MD: Reply to Hadrien Croubois article “About Trust and Agents Incentives”
HC: Hadrien Croubois
Oct 11, 2017 PoCo Series #1 — About Trust and Agents Incentives
Who am I?
My name is Hadrien Croubois and I am a Ph.D. student at ENS de Lyon. My research as a Ph.D. student focuses on middleware design for the management of shared Cloud-based scientific-computing platforms; and more particularly how to optimise them for workflow execution.
MD: Why in the world should “cloud-based” systems even exist?
HC: However, my interests are much broader and include HPC, physics, and biology large-scale simulations, image rendering, machine learning and of course cryptography and blockchain technologies.
Since September 2017 I am also a scientific consultant for iExec. I met Gilles at ENS de Lyon and it was the perfect opportunity for me to experience working in a team designing innovative solutions.
My role as a member of this team is to study existing work from the research community and provide insight into the design of a proof-of-contribution protocol for iExec. This article is by no means a solution to this complex issue. It is rather an overview of our understanding and ideas regarding this issue.
Why iExec needs Proof-of-Contribution?
The iExec platform provides a network where application provider, workers, and users can gather and work together. Trust between these agents is to be achieved through the use of blockchain technology (Nakamoto consensus) and cryptography.
MD: COIK (Clear Only If Known). The key here is how Nakamoto establishes consensus. You really can’t know from reading the white paper that got all this started. In short, it comes down to “democracy” … i.e majority rules. In this case, over 1/2 the population. Anyone who has looked into democracy knows it cannot work with more than 50 parties involved.
HC: Our infrastructure is divided into 3 agents:
Application providers: They provide applications, which are seen as services.
MD: How do “application providers” originate?
HC: These applications can be called by the users with specific parameters. Application providers are paid for each execution of their application.
MD: Who pays the application providers. Almost the entire Android community of applications are provided at no cost whatever.
HC: The applications rely on the iExec smart contract to manage communications between the ethereum blockchain and the off-chain computing platform.
MD: COIK … what is a “smart” contract? Is it transparent? Who can see it? Who cannot?
HC: Users: They are the clients of the infrastructure. They pay to obtains results computed by the application.
MD: Seems like a non-competitive model. Take the internet itself. It is an infrastructure with no clients and no providers … or better yet, where everyone is both a client and provider. What problem is being solved here?
HC: Workers: They are computing entities that provide computing resources. These resources are used for the off-chain execution of the applications. Workers are paid based on their contribution to the computation of the applications.
MD: Again COIK. Why would workers be just “computing resources?” Seems like (reading way between the lines here) anyone being a source, or an opposition to a source, of information is a worker.
HC: The goal of the Proof-of-Contribution protocol is to achieve trust between the different agents, and more particularly between users and workers, in order for the users to be able to rely on the results computed by an external actor whose incentive is, at best, based on income.
MD: I once sat in a meeting where they made the rule that you had to say 5 nice things before you could say 1 thing critical. Want to guess how that meeting went?
HC: In particular, we want to achieve protection against Byzantine workers (who could provide bad results to penalize users) and users (who could argue against legitimate work performed by legitimate workers).
MD: Right. In sports we call those referees. But in real sports, the contestants referee themselves. We lose it when we establish rules and laws. What we really have is principles … and very few of them, the “golden principle” being paramount. Rules and laws just dilute principles. They essentially say, by defining this particular instance of the application of the principle, we declare all other applications unlawful … and thus have to define all particular instances in law after that … and thus totally lose sight of the principle. It’s called “gaming the system”.
HC: First approach: the result contribution validation scheme
Validation of the work performed by the worker can be achieved in two different ways:
Majority voting on the (hash of the) result.
MD: Like the long list of scientists who “vote” that global warming is real … when almost none of them are meteorologists or have the slightest clue of things physical?
HC: This helps mitigate against Byzantine workers but at the price of computing power overhead. Validating the result for a specific execution requires multiple workers to compute it, thus multiplying the execution cost by a factor m. In desktop grid or volunteer computing platforms (BOINC), this factor m can range from 3 all the way to 20~50. With more replication come more confidence in the result, but that also means that the reward is shared among more worker, reducing the incentive to the workers to contribute.
MD: Have you thought of a hierarchical structure to get around the fact that democracy doesn’t work with more than 50 people involved? The solution is to have each group of 50 solving the problems they can solve. They select a representative for the next lower group of 50 … and so on until you get to the final group of 50. Nothing should make it down to the bottom group of 50 and if it does, that group should come to a unanimous conclusion (establishing the principle) … not a majority conclusion. With this structure you can “democratically” represent the entire population on earth in just 6 layers of 50 person groups.
HC: Relying on a court system to solve conflicts between users and workers (TrueBit). This solution is however complicated both in terms of efforts from the users, who have to check every single result and from the platform which has to implement complex arbitration mechanisms. While this method does not require the work to be executed many times, the arbitration mechanism might call for heavy instrumentation of the execution in order for the worker to provide elements of proof if their execution is challenged.
MD: Better to make users and workers show where what they are doing “is” principled when challenged. Then let a small democratic group judge their “principled” defense … i.e. would they really want to be treated the way they are treating?
HC: A significant contribution was published by Luis Sarmenta (2002. Sabotage-tolerance mechanisms for volunteer computing systems. Future Generation Computer Systems, 18(4), 561–572). The proposed approach is based on majority voting but rather than relying on a fixed m factor, it dynamically “decides” how many contributions are necessary to achieve consensus (within a specific confidence level). The replication level is therefore dynamic and automatically adapted, during execution, by the scheduler. This helps to achieve fast consensus when possible and to solve any conflicts.
MD: Did it ever occur to you that if we had computers before we had internal combustion engines and the subsequent invention of governors that we couldn’t even mow our lawns today? The mower would become too complicated to use … and enormously unreliable … in spite of the enormous computing power that is thrown at the problem.
HC: Fig 3 from Sarmenta’s paper, describing how workers contribute to different jobs by voting on the result.
This approach relies on worker reputation to limit the potential impact of Byzantine agents and to achieve consensus.
MD: Did you read the global warming emails. You see how workers reputations are easily co-opted … how the best of systems are easily gamed by gangsters.
HC: Yet this approach is designed for desktop grid infrastructures, where money is out of the equation. Using the financial incentive of the different actors, we can modify and improve their approach to better fit our context:
Each worker retribution for computing a task can be indexed on their impact on the consensus for this task. In addition, having a good reputation helps to achieve fast consensus with fewer agents (meaning a bigger share for each agent). This gives the workers a financial incentive to act well and have their reputation go up.
MD: Do you think Digital Research would have won out over the deficient Microsoft if your rules were in place? Do you think Borland would still exist?
HC: Workers are required to commit a security deposit (stake) which is seized in case of bad behavior. This gives the worker an additional financial incentive to behave correctly.
MD: And the process for “seizure” is???
HC: The main drawback of Sarmenta’s article is the assumption that Byzantine workers are not working together and do not coordinate their attacks. While this assumption does not hold in our context, we believe we can still achieve it by selecting workers randomly among the worker pool. Therefore Byzantine workers controlled by a single entity should statistically be dispatched on many different tasks and should therefore not be able to overtake the vote for a specific task.
HC: Adapting Sarmenta’s result certification mechanism to off-chain execution
While Sarmenta’s work is interesting, a few modifications are required to work in our context. In this section, we discuss preliminary ideas on how we believe this work could be adapted to iExec needs. Our idea is to orchestrate the exchanges between the users and the workers as described below.
MD: You better find a different word than “orchestrate” if you want to establish trust. Global warming is a perfect example of “orchestration”. Climate change is a perfect example of “orchestration soiling its own nest and having to change its feathers”.
HC: In addition to the users and workers, we have an additional component: the scheduler. Schedulers manage pools of worker and act as middlemen between the blockchain (listening to the iExec smart-contract) and the workers. A scheduler can, in fact, be composed of multiple programs which complementary features but we will here consider it as a single “virtual” entity.
MD: Right. Always leave openings for large numbers of regulators and bureaucrats. Did it ever occur to you that a full 3/4ths of the fruits of your labor go to government? Really bright people, when given the task of maintaining a broom in upright position, would create an enormously complicated platform using all kinds of sensors and PID controllers. Any maid would just suspend it from the top and rely on it’s naturally stable tendencies.
HC: One should notice that our discussion here does not deal with the scheduling algorithm itself. In a scheduler, the scheduling algorithm handles the logic responsible for the placement of jobs and handles execution errors. The scheduler is free to use any scheduling algorithm it desires as long as it can deal with step 3 and 5 of the following protocol.
MD: Ah yes … and to change it dynamically and often to suit conflicting whims. Ask Facebook how that’s working as they bend to demands to filter out fake news … when all they really are is a medium of communication and the content should be none of their business or responsibility. The gangsters are trying to do the same thing to the internet. Their ox is being gored badly … and what could be better than to gore their ox out of existence?
HC: Workers register themselves to a scheduler.
MD: I’m not going to comment further. This is a perfect example of the condition: “losing sight of our objective we redouble our efforts”. It’s also an example of “if I am a hammer, everything looks like a nail”. It’s also an example of “the first and best solution to every issue is government and regulation”.
Read on at your own risk!
HC: Users submit tasks to scheduler managing the work pool they chose.
Workers ask the scheduler for work to execute. The scheduler gives them tasks to be executed. Note: If we are coming from step 5 we should not ask a worker to compute a task it has already contributed to.
The worker computes the result (A) of the task. In order for this result to be validated, the platform has to achieve a consensus on this result. This is achieved through Sarmenta’s voting. In order to contribute to this consensus, the worker commits the result to the scheduler:
a. Generate and memorize (but not publish) a random value r (private disposable personal identifier).
b. Submit a transaction (contribution) with :
i. hash(A) → used to vote on an answer;
ii. hash(r) → used as a public disposable personal identifier;
iii. hash(A+r) → used as proof of knowledge of A;
iv. commitment fund (with a minimum value) → incentive to only commit good results (see later). A higher commitment fund increases the Cr (cf Sarmenta, L.F.) and thus increases the potential returns (see later);
v. A tamper-proof timestamp → Used by the worker to prove its contribution and claim its reward.
With each new vote (contribution) by the workers, the scheduler checks if an answer (hash(A)) achieves the expected likelihood threshold using Sarmenta’s voting.
a. If we do not have a consensus, the scheduler will ask more nodes to compute the same task (dynamic replication) and contribute to the consensus → go back to 3;
b. If we have a consensus continue to 6.
An answer has been selected. The scheduler can now:
a. Publish the elected hash(A). At this point no new contribution is possible.
b. Ask the winning workers for A and r. Having a value of r which matched a correct transaction dating from before the election result is a proof of contribution. At this point A can be published by any worker. The value for r shows that a worker knew the answer they voted for before the results of the election. That way they cannot claim a contribution by just submitting a transaction with the hash(A) published by other voters.
c. Check the correctness of each worker contribution.
d. Put the deposit fund (stake) of all workers who voted for another answer in the reward kitty.
e. Distribute the reward kitty (users payment + deposit fund from wrong workers) among the winning workers proportionally to their contribution (Cr value computed from the reputation and the funds committed to the vote). The scheduler may take a commission for its work.
f. Increase the reputation of winners, decrease (reset) the reputation of losers.
g. Send the, now validated, answer to the user.
Equations used by Sarmenta to compute the credibility of a result from the credibility of the voters.
Trust level, worker pools, and billing policy
Sarmenta’s voting helps to achieve the given level of confidence using worker reputation and dynamic replication. This confidence level is defined by a value ε which describes the acceptable error margin. Results should only be returned if a confidence level higher than 1-ε is achieved. This value is a balance between cost and trust. A lower ε means more confidence in the result, but also requires more reputation/contributions to achieve consensus, and therefore more work to be performed. While this value could be defined by the user for each task, they might not know how to set it and it might cause billing issues.
