On my trip to Singapore two weeks ago I read through a new book The Age of Cryptocurrency, written by Michael Casey and Paul Vigna — two journalists with The Wall Street Journal.
Let’s start with the good. I think Chapter 2 is probably the best chapter in the book and the information mid-chapter is some of the best historical look on the topic of previous electronic currency initiatives. I also think their writing style is quite good. Sentences and ideas flow without any sharp disconnects. They also have a number of endnotes in the back for in-depth reading on certain sub-topics.
In this review I look at each chapter and provide some counterpoints to a number of the claims made.
[Note: I manually typed the quotes from the book, all transcription errors are my own and should not reflect on the book itself.]
The book starts by discussing a company now called bitLanders which pays content creators in bitcoin. The authors introduce us to Francesco Rulli who pays his bloggers in bitcoin and tries to forbid them from cashing out in fiat, so that they create a circular flow of income.1 One blogger they focus on is Parisa Ahmadi, a young Afghani woman who lacks access to the payment channels and platforms that we take for granted. It is a nice feel good story that hits all the high notes.
Unfortunately the experience that individuals like Ahmadi, are not fully reflective of what takes place in practice (and this is not the fault of bitLanders). For instance, the authors state on p. 2 that: “Bitcoins are stored in digital bank accounts or “wallets” that can be set up at home by anyone with Internet access. There is no trip to the bank to set up an account, no need for documentation or proof that you’re a man.”
This is untrue in practice. Nearly all venture capital (VC) funded hosted “wallets” and exchanges now require not only Know-Your-Customer (KYC) but in order for any type of fiat conversion, bank accounts. Thus there is a paradox: how can unbanked individuals connect a bank account they do not have to a platform that requires it? This question is never answered in the book yet it represents the single most difficult aspect to the on-boarding experience today.
Starting on page 3, the authors use the term “digital currency” to refer to bitcoins, a practice done throughout the remainder of the book. This contrasts with the term “virtual currency” which they only use 12 times — 11 of which are quotes from regulators. The sole time “virtual currency” is not used by a regulator to describe bitcoins is from David Larimer from Invictus (Bitshares). It is unclear if this was an oversight.
Is there a difference between a “digital currency” and “virtual currency”? Yes. And I have made the same mistake before.
Cryptocurrencies such as bitcoin are not digital currencies. Digital currencies are legal tender, as of this writing, bitcoins are not. This may seem like splitting hairs but the reason regulators use the term “virtual currency” still in 2015 is because no jurisdiction recognizes bitcoins as legal tender. In contrast, there are already dozens of digital currencies — nearly every dollar that is spent on any given day in the US is electronic and digital and has been for over a decade. This issue also runs into the discussion on nemo dat described a couple weeks ago.
On page 4 the authors very briefly describe the origination of currency exchange which dates back to the Medici family during the Florentine Renaissance. Yet not once in the book is the term “bearer asset” mentioned. Cryptocurrencies such as bitcoin are virtual bearer instruments and as shown in practice, a mega pain to safely secure. 500 years ago bearer assets were also just as difficult to secure and consequently individuals outsourced the security of it to what we now call banks. And this same behavior has once again occurred as large quantities — perhaps the majority — of bitcoins now are stored in trusted third party depositories such as Coinbase and Xapo.
Why is this important?
Again recall that the term “trusted third party” was used 11 times (in the body, 13 times altogether) in the original Nakamoto whitepaper; whoever created Bitcoin was laser focused on building a mechanism to route around trusted third parties due to the additional “mediation and transaction costs” (section 1) these create. Note: that later on page 29 they briefly mentioned legal tender laws and coins (as it related to the Roman Empire).
On page 8 the authors describe the current world as “tyranny of centralized trust” and on page 10 that “Bitcoin promises to take at least some of that power away from governments and hand it to the people.”
While that may be a popular narrative on social media, not everyone involved with Bitcoin (or the umbrella “blockchain” world) holds the same view. Nor do the authors describe some kind of blue print for how this is done. Recall that in order to obtain bitcoins in the first place a user can do one of three things:
purchase bitcoins from some kind of exchange
receive them for payments (e.g., merchant activity)
In practice mining is out of the hands of “the people” due to economies of scale which have trended towards warehouse mining – it is unlikely that embedded ASICs such as from 21 inc, will change that dynamic much, if any. Why? Because for every device added to the network a corresponding amount of difficulty is also added, diluting the revenue to below dust levels. Remember how Tom Sawyer convinced kids to whitewash a fence and they did so eagerly without question? What if he asked you to mine bitcoins for him for free? A trojan botnet? While none of the products have been announced and changes could occur, from the press release that seems to be the underlying assumption of the 21 inc business model.
In terms of the second point, nearly all VC funded exchanges require KYC and bank accounts. The ironic aspect is that “unbanked” and “underbanked” individuals often lack the necessary “valid” credentials that can be used by cheaper automated KYC technology (from Jumio) and thus expensive manual processing is done, costs that must be borne by someone. These same credential-less individuals typically lack a bank account (hence the name “unbanked”).
