24, 2014 []
  9. The Idea of Smart Contracts by Nick Szabo []
  10. Ethereum Introduction from BTC Miami []
  11. Personal correspondence, January 24, 2014 []
  12. On March 18, 2013, the Financial Crimes Enforcement Network (FinCEN) which is part of the US Department of Treasury issued guidance (pdf) related to Anti-Money Laundering Laws (AML) which specifically discussed virtual currencies such as Bitcoin.  See History of Anti-Money Laundering Laws.  For KYC and MSB see also, Understanding global KYC differences from PriceWaterhouseCoopers, FinCEN Brings KYC Requirements To Bitcoin? from Bitcoin Money and FinCEN Declares Bitcoin Miners, Investors Aren’t Money Transmitters from CoinDesk []
  13. Last year alone, nearly all Bitcoin-fiat exchanges were shut down due to legal reasons in the US.  See Dwolla Account Seizure Reveals Mt Gox on Brink of US Indictment from Contrarian Compliance, Bitcoin Foundation Receives Cease And Desist Order From California from Forbes, Bitfloor: Largest U.S. Bitcoin Exchange Shuts Down from Mashable, OKPay suspends payment processing to all Bitcoin exchanges from The Register, Transferwise suspends operations from TransferWise, BitCoin Mining, Other Virtual Activity Taxable Under US Law from Slashdot and Fixing Bitcoin’s shaky exchange infrastructure from CoinDesk []
  14. Another question is: what happens if they are stolen?  Does Alice, a hacker in Russia now own Bob’s car?  While there are ways to sign transaction by multiple parties before they get sent, it is still a long way to go for this, asset management system to become trusted and adopted by the average consumer. []
  15. Each political jurisdiction is different.  For example, in Israel the “DMV” (Misrad Harishui) serves to license drivers only.  The tracking of vehicle related registrations happens at the post office (e.g., license plate’s transfer with the vehicle, not the registrant.  If Bob sells Alice his car, they would both go to the post office and make notice of the transfer of the ownership, and Alice would drive away with the existing plates). []
  16. “Will the last miner please save a copy of the blockchain before leaving the room?” []
  17. Again, a user would not need to purchase 1 BTC or 1 LTC, you could use a fraction of a token which is then used to represent and track the smart contract.  The costs of obtaining this fractional token could be minimal. []
  18. Much as standardized shipping containers (ISO intermodal container) have served as the backbone for global commerce over the past five decades, the potential for building light-weight but tamper-resistant packaging (e.g., polycarbonate, thermoplastic) coupled with embedded smart property features allowing near-real time tracking, may enable cryptobarter to germinate.  See The Box: How the Shipping Container Made the World Smaller and the World Economy Bigger by Marc Levinson []
  19. On the blockchain, nobody knows you’re a fridge by Richard Brown []
  20. In economic terms these are called “transaction costs.”  See The Nature of the Firm and The Problem of Social Cost by Ronald Coase and Transaction Costs by Douglas Allen. []
  21. Formalizing and Securing Relationships on Public Networks by Nick Szabo []
  22. Dr. Strangelove or: How I Learned to Stop Worrying and Love the Bomb []
  23. Kevin Mitnick is perhaps the most infamous example of the early ‘hackers.’  Mitnick was a hacker in the 1980s who used social engineering (e.g., manipulating secretaries to give him secure access) to compromise corporate networks such as DEC and Motorola.  See The Art of Deception: Controlling the Human Element of Security by Kevin Mitnick and Takedown: The Pursuit and Capture of Kevin Mitnick by Tsutomu Shimomura []
  24. For more about EDI see, Electronic Data Interchange (EDI): An Introduction by Roger Clarke []
  25. Ingram Micro Buys Shipwire, The Cloud Logistics And Supply Chain Management Platform from TechCrunch []
  26. Pacejet raises $4.5M to bring shipping to the cloud from VentureBeat []
  27. Formalizing and Securing Relationships on Public Networks by Nick Szabo []
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Chapter 3: Next Generation Platforms

[Note: below is chapter 3 to Great Chain of Numbers]

As innovative and groundbreaking as Bitcoin has been, it has several known technical limitations.1 Simultaneously, the current development team is hard at work on priorities revolving around improving the security of the protocol from vulnerabilities and exploits.2 This is not a criticism of their activities and actions, especially in light of the transaction malleability issue that caused frenetic activity within the ecosystem during the middle of February.3 Other developers in the community have tried to assume the mantle of responsibility for improving the functionality and capabilities of this space.  Some projects involve fusing exoskeleton systems built around the Bitcoin protocol; others create their own independent ledgers; still others have even created bridges between Bitcoin and other ledgers.

Below, I introduce eight projects that are currently developing a mechanism to design and transport smart contracts or smart contract functionality.4 For each, I attempted to interview the main developers.

Colored Coins

As noted above, one way to utilize a crypto blockchain to verify wares is through a process being developed called Colored Coins.5 In a nutshell, this endeavor allows users to “color” a token to represent a specific asset such as a car, home, boat, commodity, a share, a bond – virtually any type of asset (e.g., 0.5 BTC colored green to represent your home).  These tokens can then be exchanged, just like bitcoin tokens, by anyone anywhere.  This enables a decentralized, trustless form of asset management that uses a blockchain as both a ledger and transportation mechanism.

Alex Mizrahi, who is leading the development of the Chroma Wallet used by the Colored Coins project says that “it is going to be very easy for the asset management industry as a whole to use Colored Coins.6 For example, some of the first places we are going to have adoption will likely be real-estate and portfolio management.  In fact, for any type of asset management it’s going to be simple to issue his own color that represents his goods.  A portfolio manager can issue one color that represents a portfolio of stocks backed by the real holding and sell it globally.  If he is savvy and his products are good, his colors are going to have demand.  So transferring ownership is very easy, quick and safe — just like bitcoins.  In the real estate industry someone can issue their apartments using colored coins and have them float on the blockchain, or manage time-sharing based on color.”7

Meni Rosefeld, another member of the development team, described several of the advantages of using a secondary attribute (color) within the asset management industry. “The greatest advantage is the removal of barriers of entry.  Currently, new businesses wishing to raise capital use cumbersome and inefficient private deals; and those aspiring to be listed in order to allow for the market to valuate them with an efficient mechanism, can only do so with a great expenditure. With colored coins, anyone can easily raise funds in exchange for equity, removing barriers of entry, encouraging innovation and allowing society as a whole to better allocate its resources between ventures.”

One area of confusion within the Bitcoin community is the misplaced understanding – that centralized servers are needed to issue and track a secondary attribute (the “color”).  According to Rosefeld, this is incorrect. “No centralized servers are needed for tracking – this is done in the decentralized network of the host currency (such as Bitcoin).  There does need to be an entity issuing each particular colored coin – however, an entity raising funds for a generic purpose is not usually in the business of running an exchange. Without colored coins, they would have to resort to a large 3rd party exchange with all the usual problems of barrier of entry (for both issuers and exchanges) and vendor lock-in.  With colored coins, they can outsource the tracking and exchange to the efficient decentralized network.  The issuer is only involved when issuing or recalling the coins; investors can then trade the coins between themselves without involving any 3rd party, which has implications for privacy, efficiency, and the kind of advanced transactions one can do.”

I also spoke with Amos Meiri, head of dealing at eToro, another member of the development team for the Colored Coins project.8 I asked: would it be easier to simply conduct all trade privately at the centralized exchange where it will be more scalable and private.  In his view, “Centralized exchanges definitely have their advantages, but colored coins can be useful for following reasons.  First, users do not need to trust their bitcoins to a centralized exchange.  Companies cannot manipulate ownership records (to commit fraud, for example).  So basically, if somebody gives you an IOU, it isn’t a good idea to leave it with the person who issued it or to affiliated parties.  Another reason is that companies cannot control how its shares are being traded, thus it cannot block trade.   And lastly, there is no need to maintain servers or manage security due to its integration with the blockchain.”

While this is obviously easier said than done, as noted above, this idea of using cryptoledgers to manage smart property has inspired and motivated numerous other groups to put forth similar efforts.  For example, Counterparty was launched in January.9 Its mysterious, relatively anonymous development team has released similar open-source applications, documents, binaries and tools that allow users and entrepreneurs to build smart property functionality such as derivatives and dividends in a decentralized manner.  Also in January, reporter Jon Southurst discussed several other groups including Reality Keys that can utilize a crypto protocol to build a predictions market or a way to hedge against currency fluctuations.10

Mastercoin

At the beginning of January 2014 I spoke with Taariq Lewis, the founder and CEO of BitcoinBusiness, a Bitcoin advisory firm and he is also the Smart Property and Business Development Lead of the Mastercoin Project.11 Mastercoin is a crowdfunded, non-profit endeavor to create an open-source decentralized exchange protocol for Bitcoin.  As noted above, the Mastercoin project has received 4,700 bitcoins ($5 million at the time) in crowdfunding which has been used to pay for bounties, building tools and write documentation all of which is ultimately released on an open-source basis.1213

According to Lewis, “we are on the tip of the iceberg of the democratization of upper level finance and investment management.  One apt analogy is that the current system involves a highly siloed, highly centralized organization reminiscent to the music industry prior to P2P innovations.  We are now approaching the first wave of people being able to distribute financial products to each other on a peer-to-peer basis.  While this obviously has regulatory repercussions such as the SEC and CFTC oversight in the US, there is no “Wolf of Wall Street” in crypto.  In fact, projects like Colored Coin, Counterparty and Mastercoin will create applications that will decentralize stock and bond exchanges allowing individuals and entrepreneurs to build dividend products and distribute the assets without middlemen.”

I also spoke with Ron Gross, co-founder of Bitblu and executive director at the Mastercoin Foundation, who also pushes the open-source nature of the project. “With Mastercoin, we are all developing open source software and tools that eventually will enable anyone to build their own applications on the platform.  We are still hiring people for the core development team yet ultimately we want to move into a decentralized structure where we as team do not actually own anything or manually hire and fire but rather a Decentralized Autonomous Application (DAA) does.  In addition we have put together a series of external bounties, where we give away $100,000 each month to developers outside the organization either working on specific milestones or just doing general innovation around the ecosystem. Thus new programmers to this space could immediately be financially rewarded for looking through a list of bounties and submitting solutions to them, or for being creative and building around the infrastructure.”

Gross sees this ecosystem eventually mapping the real world in a digital space: as self-reinforcing entrepreneurial activity – continuously builds the ecosystem a new financial system will emerge that serves as a bridge between cryptoledgers and the existing world.  As part of this vision, a natural outgrowth encompasses decentralized applications, bonds, asset backed coins, commodities, real estate, betting and prediction markets that correspond to a smart property token will emerge.  One on-going project he highlighted in particular was an open-source omniwallet, which will eventually be capable of handling and tracking the cornucopia of altcoins, metacoins, and even colored coins.

Yet getting there will obviously involve hurdles.  According to Gross, “just getting the protocol developed and robust will be a rewarding challenge.  The infrastructure is not quite ready for large more complicated projects and is undergoing massive development yet Mastercoin and all the other protocols in the same space are still accessible due to the open-source nature.  Any developer, anyone can come – look at the spec, go into the debates, send in your pull requests, look at the code – and contribute immediately.  There is no need for a central brick-and-mortar building because if you contribute anything that is positive, you will get rewarded for it.  BitAngels is launching a fund soon that is going to invest in protocols, development of DAOs and other “2.0” initiatives through hackathons where the top winners will receive a $500,000 investment.14 And through these efforts we will build a better financial system, one that is decentralized and creates complete financial freedom. The impact of creating such tools is obviously a matter of speculation but even a fraction of the pie is going to be really large.”

I also spoke with David Johnston, managing director of BitAngels, the first angel investment network focused on digitial-currency startups, and a board member at the Mastercoin Foundation.15 In his view, “cryptocurrencies are more than a payment network, it is more than a new type currency or store of wealth.  It is a whole new platform and is a way for people to now make programmable money and that gives rise to smart contracts.  Now that this money is programmable I can put it into applications, I can create other digital tokens.  That’s what really gets me excited where anyone can build anything.  In the long-run we also plan to turn the entire project into a DApp, to maximize resources and improve efficiencies.”

A DApp is short for decentralized application.  The Mastercoin platform, like arguably every other one, is still a work in progress and has gone through several iterations based on community feedback.  It also faces market competition from several others in this space such as Open-Transactions, Invictus (formerly BitShares).  As a consequence, it looks like a promising area for Christensen-style innovation.

NXT

Launched in late November 2013, NXT is a new cryptoplatform written entirely from scratch in Java.16 The platform has the ability to natively track “colored coins” – tokens that represent a specific asset based on their “color” (e.g., using a fraction of NXT to represent a car or house).  It also includes a decentralized asset exchange, which means you can buy and sell assets without going through a 3rd party.  For instance, one of the problems that impacts centralized exchanges and online stores today is that both your fiat and tokens are vulnerable to theft, hacking and other abuse.  In one notable instance, in December 2013, an online commerce site called Sheep Marketplace was hacked and 96,000 bitcoins were removed from its web-based wallet making it the largest known cryptoheist.17 This type of abuse is nearly impossible in a decentralized peer-to-peer exchange because there is no single centralized point of attack.18

In February 2014, I exchanged messages with “Uniqueorn,” contributor to the NXT development team.19  In his view, “the best way to compare NXT to the other cryptocurrencies is basically to not do it. NXT is not an altcoin at all.  While most of the cryptocoins being circulated are typically clones of the Bitcoin codebase with a few slight variations, very few of them bring anything new or substantial to cryptocurrency functionality.  On top of this is a built-in encrypted messaging system (like BitMessage) and anonymous payments (similar to Zerocoin) which adds an additional layer of privacy to protect confidential information and trade secrets.  Yet a lot of work still needs to be done both with our platform and the rest of the industry.  You cannot expect that your mother and father are going to sit down and understand this. For them it is supposed to be a tool to make their lives easier, not harder.”

Another key difference is that unlike Bitcoin and Litecoin which utilize proof-of-work mechanisms that scale in difficulty with network hashrate (i.e., additional hashrate added to a cryptoledger proportionally increases the block difficulty level); NXT instead utilizes something called ‘Forging,’ which is basically recirculation of NXT (Proof-of-Stake).20 “Uniqueorn” noted that, “proof-of-stake allows ‘miners’ to generate NXT without requiring the use of relatively large sums of electricity that other cryptocoin proof-of-work systems currently do.”  In other words, the barriers to entry are significantly lower as user does not need to utilize a top-of-the line ASIC machine which is discussed later in Chapter 7.  Therefore, a user can “forge” tokens on a smart phone, a solar powered Raspberry Pi, or a laptop computer.  In practice, an algorithm randomly picks one node to process all of the transactions and all other machines know this system is the sole transaction ‘forger’ – thus all other erroneous transactions can be discarded.  All machines participating in this ‘forging’ effort are rewarded according to the proportional amount of NXT they have; thus if you have 1% of the tokens you have a 1% chance of being selected to forge the next block.  Because the transactions nodes are known, this provides increased security, an estimated 90% of the NXT tokens must be controlled by one agent in order to compromise the network via a double-spend (e.g., 51% attack).21

I also corresponded with ‘Graviton’ who is the Nextcoin.org community founder.22 According to him, one of the motivations for why the core team decided to move beyond Bitcoin was, “there certainly seemed to be demand for a technically advanced cryptocurrency with a completely new codebase that puts away the requirement for energy expensive Proof-of-Work once and for all.  The environmentally green and attack resistant Proof-of-Stake algorithm, plus the important fact that NXT is not only a payment instrument but a new generation platform natively supporting a suite of services such as decentralized trading and encrypted messaging, seems to have filled gaps that were shining open wide with the existing old school cryptocurrencies.”