We believe this value should be fixed for a worker pool. Therefore the billing policy could be defined for a worker pool depending on the performance of the workers (speed) and the ε value used by this worker pool scheduler (level of confidence). The user would then be free to choose between worker pools. Some worker pools might only contain large nodes running technology like Intel SGX to achieve fast result with low replication. Other worker pools could contain (slower) desktop computers and have their consensus settings adapted to this context.
With consensus managed by the scheduler and financial opportunities for late voters provided by the security deposit of opposing voters, the users should not worry about anything. Users pay for a task to be executed on a pool of worker, regardless of the number of workers that end up involved in the consensus. If consensus is fast and easy the payment of the user is enough to retribute the few workers who took part in the vote. If the consensus is hard and requires a lot of contributions, the workers are retributed using the security deposit of losing voters. This gives the workers a financial incentive to contribute to a consensus with many voters without requiring the user to pay more.
In the current version of this work, the protocol is such as the user has no part in the consensus. Payments are done when submitting the task and no stake is required. Results are public and guaranteed by the consensus. Users can therefore not discuss a result.
Assumptions and agents incentives
We believe the protocol described previously to be secure providing a few assumptions are met :
The first strong assumption is the ability of workers to publish their transaction (contribution) in a public manner. The medium used to publish those contributions has to provide a secure way for anyone to verify that contribution have been done prior to the election results. This can simply be achieved using current blockchain technology such as ethereum smart contracts. Still, that should not prevent us from considering other approaches like DHT (distributed hash tables).
The second assumption is that the voting algorithm will, in fact, give good results. This assumption is equivalent to saying that 51% of the reputation (of a worker pool) is not controlled by a single malicious user. We believe this is not a flaw of the protocol for two reasons:
a. All voting based systems, including the Nakamoto protocol, are subject to such attacks. This flaw is not in the design of the protocol.
b. There are strong (financial) penalties for bad actions on the platform and spot checking can be enforced to give more power to the scheduler and help them deal with bad actors. It is a matter of balance between the scheduler and the workers to enable spot-checking or not. We can imagine multiple worker pools, run by different independent schedulers which specific policy. Ultimately those pools could compete to attract the users (with elements such as the achieved quality of results and pricing).
Finally, we believe that both scheduler and workers will be inclined to work correctly in order to provide a good service to the users and benefit from the iExec ecosystem. Having 51% of the reputation controlled by actors wanting to do things right and benefit from it should not be an issue.
Incentives for the different agents are as follows
Users: They are requesting work to be done, and money in a healthy system would only come from them. User incentive to use the platform is to obtain good results for a low price. This will lead them to create a competition between worker pools. Their ability to chose or boycott worker pools create an incentive for workers and schedulers to work together in order to achieve the best service possible and attract users.
Workers: Their incentive is to gain as much money as possible for their work. To maximize their gain, they should maximize their contribution. Contribution can be obtained by having a good history (reputation) and/or by committing more funds when submitting a contribution. Giving bad results would make them lose both funds and reputation, which they should avoid at all cost.
a. New actors, with no history, start with a low reputation, meaning they will weigh less in the vote. Their chance to overtake a vote against trusted workers is small, and it would be a waste of fund from an attacker.
b. An old actor with a good history can win a lot by using their reputation to perform computations. As they are trusted, fewer contributions are needed to settle a vote and the reward kitty is therefore shared among fewer agents. On the other hand, by submitting bad results they risk losing all their reputation (and the money they committed with the contribution). Reputation does not guarantee them to win votes and spot-checking can help to detect bad contributors with high reputation.
Scheduler: Their incentive is to gain money by helping coordinate the platform. They make money through:
a. Commissions on all transactions;
b. Unclaimed rewards: if a worker doesn’t claim the reward after a contribution the corresponding fund would be kept by the scheduler.
In order to make money, the scheduler requires users to submit jobs and workers to register in its worker pool. This gives him the incentive to manage the worker pool correctly and grow strong.
Public schedulers for a fully decentralized platform
One of the key elements that could ultimately help a scheduler getting bigger and attracting more workers and users is to be open about its decisions. We believe that a scheduler could rely on a blockchain mechanism to orchestrate the protocol described above. In fact, this protocol is designed so that every message can, and should, be public. Security is achieved using cryptography. In particular, the use of a blockchain solves the issue of proving a contribution existence (presence on the blockchain) and validity (precedence to the vote results).
The main issue that still has to be solved is the worker designations. At step 3, the scheduler submits the task to specific workers. This is important for two reasons:
We don’t want workers to race. This would favor fast nodes and one could attack the voting system by coordinating many fast nodes to take over the vote before other nodes can contribute.
We don’t want malicious nodes to take over some votes. By randomly assigning workers to jobs we distribute malicious nodes amongst many votes where they would not be able to take over and where their best play is to provide good results and benefit from the platform working correctly.
Such a mechanism requires a source of randomness which any observers of the blockchain can agree on. This problem is beyond the scope of this post. Having such a source of entropy could help the scheduler designate workers using a random yet verifiable algorithm. The data required for verification would be public. The only change required to the protocol would be that a valid contribution from a worker would require a proof that the worker was designated by a scheduler.
To understand the difference between a blockchain and a traditional database, it is worth considering how each of these is designed and maintained.
Distributed nodes on a blockchain.
Traditional databases use client-server network architecture.
MD: There is no such thing as a traditional database. Databases existed way before there was a client-server orientation. But we’ll assume your client-server model for purposes of this critique.
HN: Here, a user (known as a client) can modify data, which is stored on a centralized server. Control of the database remains with a designated authority, which authenticates a client’s credentials before providing access to the database.
MD: Do you think the DNS (Domain Name Service) databases fit this model?
HN: Since this authority is responsible for administration of the database, if the security of the authority is compromised, the data can be altered, or even deleted.
MD: Can we replace “authority” with “protocol” or “process” and still assume we are talking about the same thing?
HN: Traditional Databases.
Blockchain databases consist of several decentralized nodes. Each node participates in administration: all nodes verify new additions to the blockchain, and are capable of entering new data into the database. For an addition to be made to the blockchain, the majority of nodes must reach consensus. This consensus mechanism guarantees the security of the network, making it difficult to tamper with.
MD: Don’t “shared” and “distributed” databases have this trait? If not, how can they possibly work? How about “journaled” databases?
HN: In Bitcoin, consensus is reached by mining (solving complex hashing puzzles), while Ethereum seeks to use proof of stake as its consensus mechanism. To learn more about the difference between these two consensus mechanisms, read my earlier post.
A key property of blockchain technology, which distinguishes it from traditional database technology, is public verifiability, which is enabled by integrity and transparency.
MD: Actually “public” is a relative term. Corporations have databases that do this without blockchain technology for their own “public” that can be very large and use very distributed database technologies. And airline reservations do this through federation with franchised travel agents … all without blockchain.
HN: Integrity: every user can be sure that the data they are retrieving is uncorrupted and unaltered since the moment it was recorded
MD: Only if they are believers. The only users with anything close to such an assurance are the “developers” who supposedly know “all” the complicated mechanism involved. A distributed public transparent data organization, where “anyone” can see everything gives better assurance. This is the mechanism favored by a “proper” MOE process.
HN: Transparency: every user can verify how the blockchain has been appended over time
MD: By using “trusted” API’s. There’s no way they can know the API’s they’re using should be trusted. They’re too complicated … and they’re not open.
HN: A map of Dashcoin masternodes distributed across the world.
CRUD vs Read & Write Operations
In a traditional database, a client can perform four functions on data: Create, Read, Update, and Delete (collectively known as the CRUD commands).
MD: And if the database is distributed and journaled they can do this without the “delete” and “update” … a necessary requirement for “true” transparency.
HN: The blockchain is designed to be an append only structure. A user can only add more data, in the form of additional blocks.
MD: And this causes unnecessary and undesirable latency (which is killing Bitcoin right now). Ideally, every transaction journaled into the database is “related” by hash to every other “related” transaction. What is needed is a hash linking the journal entries … and that is very easy to provide by including an input and output hash into the hashing process itself. Most transactions in a so-called blockchain block have no relevance to each other. It makes more sense to keep “related” transaction chains together rather than “all” transaction chains. This reduces latency and synchronization problems enormously.
HN: All previous data is permanently stored and cannot be altered. Therefore, the only operations associated with blockchains are:
Read Operations: these query and retrieve data from the blockchain
Write Operations: these add more data onto the blockchain
MD: Which I have described above is not “novel” at all. We have had it with journaled distributed databases for a very long time now. We have many of the mechanisms in the various forms of RAID (Random Array of Inexpensive Drives).
HN: Validating and Writing
The blockchain allows for two functions: validation of a transaction, and writing of a new transaction. A transaction is an operation that changes the state of data that lives on the blockchain. While past entries on the blockchain must always remain the same, a new entry can change the state of the data in the past entries.
MD: This is deceptive. The data in past entries never changes. The state of the current data changes by adding transactions to previous states. And you can mitigate corruption of this process with an input and output hash linking them and included in the hash of the new transactions. No block is required. Just a journal entry with two hashes … an input hash and an output hash which includes the input hash. The input hash can be verified back in time as far as the user chooses to do so … and all users my choose to do so any time they want to prove the process integrity.
HN: For example, if the blockchain has recorded that my Bitcoin wallet has 1 million BTC, that figure is permanently stored in the blockchain.
MD: A “real” money process has no such thing as a “bitcoin” wallet. It only has to prove that something claiming to be a bitcoin is not a counterfeit. A huge flaw in the bitcoin process is the fractioning of bitcoins. This is not different in end result than the fractioning of Indian (native American) lands … where they have been fractioned so many times the parcels are too small to be of use and they cannot be practically re-aggregated.
HN: When I spend 200,000 BTC, that transaction is recorded onto the blockchain, bringing my balance to 800,000 BTC.
MD: A “real” and “proper” process cares nothing about the money once it is created by traders. It only cares that it cannot be counterfeited and that the promise creating it is delivered as promised. No money is in circulation without a relation (albeit not direct) to a trader’s “in-process” promise. For any given creation, money does not exist before the promise, nor after the promise is fulfilled. In the mean time it is the most common object in every simple barter exchange … because it works. And it works because it never changes value over time an space. The “process” or “protocol” guarantees it and cannot be manipulated.
HN: However, since the blockchain can only be appended, my pre-transaction balance of 1 million BTC also remains on the blockchain permanently, for those who care to look. This is why the blockchain is often referred to as an immutable and distributed ledger.
MD: With a “real” process, the money “used” by traders is totally anonymous and unaudited. It is usually just a ledger entry in a “trusted” account … trusted by the traders using it. It may temporarily be in use as a coin or currency and returned to a ledger entry. The coin and currency are just uncounterfeitable tokens that when converted to a ledger entry are placed in storage and have no value at all. “Creation” and “destruction” and “default” and “interest” collection are a different matter (than “usage”) entirely. The traders are known and singular. They aren’t groups. They aren’t aliases. Their locations are known and they can be visited. That’s what keeps the process honest and leads other traders to “use” the money. As an example, we all “create” money when we buy a house on time. The documents recording our “promise” are recorded by the county clerk and available for all to see. We know how to do this. We also know how to streamline it (by using things like credit bureaus and title companies). As we pay back our “mortgage” we return money and it is destroyed. We don’t return the same money we created … that’s just not necessary nor can it work in practice.
HN: Centralized vs. peer to peer.
In short, the difference is Decentralized Control
Decentralized control eliminates the risks of centralized control. Anybody with sufficient access to a centralized database can destroy or corrupt the data within it. Users are therefore reliant on the security infrastructure of the database administrator.
MD: And as I have illustrated, that is not the difference, because a distributed journaled database of any kind “must” have decentralized control. What is central and known is the “process” or “protocol”.
HN: Blockchain technology uses decentralized data storage to sidestep this issue, thereby building security into its very structure.