Lastly with the third point, while there are any number of merchants that now accept bitcoin, in practice very few actually do receive bitcoins on any given day. Several weeks ago I broke down the numbers that BitPay reported and the verdict is payment processing is stagnant for now.
Why is this last point important to what the authors refer to as “the people”?
Ten days after Ripple Labs was fined by FinCEN for not appropriately enforcing AML/KYC regulations, Xapo — a VC funded hosted wallet startup — moved off-shore, uprooting itself from Palo Alto to Switzerland. While the stated reason is “privacy” concerns, it is likely due to regulatory concerns of a different nature.
In his interview with CoinDesk last week, Wences Casares, the CEO and founder of Xapo noted that:
Still, Casares indicated that Xapo’s customers are most often using its accounts primarily for storage and security. He noted that many of its clientele have “never made a bitcoin payment”, meaning its holdings are primarily long-term bets of high net-worth customers and family offices.
“Ninety-six percent of the coins that we hold in custody are in the hands of people who are keeping those coins as an investment,” Casares continued.
96% of the coins held in custody by Xapo are inert. According to a dated presentation, the same phenomenon takes place with Coinbase users too.
Perhaps this behavior will change in the future, though, if not it seems unclear how this particular “to the people” narrative can take place when few large holders of a static money supply are willing to part with their virtual collectibles. But this dovetails into differences of opinion on rebasing money supplies and that is a topic for a different post.
On page 11 the authors describe five stages of psychologically accepting Bitcoin. In stage one they note that:
Stage One: Disdain. Not even denial, but disdain. Here’s this thing, it’s supposed to be money, but it doesn’t have any of the characteristics of money with which we’re familiar.
I think this is unnecessarily biased. While I cannot speak for other “skeptics,” I actually started out very enthusiastic — I even mined for over a year — and never went through this strange five step process. Replace the word “Bitcoin” with any particular exciting technology or philosophy from the past 200 years and the five stage process seems half-baked at best.
On page 13 they state, “Public anxiety over such risks could prompt an excessive response from regulators, strangling the project in its infancy.” Similarly on page 118 regarding the proposed New York BitLicense, “It seemed farm more draconian than expected and prompted an immediate backlash from a suddenly well-organized bitcoin community.”
This is a fairly alarmist statement. It could be argued that due to its anarchic code-as-law coupled with its intended decentralized topology, that it could not be strangled. If a certain amount of block creating processors (miners) was co-opted by organizations like a government, then a fork would likely occur and participants with differing politics would likely diverge. A KYC chain versus an anarchic chain (which is what we see in practice with altchains such as Monero and Dash). Similarly, since there are no real self-regulating organizations (SRO) or efforts to expunge the numerous bad actors in the ecosystem, what did the enthusiasts and authors expect would occur when regulators are faced with complaints?
With that said — and I am likely in a small minority here — I do not think the responses thus far from US regulators (among many others) has been anywhere near “excessive,” but that’s my subjective view. Excessive to me would be explicitly outlawing usage, ownership and mining of cryptocurrencies. Instead what has occurred is numerous fact finding missions, hearings and even appearances by regulators at events.
On page 13 the authors state that “Cryptocurrency’s rapid development is in some ways a quirk of history: launched in the throes of the 2008 financial crisis, bitcoin offered an alternative to a system — the existing financial system — that was blowing itself up and threatening to take a few billion people down with it.”
This is retcon. Satoshi Nakamoto, if he is to be believed, stated that he began coding the project in mid-2007. It is more of a coincidence than anything else that this project was completed around the same time that global stock indices were at their lowest in decades.
On page 21 the authors state that, “Bitcoin seeks to address this challenge by offering users a system of trust based not on human being but on the inviolable laws of mathematics.”
While the first part is true, it is a bit cliche to throw in the “maths” reason. There are numerous projects in the financial world alone that are run by programs that use math. In fact, all computer programs and networks use some type of math at their foundation, yet no one claims that the NYSE, pace-makers, traffic intersections or airplanes are run by “math-based logic” (or on page 66, “”inviolable-algorithm-based system”). A more accurate description is that Bitcoin’s monetary system is rule-based, using a static perfectly inelastic supply in contrast to either the dynamic or discretionary world humans live in. Whether this is desirable or not is a different topic.
On page 26 they describe the Chartalist school of thought, the view that money is political, that “looks past the thing of currency and focuses instead on the credit and trust relationships between the individual and society at large that currency embodies” […] “currency is merely the token or symbol around which this complex system is arranged.”
This is in contrast to the ‘metallist’ mindset of some others in the Bitcoin community, such as Wences Casares and Jon Matonis (perhaps there is a distinct third group for “barterists”?).
I thought this section was well-written and balanced (e.g., appropriate citation of David Graeber on page 28; and description of what “seigniorage” is on page 30 and again on page 133).