He is also looking forward to the deployment of a decentralized asset exchange as well as colored coin functionality on the NXT platform and believes that these will “become a popular standard for quite a bit of trading applications, for both – cryptocurrencies and assets denominated in them.  The rest of the industry will integrate seamlessly to that, so the distinctions between various crypto brands will start to dissipate.”  And like several other developers interviewed, “the killer app would be to have available the simplest possible means to pay for merchandise & services in fiat nomination but from one’s cryptocurrency wallet, to be able enjoy the fiat price appreciation with the same wallet, and to flip your wallet contents to another crypto with a push of a button.  Preferably on mobile.”

Ethereum

Another “2.0” project that is gaining traction is Ethereum, announced in January 2014 which brings together both a cryptoledger and a Turing-complete programming language.  In short, a Turing-complete programming language means that the language can be used to simulate any other computer language (not just its own).  The original Bitcoin protocol and software implementation released in 2009 included a language called Script that had many limitations (it was intentionally not Turing-complete) and as a consequence has largely been underutilized.  As a consequence, developers have had to try and use these duct-taped exoskeleton wrappers to build on top of the protocol to enable new functionality.  Many developers, including those with the Ethereum project, recognized this limitation and, rather than building and providing a specific feature set, will instead use a Turing-complete C-like language (CLL) that software developers can then use to build a cornucopia of tools, including any type of smart contract, asset management instrument or even a decentralized autonomous organization (DAO) that can then be automatically executed, controlled, and audited by the Ethereum ledger.23 While its approach is one of the most holistic thus far, its long-term success still requires a critical mass, mind-share and the network effect.

To find out more about Ethereum, I corresponded with Vitalik Buterin, head writer at Bitcoin Magazine and a lead developer on the Ethereum project.24 Because of the all-encompassing abilities “2.0” projects are slated to have, it could be confusing for developers to determine on which platform to initially build their apps, but that may not be the only hurdle.  In his view, “I would say the main challenge in the 2.0 space is going to be (1) building contracts, and (2) building interfaces. These have always been problems, of course, but up until now they have been eclipsed by other, larger, problems, like maintaining server infrastructure and scalability, ensuring security of funds, regulatory compliance and having banking relationships. With decentralized apps, most of those problems are gone, so the only two issues that still remain – contract design and interface design – are now at the forefront. The two problems can easily be handled separately; someone should be able to write a derivatives trading GUI and have that port over automatically to various systems inside of Ethereum, BitsharesX and whatever else people want to trade on.”25

Several other developers and investors I spoke with had similar sentiments: creating easy-to-use, intuitive interfaces for end-users would quickly set your product apart from the pack.  While there have been many advances, especially for merchant plugins, backing up and securing wallets can be quite cumbersome and even a chore to handle at times, stunting wider-spread adoption.26

Buterin had previously worked on both the Colored Coins and Mastercoin project.  While portable, both of these currently utilize the Bitcoin protocol, which has a couple of limitations.  In Buterin’s view, “one of the key features of Bitcoin is that it has a concept of “simplified payment verification” (SPV), where a Bitcoin node can verify the validity of a transaction in the blockchain by only downloading the very small subset of data in the blockchain that is relevant to that particular transaction.  Given that a “full” Bitcoin node now takes 14 GB of space to run, beyond the reach of many users, this mechanism has become an essential part of Bitcoin security. The problem with on-blockchain meta-protocols, however, is that they do not benefit from this protocol. The underlying Bitcoin layer has no way of knowing whether or not a given transaction is valid in the context of the meta-protocol, so the Bitcoin blockchain will include transactions that are both valid and invalid, and so the validity of a given meta-protocol transaction can only be calculated by recalculating the entire state of the protocol up until that point – requiring the full blockchain.  Ethereum solves these issues by not being a meta-protocol, instead relying on an independent blockchain.”

SPV is a type of thin client that provides Bitcoin users a lightweight method for sending and confirming transactions without having to carry around the entire database.27 It does this by downloading only the headers for all the blocks (i.e., the Merkle tree) and not the entire blockchain itself.  As a consequence, this flexibility enables Bitcoin clients to be used by point-of-sale registers that may not have enough space or bandwidth to continuously download the entire blockchain.  And at this time, as Buterin notes, the only way to completely confirm that a transaction based on Colored Coins or meta-coins like Mastercoin is valid is to re-check the entire blockchain.  This presents a significant obstacle to scalability.

When describing and defining what a “smart contract” and “DAO” are, it can be confusing at times because a robust smart contract is sometimes used synonymously with a DAO.  According to Buterin, “I would say there is no clear-line distinction between the two, but there are some general differences in connotation. To me, a smart contract is something that is single-purpose and ephemeral, so they are created for a specific task and can disappear at the end. A financial contract is a good example there. An autonomous agent is something that is more long-term focused, and includes an internal AI to make decisions. And finally, a decentralized autonomous organization is a long-term contract between many people, perhaps even with the ability for people to join in as signatories or trade their positions away, whose main role is to hold on to assets and use some kind of voting system to manage their distribution. There can be many different types of DAOs; the more basic ones live entirely on the blockchain, but more advanced ones might have some of their data stored on other decentralized networks or across a number of servers.”28

Throughout this manuscript, several of Mike Hearn’s presentations are referenced, including the Turing 2013 conference.29 While both Hearn and Vitalik Buterin use the same name, DAO, the definitions for what the term implies, varies.  In an email exchange, according to Hearn, “what Vitalik calls DAO’s are not quite the same as what I discussed in the Turing talk. I used to think they were the same, but on closer inspection he called Bitcoin itself a DAO so it’s obviously different.  Assuming you mean agents, there are so many challenges I doubt it will happen any time soon. Really you need trusted computing for it to work well and that won’t work well at least until Intel release CPU’s supporting their SGX extensions, which they didn’t even announce a date for.”

Trusted computing is a term for computers that can be controlled a certain way via encryption.  Many governmental agencies such as the US Department of Defense require that computers acquired by vendors have such functionality.  In September 2013, Intel released its programming reference manual for Software Guard Extensions (SGX) which could potentially create similar functionality in consumer-based systems.30

Throughout this guide I describe simple “smart contracts” with the assumption they do not have any sophisticated internal AI components.  Similarly I refer to relatively simple DAOs that wholly reside on the blockchain.  As programmers become more acquainted with decentralized software and the technology evolves and begins to be used in practical applications, it is likely the specific meaning of each term will be subject to change.

BitShares

This last point is viewed as a critical issue to other 2.0 project managers as well.  I had an email exchange with Daniel Larimer, the creator of BitShares, and the first person to describe Bitcoin as a Decentralized Autonomous Company (DAC).31 BitShares is a new way to view cryptocurrencies where you view your wallet balance as shares rather than coins.   According to Larimer, Bitcoin can be viewed as a DAC where each bitcoin represents one share in the Bitcoin ecosystem.  The transaction fees that Bitcoin charges can be viewed as revenue to Bitcoin and the mining rewards can be viewed as expenses paid by Bitcoin to secure the network.

Larimer decided to change the analogy from coins to shares so that the underlying economics could be considered when designing next generation crypto systems.   Based on this analogy, he sees several ways to improve Bitcoin when viewed as a company.  In his view, the driving principle is that all companies should generate profits by minimizing expenses while maximizing revenue from product sales.

In the case Bitcoin, the primary expense is security which is provided by an expensive proof-of-work (PoW) process described in chapter 2.  In BitShares systems all security is provided by proof-of-stake (PoS).  In his view, a PoS (which is also used in NXT) can be thought of as having the shareholders vote on the valid transaction ledger.  In this way those who own the system secure the system without having to spend increasingly larger sums of capital to do more work than any attacker can.  This last point was recently described by Nicolas Houy, a researcher at CNRS, stating, “Bitcoin miners have engaged in an arm race to computational power and in the end, much hardware, engineering and energy are used to solve mathematical problems that are artificially made extremely complex.”32 A PoS system is supposed to remove this artificially complexity and lower the capital costs for entry.

The other thing BitShares systems do, according to Larimer, is focus on increasing the value of the transactions that can be performed and thereby generating additional transaction fees.  Because there are no miners to pay, transaction fees can be viewed as profits for the system and these profits are used to buy back and retire shares.  This has the effect of increasing the value of the shares still in circulation.  It is economically similar to earning a dividend.  The value from the fees is transferred to the shareholders proportional to their stake.

The first BitShares system being developed by his team is called BitShares X which continues with the company analogy to implement the business model of a bank and exchange simply be defining a new set of transactions supported by the blockchain.  According to Larimer, one unique attribute about BitShares X is that there are no counter-parties, employees, vaults, or contracts and yet according to him, BitShares X facilitates the creation of BitUSD purportedly the same way that the Federal Reserve creates FedUSD: it lends it into existence backed by collateral.

BitShares X uses shares in the system as collateral to back BitUSD.  BitUSD can be thought of as an asset that you can sell for a dollar’s worth of shares in BitShares X.  Depending upon when you buy or sell your BitUSD you will get a different number of shares, but based on their initial model the purchasing power should be approximately a dollar.  And according to him, like Bitcoin where there are no issuers backing the value of a bitcoin, there are no issuers of BitShares X shares or BitUSD.  The entire system operates on nothing but a chain of numbers following a predefined set of rules enforced by the consensus of the network.

Larimer also believes that BitShares X is just one of many potential business models that could be defined entirely in software.  And while one of the challenges is finding developers with an understanding of both economics and consensus, yet other business models his team sees opportunities in include insurance, domain names, gaming, auctions, and voting.  Voting is another issue that other entrepreneurs in this space touched on, which is described in greater detail in the NGO segment in chapter 8.

I also spoke with Charles Evans, economic advisor with the Invictus-run BitShares project.  The way he looks at BitShares is that

“a share can be issued for agricultural commodities, like coffee, tea, cardamom, etc. If someone who grows a commodity that has a corresponding BitShare sees that the BitShare can be sold for more than it would cost to deliver the commodity, then the grower can offer, e.g., 100 kg of cardamom in exchange for 100 kg of BitCardamom, sell the BitCardamom on the open market, and ship the cardamom to the buyer.  Note that the BitCardamom is not “backed” by cardamom. It trades on a prediction market, in which players worldwide try to discover a single, global price for a fungible commodity. When someone with specialized local knowledge sees an arbitrage opportunity—here, simultaneously buying BitCardamom with a promise to deliver cardamom and selling the BitCardamom on the open market—that party can exploit the opportunity.  Instead of negotiating with local wholesalers, who might have information advantages over local growers, and relying on one’s own ability to haggle well, the grower can use a global information market as a guide.  Likewise, if the price of BitCardamom rose over time, prospective growers worldwide would be able to see the price and respond to the price signal.”

Counterparty

For perspective I had an email exchange with Ryan Orr, who is a professor at Stanford University (teaching Global Project Finance and Infrastructure Investment) and chairman at Zanbato.33 Orr has also been closely following Counterparty, which is the first functioning protocol layer fully integrated with the Bitcoin blockchain that supports peer-to-peer transfers of a coin called XCP.34 At the beginning of January the Counterparty development team announced that they had successfully released a working protocol including asset-backed issuance, betting, dividends, callable assets and the world’s first decentralized exchange.35

As the next few months will involve a race between Colored Coins, Mastercoin, and Counterparty as well as other non-blockchain equivalents such as Ripple and Open-Transactions, with each system bringing its new innovations, many outside commentators have expressed interest over Counterparty’s integration with the Bitcoin blockchain and execution to date.  “The fact that we have six serious competitors is a huge development for the entire segment,” says Orr, “The early days of this race will be about tech execution whereas the later days will involve regulatory finesse. The ‘value web’ (as opposed to the ‘information web’) is finally here.  The significance of these developments for the future of the field finance are gargantuan – what we are witnessing could be the equivalent of the invention of http on top of TCP/IP, and these are the protocols that are likely underpin the evolution of the value-web over the coming decades.”

In February 2014 I exchanged messages with one of the lead developers, who used the pseudonym “PhantomPhreak.”36 According to him, “Counterparty is a protocol, and a piece of software, that takes the technology underlying Bitcoin and extends it beyond simple payments, implementing a wide range of financial instruments.  It may be used to trade cryptocurrencies, create assets, make bets, and more, with all other Counterparty users, safely and anonymously, with no middleman at all.  It is built on top of the Bitcoin blockchain, so it can be very simple and reliable. It is being developed very quickly, and it has a large feature set already. Counterparty inherits all of Bitcoin’s security and reliability.  It is open-source, and its launch was entirely decentralised, as is the protocol itself.  And as its name suggests, implements a completely distributed, automatic and deterministic clearing house, so there is no counterparty risk to speak of in most transactions. Of course, if someone were to issue an IOU using Counterparty that he did not make good on, then the anonymous nature of the protocol would leave the slighted party with little legal recourse.”

This last sentence is of particular interest as it still shows a problem that is currently not solved in a decentralized manner, as Preston Byrne identifies in Chapter 2.  As this space matures, developers will need to learn how to structure smart contracts so they are legally and commercially useful.  How to enforce these clauses without an escrow-based DAO, without an independent mediator or without a reputation system (e.g., credit score) can and will be tricky but could be a business opportunity for experienced professionals in those segments who are looking to get exposure to the cryptocurrency sector.  One competing developer explained to me that, “Counterparty is way ahead of the game because their distributed financial system is deployed today.  In many ways, the team is reminiscent of Satoshi: they are people in our community who saw a problem with prior attempts and are fixing it.  All others are still spinning their wheels and really need to deliver functionality on which we can all explore further.  What’s more, proof-of-burn is a big commitment and raises the stakes for everyone. That’s why there’s so much development activity going on with Counterparty. The investors have to pull to make the coin work and they’re pulling hard.   They released alpha software and folks are losing money, but they’re shipping code updates daily which means the software is getting better and the markets more active. This is an exciting space and this level of competition motivates all of us to take it up a notch.”