MD: The blockchain has nothing to do with centralization or decentralization. It has everything to do with mitigating “forging” and “counterfeiting” and it does it unnecessarily inefficiently, expensively, slowly, and in an unnecessarily complicated fashion.
HN: Though blockchain technology is well-suited to record certain kinds of information, traditional databases are better suited for other kinds of information. It is crucial for every organization to understand what it wants from a database, and gauge this against the strengths and vulnerabilities of each kind of database, before selecting one.
MD: A journaled database can just manage documents or links … or links to links … or links to links to links. That is irrelevant. What is relevant is transparency of what it is managing and who is interacting with it. That’s what journaling does.
The proof of stake system is attracting a lot of attention these days, with Ethereum switching over to this system from the proof of work system.
The Bitcoin (i.e. blockchain) people claim it’s main asset is that there is no central authority. But there is certainly a central process or “switching over” wouldn’t be possible. The RFC process of the entire internet has shown us it is possible to have a universally accepted process … without cryptography and without block chains and without a central authority. The DNS (Domain Name System) is a distributed database protocol that has many attributes useful for a distributed database system with no central authority. And of course it has some serious issues.
HN: Proof of stake is an alternative process for transaction verification on a blockchain. It is increasing in popularity and being adopted by several cryptocurrencies. To understand proof of stake, it is important to have a basic idea of proof of work. As of this writing, the proof of work method is used by Bitcoin, Ethereum and most other major cryptocurrencies.
MD: At MD we know for “real” money you don’t need “proof” of anything. What you need is universal transparency to things. Those things are the “creation and delivery on time and space spanning promises made by traders.”
HN: Proof of work
Proof of work is a mining process in which a user installs a powerful computer or mining rig to solve complex mathematical puzzles (known as proof of work problems). Once several calculations are successfully performed for various transactions, the verified transactions are bundled together and stored on a new ‘block’ on a distributed ledger or public blockchain. Mining verifies the legitimacy of a transaction and creates new currency units
MD: Digging a hole and filling it right back in is work … totally useless work. A money system that relies on useless work is an open admission that the “money” itself has zero value. Rather it “represents” something of “perceived” value … and that perception must be universal. Thus, here we have open admission of a failure of the “proof of work” scheme.
HN: The work must be moderately difficult for the miner to perform, but easy for the network to check. Multiple miners on the network attempt to be the first to find a solution for the mathematical problem concerning the candidate block. The first miner to solve the problem announces their solution simultaneously to the entire network, in turn receiving the newly created cryptocurrency unit provided by the protocol as a reward.
MD: This is admission that this scheme is even more stupid than using precious metals as money (being proof of work). At least with precious metals all miners are creating something of “real” value. And when someone else gets there first, they don’t lose their work.
HN: As more computing power is added to the network and more coins are mined, the average number of calculations required to create a new block increases, thereby increasing the difficulty level for the miner to win a reward. In proof of work currencies, miners need to recover hardware and electricity costs. This creates downward pressure on the price of the cryptocurrency from newly generated coins, thus encouraging miners to keep improving the efficiency of their mining rigs and find cheaper sources of electricity.
MD: Another open admission of the absurdity of this process. We see the predictable today. So-called “miners” use exotic bots to “steal” computer cycles from internet users. They sneak onto government owned super computers. They also create faster machines that quickly obsolete existing machines thus wasting more “real” resources. It’s not unusual for brand new state of the art ASIC and FPGA based machines to pay themselves off in one to three months … and be totally obsolete in three to six months. In the meantime, they make so much noise they drive their owners out. But they do have an advantage. They use so much electricity, they can mask a hidden marijuana operation.
HN: Bitcoin is an example of a cryptocurrency that uses the proof of work system.
MD: There is no need for the “currency” to be encrypted. In fact, in a “real” money process, the traders, the process, and the terms must be in universal plain view … and unchangeable. This is easily accomplished with simple universal hashing protocols.
HN: Mining rigs in a bitcoin mining facility.
Proof of Stake
Unlike the proof of work system, in which the user validates transactions and creates new blocks by performing a certain amount of computational work, a proof of stake system requires the user to show ownership of a certain number of cryptocurrency units.
MD: In a “real” money system, new traders creating money don’t have to be existing large money changers. Here is open admission that the “proof of stake” system copies a myth from our existing flawed (rigged actually) Medium of Exchange (MOE) process.
HN: The creator of a new block is chosen in a pseudo-random way, depending on the user’s wealth, also defined as ‘stake’. In the proof of stake system, blocks are said to be ‘forged’ or ‘minted’, not mined. Users who validate transactions and create new blocks in this system are referred to as forgers.
MD: In any MOE system, counterfeiters are often “forgers”. Interesting choice of terms isn’t it. Presumably they’re using the “forge” metaphor where existing metal is hammered into different shapes. But there is also the “faking” form where signatures and whole documents are forged. Any MOE process must prevent this. In a “real” MOE process, it is the only leak possible and is mitigated by total transparency of the money creation and destruction activity.
HN: In most proof of stake cases, digital currency units are created at the launch of the currency and their number is fixed.
MD: Bad idea. This fixing of the number “guarantees” the process will be deflationary. In a “real” process, inflation (deflation) is perpetually zero.
HN: Therefore, rather than using cryptocurrency units as reward, the forgers receive transaction fees as rewards. In a few cases, new currency units can be created by inflating the coin supply, and forgers can be rewarded with new currency units created as rewards, rather than transaction fees.
MD: What are these cases? If this can be done, how can they say the number is fixed? Also notice that their process seems to “require” that the creators of the money be “rewarded”. This is also taken from our flawed (corrupt) existing system. They implement a process of elites with power and privilege and ability to demand tribute … just like our current flawed system.
HN: In order to validate transactions and create blocks, a forger must first put their own coins at ‘stake’. Think of this as their holdings being held in an escrow account: if they validate a fraudulent transaction, they lose their holdings, as well as their rights to participate as a forger in the future.
MD: So they take their fake wealth and risk it … like putting it up as collateral. This is also from our existing flawed system. The capitalists take just two years to reclaim their stake (they collect 40%/year interest which doubles in two years). After that, they are forever playing with OPM (Other People’s Money) and risk nothing themselves at all. A “proper” MOE process uses perfect “transparency” and “interest collection according to propensity to default” to keep the players honest and provide negative feedback for stability. In a proper process, these deadbeats can pay back their defaults and return to good standing.
HN: Once the forger puts their stake up, they can partake in the forging process, and because they have staked their own money, they are in theory now incentivized to validate the right transactions.
MD: Myth in the open. Putting up a stake does not mean putting up their own money. They’ve gotten back their own money through deflation very quickly.
HN: This system does not provide a way to handle the initial distribution of coins at the founding phase of the cryptocurrency, so cryptocurrencies which use this system either begin with an ICO and sell their pre-mined coins, or begin with the proof of work system, and switch over to the proof of stake system later.
MD: Now they’re borrowing from the corporate model where a group can create a vision, sell a little less than half to suckers (in the form of stocks), hype the vision, pull out their stake but leave themselves in control, and bingo … you have another form of elite gaming of the system. And again, how do they switch systems later.?This sounds like they’re destroying the money and then using it to buy gold. Our current MOE manipulators call this the “business cycle”. It’s their “farming operation”.
HN: Cyptocurrencies that currently run the proof of stake system are BlackCoin, Lisk, Nxt and Peercoin, among others.
Proof of work mining versus proof of stake forging.
Block Selection Methods
For a proof of stake method to work effectively, there needs to be a way to select which user gets to forge the next valid block in the blockchain.
MD: There must be privileged users. In our present corrupt system we call them bankers (and sometimes governments) and they get 10x leverage over the rest of us.
HN: Selecting the forger by the size of their account balance alone would result in a permanent advantage for the richer forgers who decide to stake more of their cryptocurrency units. To counter this problem, several unique methods of selection have been created. The most popular of these methods are the ‘Randomized Block Selection’ and the ‘Coin Age Based Selection’ methods.
MD: This is characteristic of processes invented by very smart people with very good memories. Rather than seeing the rudimentary flaws in what they are doing, scrapping it, and starting over with a better concept, they run into obvious flaws we less smart people see immediately, and come up with more and more complicated workarounds … and the process soon stops because no one understands it.
HN: Randomized block selection
In the randomized block selection method of selection, a formula which looks for the user with the combination of the lowest hash value and the size of their stake, is used to select the next forger. Since the size of the stakes are public, each node is usually able to predict which user will be selected to forge the next block. Nxt and BlackCoin are two proof of work cryptocurrencies that use the randomized block selection method.
MD: This looks like an open invitation to corruption and manipulation. And when you have a “randomizing” process, the pseudo-random number generator must be open and fixed. Everyone must use the same process. The same random seed must yield the same next random number. This is problematic for obvious reasons.
HN: Coin Age based selection
The coin age based system selects the next forger based on the ‘coin age’ of the stake the potential forger has put up. Coin age is calculated by multiplying the number of days the cryptocurrency coins have been held as stake by the number of coins that are being staked.
MD: Look how long Bitcoin ran before people started to pay attention … it was several years. During that time they were giving coins away just to make it look like there was activity. Mining costs were trivial and the supply grew very quickly with the demand not growing at all. Now that it is starting to catch on (the hook is getting set), these early worthless “coins” own the process. What’s not to like about that? Duh? A Ponzi scheme with no Ponzi.
HN: Coins must have been held for a minimum of 30 days before they can compete for a block.
MD: This is building a time constant into the process … and is open for manipulation. A proper MOE process has no openings for manipulation at all.
HN: Users who have staked older and larger sets of coins have a greater chance of being assigned to forge the next block. Once a user has forged a block, their coin age is reset to zero and then they must wait at least 30 days again before they can sign another block
MD: How is this done? Does this mean the “timestamps” for the coins … used for determining age … can be manipulated too? What’s not to like?
HN: The user is assigned to forge the next block within a maximum period of 90 days, this prevents users with very old and large stakes from dominating the blockchain thereby making the network more secure.
MD: Another knob to manipulate … another opening for fraud and corruption … by regulators.
HN: Because a forger’s chance of success goes up the longer they fail to create a block, forgers can expect to create blocks more regularly. This mechanism promotes a healthy, decentralized forging community.
MD: This is classic complication delivering fairness. Hint people: Fairness is not complicated. But it does go against something that is current flawed wisdom … wisdom that says centralization is good. This says centralization is “not” good. So let’s apply that wisdom … iterative secession. BTW: With a “proper” MOE process, there can be any number of independent processes as long as they all deliver the same transparency and follow the same simple rule (DEFAULT perpetually equals INTEREST collected). No system can be better in any way so all competing systems are equal in performance to the traders using it.
HN: Peercoin is a proof-of-stake system based cryptocurrency which uses the coin age selection process combined with the randomized selection method. Peercoin’s developers claim that this makes a malicious attack on the network more difficult, since purchasing more than half of the coins is likely costlier than acquiring 51% of proof-of-work hashing power.
MD: Notice how all these “complicated” processes have “developers” making “claims” and solving open flaws in other complicated processes … such flaws being prone to “malicious attacks” … opened by their complexity.
HN: Most proof of stake coins that pay a reward in the form of a transaction fee for verifying transactions and creating new blocks, set a target interest rate which users can expect to earn from staking their coins.
MD: Another knob (interest) that a proper MOE process knows should never exist but rather should be an automatic negative feedback mechanism with no opening for intervention. A proper MOE process has no monetary policy. Rather, it precludes it totally.
HN: In the case of cryptocurrencies where forgers create new coins, this rate also becomes the maximum rate at which the currency supply is inflated over time.
MD: “Maximum rate”? For inflation? Over time? What a joke. They clearly have no understanding of what money is. Hint: Don’t try to create a money process without know what money is. Hint: Money is “an in-process promise to complete a trade over time and space and is “always” and only created by traders”.