On page 27 the authors write, “Yet many other cryptocurrency believers, including a cross section of techies and businessmen who see a chance to disrupt the bank centric payments system are de facto charatalists. They describe bitcoin not as a currency but as a payments protocol.”
Perhaps this is true. Yet from the original Nakamoto whitepaper, perhaps he too was a chartalist? Stating in section 1:
Commerce on the Internet has come to rely almost exclusively on financial institutions serving as trusted third parties to process electronic payments. While the system works well enough for most transactions, it still suffers from the inherent weaknesses of the trust based model. Completely non-reversible transactions are not really possible, since financial institutions cannot avoid mediating disputes. The cost of mediation increases transaction costs, limiting the minimum practical transaction size and cutting off the possibility for small casual transactions, and there is a broader cost in the loss of ability to make non-reversible payments for non-reversible services. With the possibility of reversal, the need for trust spreads. Merchants must be wary of their customers, hassling them for more information than they would otherwise need. A certain percentage of fraud is accepted as unavoidable. These costs and payment uncertainties can be avoided in person by using physical currency, but no mechanism exists to make payments over a communications channel without a trusted party.
A payments rail, a currency, perhaps both?
Fun fact: the word “payment” appears 12 times in the whole white paper, just one time less than the word “trust” appears.
On page 29 they cite the Code of Hammurabi. I too think this is a good reference, having made a similar reference to the Code in Chapter 2 of my book last year.
On page 31 they write, “Today, China grapples with competition to its sovereign currency, the yuan, due both to its citizens’ demand for foreign national currencies such as the dollar and to a fledgling but potentially important threat from private, digital currencies such as bitcoin.”
That is a bit of a stretch. While Chinese policy makers do likely sweat over the creative ways residents breach and maneuver around capital controls, it is highly unlikely that bitcoin is even on the radar as a high level “threat.” There is no bitcoin merchant economy in China. The vast majority of activity continues to be related to mining and trading on exchanges, most of which is inflated by internal market making bots (e.g., the top three exchanges each run bots that dramatically inflate the volume via tape painting). And due to how WeChat and other social media apps in China frictionlessly connect residents with their mainland bank accounts, it is unlikely that bitcoin will make inroads in the near future.
On page 36 they write, “By 1973, once every country had taken its currency off the dollar peg, the pact was dead, a radical change.”
In point of fact, there are 23 countries that still peg their currency to the US dollar. Post-1973 saw a number of flexible and managed exchange rate regimes as well as notable events such as the Plaza Accord and Asian Financial Crisis (that impacted the local pegs).
On page 39 they write, “By that score, bitcoin has something to offer: a remarkable capacity to facilitate low-cost, near-instant transfer of value anywhere in the world.”
The point of contention here is the “low-cost” — something that the authors never really discuss the logistics of. They are aware of “seigniorage” and inflationary “block rewards” yet they do not describe the actual costs of maintaining the network which in the long run, the marginal costs equal the marginal value (MC=MV).
This is an issue that I tried to bring up with them at the Google Author Talk last month (I asked them both questions during the Q&A):
The problem for Vigna’s view, (starting around 59m) is that if the value of a bitcoin fell to $30, not only would the network collectively “be cheaper” to maintain, but also to attack.
On paper, the cost to successfully attack the network today by obtaining more than 50% of the hashrate at this $30 price point would be $2,250 per hour (roughly 0.5 x MC) or roughly an order of magnitude less than it does at today’s market price (although in practice it is a lot less due to centralization). Recall that the security of bitcoin was purposefully designed around proportionalism, that in the long run it costs a bitcoin to secure a bitcoin. We will talk about fees later at the end of next chapter.
On page 43, in the note at the bottom related to Ray Dillinger’s characterization that bitcoin is “highly inflationary” — Dillinger is correct in the short run. The money supply will increase by 11% alone this year. And while in the long run the network is deflationary (via block reward halving), the fact that the credentials to the bearer assets (bitcoins) are lost and destroyed each year results in a non-negligible amount of deflation.
For instance, in chapter 12 I noted some research: in terms of losing bitcoins, the chart below illustrates what the money supply looks like with an annual loss of 5% (blue), 1% (red) and 0.1% (green) of all mined bitcoins.
Source: Kay Hamacher and Stefan Katzenbeisser
In December 2011, German researchers Kay Hamacher and Stefan Katzenbeisser presented research about the impact of losing the private key to a bitcoin. The chart above shows the asymptote of the money supply (Y-axis) over time (X-axis).
According to Hamacher:
So to get rid of inflation, they designed the protocol that over time, there is this creation of new bitcoins – that this goes up and saturates at some level which is 21 million bitcoins in the end.
But that is rather a naïve picture. Probably you have as bad luck I have, I have had several hard drive crashes in my lifetime, and what happens when your wallet where your bitcoins are stored and your private key vanish? Then your bitcoins are probably still in the system so to speak, so they are somewhat identifiable in all the transactions but they are not accessible so they are of no economic value anymore. You cannot exchange them because you cannot access them. Or think more in the future, someone dies but his family doesn’t know the password – no economic value in those bitcoins anymore. They cannot be used for any exchange anymore. And that is the amount of bitcoins when just a fraction per year vanish for different fractions. So the blue curve is 5% of all the bitcoins per year vanish by whatever means there could be other mechanisms.