Proof-of-burn (POB) is a unique turn on allocating “scarce resources” (tokens).  Whereas cryptocurrencies such as Bitcoin, Litecoin and Dogecoin use proof-of-work to allocate resources (e.g., a token), proof-of-burn requires that the miners (or any user actually) send their tokens such as a bitcoin to a provably unspendable address (a terminator address) where they are untouchable forever by any party.37 The first and only “burn” took place beginning on January 2, 2014 and lasted for thirty days – now all of the XCP that will ever exist have been created.  During that time, 2,130 BTC were effectively destroyed amounting to roughly $2 million in market prices (the actual repercussion was that all other holders of bitcoin saw a net gain in value by roughly 0.01%).38 Counterparty then automatically converted the “burned” token into its own unit, called an XCP resulting in no premine or foundershares.  It currently takes five XCP to create your own asset, the five are destroyed in the process as a spam control function.  While it is a controversial method, proof-of-burn does remove the human element from the equation.  That is to say, while other ‘”2.0” projects are typically funded by IPOs whose assets are then (usually) managed by a non-profit organization, because there is still a trusted 3rd party involved, abuse can occur.  That is not to suggest that any abuse is happening, but rather that Counterparty is re-solving the Byzantine General’s problem in a different yet mathematically similar, manner than what Satoshi did in 2008.39

“PhantomPhreak” also sees potential in other decentralized platforms, “I think that there’s a very good chance that so-called second-generation cryptocurrencies will “take off” in the next year or so. Bitcoin was a revolution, in a number of ways, and now it’s time for an evolution of the core concepts and paradigms that it introduced.  Computer science has to catch up with it, so to speak.  A secure, distributed blockchain can be used for so much more than simple payments: advanced financial instruments (a la Counterparty), messaging protocols (c.f. Bitmessage, Twister), etc.  Certainly the future of finance is more decentralised than the present, and the economy as a whole will have to change accordingly.”40

Bitmessage is a peer-to-peer protocol that allows users to send encrypted messages to anyone in a decentralized trustless manner (i.e., Bitcoin for messaging).41 Twister is an encrypted decentralized peer-to-peer microblogging application that uses both the Bitcoin and BitTorrent protocols to enable users to tweet and communicate anonymously.42 Other projects in this space are Bitcloud (decentralized cloud services), Maidsafe (decentralized dropbox and API platform) and SyncNet (decentralized web browser).43

In addition, he believes there are many applications that financial instrument designers could contribute to this space and in particular Counterparty, stating: “the most obvious possible contributions are simply new features.  Right now, for instance, Counterparty only has two different types of ‘bets’, namely simple ‘Equal/NotEqual’ bets and contracts for difference.  Counterparty, however, has the potential to implement very nearly the entire range of tools commonly available to professionals in the financial industry.  Of course, pretty much any developer could contribute a lot to the Counterparty project, which still has a relatively small codebase and an underdeveloped software ecosystem, simply by writing user-friendly interfaces, or algorithmic trading engines, for example, on top of the reference client.”

I also exchanged messages with “cityglut” who is another member of the development team.  In terms of business opportunities, it is his view that, “what cryptocurrencies in general and Counterparty in particular allow for that is arguably most significant is further decentralization.  I believe that businesses which capitalize on this aspect of Counterparty will have opportunities they have not had until now.”  As noted above, this project does have code that is shipped and is currently being used by the community at large.

He also sees that there are a number of areas of low-hanging fruit.  According to him, “in my mind the most obvious financial instrument that Counterparty is currently lacking is a real options function. Counterparty allows for binary (Equal/NotEqual) bets and the creation and (distributed) sale of assets, and I believe that a combination of these functions could create a full-blown options function, but it may well be that in Counterparty’s current implementation this is infeasible.  Even if an options function can’t be built from Counterparty’s extant functions, it seems to me both possible and desirable to implement options in Counterparty in some way.”

Yet there are challenges too, “It is precisely Counterparty’s brand new functionality that entails greater necessary due diligence on the part of users. Since anyone can make an asset, and anyone can publish a broadcast upon which to bet, users must do what they can to make sure the asset they are purchasing is legitimate, and that the broadcast upon which they are betting has not been “tampered” with.  In an effort to facilitate the former, we have recently implemented a description space for every asset: issuers of assets can include up to 42 bytes (in UTF-8) with each issuance, describing the asset being issued. Regarding broadcasts, aside from the financial incentive feed-operators have to stay honest (namely, collecting betting fees), we imagine that an – albeit informal – reputation system will naturally evolve, helping users to decided which addresses’ broadcasts to bet on and which to avoid.”

This secondary attribute, a type of descriptive space is a feature that many of the other platforms are trying to enable in order to organize and manage different types of assets.  The issue involving reputation is also a theme repeated by many other investors, developers and experts and one that a DAO escrow could potentially resolve.

Open-Transactions

Chris Odom is a cofounder and CTO of Monetas and the lead developer of Open-Transactions (OT).44 Open-Transactions is an open-sourced digital software suite that utilizes current technology to enable trustless financial cryptographic interactions through privacy features such as blind signatures.  It is also portable and ledger agnostic allowing developers to bridge its applications to other cryptoledgers.

Many outside investors and businesses frequently ask Odom a theme on the same question, what business solutions can be developed for this segment?  Yet according to Odom, “asking what profitable business opportunities there are for crypto currency is the same as asking that question for the Internet in general. It is extremely broad in scope.  I think we are talking about a transformative invention, comparable to electricity, computers or the Internet.  It’s going to create all new spaces, and it’s also going to transform all existing sectors.  While Open-Transactions currently is integrated with Bitcoin, it is ledger agnostic because it is a financial crypto library, similar to how OpenSSL is a communications crypto library.  In terms of immediate opportunities, we have some bounties posted on CIYAM.org/open.  However, people should definitely be aware of risks.  Cryptocurrency can be used in legal and illegal ways, so it’s not the currency itself, so much as how you use it.  You just have to watch out for regulatory compliance issues, and if those get too onerous, you have to look at moving your company to another country.  Some countries are less free than others.  For an investor I might also point out some of the unique propositions of OT, one being its ability to operate in a low-trust way, that it is federated.  And that it’s also able to fill the gap and do the things that all the other servers do in the Bitcoin world like the MtGox server, or the BitStamp server, or any of these Bitcoin services that use a server.  Any of them could be replaced in a lower-trust fashion, using OT at least, using OT as the financial engine, not necessarily the web GUI pieces.”

One advantage that Open-Transactions has over conventional blockchains which have algorithmic delays, is that because it uses known servers, Bob can trade near instantaneously.  Whereas confirmation of bitcoins, bitshares and other blockchain based instruments are measured in minutes, users can only execute trades in those intervals as well.  And if you can put OT on a distributed database, in theory that means you can have cryptocurrencies that confirm instantly without centralized control as well.

Ripple

Ripple, commercialized by Ripple Labs, is a payments protocol that acts as a payment platform, decentralized currency exchange, and smart contract network that can be used with any digital currency, including Bitcoin.  Ripple provides a solution for implementing an asset cloud via “trusted” gateways.4546 At scale, Ripple or Ripple like systems provide instant liquidity and exchange between counter parties, where there can be a trustless exchange between 3rd parties, and those 3rd parties can decide where their exchanged assets will settle within the network, such as any gateway who provides redemption for the represented asset.  In addition, unlike other payment platforms that use variants of proof-of-work, it uses a consensus ledger which is distributed to a global network of servers.47 These servers continually receive transactions and proposals from other servers on the network and these are compiled into a “Unique Node List” (UNL).  Proposals from servers not in the network are discarded while those remaining are vetted and algorithmically “voted” on by the servers.  Once a consensus (defined at 80% agreement on what transactions are legitimate) is reached, the server validates the proposals and closes the ledger, creating a “last closed ledger” (similar to a block).  The process then repeats itself.  This process takes roughly five to fifteen seconds allowing quicker transactions than nearly any proof-of-work system today.  Altogether its network processes roughly $20 million each month from approximately 68,000 user accounts.48

Beginning last year, Ripple Labs created an initial money supply of 100 billion XRP which was predetermined to be enough to last for hundreds of years.49 The designers of Ripple realized they had a problem if someone wanted to flood the network with useless transactions, which is the currency equivalent to spam.   To this the network charges a transaction fee which permanently deletes 3 “drops” of XRP.  Each drop is equivalent to the smallest possible amount of XRP, thus .000003 per network transaction cost.  A drop is equivalent to the Bitcoin “satoshi” the smallest possible unit of BTC which is .00000001.  As of this writing more than 3,500 XRP have been permanently removed from the network.

According to Jon Holmquist, an early Bitcoin adopter and Community Liaison at Ripple Labs, “beginning 15 years ago a merchant could create a webshop in 10 minutes and attract visitors from around the globe.  Yet, they could not easily pay for the merchandise until 5 years ago.  With the development of cryptocurrencies such as Bitcoin, consumers can now use money without borders.  However one of the biggest issues today is obtaining bitcoins especially when you reside in an economically depressed region.  Ripple lets you exchange and obtain whatever currencies you want to use.  As Ripple continues to build partnerships, the network creates a self-reinforcing positive feedback loop that takes care of itself.  As a consequence, because Bitcoin has gotten a lot of push behind it, it is possible to have a fiat exchange in every country which then allows customers to finally purchase from any country, with their own currency.”

A math-based currency is a term often used by members of the Ripple Labs team to describe the concept of “programmable money” – that is to say, virtual tokens that are mathematically constrained by algorithms and difficult if not impossible to forge.5051 The Ripple payment system works alongside Bitcoin by enabling users to use XRP, a token, to represent certain financial instruments (like currencies) which can then be instantly transferred globally and exchanged for Bitcoin and then a fiat currency.

Both XRP and the Ripple protocol can be leveraged in other ways as well.  Steve Bennet, a finance professor at San Jose State University and an angel investor with CrossCoin Ventures which is a new business incubator partnered with Ripple Labs, points out that the project has “built a new incubator which will later become an accelerator focused on building out the Ripple ecosystem.52 Currently we are focused on attracting Bitcoin-related companies which can leverage the Ripple platform to provide new value to customers globally.”  Bennet’s team (including Ryan Orr mentioned above) plans to work with both new startups and existing companies, provide them access to Ripple’s management and even exchange Ripple for a percent of equity much like several other “2.0” projects have done (e.g., Mastercoin, NXT).  His vision is to leverage the incubators’ resources (e.g. networking, mentoring, legal) and help the incubated teams focus their energy on providing value-added services to a broad array of consumers who are unfamiliar with cryptocurrencies.

I also spoke with Stefan Thomas, co-founder of WeUseCoins, creator of bitcoinJS and CTO of Ripple Labs.  In his mind, “the easiest way to describe Ripple right now is that it is a FOREX platform that removes most intermediaries and does so in a matter of seconds.53 And because you reduce the total amount of fees that are charged from the remittance process, this provides thinner spreads for users who traditionally have had to worry about currency fluctuations.  That is to say, in the past, it could take hours or days for funds to move across borders whereupon the value of the currency could decrease.”  Yet as noted above, Ripple’s platform is nearly instantaneous and powered by a distributed network of ledger “processors” (slightly akin to “miners” but requiring very little infrastructure) and gateways.

And according to Thomas, “while processor nodes do vote and verify the ledger integrity to prevent forgery and double-spending like a blockchain, these processors are unlike the “miners” used in blockchains because of the way the light-weight method consensus is determined which requires substantially less infrastructure (e.g., no need for ASICs or GPUs).  Consensus of the ledger is done through a peering method; similar to how peering with trusted nodes works with internet providers.  The ledger itself is a bundle of digitally signed data transactions which is sent through the network and voted upon by client peers (nodes).  These nodes poll one another to see which transactions came first, the ones that are determined to be false or illegitimate are discarded and all others are included in a verified ledger state that is then considered closed.  This entire process takes between every 5 to 15 seconds and nodes that become unreliable with spam are then ignored by peers.  The reason the timing is not a fixed rate because transaction bundles not only vary by size (e.g., consumption by consumers does not happen at a unison, flat rate) – and it also illustrates how data itself is processed globally through current public infrastructure.  In contrast, the reason that Visa is slightly faster is that they use private centralized nodes which requires significantly more overhead and capital expenditures.”

“Gateways are the actual organizations that move assets in and out of the Ripple network.  They can range from single-individuals to large banks.  Users establish trust lines with gateways which can be located in any part of the world, providing liquidity into nearly any local currency.  A unique feature about gateways is, that while they may be a single-point-of-failure in the traditional sense, users can still route around censored nodes.  Furthermore, gateways cannot appropriate the assets of one specific user: either they default for everyone or none at all.  So for example, Bob can create a debt line with Alice who is trusted party, a gateway.  Gateways live by reputation, so they have an incentive to fulfill their obligations.  Bob can then exchange a local currency with Alice for IOUs (XRP) with which Bob can then send to any other gateway and convert XRP into the local currency.  This can be done in a matter of seconds, which is significantly faster than any blockchain-based system, yet is actually more secure (51% versus 80%).”

Ripple Labs refer to their technology as a ‘value web’, an ‘Internet for money’, and ‘http for money.’ Existing financial institutions could serve as gateways today by establishing ‘trust lines’.  The gateway system enables financial institutions to exchange value in the form of digitized assets (e.g., commodities, fiat currency).   For instance, Bob’s Bank of Buffalo could set up a gateway and trustline with Alice’s Agriculture Bank in China.  Bob could provide USD liquidity to Alice and Alice could provide RMB liquidity to him in a cheaper and quicker manner (between 5-15 seconds) than existing wire services which could take days and charge relatively high fees.  Ripple acts as trusted ledger for all participants, yet cash balances must be settled outside of the Ripple protocol.  XRP is the only currency native to the network.

Thomas continued with, “another competitive advantage that the Ripple protocol has over others in this space is that our code uses the smallest amount of trusted code base, basic OP codes which provide the most secure assembly code to which to build from (e.g., interacts directly with the iron, with the metal of the semiconductors).  Thus the native software client is less vulnerable to exploits that occur from building above with other higher-language layers.  And over the past two years we have open-sourced a significant amount of codebase including the protocol to the public.  This in turn has led to further refinements and security fixes.  In addition, we are continually looking at ways to expand the protocol’s use, making the ledger essentially a database that will allow for the transaction of smart contracts.54 And because this network is slightly more efficient than most other platforms, this allows for new innovations to take place down the road.”  This contract-based system will be Turing complete and include two-stages, the first of which is non-deterministic which enables contracts to interact with real-world protocols such as DNS and HTTP and also allows users to include language interpreters and reference libraries.