HN: Proof of stake systems are more environmentally friendly and efficient, as the electricity and hardware costs are much lower than the costs associated with mining in a proof of work system.
MD: A “proper” MOE process is “perfectly” environmentally friendly and efficient. It costs nothing to create and destroy money. There is no “profit” to be made in the process anywhere. The total cost is always borne by the traders and is trivial to the size of their trades. Ideally, it is absorbed as an implicit default and is paid through interest collections on deadbeat traders. Responsible traders pay nothing at all.
HN: A greater number of people are encouraged to run nodes and get involved because it is easy and affordable to participate in this system; this results in more decentralization.
MD: In a proper MOE process, the only incentive to become a node is to decrease latency … and that is a huge incentive. It’s like a communication system with no backbone. Rather it is a mesh system where all nodes make up the connection path. This would be an obvious improvement over the current (easily manipulated) internet process. Can you say “network neutrality?”
HN: This is only a general guide to the proof of stake system. Each cryptocurrency issuer will most likely customize this system with a unique set of rules and provisions of their own as they issue their currency or switch over from the proof of work system.
MD: But the different monies themselves must be indistinguishable to the “users” (as opposed to the “creators”) of the money. And they must be non-counterfeit able.
HN: Additionally, this is a rapidly evolving industry, and apart from proof of work and proof of stake, there are currently several other systems and methodologies of transaction verification and block creation being tested and experimented with.
MD: All equally complicated and demented I’m sure.
MD: You can’t get so-called crypto currencies right if you don’t know what money is. Money is obviously and provably “an in-process promise to complete a trade over time and space.” Money is always, and “only” created by traders making such promises. Money is destroyed as those traders deliver as promised. And if they fail to deliver as promised the resulting DEFAULT is immediately reclaimed by INTEREST collections from new money-creating traders with a like propensity to default.
Knowing this, let’s parse this article and expose this writer’s delusions.
Bitcoin suffers a big correction after swinging wildly in the last 10 days of December. … Sometime in the next three months we will see a sell-off as latecomers panic and sell. Long-term investors will remain in bitcoin and it will creep back up, but will not revisit its December highs.
MD: Admission of failure. “Real” money doesn’t have big corrections and swings.
I nailed it.
Bitcoin peaked about a month ago, on December 17, at a high of nearly $20,000. As I write, the cryptocurrency is under $11,000 … a loss of about 45%. That’s more than $150 billion in lost market cap.
Cue much hand-wringing and gnashing of teeth in the crypto-commentariat. It’s neck-and-neck, but I think the “I-told-you-so” crowd has the edge over the “excuse-makers.”
Here’s the thing: Unless you just lost your shirt on bitcoin, this doesn’t matter at all. And chances are, the “experts” you may see in the press aren’t telling you why.
In fact, bitcoin’s crash is wonderful … because it means we can all just stop thinking about cryptocurrencies altogether.
The Death of Bitcoin…
In a year or so, people won’t be talking about bitcoin in the line at the grocery store or on the bus, as they are now. Here’s why.
Bitcoin is the product of justified frustration. Its designer explicitly said the cryptocurrency was a reaction to government abuse of fiat currencies like the dollar or euro. It was supposed to provide an independent, peer-to-peer payment system based on a virtual currency that couldn’t be debased, since there was a finite number of them.
MD: Delusion admission: When you’re talking about “real” money, there is a perpetual perfect balance between supply and demand for the money itself. And of course both are finite and both vary in lock step.
That dream has long since been jettisoned in favor of raw speculation. Ironically, most people care about bitcoin because it seems like an easy way to get more fiat currency! They don’t own it because they want to buy pizzas or gas with it.
MD: Common slur from those deluded about money. They call it “fiat” currency. Since all money represents a promise, and all promises are fiat, all money is fiat
Besides being a terrible way to transact electronically — it’s agonizingly slow — bitcoin’s success as a speculative play has made it useless as a currency. Why would anyone spend it if it’s appreciating so fast? Who would accept one when it’s depreciating rapidly?
MD: Bitcoin’s major flaw in this regard is its insistence on keeping track of every single trade (and thus fractioning) of the bitcoins once created. This is totally unnecessary. All you must keep track of is the creation of “real” money by traders and the destruction of it as they deliver. You must keep track of defaults and meet them immediately with like interest collections. Beyond that, the “real” money trades totally anonymously.
Bitcoin is also a major source of pollution. It takes 351 kilowatt-hours of electricity just to process one transaction — which also releases 172 kilograms of carbon dioxide into the atmosphere. That’s enough to power one U.S. household for a year. The energy consumed by all bitcoin mining to date could power almost 4 million U.S. households for a year.
MD: Tying the Bitcoin nonsense to the global warming nonsense is truly humorous. That not-withstanding, a “real” money process consumes virtually zero energy. The trees have to look elsewhere for their carbon dioxide.
MD: Governments are helpless (in a competitive sense) in defending themselves against a “real” money process. Once people see it, the nonsense of government itself is quickly exposed and governments wilt on the vine … a bloodless war ending quickly
China, South Korea, Germany, Switzerland and France have implemented, or are considering, bans or limitations on bitcoin trading. Several intergovernmental organizations have called for concerted action to rein in the obvious bubble. The U.S. Securities and Exchange Commission, which once seemed likely to approve bitcoin-based financial derivatives, now seems hesitant.
And according to Investing.com: “The European Union is implementing stricter rules to prevent money laundering and terrorism financing on virtual currency platforms. It’s also looking into limits on cryptocurrency trading.”
We may see a functional, widely accepted cryptocurrency someday, but it won’t be bitcoin.
MD: All will fail just as bitcoin will fail. Why? Because none of them behave as real money. Nothing can out-compete real money. At best, it can only tie.
…But a Boost for Cryptoassets
Good. Getting over bitcoin allows us to see where the real value of cryptoassets lies. Here’s how.
To use the New York subway system, you need tokens. You can’t use them to buy anything else … although you could sell them to someone who wanted to use the subway more than you.
In fact, if subway tokens were in limited supply, a lively market for them might spring up. They might even trade for a lot more than they originally cost. It all depends on how much people want to use the subway.
MD: Subway tokens are close to “real” money. They are created by those intending to travel. They are destroyed as they complete their trip. In the process, there is perfect balance between supply and demand for them. They fail as real money because they can only be used in one very narrow marketplace … the subway.
That, in a nutshell, is the scenario for the most promising “cryptocurrencies” other than bitcoin. They’re not money, they’re tokens — “crypto-tokens,” if you will. They aren’t used as general currency. They are only good within the platform for which they were designed.
MD: With real money, there is no distinction between tokens, coins, currency, or ledger entries. The money can move from one form to the other with perfect freedom. Just like a baton plays no role in running a race, the tokens themselves play no role in actual trading. They are simply a score keeping mechanism.
If those platforms deliver valuable services, people will want those crypto-tokens, and that will determine their price. In other words, crypto-tokens will have value to the extent that people value the things you can get for them from their associated platform.
MD: Nonsense. The proper unit of measure of real money would be the HUL (Hour of Unskilled Labor). It never changes its value over time and space. It always trades for the same size hole in the ground. So does real money.
That will make them real assets, with intrinsic value — because they can be used to obtain something that people value. That means you can reliably expect a stream of revenue or services from owning such crypto-tokens. Critically, you can measure that stream of future returns against the price of the crypto-token, just as we do when we calculate the price/earnings ratio (P/E) of a stock.
MD: Tokens and currency are real assets with “recorded” value, not intrinsic value. If I have currency and I exchange it for a ledger entry, that currency (which has never had intrinsic value but does have trading value) can be burned and there is no change in value anywhere. Money in the form of currency or tokens is only money when it is involved in trade. And if someone puts them under a mattress, it “is” involved in trade. However, if the process exchanges it for a ledger entry and the currency or token is placed on a pallet, in that store it has zero value … just like a baton sitting in a locker before or after a race plays no role in a race.
Bitcoin, by contrast, has no intrinsic value. It only has a price — the price set by supply and demand. It can’t produce future streams of revenue, and you can’t measure anything like a P/E ratio for it.
MD: This is a major major delusion. Money has a unit of measure (ideally the HUL – Hour of Unskilled Labor) but no price. This is because the supply/demand ratio is guaranteed to be perpetually unity.
One day it will be worthless because it doesn’t get you anything real.
MD: Real money will always have value as long as “responsible” traders exist. Responsible traders don’t default. They use money as it should be used … as an in-process promise to complete a trade over time and space. And the vast majority of us are responsible traders. There are really very few deadbeats and the proper money process quickly makes them uncompetitive traders and they are naturally ostracized from the marketplace.
(For more of my thoughts on the differences between cryptocurrencies and crypto-tokens, click on the video below.)
Ether and Other Cryptoassets Are the Future
The crypto-token ether sure seems like a currency. It’s traded on cryptocurrency exchanges under the code ETH. Its symbol is the Greek uppercase Xi character (Ξ). It’s mined in a similar (but less energy-intensive) process to bitcoin.
MD: Oh really? What is the distinction? What is the difference?
But ether isn’t a currency. Its designers describe it as “a fuel for operating the distributed application platform Ethereum. It is a form of payment made by the clients of the platform to the machines executing the requested operations.”
MD: With real money a process is needed to keep track of things. But that cost is negligible compared to the cost of the things being tracked.
Ether tokens get you access to one of the world’s most sophisticated distributed computational networks. It’s so promising that big companies are falling all over each other to develop practical, real-world uses for it.
Because most people who trade it don’t really understand or care about its true purpose, the price of ether has bubbled and frothed like bitcoin in recent weeks.
MD: This isn’t because of misunderstanding. It’s because there is not guaranteed perpetual balance between supply and demand for the stuff.
But eventually, ether will revert to a stable price based on the demand for the computational services it can “buy” for people. That price will represent real value that can be priced into the future. There’ll be a futures market for it, and exchange-traded funds (ETFs), because everyone will have a way to assess its underlying value over time. Just as we do with stocks.
MD: Does this suggest it somehow maintains perfect supply/demand balance for the money itself? How does it do that???
What will that value be? I have no idea. But I know it will be a lot more than bitcoin.
MD: Proving you are deluded. If you knew what money was and you knew what you speak of to be money, you know perpetually what its value will “always” be.
My advice: Get rid of your bitcoin, and buy ether at the next dip.
MD: This reminds me of the quip “you have to love standards … there are so many to choose from”.
MD: If you understand money, you know the proper process to enable it “guarantees” perpetual perfect supply/demand balance for the money itself. Thus, it is neither inflationary nor deflationary.
The Bitcoin process thinks (like the gold bugs think) that money needs to be rare to be viable. This is nonsense of course. But Bitcoin is enormously “deflationary” as a consequence of its process. Supply is severely limited and ultimately capped. Demand is exploding because of this (because it is deflationary) … not because Bitcoin is viable money.
Nobody in their right mind owning bitcoins would ever part with them (unless the inevitable collapse was in progress). That’s the nature of a “deflationary” asset. The only appeal to bitcoins is their anonymity. And thus it is illicit trade that is really finding bitcoin useful. Everyone else holding them is gambling … plain and simple.
I have never tried to really understand the underlying process of bitcoin mining. The reason for this is the process is bogus on its face. It has no way of matching supply and demand. If this is a characteristic of all cryptocurrencies (and block chain mechanisms) in general, then all are not viable. However, I see no reason a block chain concept cannot be devised that creates new transparent, unchangeable blocks at zero cost. Then the proper MOE process uses the block chain to deliver the necessary “transparency” attribute of a proper MOE process.
As always, I’ll now intersperse comments as appropriate to highlight these obvious principles and violations thereof.
Dimon said at an investment conference that the digital currency was a “fraud” and that his firm would fire anyone at the bank that traded it “in a second.” Dimon said he supported blockchain technology for tracking payments but that trading bitcoin itself was against the bank’s rules. He added that bitcoin was “stupid” and “far too dangerous.”