It is unclear exactly how many bitcoins can be categorized in such a manner today or what the decay rate is.
On page 45 the authors write, “Some immediately homed in on a criticism of bitcoin that would become common: the energy it would take to harvest “bitbux” would cost more than they were worth, not to mention be environmentally disastrous.”
While I am unaware of anyone who states that it would cost more than what they’re worth, as stated in Appendix B and in Chapter 3 (among many other places), the network was intentionally designed to be expensive, otherwise it would be “cheap to attack.” And those costs scale in proportion to the token value.
As noted a few weeks ago:
For instance, last year O’Dwyer and Malone found that Bitcoin mining consumes roughly the same amount of energy as Ireland does annually. It is likely that their estimate was too high and based on Dave Hudson’s calculations closer to 10% of Ireland’s energy consumption.23 Furthermore, it has likely declined since their study because, as previously explored in Appendix B, this scales in proportion with the value of the token which has declined over the past year.
The previous post looked at bitcoin payments processed by BitPay and found that as an aggregate the above-board activity on the Bitcoin network was likely around $350 million a year. Ireland’s nominal GDP is expected to reach around $252 billion this year. Thus, once Hudson’s estimates are integrated into it, above-board commercial bitcoin activity appears to be about two orders of magnitude less than what Ireland produces for the same amount of energy.
Or in other words, the original responses to Nakamoto six and a half years ago empirically was correct. It is expensive and resource intensive to maintain and it was designed to be so, otherwise it would be easy to attack, censor and modify the history of votes.
Starting on page 56 they describe Mondex, Secure Electronic Transaction (SET), Electronic Monetary System, Citi’s e-cash model and a variety of other digital dollar systems that were developed during the 1990s. Very interesting from a historical perspective and it would be curious to know what more of these developers now think of cryptocurrency systems. My own view, is that the middle half of Chapter 2 is the best part of the book: very well researched and well distilled.
On page 64 they write:
[T]hat Nakamoto launched his project with a reminder that his new currency would require no government, no banks and no financial intermediaries, “no trusted third party.”
In theory this may be true, but in practice, the Bitcoin network does not natively provide any of the services banks do beyond a lock box. There is a difference between money and the cornucopia of financial instruments that now exist and are natively unavailable to Bitcoin users without the use of intermediaries (such as lending).
On page 66 they write, “He knew that the ever-thinning supply of bitcoins would eventually require an alternative carrot to keep miners engaged, so he incorporated a system of modest transaction fees to compensate them for the resources they contributed. These fees would kick in as time went on and as the payoff for miners decreased.”
That’s the theory and the popular narrative.
However, what does it look like in practice?
Above is a chart visualizing fees to miners denominated in USD from January 2009 to May 17, 2015. Perhaps the fees will indeed increase to replace block rewards, or conversely, maybe as VC funding declines in the coming years, the companies that are willing and able to pay fees for each transaction declines.
On page 67, the authors introduce us to Laszlo Hanyecz, a computer programmer in Florida who according to the brief history of Bitcoin lore, purchased two Papa John’s pizzas for 10,000 bitcoins on May 22, 2010 (almost five years ago to the day). He is said to have sold 40,000 bitcoins in this manner and generated all of the bitcoins through mining. He claims to be the first person to do GPU mining, ramping up to “over 800 times” of a CPU; and during this time “he was getting about half of all the bitcoins mined.” According to him, he originally used a Nvidia 9800 GTX+ and later switched to 2 AMD Radeon 5970s. It is unclear how long he mined or when he stopped.
In looking at the index of his server, there are indeed relevant OpenCL software files. If this is true, then he beat ArtForz to GPU mining by at least two months.
Source: Laszlo Hanyecz personal server
On page 77 they write, “Anybody can go on the Web, download the code for no cost, and start running it as a miner.”
While technically this is true, that you can indeed download the Satoshi Bitcoin core client for free, restated in 2015 it is not viable for hoi polloi. In practice you will not generate any bitcoins solo-mining on a desktop machine unless you do pooled mining circa 2011. Today, even pooled mining with the best Xeon processors will be unprofitable. Instead, the only way to generate enough funds to cover both the capital expenditures and operating expenditures is through the purchase of single-use hardware known as an ASIC miner, which is a depreciating capital good. Mining has been beyond the breakeven reach of most non-savvy home users for two years now, not to mention those who live in developing countries with poor electrical infrastructure or uncompetitive energy rates. It is unlikely that embedded mining devices will change that equation due to the fact that every additional device increases the difficultly level whilst the device hashrate remains static.
This ties in with what the authors also wrote on page 77, “You don’t buy bitcoin’s software as you would other products, which means you’re not just a customer. What’s more, there’s no owner of the software — unlike, say, PayPal, which is part of eBay.”