“This space is rapidly evolving; for instance, the original Bitcoin client was much more cumbersome than it is today.  For beginners it used to take 24 hours to download the blockchain and confirm transactions.  Now there are numerous projects each of which trying to provide value-added services and this competition is pushing us to look at new ways to innovate, such as peer-assisted key derivation function (PAKDF) – a mathematical way of utilizing blind signatures.55 One of the user-adoption problems in this space is that it is hard to memorize long secure passwords and frustrating for new users to learn how to securely save passwords on disk drives.  In contrast, PAKDF will allow Alice to use relatively weak passwords that can be sent to Bob who will sign something (e.g., a contract) without knowing and therefore unable to break Alice’s password.  This is called a blind signature which adopts a form of homomorphic encryption and we are integrating into Ripple.”56

Whereas a user would need to memorize a long passphrase, this specific application of securely signing a password could lead to ease-of-use for end-users.  In a nutshell, a blind signature scheme “allows a person to get a message by another party without revealing any information about the message to the other party.”57 The analogy typically used to describe how this worked is, Alice places a message inside a carbon lined envelope.  This envelope is sent to Bob, who cannot read or see any of the information, but can sign on the outside of the envelope, which imprints the signature on the carbon inside the envelope.

Current Cryptoprotocol Infrastructure

current cryptoprotocol infrastructure

This Euler diagram shows two main systems, those currently part of a cryptoledger and those that are not, which in this case is solely Open-Transactions (OT).58 As noted earlier in the chapter, OT works by connecting its OTX protocol to other services (much like SSL does with other databases) such as Bitcoin and is therefore ledger agnostic.

Within the cryptoledger diagram are essentially two other distinctions, those that use a blockchain and those that use a consensus ledger.  At the time of this writing only the Ripple protocol uses a consensus ledger.   When it was first created, Namecoin was also originally its own independent blockchain but the mining process has since merged with the Bitcoin ledger.  The other independent blockchains above are Litecoin, Dogecoin, NXT, BitShares and Ethereum.   At the time of this writing, the Ethereum team has not settled on which system it will use – it may use a hybrid approach similar to what Peercoin has done (proof-of-work and proof-of stake).

Proof-of-work (PoW) involves a network of mining machines as originally employed by Bitcoin in 2009.  Computers are given a series of increasingly difficult benign math problems which they complete as a way to stave off rogue attackers.  In this example above, Litecoin, Dogecoin, Namecoin, Bitcoin and potentially Ethereum use a proof-of-work method.

Proof-of-stake (PoS) is different in that the transaction node for a block is randomly assigned and all network participants communicate directly with it.  One advantage to this approach as it reduces the amount of hashing power needed to secure the network.  At the time of this writing, only NXT in the above diagram uses a pure PoS method; Peercoin uses a hybrid and Ethereum may also use a hybrid as well.

Proof-of-burn (PoB) is a unique method that has only been used thus far with Counterparty; a user sends a token (a bitcoin) to a provably unspendable address (a terminator address).  The largest benefit of using this approach is that it removes the need to have a trusted party or a custodian to look after “IPO” assets.

The inner red diagram illustrates the smart contract features described in this chapter.  While the Bitcoin protocol could conceivably utilize such contracts, the functionality has not been ‘turned-on’ by the development team (version 0.9 will allow for 80-byte hashes that could include a hash of a distributed contract).  While there are multiple different platforms that will offer such functionality, a stop-gap solution based on bitcoinJS (a Java-implementation) is being developed by Bitpay called bitcore and is described in chapter 7.  Other platforms that can or will shortly allow smart functionality include Colored Coins, Mastercoin, Counterparty, NXT, BitShares, Ethereum and Ripple.

Projects that are being built on top of a blockchain include Colored Coins, Mastercoin and Counterparty.  Both Colored Coins and Mastercoin work exclusively with Bitcoin’s blockchain, and while Counterparty does as well, other projects such as Peercover (discussed in chapter 5) have enabled Counterparty’s currency to bridge with Ripple’s network.

While Ethereum and Ripple are categorized as being the only Turing-complete platforms above, it should be noted that Ethereum has not yet shipped but is expected to in the next six months.  In addition, developers with NXT and BitShares expect to include similar robustness if not full Turing complete functionality at some point in the future.59

One large category that is not distinguished in the above diagram is that of “altcoins.”60 Strictly speaking, anything that is not Bitcoin is considered by early adopters as an altcoin.  Thus everything but Open-Transactions in the diagram is considered by some, as a type of altcoin.  However, this devolves into individual preferences and politics, so it is best ignored.

  1. Numerous proposals have been submitted by core developers to improve the functionality; one common analogy used is that Bitcoin core development right now is trying to upgrade the original Wright Flyer to a Boeing 787 without landing.  While many advocates want Bitcoin to be an answer to all payment problems, these limitations likely impair it beyond the role of store of value and remittances.  See chapter 6 for more on remittances and chapter 8 for payment processing details.  See also Hardfork Wishlist []
  2. Bitcoin Core Development Falling Behind, Warns BitcoinJ’s Mike Hearn from CoinDesk []
  3. See The Bitcoin malleability attack graphed hour by hour by Ken Shirriff and Ripple Labs Chief Cryptographer David Schwartz Talks About Malleability In Bitcoin from Newfination []
  4. There are other projects currently under development such as eMunie or even released such as Freicoin. []
  5. Colored Coins []
  6. Chroma Wallet []
  7. Losing the private key to a smart contract (or Colored Coin in this example) could be problematic.  Currently bitcoins are still being lost and stolen despite awareness of web-based wallet vulnerabilities.   If security does not improve, growth might be difficult for smart assets. []
  8. eToro []
  9. Counterparty.co []
  10. See Reality Keys: Bitcoin’s Third-Party Guarantor for Contracts and Deals from CoinDesk and a slightly different idea but in a similar segment, RealityShares []
  11. BitcoinBusiness []
  12. The Mastercoin protocol supports the OP_Return function.  One way the user-defined assets are tracked in the Bitcoin blockchain is by sending a certain amount of satoshis (5430), just above the dust limit.  Note however, that the dust limit was originally announced at 5430 but was subsequently discovered to be 5460 which may impact some mastercoin transactions. See Dust limit defined as 5460 satoshi instead of 5430 in Bitcoin core at github []
  13. How is this functionality achieved?  There is not any ‘syncing’.  Nothing is every ‘synced’ with any blockchain.  Mastercoin does not use ‘OP_RETURN,’ though it plans to add support for it eventually. Counterparty supports `OP_RETURN` now, but it cannot really be used until Bitcoind 0.9 comes out.  Both Counterparty and Mastercoin support using multi-signature transactions to store data in the Bitcoin blockchain.  Just to clarify one misconception, there is no such thing as the ‘0.9 protocol’ — there is a 0.9 Bitcoind.  Also, Bitcoind uses LevelDB and Counterpartyd uses SQLite3. []
  14. $1 Million-Plus in Prizes, Contracts at Texas Bitcoin Conference Hackathon from MarketWired []
  15. BitAngels []
  16. See NXT :: descendant of Bitcoin from Bitcointalk and What is NXT? []
  17. There’s a £60m Bitcoin heist going down right now, and you can watch in real-time from NewStateman []
  18. There are ways that peers could be compromised vis-à-vis Sybil attacks.  See Establishing the Trustworthiness of Nodes without External Tokens (eg Passports) and Selfish Mining: A 25% Attack Against the Bitcoin Network by Vitalik Buterin []
  19. Personal correspondence, Nextcoin.org []
  20. NXT – Proof of Stake and the New Alternative Altcoin by Adam Hofman []
  21. The potential for such an occurrence is being argued in academic literature; see It Will Cost You Nothing to ‘Kill’ a Proof-of-Stake Crypto-Currency by Houy Nicolas.   A state agent, under the direction of a central bank and simultaneously uninterested in seeing their assets appreciate in value could conduct such an attack.  Otherwise it would likely be cost prohibitive for nearly any other value investor.  In addition, Nicolas’ argument is problematic in that it requires sufficient liquidity, that is to say even if the state actor would be willing and able to spend any amount of funds to acquire the tokens, he or she would still need to induce liquidity to participants holding 90% of the tokens. []
  22. Personal correspondence, February 25, 2014.  See also Interview with Graviton, Nextcoin.org Community Founder from Cryptocoinsnews []
  23. Satoshi Nakamoto recognized this shortcoming but deliberately chose to use Script to mitigate potential abuses (e.g., infinite loops freezing the blockchain).  One reviewer of this manuscript mentioned that developers should also realize that hypothetical constructs like a DAO essentially involve coding organizational law into programs.  While this may sound easy, law was built to enable release valves of forgiving judgment.  Code is not forgiving.  Thus if something happens in the real world, even the simplest unforeseen effect could derail an otherwise streamlined exchange process. []
  24. Bitcoin Magazine []
  25. For an example of Ethereum sub-currency contracts see this video from Joel Dietz and Joris Bontje.  See also Writing a Contract in LLL by Gav Wood []
  26. I have a friend who used the following method to generate bitcoin addresses and store the keys: 1) in offline mode store the private/public key pairs on USB sticks with Truecrypt partitions, with paper as backup (encrypted and printed out).  To a certain extent this mirrors what Coinbase does.  2) To reduce the chance of vendor back-doors, each of these drives should be different brands bought from different locations.  3) To generate the actual keys you have to deal with the issue of true randomness, plus not leaving any reproducible trace (e.g., logic stored in cache or writing on carbon-copies) thus an individual could buy a dozen non-loaded dice and use this to generate private keys.  4) For users who might be suspicious of the entropy coming from the Linux random number generator (RNG) you could randomly mash the keyboard, turn on the webcam and simultaneously run commands and programs from the start menu to generate some additional entropy.  5) Then use an air-gapped laptop with a freshly boot distribution of Linux. Here in particular you have to be careful as you would need to only use an in-memory distribution (e.g., boot from thumbdrive), because a user does not want the private keys cached anywhere at all on disk.  6) In addition a user would also want a distribution which will work with a standard USB printer for printing purposes because you never want the private keys to go over the wire. []
  27. See Scalability and Thin Client []
  28. Vitalik Buterin has recently written several more article detailing what he thinks DAOs can and cannot do, see: DAOs Are Not Scary, Part 1: Self-Enforcing Contracts And Factum Law and DAOs Are Not Scary, Part 2: Reducing Barriers []
  29. See Mike Hearn, Bitcoin Developer – Turing Festival 2013 video []
  30. Intel SGX for Dummies (Intel® SGX Design Objectives) from Intel []
  31. Invictus Innovations is leading the development of BitShares; whitepaper []
  32. CNRS is part of Groupe d’Analyse et de Théorie Economique.  See The economics of Bitcoin transaction fees by Nicolas Houy []
  33. Zanbato []
  34. While a completed technical white-paper has not been released, the development team has published The Counterparty Protocol []
  35. They had successfully released ‘callable assets,’ stating that, “Assets are now callable, if they are set to be so upon first issuance. An asset may be able to be ‘called back’ by its issuer at a fixed price from a particular date.” See Counterparty Protocol, Client and Coin (built on Bitcoin) – Official from Bitcointalk []
  36. Personal correspondence, February 4, 2014 via Bitcointalk []
  37. This terminator address is based on Vanitygen.  Based on known computational technology it would purportedly take 93,215,140,000,000,000,000,000,000,000,000 years to generate the private key to 1CounterpartyXXXXXXXXXXXXXXXUWLpVr with an i5 processor.  For critics who claim that the Bitcoin network is insecure, they could prove their skepticism by trying to generate the private key to that address.  See also Wallet security: why only 128 bit for secret seed? from Ripple []
  38. See I burned BTC through blockchain.info, how do I access my XCP? from Counterparty.co and the exact address was 1CounterpartyXXXXXXXXXXXXXXXUWLpVr.  On the first day a user would receive 1500 XCP for 1 BTC.  By the end of the fundraiser, it was 1000 XCP for 1 BTC.  Ultimately 2,648,756 XCP were created in total. []
  39. See Paul Bohm’s detailed explanation of this mathematical problem. []
  40. Personal correspondence, January 29, 2014 []
  41. See Bitmessage and Bitmessage Sends Secure, Encrypted, P2P Instant Messages from Lifehacker []
  42. See Twister and Out in the Open: An NSA-Proof Twitter, Built With Code From Bitcoin and BitTorrent from Wired []
  43. Maidsafe, SyncNet, Bitcloud and Bitcloud developers plan to decentralise internet from BBC []
  44. Monetas and Open-Transactions []
  45. While the XRP are centrally issued, the gateways are distributed.  The process for being a gateway for a ‘coin’ generally works as follows: 1) announce you are issuing a coin, 2) anyone can “trust” you for the coin, 3) accept the real coin, 4) make a Ripple payment for the coin.  Thus you can create fully backed precious metals on the Ripple network.  Ripple itself does not send USD, EUR, CAD or other currencies. It actually sends IOU’s for these currencies which must be redeemed by specific issuers who are acting as “gateways” into and out of the legacy banking system. []
  46. One way to audit and verify if a 3rd party gateway (and exchanges in general) is not running a fractional scheme is to implement a ‘proof of reserves’ process Greg Maxwell recently proposed.  Another option that could happen is that exchanges may hire independent auditors in order to become covered by insurance; these audits could then be posted.  An unnamed insurance company purportedly provides services to one Bitcoin vault called Elliptic, which protects against a failure in a business’ storage methods, with customers opting for a “liability limit” for how much they want covered.  Another idea being discussed is some sort of FDIC-like insurance.  A company in beta called Inscrypto, which is located in Boston, claims it will be a “privately funded, decentralized version of the FDIC,” to help you “reduce or completely eliminate the risks of owning bitcoin.”   It is likely that following the Mt. Gox bankruptcy, many exchanges will seek such independent measures and likely have an incentive to do so (e.g., satiate consumer demand, provide transparency as a precursor to being acquired in the future).   See also Proving Your Bitcoin Reserves by Zak Wilcox, Bitcoiners Demand Greater Transparency in Exchanges from Cryptocoinsnews, Audit Report: Transparency and Accountability from Coinkite, After the Mt. Gox fiasco, calls for regulating bitcoin from Pandodaily and Will Bitcoin’s Libertarians Pay for Private Deposit Insurance? from BloombergBusinessweek []
  47. Introducing Ripple by Vitalik Buterin []
  48. See Making Money from Technology Review and Ripple Charts []
  49. Ripple credits []
  50. Chris Dixon of Andreessen Horowitz was one of the first persons to use that term.  Naval Ravikant founder of AngelList popularized the term “programmable money” which has a similar meaning.  See Real money starts to pour into math-based currencies like bitcoin from Quartz and Inside Bitcoin, The Programmable Currency For Our Digital Future from TechCrunch []
  51. A successful double-spend attack could be conducted against a proof-of-work-based algorithm if 51% of the hashrate is controlled by a malicious agent; and a similar attack is theoretically able to successfully take over a proof-of-stake if 90% of the token is controlled by one agent.   But there are many ways to recover from it (e.g., hardforks) and this topic has filled countless volumes already.  Yet, for an objective view on this matter of network attacks, I asked Nick Szabo (Personal correspondence, January 25, 2014), who had some original insights about how to prevent and mitigate this issue:

    “One contingency is to have a bunch of different cryptocurrencies around […] and if one gets successfully attacked users switch to another. We already have enough cryptocurrencies around for this purpose, but this doesn’t help the people holding Bitcoin or who’ve made other Bitcoin-specific investments. And there are substantial costs in switching to a new cryptocurrency, and such a crisis might persuade many merchants to give up on cryptocurrencies generally rather than switch.