MD: It went into bubble territory right out of the box.
Schiff, who predicted the 2008 mortgage crisis, famously referred to bitcoin as digital fool’s gold and compared the cryptocurrency to the infamous bubble in Beanie Babies.
Moreover, the recent run-up in bitcoin hasn’t softened Schiff’s view: If anything, it’s reinforced his sense of impending doom.
Schiff told CoinDesk:
“There’s certainly a lot of bullishness about bitcoin and cryptocurrency, and that’s the case with bubbles in general. The psychology of bubbles fuels it. You just become more convinced that it’s going to work. And the higher the price goes, the more convinced you become that you’re right. But it’s not going up because it’s going to work. It’s going up because of speculation.”
MD: The fact that it is going up is proof that it “does not work”. Real money never goes up or down. It stays constant over all time and space.
“What it comes down to is that bitcoin ain’t money.”
“Libertarian-minded crypto fans saw this was a way to liberate people from the government,” he said, concluding:
“I think it will have the opposite effect. People are going to lose money. This could really backfire, giving libertarian ideals a bad name by making fiat look good. The downside can be really spectacular.”
MD: Actually, a competitive proper MOE process would give people an alternative to the “improper” MOE process commanded by the money changers and the governments they institute. If instituted properly (i.e. guaranteeing zero inflation), and in multiplicative fashion (like credit cards) nobody would continue to use government money, It couldn’t compete. The government would be forced to demand use of government money (for more than just paying taxes) and that would tip their hand … i.e. that they are simply the money confiscation machine instituted by money changers. Right now that machine is confiscating 3/4ths of everything each of us makes.
Cryptocurrencies are currencies with no government in the middle. No bank in the middle. No organizations in the middle keeping track of all your payments, or taking advantage of your spending so they can invade your privacy, and on and on.
Cryptocurrencies solve trillions of dollars’ worth of problems, which is why they will be worth trillions of dollars one day.
MD: He says about three things that are right and then caps it off by saying something that proves they solve no problems at all.
Consider the potential:
There is currently $200 trillion in cash, money and precious metals used as currencies in the world. Meanwhile, there’s only $200 billion in cryptocurrencies. Cryptocurrencies are eventually replacing traditional currencies.
MD: If he knew what he was talking about … i.e. what money really is … he would also say there are currently $200 trillion in-process trading promises (net of government counterfeiting that is demonstrably about 4%). But of course that isn’t true because government trading promises are always defaulted … i.e. counterfeiting right out of the box.
So that $200 billion will eventually rise to the level of currencies. And probably sooner than we can imagine.
MD: Admitting he is clueless about money. Supply and demand for real money rise and fall in lock step.
Ask yourself, why does the world need multiple currencies? There’s actually no real reason. The only reason we have a U.S. dollar and also a Canadian dollar is that in 1770 the people in Canada decided not to join the U.S. So an artificial border created two currencies. It’s all dictated by artificial borders.
MD: Actually, it’s because “none” of the world’s currencies are from a “proper” MOE process. If we had a proper MOE process that “guaranteed” zero inflation, then there would be no need for multiple currencies (exchange rates would be perpetually constant). However, there always should be multiple processes in operation … just like there should be multiple insurance companies in operation. They’re addressing an identical problem and are disciplined and driven to efficiency by transparency and competition.
In the past, an ounce of gold would be accepted almost anywhere in the world. In that sense, unbacked modern fiat currencies are a step backwards.
MD: As it is today. Gold becomes more acceptable in trade as the MOE process in place becomes more and more “improper” (i.e. tolerates more and more counterfeiting by governments and more and more tribute demands by the money changers. Gold is just a clumsy inefficient stand-in for real money.
But in cryptocurrency world, there are what I call “Use Borders.” Every currency is defined by its use. For instance, Ethereum is like Bitcoin but it makes “smart contracts” easier. Contract Law is a multi-trillion dollar industry so this has a huge use case. Filecoin makes storage easier. It’s a $100 billion industry. And on.
Studying the “use” cases, and the effectiveness of the coin to solve those use cases can help us make investment decisions confidently.
MD: KISS (Keep is Simple Stupid). Money is not about “use cases” … it is about trade over time and space. Block chains may be about use cases, but those cases are not cryptocurrency. They’re not currency at all. Who ever thought of a contract as being currency? Just trapped myself didn’t I … because in a proper MOE process, the money represents a contract … a promise by a trader to the whole trading community that he will deliver on a trade over time and space.
This is the great promise of cryptocurrencies and why they will change the world. It’s just getting started.
No normal non-expert should expect to make sense of the above. So let’s just assume that the cryptocurrency universe will continue to expand for a while and narrow the discussion down to a single question: Are cryptocurrencies inflationary? That is, will their spread lead to higher or lower prices for the average person, and greater or lesser financial instability for the markets, and what does this mean for today’s fiat currencies?
MD: That’s his judge of inflation? Higher (or lower prices)? Prices are just a crude measure of inflation. Inflation can’t be measured. But a proper process can guarantee it to be zero … and thus requires no measurement. No block chain process I have ever seen described attempts to maintain perfect balance between supply and demand for the money (i.e. trading promises) it represents.
MF: I suggest you continue to read this article if you find it interesting. If you do, I suggest you continue to annotate it in your mind knowing the principles of “real” money and how they apply. This article is making me tired.
One common opinion is that cryptocurrencies can’t be inflationary because their owners have to pay for them in fiat currencies. So one bitcoin bought means one dollar, yen, or euro sold, with the net effect on prices being zero.
This makes intuitive sense at first glance, but only holds for the moment of purchase. Consider what happened after someone in, say, 2014 exchanged dollars for bitcoins. The dollars held most of their value, which means the total amount of dollar purchasing power in the world remained constant. But those bitcoins went up by several thousand percent, dramatically increasing the purchasing power – and thus the potential inflationary impact – of the bitcoin complex.
In a Tweet on Saturday, Assange said the group’s investment in the cryptocurrency has seen a return greater than 50,000% since 2010. Wikileaks began investing in bitcoin back then because global payment processors like Visa, Mastercard, and Paypal were under pressure by the U.S. government to block the ability of the group to take payments.
In fact, Bitcoin has seen a more-than 9 million percent return over the dates Assange references. In certain periods in 2010, bitcoin was trading for mere pennies. According to coindesk.com, one unit of bitcoin is now worth a record high of roughly $5,700. Anyone buying bitcoin through much of 2011 and 2012, when one unit was sometimes trading below $1 and was often under $10, would indeed see a return on investment of more than 50,000%, assuming they never sold.
The difference between Wikileak’s purchasing power pre and post-bitcoin is immense. If Assange decides to spend his windfall on goods and services he’d have, at the margin, an inflationary impact on the stuff he buys.
So the answer to the question of cryptocurrencies’ impact on price levels depends on how their values change. If they rise after people buy them, then they’re inflationary. If they rise a lot, they’re potentially very inflationary.
In this sense, it might be helpful to view cryptocurrencies as assets like houses or stocks rather than as money. When they rise relative to fiat currencies they increase the purchasing power of their owners, generate a “wealth effect” in which owners feel richer and more comfortable with splurging, and in that way push up prices. Based on the following chart, a lot of early adopters are feeling a whole lot richer these days.
Which then leads to what might be the major cryptocurrency theme of the coming year: Why would governments allow such an inflationary supernova to explode right in front of them when they presumably have the power to stop it? Here’s one possible — and of course disturbing — answer:
Will cryptocurrencies trash cash? ‘Fedcoin’ could do it
Economist Ed Yardeni of Yardeni Research asks the obvious question: Why would central banks—which derive their power as the centralized gatekeepers of fiat currency creation, check clearing and payment processing—embrace a movement that’s primary motivation has been to usurp this power in a decentralized way?
Part of that, according to St. Louis Federal Reserve president James Bullard, is recognition that the technology has achieved critical mass. Thus, there’s a fear of being left behind as the very foundations of banking and monetary policy—intermediation, funds transfers, transactions—rapidly change, not unlike the way the creation of mortgage-backed securities and credit default swaps changed housing finance in the mid-2000s.
There’s another, more self-serving purpose: Central banks could use their own cryptos to put the squeeze on paper currency. Why? To facilitate the use of negative interest rate policy, which has been deployed in Europe and Japan in recent years in half-baked forms. Currently, in Switzerland, short-term interest rates are at -0.75%.
When another recession hits, especially if one comes soon, a dive to even deeper rates of negative interest would be hampered by the hoarding of cash since banks would charge for deposits (vs. absorbing the cost of negative rates themselves, as they’re doing now). This is known by the economics cognoscenti as the “zero lower bound” in that interest rates cannot go much below negative before the traditional functions of deposits, loans and fractional money creation break down. Mattress stuffing ensues en masse.
The Fed is clearly thinking about it. In testimony to Congress last year, Fed chairman Janet Yellen admitted policymakers “expect to have less scope for interest-rate cuts than we have had historically,” adding she would not completely rule out the use of negative interest rates.
The BIS—the central bank of central banks—in its latest quarterly review posited that a crypto backed by the Fed “has the potential to relieve the zero lower bound constraint on monetary policy.” Any distinction between regular dollars and this new “Fedcoin” could be removed by establishing a fixed one-to-one valuation. Any competition from the likes of bitcoin could be squashed by regulation; not unlike how the private ownership of gold was outlawed in the 1930s when it threatened the Fed’s ability to ease credit conditions.
At the risk of being repetitious, pretty much all of the above looks good for gold and great for silver.
MD: Remembering what money really is … “an in-process promise to complete a trade over time and space” … that it is only created by traders … and that for any given trading promise, it only exists for the duration of that promise … and that during that interim time, there is perpetual perfect supply/demand (i.e. zero inflation) of that money created … knowing all that, look how silly such articles like this become.
by Izabella Kaminska
In 1999, the actor Whoopi Goldberg made a bold decision. Rather than be paid for an endorsement for a dotcom start-up, she took a 10 per cent stake in the business. It seemed wise. At the time, everyone was investing in internet businesses and a rush of initial public offerings was making early investors into millionaires. I was reminded of this amid a flurry of news about the new boom in cryptocurrencies — and their celebrity backers. Ms Goldberg’s venture, Flooz, was billed as the future of money in a digital world and it hoped one day to rival the dollar.
MD: Let’s see if there is evidence that they had any clue about what money is before starting this venture. Nope!
The way it worked, however, was much less revolutionary. The service resembled a gift certificate: customers paid in dollars and received Flooz balances. These could be redeemed at participating merchants, with the hope that credits would one day circulate as money in their own right.
MD: What’s the point? How were they supposed to work without dollars kicking them off in the first place? When they replaced the dollar, what was going to create them?
The problem for Flooz was that little prevented mass replication of its model. One prominent competitor, Beenz, differed only slightly, by allowing its units to trade at fluctuating market prices.
MD: A “proper” MOE process can have no competitors. A competitor either does the exact same thing as this proper MOE process, or it isn’t competitive. And since there is no money to be made in the process (contrasted to the similar casualty insurance process where money is made on investment income), it’s not going to attract many competitors. It would be the trading commons themselves who would steward the process. We have experience with this. The internet is just such a process example … a technology commons.
Like banking syndicates before them, the ventures decided to club together for mutual benefit by accepting each other’s currencies in their networks. Even so, by 2001 both companies had failed, brought down by a lack of the one ingredient that counts most in finance: trust. Flooz was knocked by security concerns after it transpired that a Russian crime syndicate had taken advantage of its currency, while the fluctuating value of Beenz soon put users off.
MD: Fluctuating value turning users off is a good sign. Users aren’t as clueless as these entrepreneurs.
Their loss turned into PayPal’s gain, the latter succeeding precisely because it had set its aspirations much lower. Rather than replace established currencies, PayPal focused on improving the dollar’s online mobility, notably by creating a secure network that gained public support. This, it turned out, is what people really wanted.