This is a bit misleading. In order to use the Bitcoin network, users must obtain bitcoins somehow. And in practice that usually occurs through trusted third parties such as Coinbase or Xapo which need to identify you via KYC/AML processes. So while in 2009 their quote could have been true, in practice today that is largely untrue for most new participants — someone probably owns the software and your personal data. In fact, a germane quote on reddit last week stated, “Why don’t you try using Bitcoin instead of Coinbase.”
Furthermore, the lack of “ownership” of Bitcoin is dual-edged as there are a number of public goods problems with maintaining development that will be discussed later.
On page 87 they describe Blockchain.info as a “high-profile wallet and analytics firm.” I will come back to “wallets” later. Note: most of these “wallets” are likely throwaway, temp wallets used to move funds to obfuscate provenance through the use of Shared Coin (one of the ways Blockchain.info generates revenue is by operating a mixer).
Overall Chapter 3 was also fairly informative. The one additional quibble I have is that Austin and Beccy Craig (the story at the end) were really only able to travel the globe and live off bitcoins for 101 days because they had a big cushion: they had held a fundraiser that raised $72,995 of additional capital. That is enough money to feed and house a family in a big city for a whole year, let alone go globe trotting for a few months.
On page 99 they describe seven different entities that have access to credit card information when you pay for a coffee at Starbucks manually. Yet they do not describe the various entities that end up with the personal information when signing up for services such as Coinbase, ChangeTip, Circle and Xapo or what these depository institutions ultimately do with the data (see also Richard Brown’s description of the payment card system).
When describing cash back rewards that card issuers provide to customers, on page 100 they write, “Still it’s an illusion to think you are not paying for any of this. The costs are folded into various bank charges: card issuance fees, ATM fees, checking fees, and, of course, the interest charged on the millions of customers who don’t pay their balances in full each month.”
Again, to be even handed they should also point out all the fees that Coinbase charges, Bitcoin ATMs charge and so forth. Do any of these companies provide interest-bearing accounts or cash-back rewards?
On page 100 they also stated that, “Add in the cost of fraud, and you can see how this “sand in the cogs” of the global payment system represents a hindrance to growth, efficiency, and progress.”
That seems a bit biased here. And my statement is not defending incumbents: global payment systems are decentralized yet many provide fraud protection and insurance — the very same services that Bitcoin companies are now trying to provide (such as FDIC insurance on fiat deposits) which are also not free.
On page 100 they also write, “We need these middlemen because the world economy still depends on a system in which it is impossible to digitally send money from one person to another without turning to an independent third party to verify the identity of the customer and confirm his or her right to call on the funds in the account.”
Again, in practice, this is now true for Bitcoin too because of how most adoption continues to take place on the edges in trusted third parties such as Coinbase and Circle.
On page 101 they write:
In letting the existing system develop, we’ve allowed Visa and MasterCard to form a de facto duopoly, which gives them and their banking partners power to manipulate the market, says Gil Luria, an analyst covering payment systems at Wedbush Securities. Those card-network firms “not only get to extract very significant fees for themselves but have also created a marketplace in which banks can charge their own excessive fees,” he says.
Why is it wrong to charge fees for a service? What is excessive? I am certainly not defending incumbents or regulatory favoritism but it is unclear how Bitcoin institutions in practice — not theory — actually are any different.
And, the cost per transaction for Bitcoin is actually quite high (see chart below) relative to these other systems due to the fact that Bitcoin also tries to be a seigniorage system, something that neither Visa or MasterCard do.
On page 102 when talking about MasterCard they state, “But as we’ve seen, that cumbersome system, as it is currently designed, is tightly interwoven into the traditional banking system, which always demands a cut.”
The whole page actually is a series of apples-and-oranges comparisons. Aside from settlement, the Bitcoin network does not provide any of the services that they are comparing it to. There is nothing in the current network that provides credit/lending services whereas the existing “cumbersome” system was not intentionally designed to be cumbersome, but rather is intertwined and evolved over decades so that customers can have access to a variety of otherwise siloed services. Again, this is not to say the situation cannot be improved but as it currently exists, Bitcoin does not provide a solution to this “cumbersome” system because it doesn’t provide similar services.
On page 102 and 103 they write about payment processors such as BitPay and Coinbase, “These firms touted a new model to break the paradigm of merchants’ dependence on the bank-centric payment system described above. These services charged monthly fees that amounted to significantly lower transaction costs for merchants than those charged in credit-card transactions and delivered swift, efficient payments online or on-site.”
Except this is not really true. The only reason that both BitPay and Coinbase are charging less than other payment processors is that VC funding is subsidizing it. These companies still have to pay for customer service support and fraud protection because customer behavior in aggregate is the same. And as we have seen with BitPay numbers, it is likely that BitPay’s business model is a losing proposition and unsustainable.
On page 103 they mention some adoption metrics, “The good news is found in the steady expansion in the adoption of digital wallets, the software needed to send and receive bitcoins, with Blockchain and Coinbase, the two biggest providers of those, on track to top 2 million unique users each at the time of the writing.”