    A practical means of disaster preparedness is for a number of independent engineers and auditors to keep copies of the block chain, as up-to-date as possible, even if they aren’t participating as a miner or mining pool. Just the fact that a few good engineers have up-to-date copies of the block chain should be enough to dissuade most 51% attacks. 51% is enough to persuade the cryptocurrency algorithms to believe a lie, but it’s not enough to persuade engineers (or auditors with suitable tools) who manually inspect the block chain, if the payor or payee who’ve been blocked or defrauded resend the original payment instructions directly to those engineers. Of course we don’t want to rely on such a manual process in the normal course of business, just for dire contingencies.

    In the event of a 51% attack there is a fork in the block chain, and the job of these engineers or auditors would then be to persuade users to use the minority but correct block chain and exclude the incorrect majority. It would be expensive but doable. Not something you want to normally see happen.

    Another way to put it is if there is a 51% attack we have to fall back on methods of ensuring integrity that, like the traditional financial system, are manual and expensive, and the big cost savings from the automated security are temporarily lost.  You might call this [ad hoc solution] “proof by engineer,” which would be replacing proof-of-work in the temporary emergency for the purposes of the transactions being disputed in the block chain fork.” []

  52. CrossCoin Ventures []
  53. The way the current system is setup, remittances and funds sent abroad go through multiple institutions via ‘correspondent accounts’ or ‘correspondent banking.’ []
  54. Ripple Developer Conference 2013: Future Focus of Our Engineering Team presentation by Stefan Thomas []
  55. Peer-Assisted Key Derivation Function (PAKDF) by Stefan Thomas []
  56. See What is Homomorphic Encryption, and Why Should I Care? by Craig Stuntz, Blind Signatures for Untraceable Payments by David Chaum and Untraceable electronic mail, return addresses, and digital pseudonyms by David Chaum []
  57. Blind Signature Scheme by Asanka Balasooriya and Kelum Senanayake []
  58. I designed it with Creately; the image is released under Creative Commons 4.0 Attribution license. []
  59. A Turing-complete solution proposed by NXT is to use the Automated Transaction Specification []
  60. Another category that was not highlighted is the proof-of-work algorithms: both Bitcoin and Namecoin are SHA256d based and Litecoin and Dogecoin use Scrypt. []
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Chapter 2: Smart Contracts

[Note: below is chapter 2 to Great Chain of Numbers]

“Setting something in stone” is a common phrase used to describe permanence of a promise or obligation.  While there are numerous historical and sacred texts that deal with justice, tort, and commerce, one example illustrating the confluence of permanence and clearly defined obligations etched in stone comes from Mesopotamia.  The Babylonian Code of Hammurabi dates back to roughly 1772 BCE and consists of 282 laws.  While the famous “eye for an eye” (lex talionis) is inscribed on surviving clay tablets, roughly half of the code deals with contracts involving payment of wages, rent and liability for damaged property.  Other clay tablets from Mesopotamia record interest-bearing loans and debts.  While the interpretation and enforcement of these obligations is a matter of speculation and historical restoration, the human endeavor to codify duties and responsibilities is a never-ending story.

A more recent example, contrary to common belief, Samuel Goldwyn actually said, “his verbal contract is worth more than the paper it’s written on.”1 Yet either way it is stated, Goldwyn’s oft misquoted catch phrase illustrates one of the core issues that continually impacts property law and rivalrous resources: how to create clearly defined terminology, guidelines and terms of service in a reliable way.

In 2006 Nick Szabo, the progenitor of the idea of cryptographic contracts, compared humankind’s current analog spectrum of decision making to a digital system to describe the differences between “wet code,” which is interpreted by human brains and “dry code” which is interpreted by computers.2 In contrast to the seemingly binary logic of machine language, even though contracts, rules and regulations may be written by ostensibly objective parties, they must still be interpreted and enforced by yet another party or parties of humans.  And as a consequence stipulations do not always go as they were originally delineated.  This may change however as Szabo also described how computer programs have been and will continue to slowly edge towards mastering different niche domains that reach farther into “wet code” – into the human realm of nebulous obfuscation, fickleness, inconsistency, and abuse.  This is the subject of disagreement in this manuscript and will likely continue to be in the near future.

What is safe to say is that smart contracts and cryptoledgers are not a silver-bullet panacea solving ambiguity in human interactions beyond the reach of the algorithms.  According to its latest biannual arbitration scorecard, The American Lawyer’s 2013 survey highlighted 165 treaty arbitrations and 109 contract arbitrations involving $121 billion in disputes, a record.3 Similarly, Fulbright & Jaworski publish an annual Litigation Trends and Survey Report in which they survey senior corporate counsel regarding various aspects of litigation and related matters.  In the latest survey they found that contract disputes in the US (44%) and UK (57%), remained the largest type of litigation pending against their company, followed by labor and employment disputes.4 Aside from the famous fabricated contract from Paul Ceglia, few contractual disputes involve tampering of the actual contract in the developed world – more often than not the agreements are certain and the facts, or its meaning, are in dispute.5 But as discussed below, smart contracts encompass the wider spectrum of formalized agreements, such as financial instruments (synthetic assets) or codified representations of value (e.g., tokens).

Automation in commerce is increasing daily.  With the advent of NASDAQ in 1971, electronic securities exchanges have traded shares of stocks, bonds, and other instruments on a daily basis and in some cases continuously for twenty-four hours a day.  This digital creation was made despite the fact that then-contemporary paper-based exchanges capable of trading similar instruments have been in use at least since the founding of the Dutch East India Company in 1602.6 While there are numerous reasons for why the NASD built it, the primary motivating force for electronic exchange in general is that it provides users with faster logistical and organizational efficiencies, much like electronic mail does  compared with its analog counterpart; while simultaneously removing numerous intermediaries, middle men and 3rd parties though often they interpose new ones. While there are still hardcopies of securities (e.g., a share register) that in some cases must be maintained and on-file with governmental and corporate entities, in reality the instruments on all modern exchanges are just electronic bits that are representations – abstractions of various contractual obligations, conditions, and terms of service in the real world.

A smart contract is a proposed tool to automate human interactions: it is a computer protocol – an algorithm – that can self-execute, self-enforce, self-verify, and self-constrain the performance of a contract.789 Whereas Bitcoin and its direct progeny are referred to as the “1.0” generation, as shown below, contracts, on “2.0” platforms – the next generation of cryptocurrency, are able to enforce themselves.10 They do not have a physical enforcement arm the way legal contracts do.11 Rather, because they embody complex contractual relationships in computational material, they move certain defined asset(s) automatically under certain conditions.

Twenty years ago, Nick Szabo used a specific name for some of these instruments: synthetic assets.  Synthetic assets, in his words, “are formed by combining securities (such as bonds) and derivatives (options and futures) in a wide variety of ways. Very complex term structures for payments (i.e., what payments get made when, the rate of interest, etc.) can now be built into standardized contracts and traded with low transaction costs, due to computerized analysis of these complex term structures.”12 Today, both lawyers and software programmers have the ability to create these types of instruments.

Although some may have attempted to build a priori-based arguments against using such digital representations, post 1971, a fortiori, it has become clear that scarcity (a rivalrous asset in the economic sense) and value need not be solely represented by physical phenomena.13 And while each individual has his or her own subjective valuation, some currently see that there is potential utility or even speculative value in holding, using, and trading these electronic financial instruments.

In Cryptoledgers We Trust

Decentralized cryptoledgers are another refinement and evolution of Szabo’s ‘wet-to-dry’ system.14 Paper-based ledgers and electronic ledgers are typically held and maintained by 3rd parties such as banks or clearing systems; these entities create a “trusted” environment that, the argument goes, could be abused and manipulated by human elements (e.g., changing content, destroying records, double-spending) and imposes considerable cost.  When you trust a 3rd party, you are exposing yourself to the malfeasance of that 3rd party.

In November 2008, Satoshi Nakamoto – a pseudonym for one or several individuals – released a white paper that, for the first time, detailed a method for using a decentralized, encrypted software-based ledger that solves these 3rd party abuse and vulnerability issues. That white paper gave rise to Bitcoin.15

In contrast to the existing methods, argued Nakamoto, a decentralized cryptoledger called the Bitcoin protocol can serve as the sole middleman.  As an algorithm the protocol is unbiased and capable of auditing, authenticating, validating, approving, and transferring integer values along a ledger that is distributed to tens of thousands of computers (called mining machines) that are located around the world.  These computers run an open-source program that provides all of these aforementioned functions and they are rewarded for their work (seigniorage), by the provision of an integer value, a virtual-only token called a bitcoin (sometimes referred to as a “cryptocoin”).16 The Bitcoin ledger also has other potential uses that have not been fully utilized such as the ability to manage smart contracts or any instrument, asset or token that can be arithmetically encoded into software.  In fact, the upcoming version 0.9 release of Bitcoin will provide room in the ledger for each transaction (also called a tx) to include an additional 80-byte hash, just large enough to provide for a “distributed contract” – a feature that has drawn even greater outside interest over the past year due to its ability to represent any asset class or property, not just one value (fiat).17

In practical terms, the Bitcoin cryptoledger is its own 3rd party repository as it creates a consensus-based, trustless environment that negates the role of 3rd party intermediaries that existed in a paper-based analog world.  It also acts as a decentralized timestamp database.  Whereas historically timestamps were issued by a Time Stamping Authority (TSA) – or digital notary – that is vulnerable to abuse and tampering, a user can now store a timestamp on the ledger without concerns over data corruption as it stored on thousands of decentralized machines.18 More to the point, it provides the abilities of many other functionaries (e.g., accounting, auditing) and institutions (e.g., data warehouse) thus making a multitude of middlemen entirely redundant and allowing for bilateral transactions to take place.  Whereas Alice’s Accounting Co., may take a quarter of a year to audit and reconcile accounts for Bob’s Boutique Bookstore, a bitcoin transaction, as well as the entire global Bitcoin ledger, called a blockchain, is authenticated, verified, copied, and audited approximately every ten minutes (Litecoin is even faster, verifying every two and a half minutes).

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.  Simply put: bitcoins do not actually exist.19 Rather, there are only records of bitcoin transactions through a ledger, called a blockchain.  And a bitcoin transaction (tx) consists of three parts:

an input with a record of the previous address that sent the bitcoins;

an amount; and

an output address of the intended recipient.

These transactions are then placed into a block and each completed block is placed into a perpetually growing chain of transactions ―hence the term, block chain.  In order to move or transfer these bitcoins to a different address, a user needs to have access to a private encryption key that corresponds directly to a public encryption key.20 This technique is called public-key encryption and this particular method, Elliptic Curve Digital Signature Algorithm (ECDSA), has been used by a number of institutions including financial enterprises for over a decade.2122 Thus in practice, in order to move a token from one address to another, a user is required to input a private-key that corresponds with the public-key.

To verify these transactions and movements along the ledger, a network infrastructure is necessary to provide payment processing.  This network is composed of decentralized computer systems called “miners.”  As noted above, a mining machine processes all bitcoin transactions (ledger movements) by building a blockchain tree (called a “parent”) and it is consequently rewarded for performing this action through seigniorage.  Blockchain trees are simultaneously built and elongated by each machine based on previously known validated trees, an ever growing blockchain.  During this building process, a mining machine performs a “proof-of-work” or rather, a series of increasingly difficult, yet benign, math problems tied to cryptographic hashes of a Merkle tree, which is meant to prevent network abuse.23 That is to say, just as e-commerce sites use CAPTCHA to prevent automated spamming, in order to participate in the Bitcoin network, a mining machine must continually prove that it is not just working, but working on (hashing) and validating the consensus-based blockchain.2425 At the time of this writing the computational power of the network is 200 petaflops, roughly 800 times the collective power of the top 500 supercomputers on the globe.26

To prevent forging or double-spending by a rogue mining system, these systems are continually communicating with each other over the internet and whichever machine has the longest tree is considered the valid one through pre-defined “consensus.”  That is to say, all mining machines have or will obtain (through peer-to-peer communication) a copy of the longest chain and any other shorter chain is ignored as invalid and thus discarded (such a block is called an “orphan”).27 If a majority of computing power is controlled by an honest system, the honest chain will grow faster and outpace any competing chains.  To modify a past block, an attacker (rogue miner) would have to redo the previous proof-of-work of that block as well as all the blocks after it and then surpass the work of the honest nodes (this is called a 51% problem).28 Each 10 minutes (on average) these machines process all global transactions – the integer movements along the ledger – and are rewarded for their work with a token called a bitcoin.29 The first transaction in each block is called the “coinbase” transaction and it is in this transaction that the awarded tokens are algorithmically distributed to miners.30

When Bitcoin was first released as software in 2009, miners were collectively rewarded 50 tokens every ten minutes; each of these tokens can further be subdivided and split into 108 sub-tokens.31 Every 210,000 blocks (roughly every four years) this amount is split in half; thus today miners are collectively rewarded 25 tokens and in 2017 the amount will be 12.5 tokens.  This token was supposed to incentivize individuals and companies as a way to participate directly in the ecosystem.  And after several years as a hobbyist experiment, the exchange value of bitcoin rose organically against an asset class: fiat currency.

While colloquially someone may say he or she has ten bitcoins, there is no physical or even digital object that is an actual bitcoin.32 We are talking simply about the ability, by virtue of having exclusive knowledge of a given unlocking private password (a key) of a given schema, to cause a change in a ledger entry in that distributed schema.  And because all the mining systems operate with clearly defined “dry” rules, through consensus they respect the ledger entry change.  In other words, transferring a bitcoin is merely moving a specified integer value from one address to another address; all such moves are recorded on a public ledger.  As a consequence, users can actually access, transfer, and “store” these tokens through numerous mediums including a digital wallet (accessible from a laptop, tablet, smartphone), through an online browser and even through air gapped, cold-storage techniques such as a “paper wallet” or USB drive.33 Yet the actual ledger remains distributed amongst the mining equipment.

Another way to look at the Bitcoin system is through a thought experiment: try to stop using the word “property” to refer to the thing owned, the thing in which there is a property right.34 Instead, talk about an owner of some owned thing – or resource. The owner has a property right in some owned thing – in some resource.  So then ask: what is the ownership or property right in a bitcoin?  What exactly is a bitcoin?  You then have to carefully define what you mean.  And of course it is not ownership of “a bitcoin” – since there can be fractional bitcoins (the smallest unit is called a satoshi).  Economics does not have a category of “property,” as it is the study of human actors and scarce resources.  Property is a legally recognized right, a relation between actors, with respect to control rights over given contestable, rivalrous resources.  And with public-private key encryption, individuals can control a specific integer value on a specific address within the blockchain.  This “dry” code effectively removes middlemen and valueless transaction costs all while preserving the integrity of the ledger.  In less metaphysical terms, if the protocol is a cryptocurrency’s “law,” and possession is “ownership,” possession of a private key corresponding to set of transaction (tx) outputs is what constitutes possession.35 All crypto assets are essentially bearer assets. To own it  is to possess the key.  The shift from bearer, to registered, to dematerialized, and back to bearer assets is like civilization going full circle, as the institution of property evolved from possession to the registered form that predominates in developed countries today.