MD: And PayPal missed the real opportunity by not following up. If they had gone ahead and implemented micro-transactions, I would be paying a tiny (what 1 cent; 5 cents?) price for reading this article. That day has to come. Supporting the likes of FT with advertising and subscriptions is just plain nonsense.
Did we learn anything from the failures of the internet boom? Apparently not. In what is looking increasingly like a new incarnation of dotcom fever, celebrities are endorsing virtual currency systems. Heiress and reality TV star Paris Hilton tweeted this week that she would be backing fundraising for LydianCoin, a digital token still at concept stage. It offers redemption against online artificial intelligence-assisted advertising campaigns.
MD: Advertising campaigns “are” artificial intelligence. We know it as propaganda. It’s annoying … and really dangerous when it reaches the minds of the stupid.
Baroness Michelle Mone, a businesswoman, announced she would be accepting bitcoin in exchange for luxury Dubai flats. What is particularly striking about this path to riches is its “growing money on trees” character.
MD: What is “particularly striking” is that someone would part with their bitcoins for one of her flats … knowing the extraordinary deflationary nature of bitcoins.
While the internet boom was dominated by IPOs, linked to a potentially profitable venture to come, this time it is “initial coin offerings” igniting investor fervour. Most ICOs do not aspire to deliver profits or returns. Indeed, from a regulatory standpoint, they cannot — most lawyers agree doing so could classify them as securities, drawing regulatory intervention which would force them into stringent listing processes.
MD: If they knew what real money was, they would know that every trader (like you and me contracting for a house or car with monthly payments) is making an ICO. What in the world is it going to take to get these brilliant idiots to recognize and understand the obvious?
That opinion was substantiated in July when the US Securities and Exchange Commission warned: “Virtual coins or tokens may be securities and subject to the federal securities laws” and that “it is relatively easy for anyone to use blockchain technology to create an ICO that looks impressive, even though it might actually be a scam.”
MD: Now isn’t that the pot calling the kettle black. The SEC is itself a scam.
So most ICOs make do by selling tokens for pre-existing virtual currencies for promises of direct redemption against online goods, services or concepts, or simply in the hope the tokens themselves will rocket in value despite offering nothing specific in return.
MD: Stupid is as stupid does. If you know that zero inflation is the right number for any money you don’t go looking for “rocketing” value. An ideal unit for money is the HUL (Hour of Unskilled Labor). We were all a HUL doing summer jobs in high-school so we can relate to them any time in our lives … and to any trade we make. The HUL itself has not changed over all time. It trades for the same size hole in the ground. With median income now at about $50,000 per year, the median person is able to trade his skilled hours for about 3.5 HULs these days.
They still think they can succeed where other parallel currency systems have failed, by bolting into pre- established blockchain-distributed currency systems such as Ethereum or bitcoin.
MD: A proper MOE process is totally transparent when it comes to the money creation/destruction parts of the process. Block-chain techniques (i.e. universally accessible ledger) would be helpful to enhance that transparency. But there would be no mining involved. New blocks would have to be created at any time at zero cost.
These already come with a network of token-owning users. But with the numbers of conventional merchants that will accept these currencies falling rather than rising, these holders need something more compelling to spend their digital wealth on. As it stands, the real economy can only be accessed by cashing out digital currency for conventional money at cryptocurrency exchanges. This comes at some expense.
MD: So far, the expense is insignificant … because of the enormous “guaranteed” continual deflation of the cryptocurrency itself (their ridiculous mining process). It’s kind of like the reverse of our government run lotteries. With government lotteries, you are guaranteed to lose (except for the minuscule chance you win). With cryptocurrency, you are guaranteed to win (until everyone loses as what is essentially a Ponzi scheme … with no Ponzi … comes down).
But with regulators clamping down on how exchanges are governed, token holders who cannot or do not want to pass through know-your-customer and anti-money laundering procedures remain frozen out.
MD: What’s disconcerting is the knowledge that if we instituted a “proper” MOE process, the regulators would clamp down on it too. It would make their current counterfeiting impossible … and it would make it impossible for money changers to demand tribute. That would just not stand. Regulators and governments everywhere are a major part of our problem.
That leaves their holdings good for only three things: virtual currency speculation, which is ultimately a zero-sum game; redemption against dark-market goods or capital control circumvention. It is assumed ICOs offering real goods, services or real estate in exchange for cryptocurrencies can somehow tap into this sizeable, albeit potentially illicit and restricted, wealth pool.
MD: Real estate wants positive inflation. Money changers in real estate do not want real money (there’s no leverage in it … time value of real money is guaranteed to be perpetually 1.0000) … and for sure they don’t want money that is guaranteed deflationary.
Yet if competing unregulated economies really start gaining traction, governments will act. China’s central bank has already branded ICOs an illegal form of crowdfunding and more rulings are expected from other jurisdictions in coming weeks.
Then again, if history teaches us anything, the system’s own propensity to cultivate fraud and unnecessary complexity in the face of more secure and regulated competition may be the more likely thing to bring it down.
MD: Actually, if you crowd the money changers existing con … “they” are likely to bring it down. “Real” money crowds money changers out of existence. That will not stand. Too bad for us traders and producers in society.
When given the choice, people usually opt for security.
MD: Which of course we don’t have … if you call government taking 3/4ths of everything we make …. you can’t call that security. I call it slavery. If you call money changers taking “all” taxes we pay as tribute … leaving governments (which the money changers instituted to protect their con) to sustain themselves by counterfeiting … I call that criminal.
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MD: I am openly violating this request. My comments are far more valuable than anything to be learned in this article. And the fairest way to make my comments is to intersperse them in the disinformation that these articles present.
MD: Money Delusions has no illusion for what money is (see right sidebar). Bitcoin, like gold, is a clumsy stand-in for “real” money.
Well, it looks like they’re taking it a step further. On the one hand, they’re trying to give it stability while on the other hand they’re trying to give it leverage. In both cases, Bitcoin’s foundations are firmly planted in quicksand.
And the allure of Bitcoin? “It doesn’t require trust … there is no entity to be trusted”.
Well, a good way to study issues is to inspect the limits. On one limit, we have no Bitcoins. At that limit, confusion about money remains unchanged. At the other limit, everything is the Bitcoins … and just looking at the algorithm this limits the number … thus infinite value is at the upper limit. Traders (like you and me) can’t trade in that environment. When we promise to trade 360 monthly payments of money for a house today, we want that money to be worth exactly the same every one of those months. “Real” money behaves this way. Bitcoin money does not. Every month, the Bitcoin we must return is harder for us to earn.
Fisco, a Japanese financial information company, announced this week a unit of the company has issued a bitcoin bond.
MD: Where are the Bitcoins going to come from when these bonds mature? Where are the Bitcoins going to come from that pay the coupon? Bitcoin is hopelessly deflationary. Thus, buying a Bitcoin bond puts huge pressure on the seller to deliver higher valued Bitcoins when the bond matures. How are they going to do that? And with the value (through scarcity) of Bitcoin continuously increasing, the bond will continuously increase too. Why in the world would Fisco create such a thing? What’s in it for them?
The bitcoin bond “brings digital currencies into the world of high finance,” said Dan Doney, chief executive officer of Securrency.
MD: High finance is nothing but highly leveraged gambling. It only works with inflation. It strangles itself with something deflationary like Bitcoin. High leverage is instant death for these gamblers facing deflation … and with Bitcoin, that deflation is guaranteed in exponentially increasing fashion … until it just collapses totally out of self strangulation.
The development of bitcoin options, futures and now bonds could help the often volatile digital currency become a better-established asset class.
MD: “Real” money is not volatile. It is in perpetually perfect supply/demand balance. It is in perpetual free supply. Thus, there is no need for options, futures, or bonds of any kind. How could it be more obvious that Bitcoin is a terminally stupid idea?
Bitcoin is getting closer to looking like a traditional financial product.
MD: Oh really? Can you buy a ribeye steak at the super market with one?
Japanese financial information firm Fisco announced Monday it is experimenting with the country’s first bitcoin-backed bond. The news follows other announcements in the last several weeks for bitcoin options, futures and an exchange-traded fund tracking bitcoin derivatives in the U.S.
“I think it’s a very healthy and natural progression of the space,” said Adam White, Coinbase vice president and general manager of its GDAX exchange, told CNBC in a phone interview.
MD: Adam White. Might as well be Joe Jones in searching for what becomes of that idiot and his predictions.
Derivatives products will allow for greater liquidity, better price discovery and lower volatility, White said. “I think products like derivatives or an ETF effectively allow traders to do two things: speculate and hedge risk on the price speculation.”
MD: Why does Bitcoin need greater liquidity? A “real” money process has perfect liquidity. There is no restriction on its supply and it maintains perpetual perfect supply/demand balance … zero inflation. It requires no price discovery. It’s value is permanently in units of HULs which never change. You don’t need derivatives for it because leveraging zero does nothing. You don’t need ETFs for it because there are no exchanges. All money exchanges on a 1 for 1 basis after “real” money drives out all less efficient money.
Bitcoin price 12-month performance
MD: Now look at that! A “Real” money price performance curve is a straight horizontal line … for all time. Why would any trader want to make a promise spanning time and space with a time dependent curve like that? He wouldn’t!
Bitcoin has more than quadrupled in price this year, hitting a record above $4,500 Thursday and notching a market value of $74 billion amid growing institutional investor interest in the digital currency.
MD: Over the same period, any “real” money would have remained at exactly the same price. Traders? What would you rather have? Your trading promise spanning time and space linked to … an unpredictable accelerating object or to a perfectly static object?
Many governments and financial institutions see enormous potential for improving transaction security and efficiency using the blockchain technology that supports bitcoin.
MD: But does that blockchain technology dictate the scarcity Bitcoin exhibits (and cherishes)? If not, blockchain technology would be enormously helpful to “real” money too. Real money requires complete transparency of the money “creation” process and blockchain (if in free supply) would facilitate that.
But the surge in investor demand has also revealed access issues with third-party storage systems and trading platforms that fall short of the more established Wall Street markets.
MD: What is being stored is just information (ledger entries) … and it’s essentially replicated so can’t be destroyed. The blockchain, being universally distributed, implies no storage at all? It would be an increasingly rare case where “real” money using a blockchain would have to be in coin or currency form which could be physically destroyed.
Bitcoin’s price is also prone to massive swings of several hundred dollars within a day. With bitcoin futures in the works, investors will be able to protect themselves from potential sharp drops in prices through hedging.
MD: Why? “Real” money is certainly not so prone! Why are people using and advocating Bitcoin being so skittish? Remember, it requires “no trust”!
The ability to hedge bitcoin investments paves the way for other products, such as bonds.
MD: Insurance is useless when the insurer is guaranteed to fail.
The bond has a three percent annual interest rate and returns bitcoins when it matures, the release said. The total worth of the bond was 200 bitcoin, or $900,000 at Thursday’s prices.
MD: 3% paid in Bitcoins? Where are those coming from? And they’re only paid at maturity? Thus, a buyer would have to wait three years before realizing he was scammed? With an annually paid coupon, he would know the bond writer was room temperature in one year.
The bitcoin bond “brings digital currencies into the world of high finance,” said Dan Doney, chief executive officer of Securrency, which plans to launch a platform at the end of the year to allow investors to buy stocks using bitcoin. Doney was chief innovation officer at the U.S. Defense Intelligence Agency before co-founding Securrency in 2015.
MD: World of high chicanery!
The biggest challenge is “it is very difficult to predict the price of bitcoin tomorrow, let alone a year from now,” Doney said.
MD: … just as is gold. And just like gold, you can be sure it will go up over time. It has to. It is deflationary by design. Next thing they will invent is a dollar / bitcoin cocktail trying to match the dollars inflation with the bitcoins deflation. If they are able to do that perfectly, they arrive at “real” money. Why not just institute “real” money to start with. It is guaranteed to stay real … perpetually in real time.