This is at least the third time they talk about wallets this way and is important because it is misleading, I will discuss in-depth later.
Continuing they write that:
Blockchain cofounder Peter Smith says that a surprisingly large majority of its accounts — “many more than you would think,” he says cryptically — are characterized as “active.”
This is just untrue and should have been pressed by the authors. Spokesman from Blockchain.info continue to publish highly inflated numbers. For instance in late February 2015, Blockchain.info claimed that “over $270 million in bitcoin transactions occurred via its wallets over the past seven days.”
This is factually untrue. As I mentioned three months ago:
Organ of Corti pointed out that the 7 day average was indeed ~720,000 bitcoins in total output volume (thus making) the weekly volume would be about “5e06 btc for the network.”
Is it valid to multiply the total output volume by USD (or euros or yen)? No.
Why not? Because most of this activity is probably a combination of wallet shuffling, laundering and mixing of coins (e.g., use of SharedSend and burner wallets) or any number of superfluous activity. It was not $270 million of economic trade.
Blockchain.info’s press release seems to be implying that economic trade is taking place, in which all transactions are (probably) transactions to new individuals when in reality it could simply be a lot of “change” address movement. And more to the point, the actual internal volume looks roughly the same as has been the past few months (why issue a press release now?).
Continuing on page 103 they write, “For the first eight months months of 2014, around $50 million per day was passing thought the bitcoin network (some of which was just “change” that bitcoin transactions create as an accounting measure)…”
There is a small typo above (in bold) but the important part is the estimate of volume. There is no public research showing a detailed break down of average volume of economic activity. Based on a working paper I published four months ago, it is fairly clear that this figure is probably in the low millions USD at most. Perhaps this will change in the future.
On page 106 they write about Circle and Xapo:
For now, these firms make no charge to cover costs of insurance and security, betting that enough customers will be drawn to them and pay fees elsewhere — for buying and selling bitcoins, for example — or that their growing popularity will allow them to develop profitable merchant-payment services as well. But over all, these undertaking must add costs back into the bitcoin economy, not to mention a certain dependence on “trusted third parties.” It’s one of many areas of bitcoin development — another is regulation — where some businessmen are advocating a pragmatic approach to bolstering public confidence, one that would necessitate compromises on some of the philosophical principles behind a model of decentralization. Naturally, this doesn’t sit well with bitcoin purists.
While Paul Vigna may not have written this, he did say something very similar at the Google Author Talk event (above in the video).
The problem with this view is that it is a red herring: this has nothing to do with purism or non-purism.
The problem is that Bitcoin’s designer attempted to create a ‘permissionless’ system to accommodate pseudonymous actors. The entire cost structure and threat model are tied to this. If actors are no longer pseudonymous, then there is no need to have this cost structure, or to use proof-of-work at all. In fact, I would argue that if KYC/KYM (Know Your Miner) are required then a user might just as well use a database or permissioned system. And that is okay, there are businesses that will be built around that.
This again has nothing to do with purism and everything to do with the costs of creating a reliable record of truth on a public network involving unknown, untrusted actors. If any of those variables changes — such as adding real-world identity, then from a cost perspective it makes little sense to continue using the modified network due to the intentionally expensive proof-of-work.
On page 107 they talk about bitcoin price volatility discussing the movements of gasoline. The problem with this analogy is that no one is trying to use gasoline as money. In practice consumers prefer purchasing power stability and there is no mechanism within the Bitcoin network that can provide this.
The three slides above are from a recent presentation from Robert Sams. Sams previously wrote a short paper on “Seigniorage Shares” — an endogenous way to rebase for purchasing power stability within a cryptocurrency.
Bitcoin’s money supply is perfectly inelastic therefore the only way to reflect changes in demand is through changes in price. And anytime there are future expectations of increased or decreased utility, this is reflected in prices via volatility.
Oddly however, on page 110, they write, “A case can be made that bitcoin’s volatility is unavoidable for the time being.”
Yet they do not provide any evidence — aside from feel good “Honey Badger” statements — for how bitcoin will somehow stabilize. This is something the journalists should have drilled down on, talking to commodity traders or some experts on fuel hedging strategies (which is something airline companies spend a great deal of time and resources with).
Instead they cite Bobby Lee, CEO of BTC China and Gil Luria once again. Lee states that “Once its prices has risen far enough and bitcoin has proven itself as a store of value, then people will start to use it as a currency.”
This is a collective action problem. Because all participants each have different time preferences and horizons — and are decentralized — this type of activity is actually impossible to coordinate, just ask Josh Garza and the $20 Paycoin floor. This also reminds me of one of my favorite comments on reddit: “Bitcoin will stabilize in price then go to the moon.”
The writers then note that, “Gil Luria, the Wedbush analyst, even argues that volatility is a good thing, on the grounds that it draws profit-seeking traders into the marketplace.”
But just because you have profit-seeking traders in the market place does not mean volatility disappears.