In terms of the logistics and mechanics of exchanging bitcoins to and from fiat, there are several methods.  For large volume, over the past several years there have been several companies (BitStamp, Kraken, BTC-e) that have created web-based exchanges by which a user deposits a token and the exchange in turn is partnered with a physical bank in specific jurisdictions.36 Once a user “sells” the token on the exchange, this bank then provides fiat liquidity to the exchange.  Since the genesis block in 2009, approximately 12.4 million bitcoins have been mined, some of which are permanently lost (e.g., where a user has lost or forgotten the information comprising his or her private key).37 As of this writing, the current market cap of all mined bitcoins is seven billion dollars; for comparison, MasterCard’s current market cap is $125.24 billion.

Not a One-Trick Pony or One-Hit Wonder

With its decentralized, peer-to-peer abilities that allow for near-instant transfers and trustless authentication of value while simultaneously serving as a registry of all property ownership (titles) with an algorithmically controlled stable money supply, the Bitcoin protocol has several limitations.38

Since the initial release of Bitcoin, up until now, the protocol has not been natively capable of managing and tracking more than one asset class.  For instance, three years ago, when ten thousand bitcoins were traded for a pizza, the token could have just as easily become pizzacoin.3940 That is to say, while value was exchanged, those using the blockchain could have attempted to track the value of pizza.  Or more precisely, those using bitcoin as a medium of exchange (MOE) could have used pizzas as the unit of account (UOA) (e.g., when setting the bitcoin price of those alpaca socks, consult the bitcoin-to-pizza ratio).41 Instead, the users of bitcoin consulted the bitcoin-to-fiat so fiat remained the unit-of-account as prices in fiat are generally used to measure the value of goods in the physical economy.    Another way to look at this is, those using bitcoin could have treated it in a “colored coin” manner (see below); and conventionally each coin would have equaled 1/10000th of a pizza.  As a consequence, it became clear that in order to begin tracking, trading, and managing smart contracts in a decentralized manner (and thereby exchanging smart contracts and even smart property), you were limited to just a few workarounds described below.42

How do we trade assets on the blockchain?  Purely proof-of-work, blockchains present logistical problems.  One choice is to build and maintain tens of thousands of altcoin blockchains that serve as ledgers for each asset.  This in turn would require a hash generating network to verify and protect against double-spending attempts (i.e., the 51% problem).  While there is no specific engineering reason that prevents this solution from being carried out (and perhaps it could take place through endeavors like Humint),43 motivating the human element to build and maintain a mining network in a profitable manner could be very cumbersome.   At the time of this writing there are several hundred different altcoins, most of which are mere line-for-line copies of Bitcoin or Litecoin – there are even automated tools that allow users to create their own clones, such as Coingen and Razorcoin.44 Yet, despite the existence of these altcoins, their creators have thus far been unable to re-create the “network effect,” which continues to back Bitcoin.

Another approach could be to build another layer, or platform, on top of a blockchain which specifically relates to an underlying reference asset.  Of all the existing decentralized cryptochains in existence, the one with the most institutional momentum, merchant exchanges, and community involvement (both in terms of software development and user base) is Bitcoin.  In economic terms this is called the “network effect.”  That is to say, the more people who use the network, the more valuable the network is.  Other examples are social media sites like Facebook: the more your friends use it, the more potential value it has for you.  Or with credit cards, the more merchants that accept Visa, the more useful and convenient it is for you.45 While other altcoins (and altblockchains) may be invented, convincing a critical mass of user, merchant, and developmental adoption is a constant uphill battle.  It should also be noted that first-movers are not necessarily the players that the market chooses in the long run.  For example Diners Club was the first credit card; yet it was displaced by other participants and is relegated to a small niche today.  Similarly, both Friendster and MySpace were the first funded companies in the social networking space, yet it was Facebook that became the industry leader.  Kodak, Blockbuster, and Tower Records are also recent examples of incumbents that were unable to adapt to a different market landscape.  In fact, the technology industry is filled with instances of disruptive innovations and creative destruction, including most notably RIM, which spearheaded the smart phone with its Blackberry concept but after mismanagement woes is now on the verge of bankruptcy.4647

For the near future at least, Bitcoin is the protocol du jour.

While some efforts have focused on the above approach, projects like Mastercoin and Colored Coin have chosen to build on top of Bitcoin’s blockchain, to use it as a verification and transportation protocol – allowing them to focus on building asset management tools instead of building an entirely new hashing infrastructure.  Both of these projects have a different method of managing assets.  Mastercoin issues its own token called a mastercoin (a type of metacoin) that can be bought or sold like a bitcoin on an exchange.  On January 3, 2009, the genesis block for Bitcoin’s blockchain was publicly released, laying the foundation for all other future blocks to build on top of.48 Similarly, on July 31, 2013, the Exodus Address was setup for Mastercoin which the resulting framework is situated atop.49 Only a limited number of mastercoins were created during the subsequent month of August and they are only visible to users that use a specially designed wallet that can distinguish them from the rest of the blockchain.50 Despite some initial developmental hiccups, the community responded by providing 4,700 BTC ($5 million at the time) in crowdfunding.51 These mastercoins in turn insert tiny messages into the blockchain that can be used to represent user-defined assets like a derivative or gambling bet.  Special digital wallets and online tools are used to track, trade and sell these mastercoins to anyone around the world.

The Colored Coin project is a little different from Mastercoin in that a certain amount of Bitcoin (e.g., 0.001 BTC) are “colored” to represent a particular asset (e.g., green for a car, blue for a house, yellow for gold, pink for shares of stock).  Users can then exchange these “colored” assets with one another using the Bitcoin blockchain as the ledger.  For example, if you own a home, you could use 0.001 BTC (or any other arbitrary amount) to represent transfer and assign it a secondary attribute, the “color” blue or any other “color” to represent the character of the asset (e.g., a house).52 You can then send and exchange this new blue token using a special digital wallet called the Chromawallet to a buyer who uses a similar wallet.  Using an online exchange (or even decentralized exchange) the buyer can purchase your “colored” token with bitcoin or some other combination of “colored” coins.  All of this is managed through the same ledger.  The only intermediary in this process is the blockchain, which manages the tokens just as it would any other bitcoin.

While there are several other projects with similar abilities on paper (NXT, Invictus Innovations, Counterparty), they all share a main goal: to allow a decentralized cryptographic ledger (a blockchain) to serve the roles and functions that had previously been managed by numerous 3rd parties.  While it is unclear which of these, if any, will be successful, the full implications and applications of trustless asset management are spreading more widely into the larger software development community.

For perspective I contacted Mike Hearn.  Hearn is a core Bitcoin developer who recently left Google to work on the protocol full-time.53 He also has spearheaded the effort to enable smart contract functionality with the protocol, designing several codebases and use-cases for future development.  In an email exchange I asked him if he thought that smart contracts would initially be limited to financial instruments.  In his view, “well, ‘contracts’ in the sense Satoshi used them are about Bitcoin and Bitcoin is inherently about finance so yes, I think they will be restricted to finance.”

And what kind of application does he think could bring cryptocurrency to a wider audience?  “That’s the million bitcoin question isn’t it. I don’t know. There might not be one killer app in particular, but a variety of apps that are merely useful enough that everyone has a bit of Bitcoin lying around for the occasions when they need them.  I explored micropayments last summer as part of trying to answer this question.”

Due to fees set by traditional payment processors, microtransactions have been an area that was financially difficult to do until Bitcoin, which permits divisibility to the one-hundred millionth decimal place (and virtually farther if patched in later versions).  Many off-chain wallet and exchange solutions such as those at Coinbase and Circle enable users to exchange bitcoins at this granular level.  An off-chain transaction is one in which the movement of value (e.g., an asset) takes place outside the public blockchain.  That is to say, initially users sent bitcoins to one another directly through the blockchain, this is called an on-chain solution.  However, now Bob can send bitcoins from any of his wallet to his friend Alice who may be using a hosted wallet at an off-chain provider such as Coinbase (a trusted 3rd party).  Or in other words, Bob’s tokens first go to a Coinbase on-chain wallet which is synched to the public ledger, but then using an internal database, the representations of these tokens are divvied out to a specific user within Coinbase’s internal off-chain wallet system.  There are trade-offs to using each approach.  While on-chain solutions such as Blockchain.info are reliable and cannot be exploited by a 3rd party, trading and exchanges are conducted in the 10 minute time frames (due to blockchain speeds).  Yet readers should be aware that while there are advantages of using a trusted 3rd party situation (namely speed and microtransactions below the dust limit), it could also result in the total loss of tokens as illustrated by the Mt. Gox fiasco in which thousands of customers potentially lost all of their holdings.54

Similarly, Hearn and others have discussed how in the near future, a mobile device (smartphone, laptop, tablet) could pay for wireless access with random WiFi hotspots via Bitcoin-based micropayments.  That is to say, one of the problems with the current wireless infrastructure is that there is no automated, secure manner for strangers to use wireless hotspots without having to trust one of the parties, which could lead to abuse (e.g., credit card fraud).  If instead, if Alice’s WiFi router was enabled with Bitcoin functionality (i.e., had a built in wallet) then Bob could pay for usage via bitcoin – even as little as a fraction of a cent’s worth – and both parties could be satisfied.

Assurance Contracts

But are there practical, present-day uses for the technology which are not contingent on some hypothetical future blockchain gaining widespread acceptance?  Alexander Tabarrok, an economist at George Mason University and creator of the “dominant assurance contract” model and I exchanged emails in part of my initial exploration into the real-world applications of smart contracts.55 An assurance contract is a contract in which contributions to a group goal are held in escrow until the amount reaches a certain threshold, after which point the contributions are then released (e.g., crowdfunding via Kickstarter).  This has been discussed as an alternative model for funding public infrastructure (e.g., a lighthouse, water treatment plant, roads, or bridges) and consequently its objective, binary funding model has frequently put it in the spotlight as a relatively easy example for smart contract developers to encode.  The “dominant” version is a twist in that if contributions fall short of the threshold, those who contributed not only receive their original funds, but also a bonus – creating an incentive for many people to donate.  Tabarrok writes:

I see smart contracts and the internet of things as ending the problem of asymmetric information. In economics, asymmetric information problems occur when one party to an exchange has better information than the other party and out of fear of being exploited the lesser informed party backs out of the trade. Both parties lose since no trade occurs even when trade would be mutually profitable. Smart contracts and the internet of things can overcome many of these problems by making information revelation more credible and even by making trade conditional on information that neither party may even know!

Capitalism like science and technology is a dynamic system and no one can predict where it’s going to go. I expect only to be surprised by the uses people will find for dominant assurance contracts. Kickstarter and other groups have made assurance contracts more familiar (you only pay if enough people join). Dominant assurance contracts make a Kickstarter-like proposition even more compelling (you only pay if enough people join and if not enough join you get paid). I hope to see experimentation and eventually I hope that familiarity in the private realm will encourage people to experiment with DACs to fund public goods and government services which was my original motivation.

The big, immediate gain of using cryptocurrencies and cryptoprotocols is quite pedestrian, lower transaction fees. Our payments technology is expensive and cumbersome. This is true for credit card payments, dominated by a handful of firms, and even more so for the government run checking system which is basically a 19th century system.  Transaction costs are not sexy but there are a lot of transactions in the world and there are many billions to be made by improving the system.  The company that first cracks the transaction cost nut, and I think that will mostly require reputation and scale rather than new technology per se, will be for payments what Google is for advertising.  Big advances in the technology of asset management and banking, the sexy stuff, will come after and on the back of the billions made by reducing transaction fees.

A DAC is a decentralized autonomous corporation, an AI entity that performs the functions of companies (e.g., payroll, issuing dividends) and is discussed at length in chapter 5.   There are several civic crowdfunding platforms that have been launched over the past couple years including Citizinvestor, neighbor.ly and ZenFunder.56

Legalese Challenges

Implementation of DACs, however, is not without its problems.  In view of this I spoke with Stephan Kinsella, a patent attorney, author and Bitcoin investor “while there seems to be potential with cryptocurrencies, cryptoprotocols and smart contracts in general, in my experience the legal industry changes at a glacial pace.  Many if not all of the segments are highly regulated and filled with well-established incumbents especially those integrated with banks.  As a result, most clients and partners typically like to continue utilizing traditional services and solutions and thus are very resistant to innovation.  Similarly, letters of credit and dispute resolution boards have existed for decades so this is not necessarily a selling point.  While there are theoretical advantages to using independent arbitrators or escrows, many contracts for property ownership or car ownership already set up a system of clauses where parties choose an arbitrator or how to use an escrow.   For instance, in terms of percentages, even when disputes arise the amounts of parties that ultimately use an escrow are quite small.  Though, perhaps with enough buy-in this could change later in time.”57

The problem, in his view, is that cryptocurrency is competing with an existing legal and commercial transaction infrastructure. “Again, while smart contracts present a very efficient and optimized marketplace, educating a userbase will be a constant uphill battle because in some ways you may have to reinvent the wheel; or recode the wheel as it were.  For instance, to hedge against a breach of contract Bob may have to issue a $1 million bond to cover insurance.  And in the event that this happens, you would likely need to work with a 3rd party who will have to look over the evidence of the case which in turn adds cost to the transaction.  Sometimes if a deal continues to sour, Bob will sue or simply write-off the loss.  Yet these types of interactions can and will likely happen despite using cryptoledgers.   Furthermore, while cryptoprotocols offers many methods to constrain governance, such as title management I do not see why banks would rewrite their system for this service any time over the next several years.58 They are typically risk averse and conservative.  In fact, I still see legal contracts with provisions that were written decades ago – even over a century – because they withstood legal scrutiny.  While smart contracts in theory could provide similar provisions, proponents and developers of next-generation crypto platforms should be aware that it will take many years of continuous education to convince businesses to adopt this different framework.”

According to Kinsella and others I spoke to on this matter, the smart contracts which would give rise to the fewest problems would likely be narrow contracts covering easily quantifiable, fungible commodities (e.g., oil, metals, ore, agriculture) or simple services, such as those provided by auto-repair shops and beauty salons – that is to say, something that is objectively measurable, mechanical and consistent, and low on consumer protection or complex representations and warranties.  While Bob and Alice would need to be aware of the various jurisdictions that provide different guidance and policies regarding the licensure of services (e.g., cosmetics, accounting), cryptoledgers and trustless asset management could enable a frictionless environment for bartering.  Decentralized exchanges that can manage cryptotokens could allow local service providers to buy, sell, and trade in-kind without going into fiat.59 While the tax and regulatory implications will unquestionably be different depending on the jurisdiction, this type of “cryptobarter” system may become useful and socially empowering in countries with faltering monetary institutions – like Argentina or Greece.