A bitcoin-backed bond would allow large institutions to store value using the digital currency and potentially be more open to accepting bitcoin as payment, analysts said.
MD: Ah … so they think it’s a storage problem? Why? Because the dollar is inflationary? Or because it might catch fire and turn to ash? Why would large institutions store value as something that is guaranteed to blow up (or more accurately, blow-down) by design?
“It is interesting financial firms are trying to get their arms around the currency and what it can be,” said Brian Patrick Eha, author of “How Money got Free: Bitcoin and the Fight for the Future of Finance.”
MD: If I could get that guy to comment, I would welcome an opportunity to annotate his book. Otherwise, by the title, reading it would be a waste of time.
MD: If you can create a fiction like the VIX and trade it, you can create any fiction and trade it. What’s not to love about that? It’s going to become a pretty cluttered landscape isn’t it? Compare that to “real” money. Regardless of how many purveyors there are, they will all trade 1 for 1 for each other. It’s the nature of the process.
MD: You can make a market in cow dung and clear it. What’s the big deal?
Historically cryptocurrencies “were very much a domain for crypto anarchists and tech-savvy people, and that has changed in the last couple years,” said Niklas Nikolajsen, CEO of Swiss-based digital currency broker Bitcoin Suisse. “This means a whole new ballgame of people are going to get access to the market.”
MD: Right. Like religion changed after they first printed the bible. It just enabled more corruptions and variations of something that was a hoax to start with … something of the sole domain of the monks on high… (and the soul domain of the stupid) .
WATCH: Trader explains when to buy bitcoin
Here’s when you should buy Bitcoin, according to one trader
MD: Buy until it becomes a trading black hole by self strangulation. Don’t even worry about the buy low/sell high wisdom. It will essentially always be buy high/sell higher. Just before the limit, your return is infinity squared. At the limit, it strangles itself.
NOTE UP FRONT: I express my opinions here (at least at the end of the article). If you don’t like them and don’t have evidence to support your dislike, then go kick rocks.
MD: I definitely have evidence … and proof, so I don’t expect to be kicking rocks (or pounding sand). But I predict I’ll ultimately end up doing just that. Cognitive dissonance is the strongest force I’ve seen in human nature. It has sustained all religions and enabled new ones.
ICO (Initial Coin Offering) is a not problem when you have a “proper” MOE process. Only traders create money. They do it by making a trading promise spanning time and space and get it certified by the process.
It initially is just a record entry with the “score keeper” doing the certification. It usually quickly gets converted to a record entry in some other trader’s ledger or as currency or coin. In the case of the latter two, there are two instances of each: (1) physical media in circulation; (2) physical media in storage.
In both cases they ideally have HULs (Hours of Unskilled Labor) as their units of measure. These are universally known to never change trading value over time and space … you always get the same size hole in the ground when you trade one HUL for a hole in the ground.
In case (1) the HULs (money) serve in small simple barter exchange transactions … like buying a candy bar. In case (2) they are totally valueless … as long as they don’t enter circulation. They can be destroyed with no impact on trade what-so-ever. That is not true of those in case (1).
In any case, for this trading promise, no money exists before the promise, nor after final delivery (or mitigation of default by interest collection of like amount). And all money is just such a promise. From this emanates the guarantee of perpetual zero inflation. Start with 0; end with zero; 0 minus 0 is zero.
Things are moving forward quite rapidly in this space; I simply don’t have time to look at all the ICOs (ya know, full time job, podcast, wife, and stuff), but this one struck me as different while also being wildly anticipated.
MD: Multiple “proper” MOE processes can co-exist simultaneously and compete. The only front they can compete on is efficiency (and thus lowest cost and interest to traders using them in money creation).
This article digs into the Status platform ICO model, how it differentiated itself from other models, and what the results were. If you aren’t sure what they do, go read about em here.
MD: I see a case where the brilliant mind has complicated a non-problem.
You might want to start by reading their recap of the ICO. Ya know, cause they wrote it.
MD: I ignored Python from the first time I saw it. You can’t use “white space” as a programming element. It’s a fundamental concept … one that if ignored will come back to bite you over and over and over again. And I have some experience. I created GLEE (see WithGLEE.com).
In particular, I retrieved all transactions from the SNT Crowdsale contract address from Etherscan.io, and parsed out the ones that had an error or had a value of 0 ETH, for both external and internal transactions. The values refunded by the internal transactions are removed from the corresponding external amounts when grouped together. This is my dataset. All conclusions and numbers are derived from that. I don’t do an errored transaction analysis on this one, one may come afterwards if no one else does it, but people like CodeTract have been doing an excellent job of this for other ICOs. Go check out their stuff.
MD: See how complicated things can become when you’re totally confused about the problem to begin with? Think concepts! What are the concepts? KISS!!!
I’m happy to see that others are doing analysis of this space, so we can see more of the trends developing.
Status.im ICO Summary:
The Status platform prides itself on really caring about their community, the Ethereum community, and learning from previous ICO models.
MD: A “proper” MOE process cares nothing about the “community”. It has the requirement that “all” traders and “all their money creating promises” and “all their deliveries on those promises” and “all their defaults and immediate mitigating interest collections of like amount” are “always” totally transparent to everyone in any community … whether they create the exchange media or just use it in trade or are just watching. Noting is secret at the money creation or the money destruction stage of a “proper” MOE process. All “use” of the money is perfectly confidential.
By learning from previous ICO models, I mean attempting to widely distribute your token to those who are interested in its utility in the midst of a fever-pitched, FOMO induced, and irrationally exuberated (made that one up!) investor community ready to flip your ICO for profit.
MD: Contrast this nonsense with a widely recognized “proper” MOE process concept. To help, consider a Mutual Casualty Insurance Company. It is owned by the members (the users … the traders). CLAIMs perpetually equal PREMIUMS. Any money made on investment income in the meantime goes to reduction of premiums and application to costs of operation. A “proper” MOE process is only contrasted by having no investment income … there is nothing to invest. Thus, costs have to be recovered by interest collections.
But just like a Mutual Casualty Insurance Company, there can be any number of them … competing against each other. For all intents and purposes, in the risk community, they are all the same. They differ in efficiency (lower premiums, better claims service).
Proper MOE processes have a notable difference here. The exchange rates between them are perpetually 1.000. There is free exchange between them. There is no such thing as exchange of one insurance policy for another … except in the case of re-insurance which is an internal, not external, practice.
What was their plan? Two-fold:
MD: I’m not going to comment further on this concept. It is a non-issue. With a “proper” MOE process, it never comes up. I’ll scan ahead to see if there is anything else I take issue with. It’s silly for me to nit pick details when the whole process is bogus and misguided in the first place.
They created a pool of “Genesis Tokens” (SGT) to give to early contributors that clearly showed they wanted to help the platform grow, which were given out at the discretion of the core devs. This token pool corresponded to a maximum of 10% of the total token supply. After the contribution period, SGT could be converted to the ICO token (SNT) so early contributors could “get in” on the ICO token for being a contributor early. Basically, early disbursement of tokens that map to a given percentage of the total.
As for the crazy investors, they implemented a soft-cap, and subsequent “Dynamic Ceilings.” What is that? Well, you should read it from the people who implemented it here like a smart person, and then frown at my shitty explanation here. My explanation of Dynamic Ceilings, just imagine that as time went on, large investments only got a portion of their investment accepted, and the rest was refunded. This was an attempt to increase the time window for smaller investors, and slowly make it more difficult for large investments to get in. The effect of this was for every transaction that got an amount kicked back, there is one regular tx and two internal txs, for example ( numbers are for illustration ):
1.) User attempts to send 100 ETH
2.) Over time, smart contract says "screw you big investor, give the little guys a chance!"
a.) Smart contract accepts 20 ETH
b.) Smart contract refunds 80 ETH
3.) User gets 20 ETH worth of SNT and 80 ETH refund
** Note that percentages changed as time went on.
Here are the stats I pulled from various sources, as well as my personal analysis of the transactions themselves.
Start Block: 3,903,900
End Block: 3,908,029
Investment Time Period: 4,129 blocks or ~17.20 hrs
So this one got a bit hairy when summing up investor amounts from the smart contracts. You’ll notice (you probably didn’t notice) that I’m off by ~559 ETH from the reported numbers by the smart contracts themselves. This is because of the dynamic ceilings they employed.
So my analysis got a few of these transactions mixed up when combining external and internal transactions, which make my numbers slightly off, sue me (don’t). This annoys the shit out of me, but I don’t have the time to fix what went wrong. The trends will be the same, which is the main point of this article.
Total Supply Distribution:
Below is the Status graphic from the previously linked Contribution article for your convenience.
Note that the Status Genesis Allocation is “up to 10%.” Well, they didn’t actually give all of their allocation out, so the real numbers are as follows:
Status Genesis Token Holders: 6.92894026 %
Public Contribution: 44.07105974 %
Status Core Dev: 20 %
Reserved for Future: 29 %
Public Contributor Investment Distribution:
The remainder of this article is discussing that ~44% piece, specifically on how much of the total supply these investors control, and their distribution. In other words, we’d like to see how well the ICO did in “spreading their seed,” if you will. Were they premature like the majority of highly popular ICOs, or did they pace themselves well despite the crazy excitement?
MD: This is not an issue with a “proper” MOE process. There are no investors. There is no control. There is just federation of the process (like franchising of a restaurant when the franchisor … think PayPal without a linkage to banks … dictates operations and standards and otherwise has no interest).
With a “proper” MOE process, “all” franchisees must exhibit perfect transparency and thus exhibit perpetual perfect balance between the supply and demand for the money they certify. This means real time monitoring for defaults with immediate mitigation by interest collections of like amount.
Each unique address was summed up, giving its total contribution, and then placed into an “investor bin” that corresponds to how big of an investor they are. These bins are broken up by orders of magnitude of ETH, i.e.:
Important Note: These value percentages are relative to the TOTAL SNT SUPPLY, which shows what type of investor has what control over the entire Status platform. Also, it should be noted that these numbers are only good for showing the distribution at the moment the ICO ended. More on this later. Here is the table of investors:
MD: I really can’t believe this much work has gone into a concept that is so easily dispelled as total nonsense. No wonder the cognitive dissonance is so strong.
and the plot:
click the pic to blow it up
click the link below to bring up an interactive version
We can see from the numbers that smaller amount investors have significantly more control of the token supply than previous ICOs that I’ve analyzed. This is a significant pullback from the trend of very few people controlling the vast majority of tokens, albeit the trend still exists.
It should also be noted that this does not take into account the extra ~7% of token holders that are early contributors to the platform.
A few responses reminded me to point out that a unique address is not indicative of an individual, and such assumptions should not be made. I have discussed this in my TokenCard article, and did not include such a discussion. I guess it is prudent to say something.
MD: This does imply an issue that a “proper” MOE process has. At the money creation point, no trader is anonymous, no trader has more than one identity, no two traders have the same identity, and all traders are individuals … partnerships, corporations and governments need not apply. Common AAA principles (Authentication, Authorization, and Accounting) are strictly adhered to throughout.
Due to the way the ICO was structured, the savvy investor was incentivized to break up his desired large contribution amount into many smaller addresses, and spamming them into the ICO to try and see what sticks. If enough of this happens, then you basically sybil (not quite sybil, but you get it) the ICO into a DoS situation, which is what we saw. I don’t have enough data to say how much of the network congestion was due to this, maybe someone else will do a sweet analysis of that.
MD: With a “proper” MOE process there are no investors … savvy or otherwise. And there are no incentives. It’s all about trade and traders (like you and me). Further, there is no “time value of money”. Inflation is guaranteed to be zero. Thus, the cherished factor (1+i)^n is 1.000 for all “n” (“i” being always zero). Gamers in finance will need to find other work
There are some indicators that this was not the entire case, which you can read about in my response to Nick Johnson below, if you’re interested. There is another simple plot in there, for the people who just want eye candy.