Credit: George Samman
For instance, in the chart above we can see how bitcoin trades relative to commodities over the past year:
Yellow is DBC
Red is OIL
Bars are DXY which is a dollar index
And candlesticks are BTCUSD
DBC is a commodities index and the top 10 Holdings (85.39% of Total Assets):
Brent Crude Futr May12 N/A 13.83
Gasoline Rbob Fut Dec12 N/A 13.71
Wti Crude Future Jul12 N/A 13.56
Heating Oil Futr Jun12 N/A 13.20
Gold 100 Oz Futr Dec 12 N/A 7.49
Sugar #11(World) Jul12 N/A 5.50
Corn Future Dec12 N/A 5.01
Lme Copper Future Mar13 N/A 4.55
Soybean Future Nov12 N/A 4.38
Lme Zinc Future Jul12
It bears mentioning that Ferdinando Ametrano has also described this issue in depth most recently in a presentation starting on slide 15.
Continuing on page 111, the writers note that:
Over time, the expansion of these desks, and the development of more and more sophisticated trading tools, delivered so much liquidity that exchange rates became relatively stable. Luria is imagining a similar trajectory for bitcoin. He says bitcoiners should be “embracing volatility,” since it will help “create the payment network infrastructure and monetary base” that bitcoin will need in the future.
There are two problems with Luria’s argument:
1) As noted above, this does not happen with any other commodity and historically nothing with a perfectly inelastic supply
2) Empirically, as described by Wences Casares above, nearly all the bitcoins held at Xapo (and likely other “hosted wallets”) are being held as investments. This reduces liquidity which translates into volatility due to once again the inability to slowly adjust the supply relative to the shifts in demand. This ties into a number of issues discussed in, What is the “real price” of bitcoin? that are worth revisiting.
Also on page 111, they write that “the exchange rate itself doesn’t matter.”
Actually it does. It directly impacts two things:
1) outside perception on the health of Bitcoin and therefore investor interest (just talk to Buttercoin);
2) on a ten-minute basis it impacts the bottom line of miners. If prices decline, so to is the incentive to generate proof-of-work. Bankruptcy, as CoinTerra faces, is a real phenomenon and if prices decline very quickly then the security of the network can also be reduced due to less proof-of-work being generated
Continuing on page 111, “It’s expected that the mirror version of this will in time be set up for consumers to convert their dollars into bitcoins, which will then immediately be sent to the merchant. Eventually, we could all be blind to these bitcoin conversions happening in the middle of all our transactions.”
It’s unfortunate that they do not explain how this will be done without a trusted third party, or why this process is needed. What is the advantage of going from USD-> paying a conversion fee -> BTC -> conversion fee -> back into USD? Why not just spend USD and cut out the Bitcoin middleman?
Lastly on page 111, “Still, someone will have to absorb the exchange-rate risk, if not the payment processors, then the investors with which they trade.”
The problem with this is that its generally not in the mandate or scope of most VC firms to purchase commodities or currencies directly. In fact, they may even need some kind of license to do so depending on the jurisdiction (because it is a foreign exchange play). Yet expecting the payment processors to shoulder the volatility is probably a losing proposition: in the event of a protracted bear market how many bitcoins at BitPay — underwater or not — will need to be liquidated to pay for operating costs?4
On page 112 they write, ‘Bitcoin has features from all of them, but none in entirety. So, while it might seem unsatisfying, our best answer to the question of whether cryptocurrency can challenge the Visa and MasterCard duopoly is, “maybe, maybe not.”
On the face of it, it is a safe answer. But upon deeper inspection we can probably say, maybe not. Why? Because for Bitcoin, once again, there is no native method for issuing credit (which is what Visa/MasterCard do with what are essentially micro-loans).
For example, in order to natively add some kind of lending facility within the Bitcoin network a new “identity” system would need to be built and integrated (to enable credit checks) — yet by including real-world “identity” it would remove the pseudonymity of Bitcoin while simultaneously maintaining the same costly proof-of-work Sybil protection. This is again, an unnecessary cost structure entirely and positions Bitcoin as a jack-of-all-trades-but-master-of-none. Why? Again recall that the cost structure is built around Dynamic Membership Multi-Party Signature (DMMS); if the signing validators are static and known you might as well use a database or permissioned ledgers.
Or as Robert Sams recently explained, if censorship resistance is co-opted then the reason for proof-of-work falls to the wayside:
Now, I am sure that the advocates of putting property titles on the bitcoin blockchain will object at this point. They will say that through meta protocols and multi-key signatures, third party authentication of transaction parties can be built-in, and we can create a registered asset system on top of bitcoin. This is true. But what’s the point of doing it that way? In one fell swoop a setup like that completely nullifies the censorship resistance offered by the bitcoin protocol, which is the whole raison d’etre of proof-of-work in the first place! These designs create a centralised transaction censoring system that imports the enormous costs of a decentralised one built for censorship-resistance, the worst of both worlds.