Argentina

In February 2014 I spoke with Wences Casares, an Argentine native and creator of a Bitcoin wallet used by institutions.  He recalls, in his youth growing up “in Patagonia I remember when we had so much inflation twelve years ago that my mother would carry her salary around in plastic bags and spend it as soon as she got it.  She would go to a market and there were workers whose sole job was to replace the sticker prices many times throughout the day because the price levels soared.”   In addition, Casares noted that at the national level, “the government did not want to raise taxes or lower spending so they printed more, causing inflation.  And when I talk to others about Bitcoin throughout the day I use different analogies depending on the person’s background.  Yet when I describe how Bitcoin works to Argentines, they figure it out very quickly.  They realize it cannot be confiscated and can be used as a store of value.”

Between 1998 and 2002, the Argentinian economy shrank by 28% as measured by GDP.60 At the end of 2001, the national government defaulted on $132 billion in debt and inflation reached a monthly high of 10.4% in April of 2002.61 Simultaneously the unemployment rate reached 20% by December 2001 and remained near 25% the following year all the way into 2003.62 While subsequent administrations reversed several of these policies, including restructuring external debt, in 2008 the Argentinian government nationalized private pension funds, amounting to $30 billion in private savings.63

Based on his experiences, Casares says that “when I have helped process face-to-face Bitcoin exchanges in Argentina, when you look at the other side of the transaction these users are not hackers or geeks, they are common people who see it as a good store of value.  Many in fact do not have much in savings but see how Bitcoin cannot be inflated.  People with significant amounts of money can easily move into hard assets yet those at the bottom, the common person cannot.  Bitcoin helps them and I imagine will continue to do so in the future.  There are a lot of benefits of Bitcoin, different people latch onto different benefits yet if another similar inflationary event happens, because of the proliferation of mobile phones it could catch on like fire.”

Sebastian Serrano, another Argentine native and founder of BitPagos, a virtual currency merchant payment service provider, expresses similar sentiment based on his first-hand experiences, “In Argentina there was a big wave of bartering that began in early 2002 whereby people traded food, services, almost anything at ad hoc fairs.64  During late 2001 through 2002 the peso was in free fall and there was a large increase in unemployment, which motivated people to trade things for things.  In fact, a few months into this crisis, many fairs and bartering clubs were already issuing their own ’credits‘ and creating their own bills as a form of scrip.65 Eventually a federation was created that issued a general note, yet counterfeit of this credit became a big problem.  As the economy recovered, the need for these clubs diminished and people stopped going to them – and while a few may persist, most completely shut down.  Yet I think cryptocurrencies and a decentralized asset management system would have helped with this barter system out substantially.  Not so much for price discovery but rather to prevent fraud because many of these fairs suffered from counterfeit notes and lack of transparency on how the notes were issued or distributed.66 And I think we are a few iterations behind something like a smart contract-based system that could be used in a scenario like that.  And perhaps these new platforms being developed will help in the long-run, because contracts make sense when time is a factor.  Thus, it is going to be very interesting to see how this develops again if we have another financial crisis.”

In 2013 the Argentinian peso lost 25% of its value relative to a US dollar and to stem capital outflows, Argentine policymakers enacted strict capital controls.67 As a consequence, ordinary people lacking in political clout have had difficulties in protecting their peso-based savings because access to foreign currencies is restricted.  While there is a fledgling Bitcoin community in Argentina, there are few formal outlets to exchange pesos to bitcoins or other cryptoassets that can provide a store of value resistant to inflation.68 Trustless asset management could enable ordinary people to, instead of relying on the local currency (e.g., peso) to exchange goods and services, exchange their services via different cryptotokens.

Such a system, if implemented, would be a more accurate rendering of the Big Mac index.69 The Big Mac index is an annually published currency-comparison tool created by the Economist that measures the purchasing-power parity (PPP) of each country.  That is to say, a Big Mac is a relatively consistent, quantifiable good that irrespective of jurisdiction should cost the same relative to the local currency.  However, since 1986, due to internal monetary policies a Big Mac is visibly overvalued or undervalued relative to chained US dollars.   While merchants and entrepreneurs do not necessarily need to know every available global price point for haircuts, oil changes, or even in-flight training these indices could help provide price discovery, enabling Argentinians to trade their goods and services at roughly market-rate prices without using local currencies.  In fact, just as globalization acts as to arbitrage wage rates of low-skilled employment between regions (i.e., ceteris paribus, the process of making textiles should cost roughly the same irrespective of locality), ultimately a decentralized system could enable entrepreneurs to coordinate economic investment to or from certain regions.

In one speculative example, Bob the mechanic in Buenos Aires could create a variety of “colored” tokens to represent tune-ups, repairs, and oil-changes and place them on decentralized exchanges that track those specific services.  Alice from the suburb of Avellaneda is an airline pilot and could similarly create tokens to represent certain amounts of flying time (e.g., two hour in-flight training) and also place the tokens onto a decentralized exchange.  Each exchange could list both the local rate for service (i.e., what the supplier is charging in fiat) as well as various cryptocurrency rates.  While inflation may erode purchasing power of fiat currencies such as the peso, decentralized platforms could enable both goods and service providers the ability to retain and exchange value in a decentralized manner that negates the need to use a repeatedly devalued intermediary. Alice and Bob could use price-matching services to transfer service tokens directly redeemable for the said service to one another, or even exchange for other intermediary cryptocurrencies.  To exchange between specific cryptoledgers, a consensus-based DAC may require “smart contracts” to provide for escrow and arbitration mechanisms before contracts are allowed on a ledger or exchange.  Or users may be willing to accept contracts without such clauses (i.e., caveat emptor), helped along in their commercial decision by independent decentralized autonomous agents which could provide a feedback, reputational mechanism (e.g., credit score) to allow market participants to see whether either Alice or Bob is a risky merchant.

But what a cryptoledger makes up in quantitative sophistication, it lacks in the qualitative – bartering in times of economic stress might work, but a real consumer economy might not.  According to Stephan Kinsella, “tens of thousands of formal and informal contracts are used every day between individuals, small companies and large institutions – and each of these may contain different nuances and subtleties relevant to the local setting.  Even hiring someone to be a temporary assistant may require qualitative language – some formalized legalese – and it will be difficult to automate those things.  In fact, most contracts outside the financial industry may not have clauses that are entirely mechanical; thus while smart contracts and cryptoledgers create a full-proof method of tracking ownership of assets, more than likely in some instances you will still need judgment calls involving humans – and there is already a subsidized public system in place for that which many market participants may be reticent to give up.70 Thus not only do you have to provide educational outreach but also consumer buy-in.”

Another question that both Stephan Kinsella and Sean Zoltek (chapter 6) brought up: how do we inform market participants that the benefits and advantages of switching to a new system outweigh the costs of using the existing infrastructure?  For instance, homeowners in many developed countries can already sell property without a realtor by using websites.  Similarly, homebuyers can purchase a deed and register it themselves.  And if you want to sell it quickly you can simply use a real estate agent.  Furthermore, while apartments, condos and townhomes are typically homogeneous units, not all houses are fungible, as they usually have some unique attributes that need to be quantified.  While this may be a small technical challenge that can be overcome, proponents should be aware that some consumers (or homeowners) may be uninterested in quantifying their assets via programmatic contracts.

Outside perspective

While much of the current literature, both academic and software development, is typically written for a US-based audience, I spoke with Preston Byrne, a fellow at the Adam Smith Institute and a London-based securities lawyer.  In his words, “the smart contract as envisioned by Nick Szabo does not yet exist. When it does, it will need to incorporate substantially all of the legal elements of a traditional contract and express them in the functions it performs automatically, at least to the extent that it is written to do so. It may be possible for a degree of modularity to be built into the code so, e.g., specific terms recognised at law could be reflected in code (provisions relating to termination, for example, on the occurrence of specific events) and standardized for use across different transactions.”

In Byrne’s view, while not impossible, drafting commercially viable smart contracts will not be easy – and code alone will not be sufficient. “If a contract is a negotiated agreement which (in the event of a dispute) a court can enforce, a smart contract is a contract which enforces itself.  Contracts are governed for the most part by (1) agreed rules and (2) a set of very complex legal fictions which govern how those rules should apply in the circumstances. For example, in English law it is required for any contract that is formed to incorporate an agreement of some kind, an actual transfer of value moving from both parties and the intention to create legal relations between them. In the event of a breach of the agreement or its being rendered voidable or void, they have a number of remedies – rescission, for example, where the contract is rendered void ab initio, specific performance, where a court orders one party to do something it had covenanted to do, and (more usually) damages compensating the injured party for loss.  While sometimes parties to a commercial contract will be able to recognise when a breach or other misfeasance has occurred and sort out the appropriate remedies between themselves, ultimately the final arbiter of (1) what the contract means and (2) what the consequences of particular breaches will be lies in the hands of a court or arbitrator which has the ability to bind the parties and coerce them to its will. Contracts mediated entirely by distributed, pseudonymous blockchains by fully autonomous DAOs are not well suited to this role.”  This is an issue that several individuals discussed in the evolution of this manuscript.  If the theory is there, where are the smart contracts?   Ignoring the hype and handwaving, the main obstacle is the technical codebase and complementary support services that need to be implemented – the infrastructure needs to exist to allow for smart contracts to fulfill the functions described by Szabo and Byrne.

Some sources have explained it is nearly impossible to remove all human interaction in commerce – therefore why bother with using a cryptoledger system?  Byrne argues that there will nonetheless be advantages beyond reducing transaction costs that lenders will be interested in – and only when cryptoledgers become more widespread in large organizations will smart contract technology become of practical use.  According to Byrne, this should not take long: “corporates and financial institutions have high overheads for personnel and equipment. They automate their operations when they can. The idea of replacing complex server architecture with a distributed blockchain – if indeed such a thing can be done – seems to me to be a rather simpler and more elegant solution for a bank to manage its balance sheet than legions of employees. A blockchain is basically the world’s most transparent and accurate accounting product. It’s only a matter of time before proprietary blockchains crop up internally at financial institutions, governments and businesses where it will start serving that function.  Consequently, the resources saved – currently used to pay salaries of financial services professionals – will be redeployed into lending operations and the economy at large.”

“In a similar fashion,” Byrne argues, “governments could do the same thing with their own finances and practically everyone would benefit. In the UK the public sector pay bill is £167.5 billion a year – 25% of state expenditures, 12% of GDP, and £3000 per year for every man, woman and child in the country.71 The UK could create a state-backed cryptocurrency – cryptosterling – tomorrow. Just write it, ensure only the Bank of England can mine it, issue everyone in the country with a private key, trade it for cash and deposits on a 1:1 basis over six months and replace national insurance numbers with a metal card containing the corresponding public key. Paying salaries and taxes, and claiming benefits, would be as simple as scanning a QR code and a bit of online monitoring; we could abolish the welfare bureaucracy overnight and save vast quantities of expenditure.”

“Such a currency would be superior to any other form of legal tender,” Byrne says: “imagine being able to see every transaction conducted globally in sterling in real time,  all while possessing the benefits of any other crypto, including security, transparency, speed, irreversibility, and low cost. It would also have the benefit of being able to be tinkered with as the state would control the majority, if not all, of the hashpower on the network and have knowledge of at least some of the private keys. This is useful, for example, to reverse proven fraud, rescind a contract or engage in quantitative easing – arguably things any state needs to be able to do in order to maintain civilisation.”

He adds, “I am aware there are those who will howl that this is not what Satoshi intended, and that this will result in a state which has absolute control over the money supply and the ability to interfere with personal finances mediated by the official blockchain. I agree. However, advanced states have this capability already – we are just paying hundreds of thousands of bureaucrats to exercise it.  Plus, nothing about a state-backed cryptocurrency prevents us from trading out and using some other cryptocurrency of our choice (e.g., dogecoin).  If cryptocurrency is to take off we need to start thinking in these terms.”

Byrne’s proposal of replacing sterling (GBP) with a sterling cryptocurrency which provides unforgeable transparency is already being experimented with in Iceland with the new Auroracoin initiative.72 The team behind the project ‘pre-mined’ (created) 10 million Auroracoins (AUC) and no more will ever be made. The creators of Auroracoin plan to give every citizen of Iceland 31.8 AUC on March 25 as a transparent mechanism to mitigate against a future banking crisis.   Similarly, the Mazacoin project is working with the Lakota Nation, a Native American tribe, to create an alternative cryptocurrency that can “give native American communities some fiscal autonomy.”73 While it is unclear what changes to the regulatory framework will occur in each jurisdiction or if market participants will adopt and utilize these tokens, this space will likely grow with other such experiments over the coming years.

Byrne also sees other developmental issues arising from breach of contract and thinks that one particular problem stands in the way of integrating cryptoledgers with repayment prioritization: what he calls ‘trusted 3rd party dogmatism.’  In his words, “There is currently very little dialogue between cryptocurrency advocates, mainstream financial institutions, and governments on cryptocurrency’s role in the economy – developers and libertarians are working furiously on one side of the rift and government, institutions and corporations cautiously observe from the other, and both size each other up – as if getting ready for a fight.”

“Given that cryptocurrency technology was ostensibly designed to wrest control of commerce from banks and the state,” Byrne adds, “this state of affairs should not be a surprise.  The result of this dichotomy, however, is that there is a disconnect between the banks who mediate transactions in the real economy and the cryptocurrency which seeks to supplant them.  This is counterproductive; the technology is open-source and can benefit everyone, including the banks.  But the gulf, until bridged, will act as a serious hindrance to development.  Take the idea of an asset-backed (secured) peer-to-peer loan as an example, where the borrower borrows in cryptocurrency and also collateralises the loan with cryptocurrency.  Talk to a cryptocurrency advocate, and he sees an opportunity to write a smart contract protocol that disintermediates a bank, avoids taxes and allows him to earn a little cash on the side beyond the reach of the revenue authorities. Talk to a bank at the moment, and they talk about money laundering, terrorist financing and regulation.  It doesn’t have to be like this.”