If you are prepared to use trusted third parties for authentication of the counterparts to a transaction, I can see no compelling reason for not also requiring identity authentication of the transaction validators as well. By doing that, you can ditch the gross inefficiencies of proof-of-work and use a consensus algorithm of the one-node-one-vote variety instead that is not only thousands of times more efficient, but also places a governance structure over the validators that is far more resistant to attackers than proof-of-work can ever be.
On page 113, they write, “the government might be able to take money out of your local bank account, but it couldn’t touch your bitcoin. The Cyprus crisis sparked a stampede of money into bitcoin, which was now seen as a safe haven from the generalized threat of government confiscation everywhere.”
In theory this may be true, but in practice, it is likely that a significant minority — if not majority — of bitcoins are now held in custody at depository institutions such as Xapo, Coinbase and Circle. And these are not off-limits to social engineering. For instance, last week an international joint-task force confiscated $80,000 in bitcoins from dark web operators. The largest known seizure in history were 144,000 bitcoins from Ross Ulbricht (Dread Pirate Roberts) laptop.
Similarly, while it probably is beyond the scope of their book, it would have been interesting to see a survey from Casey and Vigna covering the speculators during this early 2013 time frame. Were the majority of people buying bitcoins during the “Cyprus event” actually worried about confiscation or is this just something that is assumed? Fun fact: the largest transaction to BitPay of all time was on March 25, 2013 during the Cyprus event, amounting to 28,790 bitcoins.
On page 114, the writers for the first time (unless I missed it elsewhere), use the term “virtual currency.” Actually, they quote FinCEN director Jennifer Calvery who says that FincCEN, “recognizes the innovation virtual currencies provide , and the benefits they might offer society.”
Again recall that most fiat currencies today are already digitized in some format — and they are legal tender. In contrast, cryptocurrencies such as bitcoin are not legal tender and are thus more accurately classified as virtual currencies. Perhaps that will change in the future.
On page 118 they note that, “More and more people opened wallets (more than 5 million as of this writing).”
I will get to this later. Note that on p. 123 they say Coupa Cafe has a “digital wallet” a term used throughout the entire book.
On page 124, “Bitcoins exist only insofar as they assign value to a bitcoin address, a mini, one-off account with which people and firms send and receive the currency to and from other people’s firms’ addresses.”
This is actually a pretty concise description of best-practices. In reality however, many individuals and organizations (such as exchanges and payment processors) reuse addresses.
Continuing on page 124, “This is an important distinction because it means there’s no actual currency file or document that can be copied or lost.”
This is untrue. In terms of security, the hardest and most expensive part in practice is securing the credentials — the private key that controls the UTXOs. As Stefan Thomas, Jason Whelan (p. 139) and countless other people on /r/sorryforyourloss have discovered, this can be permanently lost. Bearer assets are a pain to secure, hence the re-sprouting of trusted third parties in Bitcoinland.
One small nitpick in the note at the bottom of page 125, “Sometimes the structure of the bitcoin address network is such that the wallet often can’t send the right amount in one go…” — note that this ‘change‘ is intentional (and very inconvenient to the average user).
Another nitpick on page 128, “Each mining node or computer gathers this information and reduces it into an encrypted alphanumeric string of characters known as a hash.”
There is actually no encryption used in Bitcoin, rather there are some cryptographic primitives that are used such as key signing but this is not technically called encryption (the two are different).
On page 130, I thought it was good that they explained where the term nonce was first used — from Lewis Carroll who created the word “frabjous” and described it as a nonce word.
On page 132, in describing proof-of-work, “While that seems like a mammoth task, these are high-powered computers; it’s not nearly as taxing as the nonce-creating game and can be done relatively quickly and easily.”
They are correct in that something as simple as a Pi computer can and is used as the actual transaction validating machine. Yet, at one point in 2009, this bifurcation did not exist: a full-node was both a miner and a hasher. Today that is not the case and we technically have about a dozen or so actual miners on the network, the rest of the machines in “farms” just hash midstates.
On page 132, regarding payment processors accepting zero-confirmation transactions, “They do this because non-confirmations — or the double-spending actions that lead to them — are very rare.”
True they are very rare today in part because there are very few incentives to actually try and double-spend. Perhaps that will change in the future with new incentives to say, double-spend watermarked coins from NASDAQ.
And if payment processors are accepting zero confirmations, why bother using proof-of-work and confirmations at all? Just because a UTXO is broadcast does not mean it will not be double-spent let alone confirmed and packaged into a block. See also replace-by-fee proposal.
Small note on page 132, “the bitcoin protocol won’t let it use those bitcoins in a payment until a total of ninety-nine additional blocks have been built on top its block.”
Sometimes it depends on the client and may be up to 120 blocks altogether, not just 100.
On page 133 they write, “Anyone can become a miner and is free to use whatever computing equipment he or she can come up with to participate.”
This may have been the case in 2009 but not true today. In order to reduce payout variance, the means of production as it were, have gravitated towards large pools of capital in the form of hashing farms. See also: The Gambler’s Guide to Bitcoin