In his view, the solution is to reintroduce the trusted 3rd party (TTP) in a highly reduced but nonetheless essential custodial role. “Let’s return to that asset-backed peer-to-peer loan for a minute. For a bank to write that loan, it would normally negotiate an agreement on certain terms, take security over the assets concerned, and submit to a set of complex legal rules.  As Szabo noted:

‘Over many centuries of cultural evolution has emerged both the concept of contract and principles related to it, encoded into common law. Such evolved structures are often prohibitively costly to rederive. If we started from scratch, using reason and experience, it could take many centuries to redevelop sophisticated ideas like contract law and property rights that make the modern market work. But the digital revolution challenges us to develop new institutions in a much shorter period of time.’74

Continuing, Byrne notes that, “Szabo correctly points to the fact that the common law is a very complex body of rules.  He is also correct in that any smart contract we draft will benefit greatly by following its example.  Cryptocurrency will benefit more, however, from interaction with the law than attempting to replicate a parallel legal system of its own.  The primary, and one might say defining, characteristic of the English common law is that it was not, at least historically, made primarily through legislative fiat. Its evolution has been organic, with existing rules changing to new circumstances in the face of new and ongoing testing (litigation) – it is a form of transductive algorithm.  For example, the law relating to guarantees is notoriously complex because guarantors almost always have an economic interest in challenging the legitimacy of the instrument when the contract is called in, meaning that the rules are very specific and great caution must be exercised when drafting them.”

A transductive algorithm is inference from specific experiences and is a technique used in machine learning.75 Or in other words, being taught (or learning) about specific cases by which the knowledge can then be used for future cases in a similar domain.  And as Byrne suggests, it may take some time for the legal framework to organically form around cryptocurrencies, through a similar process.

Continuing, “Even in simple agreements, however, a hard rules-based approach – as an outsider to bank lending and law practice might perceive it – is far from the norm.  Law is ‘wet code’ not by mistake but by design.  Returning again to an asset-backed loan, let us suppose that this loan enters into default.  In the real world it is possible for one party to forbear from exercising its rights, or to seek a situation-specific solution which fits the facts on the ground.  Even if a loan is in default, it may not be in anyone’s interest to formally call it and enforce.  In my experience enforcement is an extreme solution; it is, however, the final remedy on which all faith in commercial contracts is based.  Coding smart contracts that make a role for TTPs who can be reasonably relied upon to act fairly, and have adequate resources or insurance so that if they breach their obligations they’re still worth suing, is a necessary step if cryptocurrency is to be adopted by the mainstream.  To do that, however, the cryptocurrency community needs to get over its ideological aversion to governments and banks and start selling to them.”

While his proposal will likely receive a mixed reaction, he sees this evolution in terms of the existing role of a 3rd party.  In his view, “taking the asset-backed loan as an example again, let us suppose there are multiple lenders.  Usually those lenders will enter into a contractual arrangement with an agent or trusted 3rd party, another bank or a professional trustee company, to hold and exercise their rights, at their direction and on their collective behalf.  This arrangement works because (1) the common law allows the lenders to contract with that TTP on certain terms and (2) the parties know where to find the TTP if it screws up.”

In Byrne’s view, once a trusted 3rd party is removed from simple transaction of the kind in the style proposed by Nick Szabo, such an agreement differs from a contract concluded in the normal way in that:

1) “the TTP and its associated costs are disintermediated and users become independent of existing institutions; however,

2) “the price of decentralisation is full cash collateralisation, making even the most basic lending contract unviable for ordinary commerce;

3) “the element of discretion to hold our rights in abeyance and adapt to changed circumstances is limited by the algorithm; and

4) “in all likelihood, the possibility of enforcement for losses which arise beyond the provisions made in the smart contract itself will be compromised, because

(a) by design, the technology doesn’t permit this course of action (as a party who would be liable for, e.g., consequential loss would almost certainly not hand over his private key in circumstances where his liability would increase); and

(b) even if one could present the contract to a court and trace all of the relevant assets, reintroducing a contract to the legal system when it was intentionally structured to exist outside of it does not tend to work out well for the party seeking to rely on its provisions.”

This is an issue that numerous reviewers of this manuscript asked: for digital contracts, how is the problem of real life enforcement solved?   After all, even if things are enforceable on the blockchain, a human still has to input the conditions for which contracts will be executed, and if anything happens in real life, it still has to be enforced by lawyers and the state.  However, there is no clear cut answer to this and each jurisdiction will likely react in different ways: from acceptance to outright banning.

Yet Byrne sees only one solution: invite 3rd parties back into the equation.

As Szabo said, “by extracting from our current laws, procedures, and theories those principles which remain applicable in cyberspace, we can retain much of this deep tradition, and greatly shorten the time needed to develop useful digital institutions.”76 To Byrne, this means that while “a technical understanding of jurisdiction specific legal principles is absolutely essential to smart contract design, trying to encode the sophistication of common law into an algorithm is impossible – see, for example, the Eurosail-UK 2007-3BL case, where ambiguity relating to the statutory consequences of a purely mechanical provision, which in all likelihood nobody expected would ever be invoked at the time the contract was entered into, had significant consequences for an entire industry. Reifying agreements in code and pushing for full decentralisation will create more commercial problems than it solves.”

Byrne thinks that the tradition can be easily retained and employed if it is applied, “the way in which this will be done is by ensuring smart contracts keep a foot in the real world.  We would still see a paper contract specifying what is reserved for the blockchain and what is not – automata are well suited to matters like collections, cash sweeps, swap payments and collateralisation, managing and blocking ‘accounts’ (query, if a blockchain is used, whether the need for accounts could be dispensed with as well), payment prioritisation, and even servicing issues such as title transfer on enforcement, as Nick Szabo has suggested (e.g., in the case of securities backed by a pool of automobile loans).”

“The role of an individual contract’s sole TTP,” he continues, “could be limited mainly to holding the private keys on trust and in confidence for the parties pursuant to the terms of their contractual agreement, leaving the rest to the machine, only intervening to exercise the critical discretion when things go horribly wrong – granting flexibility for complex situations involving insolvency, recovery of uncontemplated losses, and changes in the law such as reference currency re-denominations.  This human element which is held in reserve is also what would permit judicial control of the transaction.” However, Byrne added, “to move things forward on this front, computer programmers need to start talking to lawyers and bankers.  This is not to say that this would prevent anyone from using the technology outside of the legal system.  It is only to say that in order to mature, the technology will need to maintain some connection to the legal system and submit to its jurisdiction.”

While it is too early to tell how this intersection will play out in the United States, it will likely fill volumes of books over the coming decades.  In the meantime there are several cases currently being litigated that involve cryptocurrencies, including one concerning a Johns Hopkins doctor who sold prescription pain pills (oxydocone) through Silk Road – an anonymous marketplace that is largely known for its illicit drug trade.77 Similarly, Alydian was an ASIC mining company that went bankrupt and during the bankruptcy proceedings, the judge raised some questions that nearly all other jurisdictions will have to become familiar with: What is a token?  What is a cryptoledger?  Does it exist, and if so, where?  Can it be controlled or rescinded?  And so forth.78

And in Byrne’s view, there will likely emerge a balance that companies and institutions each come up with in terms of how integrated their operations will become with math, algorithms and cryptoprotocols – “a ‘balance of trustlessness,’ if you will. I think for most contracts of a large, capital-intensive nature (securitisations, corporate lending, corporate acquisitions, asset and property purchases) smart contracts will ensure they fall within legal jurisdiction in order (1) to better assess and mitigate commercial and counterparty risk and (2) to create a nexus with real-world assets which can be enforced against – the market will demand it.  The courts will develop an interpretive framework to compel people to turn over these assets.  If a trusted 3rd party knows the private keys, a central agent can control them and give effect to court orders.  The same is true for a government body using the technology, which in its hands should remain subject to both judicial and constitutional control.”

  1. They Never Said It: A Book of Fake Quotes, Misquotes, and Misleading Attributions by Paul Boller and John George []
  2. Wet code and dry by Nick Szabo []
  3. Arbitration Scorecard 2013 []
  4. Fulbright’s 9th Annual Litigation Trends Survey Report and Fulbright’s 9th Annual Litigation Trends Survey: Litigation Bounces Back; Regulation Hits High – U.S. Release []
  5. In June 2010, Paul Ceglia sued Mark Zuckerberg (creator of Facebook) claiming that a 2003 contract entitles him to an ownership of most of Facebook.  In March 2013 a judge recommended dismissal of the lawsuit as the contract was a “recently created fabrication.”  See Facebook Lawyer `Unsure’ Whether Founder Mark Zuckerberg Signed Contract from Bloomberg and Judge recommends dismissal of Paul Ceglia’s Facebook lawsuit from c|net []
  6. A type of securities exchange existed during the Roman Empire, societates publicanorum, which were organizations of contractors and leaseholders who performed services for the government. []
  7. The term smart contract is sometimes used as a bit of a misnomer, because it likely undersells the capabilities of a DAO.   An ‘active contract’ or ‘live contract’ explains that the contract itself is the mechanism that monitors and actively controls the prior agreement per the terms.  See also: WorkingWithContracts from bitcoinj []
  8. According to Mark Miller the first smart contracting system was AMIX, the American Information Exchange. []
  9. More concisely, smart contracts are about reducing default (e.g., counterparty risk).  The standard historical view has been that the state was necessary to enforce contracts (forward contracts as opposed to spot contracts).  However, Anthony de Jasay’s contends that Rousseau is misunderstood regarding the “public goods problem.”  The common view is that the optimal strategy is for both parties to default and that this somehow proved the existence of market-based contract failure.  Yet as de Jasay contends, the proponent of such a few employs a form of hedonic calculus in order to quantify the “incremental pleasure he expects to derive from having the state arrange the production of the correct amount of order and other public goods, instead of relying on a possibly quite inadequate patchwork of spontaneous arrangements, must outweigh the pain of coercion he thinks he will suffer at the state’s hands.”  See Inventing the State: The Social Contract by Anthony de Jasay []
  10. It has been called a platform, scaffold, foundation and a number of other nouns.  See Bitcoin: It’s the platform, not the currency, stupid! by Sander Duivestein and Patrick Savalle and Bitcoin 2.0 Explained: Colored Coins Vs Mastercoin Vs Open Transactions Vs Protoshares by Kyle Torpey []
  11. While smart contracts can technically self-execute, whether or not policy makers allows or recognizes them is another matter entirely. []
  12. Smart Contracts by Nick Szabo []
  13. This issue can involve entire papers and books in terms Subjective Theory of Value and preferences.  See Economics of Bitcoin: Is Bitcoin an Alternative to Fiat Currencies and Gold? by Peter Šurda and The Economics Of Bitcoin – Challenging Mises’ Regression Theorem by Michael Suede []
  14. Wet code and dry by Nick Szabo []
  15. See Bitcoin: A Peer-to-Peer Electronic Cash System by Satoshi Nakamoto.  Bitcoin also solves a long-standing mathematical thought experiment called the Byzantine General’s Problem which involves how independent parties (and strangers) can arrive at consensus as noted by Paul Bohm:

    The Byzantine Generals’ Problem roughly goes as follows: N Generals have their armies camped outside a city they want to invade. They know their numbers are strong enough that if at least 1/2 of them attack at the same time they’ll be victorious. But if they don’t coordinate the time of attack, they’ll be spread too thin and all die. They also suspect that some of the Generals might be disloyal and send fake messages. Since they can only communicate by messenger, they have no means to verify the authenticity of a message. How can such a large group reach consensus on the time of attack without trust or a central authority, especially when faced with adversaries intent on confusing them?

    Bitcoin’s solution is this: All of the Generals start working on a mathematical problem that statistically should take 10 minutes to solve if all of them worked on it. Once one of them finds the solution, she broadcasts that solution to all the other Generals. Everyone then proceeds to extending that solution – which again should take another ten minutes. Every General always starts working on extending the longest solution he’s seen. After a solution has been extended 12 times, every General can be certain that no attacker controlling less than half the computational resources could have created another chain of similar length. The existence of the 12-block chain is proof that a majority of them has participated in its creation. We call this a proof-of-work scheme.

    If that sounds confusing, don’t worry. What it means is just that consensus is reached, because computational resources are scarce. You vote with work. To rig the vote an attacker would need to control more computational power than the honest nodes. To ensure it’s more expensive for an attacker to purchase the computational power needed to attack the system, Bitcoin adds an incentive scheme. Users who contribute computational power get rewarded for their work. If the value of a Bitcoin rises and thus attacking the system becomes more profitable, it also becomes more profitable for honest users to add computational resources. At any given point, one would expect miners to invest as much resources into mining as is profitable for them. Bitcoin is a currency, because it needs incentives to protect the consensus process from attackers. This computational process (“mining”) is not wasteful at all, but an incredibly efficient way to make attacks economically unprofitable. Bitcoin never uses more computational resources than neccessary to protect the integrity of its interactions. []

  16. What Is Seigniorage? by David Kestenbaum []
  17. Core Development Update #5 by Gavin Andresen []
  18. An example is BTProof []
  19. See How do bitcoin transactions work? from CoinDesk and How the Bitcoin protocol actually works by Michael Nielsen []
  20. There is arguably actually a third key as well, a hash of the public key.  See Bitcoins the hard way: Using the raw Bitcoin protocol by Ken Shirriff []
  21. Cryptographers at GCHQ, the British intelligence agency had independently invented and used the public-private key Diffie-Hellman technique several years prior to 1976.  As a result of this and other mathematical schemas, the entire global financial industry, every diplomatic corps, cloud services and all e-commerce (to name a few) currently rely on cryptographic methods to securely transmit data. []
  22. Elliptic curve cryptography was first introduced by Victor Miller and Neal Koblitz in 1985.   While Diffie-Hellman can be used for public key encryption, not many people actually use it that way.  Also, Diffie-Hellman cannot do digital signatures which is what Bitcoin uses public key encryption for.  Furthermore, Bitcoin uses parameters set by secp256k1 (not the exploitable secp256r1).  See NSA Backdoors and Bitcoin by Chris Pacia, The Cryptography of Bitcoin by Edward Yang, An Overview of Elliptic Curve Cryptography by Julio López and Ricardo Dahab, ECDSA from StackExchange, Why can’t Diffie-Hellman be used for signing? from StackExchange and Cryptography and Contracts by Daniel Krawisz. []
  23. A Merkle tree is used to “store” the large transaction history (at the time of this writing, the blockchain is roughly 14 gigabytes and growing).  Technically transactions are not actually “stored” in a hash tree per se, but rather the proof-of-work that says a block is valid is based on hashing the Merkle tree input of all the transactions. []
  24. Bitcoin uses a modified version of Hashcash which was originally proposed in March 1997 by Adam Back; the actual cryptographic hash function is SHA256d.   It should also be noted that he recently voiced some vulnerability concerns regarding implementing a Turing-complete language with a cryptoledger, see Turing complete language vs non-Turing complete (Ethereum vs Bitcoin). []
  25. Or in short, mining as done today has very simple requirements: hard to produce results, yet easy to verify and relatively hard to hardware optimize.  This last aspect has changed with the advent of ASICs, yet due to competition there is an “arms race” between semiconductor designers.  See The Bitcoin-Mining Arms Race Heats Up from Bloomberg Businessweek []
  26. Washing virtual money from The Economist []
  27. There are actually four groups that ultimately provide “con