People are hating on Status for various reasons, which are mainly driven from garbage understanding of how the Ethereum network works, and misplacing blame.
MD: You’re going to get that when you have a totally bogus concept with brains and no experience at the helm. KISS is unknown to them.
It was clear the fervor was there. They were aware of it, and managed to raise a bunch money while still allowing “the little guys” en masse. You can’t really argue with that… look at the distribution.
MD: Ponzi had no trouble getting takers either. Heck, his scheme was doubling their money in two to three months. And none took their money out. They couldn’t afford to. It was destined to double again in two to three months.
This is a good time for me to introduce the definition of a capitalist and the proof:
Definition: A Capitalist is two years and an elite privilege.
Proof: Give a person a privilege of starting a bank with $1M. They can then create 10x that in money which they lend to traders at a 4% spread. That gives them 40% per year return. It doubles their money in less than two years. They take back their $1M and let the other $1M which they made ride forever after (or for their remaining 28 year career). 30 years later they can cash out at $24,000M … and for 28 of those years they had no skin in the game at all!
What’s not to love about capitalism … if you have the privilege!
You’re not going to have capitalism (or its alter-ego, communism) if you institute a “proper” MOE process.
So I believe that Status took steps in the right direction of both allowing smaller investors to contribute to an ICO, as well as being sure of putting tokens directly into the people that contributed early. This allowed people who actually helped build the system also take advantage of the ICO craze that is clearly going on. Full disclosure, I received SGT tokens for early contributions, which made me personally not inclined to participate in the ICO. I would predict that other SGT holders also felt this way, thus removing our would be transactions into the clusterfuck that was the contribution period.
MD: More full disclosure required. What did you give for those SGT tokens? Here again, you have issues that only exist because you’re working with a bogus concept!
The Dynamics Ceiling approach worked to keep a constant supply of incoming transactions of lower value over a longer period of time. The network congestion that people blame Status for is not their fault, unless you can blame them for building something MANY people wanted to contribute to.
MD: I’m an atheist but “OH MY GOD!!!” “Dynamics Ceiling? KISS!!!!
I talk at length about these network congestion issues raised from the ICO craze with MyEtherWallet’s Taylor one of my recent podcasts, take a listen:
MD: Why in the world would anyone listen if they know what a “proper” MOE process is … let alone if one was in actual operation? Would you listen?
Of all the transactions that tried to participate, the smart contract refunded 111,161 attempts for a total of 347,154 ETH.Status refunded back more ETH than they raised.
I’m not sure you can call that “greedy.”
MD: A “proper” MOE process only has one opportunity for greed by the franchisee (and none by the trader … and there are no investors). He can load interest collections with exorbitant costs. But then he wouldn’t be competitive with the other franchisees. No one would come to his store. With a “proper” MOE process, “all” traders enjoy zero inflation … and responsible traders (those who never default) have zero interest load … unless they go to a greedy franchisee … which of course they never would. You have to be smart to be responsible.
Holla at ya Boi!
I do this because I’m curious, and feel this type of information is lacking. We need to keep an eye on “where the money comes from” as we build this community out.
MD: You “need to come to your senses”. Grasp the concepts of a “proper” MOE process and it should be impossible for you to give this nonsense another thought … period.
As always, come listen to The Bitcoin Podcast and BlockChannel to hear me talk to people in the space about what they’re doing. Our slacks (TBP and BlockChannel) are always welcome to the community as well. I’m always present in them to talk.
MD: You think they would tolerate having their Money Delusion shattered? People this sharp are masters at their own cognitive dissonance. Look how many really smart religious leaders there are. Follow the money in all cases.
If you don’t like slack, hit me up on twitter at @corpetty or email me at email@example.com
Throw me some duckets of you like what I’m doing, and have some to spare. The donations definitely help me stay motivated to do these:
MD: Duckets? Amazing. English has abandoned me in one short lifetime!
R: I have been a bit busy, but finally have a little free time to respond.
Dissecting select statements and then sniping at them with what is often presumptuous and self serving rhetoric (as you did with the Bitcoin shop piece and other readers feedback is a “TACTIC”.
MD: Replying without even referencing the issue of focus is worse. That’s typically what I run into. You are correct. It is a TACTIC. I read an article through the frame of what I know. When I come across something that is in violation of what I know and can prove, even if all I see is a symptom, my TACTIC is appropriate for calling attention to it.
R: Apparently you believe that this type of “dialogue” places you in the critics seat or “instructor” role providing “instructive critique”; it does nothing of the kind, and rest assured you do not enjoy that relationship with me.
MD: “Apparently” is the operative word here. Its root is “appear” … and thus it must appear so … to you. I am in the critics seat. And I am an instructor if I can produce evidence that contradicts what I am reading and prove it. And that is true even if my profession is not “instructor”. The root of the word is “instruct” and it means “teach a subject or skill”. And that’s exactly what my comments do … in as unambiguous fashion as possible.
R: Allow me to demonstrate:
TM – Without even knowing what those theories are, I think it is foolish. You don’t fix an “improper” MOE process by resetting it. You don’t fix an “improper” MOE process by switching to another “improper’ process. And if you have a “proper” MOE process in operation it never requires “re-booting”………”
RD – How can you comment upon the efficacy of any theories if you do not read them. You speak of a “proper” MOE but you repeatedly fail to identify it. Your statement indicates that it is not necessary to learn anything about other theories as only your own are of importance.
MD: When I know what is true and can prove it, I don’t need to know what is theorized if the mention of the theory makes it obvious, it goes against what is provably true. Re. Failing to identify a “proper” MOE process: that takes me about 500 words. I have done it at least 4000 times over the 4+ years it has become obvious to me. I can’t begin every comment with those 500 words. If you want to know the “proper” MOE process, just ask (actually, you can now see it in the right panel). I am now using my MoneyDelusions site to annotate these articles. Contained in the right column is the definition of money and the proof. I do need to add the description of the process … but anyone understanding the definition and proof should be able to easily arrive at the process themselves … and quickly see the defects in other “theories”.
TM – [T] Who is “they”. With a “proper” MOE there are no gains! … period! Usually are reset means the create a new name for their money, you redeem the old money for the new money at 1,000,000 to 1 … and it all starts over again
RD – Who to you think “they” are? It is the authors of the piece at the link. If you read the piece you would know this.
MD: Actually, it is not the authors of the piece … even in this instance. That’s why my method of annotating the actual article is my preferred mechanism. It was actually this article that motivated me to do it create the Money Delusions site. I had done it once before sometime back under a different umbrella … but after a while I was banished for breaking some rule … I was never told what. Money Delusions is now on my own host so I don’t have to deal with such nonsense. It’s not pretty yet … and may not ever be. But the points I make are indisputable.
TM – [T] “All” money is fiat … because all promises are fiat … they are made up by the person making the problem. And that’s not a bad thing … though fiat is “always” used as a slur…..”
RD – Of course the dollar and other currencies are Fiat money. The fact that I called the dollar Fiat currency should make it obvious to you that I am well aware all paper currency is Fiat. Bellicose statements are not required.
MD: What is obvious to me is you haven’t thought very deeply on the issue. Whether money is in the form of coin, currency, or simply ledger references is irrelevant. It “always” stands for an “in-process promise to complete a trade”. It is always … and only … created by traders getting their trading promises certified so they can span time and space. And of course, “all” promises are “fiat” … so “all” money is “fiat”.
As with you, the use of the term “fiat” is to contrast it with “sound” through a slur. “Sound” implicitly means “having intrinsic value” … and the the Bitcoin nuts have to extend it … having reference to “work done”. But once money becomes sound … i.e. trades for something of intrinsic value, it ceases to be money. The trade completed. When you say gold is money, all you’re really saying is that it is an inefficient, expensive, clumsy stand-in for real money. Anyone who takes it as money must somehow exchange it in a future time and space with zero loss of value in the gold itself. And that’s impossible because the supply/demand balance for gold is far from stable. With “real” money it is “perfectly” stable … perpetually … everywhere!
You are correct: Bellicose statements are not required. They just kind of take on that tone after addressing the tone deaf for 4+ years … who, in the final analysis resort to religious arguments when they’re trapped by proof … or run away as soon as they become unhappy with the form.
R: Do you see what I mean? Your style of communication does nothing to advance the discussion let alone your own theories.
MD: My style of communication does more than your style of rebuttal. You haven’t addressed anything of substance which I have asserted. You have only addressed my form. That is “your” TACTIC. It is avoidance. Avoidance is far worse than abrasiveness.
R: I am quite busy and have little time to engage in this level of discourse, let alone time to even read the DB, and I am “done” with this communication thread.
MD: You’re not too busy to make false assertions. You are just too busy to support them and defend them. As usual … the line goes dead … not after rebuttal but after rejection. There are no gloves soft enough for engaging you people.
R: Respond if you must, and if it follows your prior “protocol”, rest assured that it will receive all of the consideration it deserves!
MD: Here’s an article from GoldMoney.com about crypto currency. They don’t get it either … and I prove them wrong. See it at:
Thiel Fellow, Harvard dropout. Working on some fun projects. Hit me up @ firstname.lastname@example.org
Ever since Nas Daily’s video came out about how I earned over $400,000 with less than $10,000 investing in Bitcoin and Ethereum, I’ve been getting hundreds of questions from people around the world about how to get started with cryptocurrency investment.
MD: I have an email conversation documenting my conversation with a mover and shaker in Bitcoin … when it was less than $10. I need to dig that out. I recognized it as misguided immediately. Would I have been an “investor” by making probably $40M by buying it back then? Knowing it was a totally bogus concept? It would have made his 40x gain look like a grain of sand. Cryptocurrency cannot be both a currency and an investment … and it is not a currency … and it is not an investment. It is a Ponzi scheme … without a Charles Ponzi. It is pyramid marketing at its finest.
First: I’m super glad there’s so much interest in cryptocurrency right now. I firmly do believe that cryptocurrency and blockchain technology has the potential to fundamentally change much of the way our world currently operates for the better. It reminds me a lot of the internet in the 90s.
MD: Ok. This is the 101 class. If we get through this class without knowing exactly what “blockchain technology” is, well … did we really expect to? Not me … but I do hold out that hope.
Second: Investment in cryptocurrency isn’t something to be taken lightly. It’s extremely risky, extremely speculative, and extremely early stage still at this point in time. Countless speculators and day traders have lost their entire fortunes trading cryptocurrency. I was no different when I first started investing in crypto. The first $5000 I put into crypto fell almost immediately to less than $500 — a net loss of over 90%.
MD: So is the government sponsored lottery. It “guarantees” you a -50% return … unless you win. Then it guarantees a -80% return.
Third: All of the following words are entirely and solely my own opinion, and do not reflect any objective truth in the world or the opinions or perspective of any other individual or entity. I write them here merely so people can know how I personally approach cryptocurrency, and what I have personally found helpful in my foray into this realm.
MD: Man. Is this a clever way of saying “don’t get me wrong … I’m straight out lying to you right now!”
I’m firmly of the opinion that one should never invest in something one doesn’t thoroughly understand, so I’m going to split this article into three parts.
The first part will speak to a broad explanation of what bitcoin and cryptocurrency at large are. The second will discuss my personal investment philosophy as it pertains to crypto. The third will show you step by step how to actually begin investing in crypto, if you so choose. Each section will be clearly delineated, so feel free to skip parts if they’re already familiar to you.
MD: So I shouldn’t have to look beyond the first part. Bet me! I guarantee you I’ll come away asking “where’s the beef?”
Part I: What is Bitcoin? Why is it useful?
Great question. If you want the full story behind the advent of bitcoin, I highly recommend the book Digital Gold. It traces the entire history of bitcoin from its inception all the way up to 2015. It’s an engrossing read, and highly informative.
MD: This is what you get when you talk to religious acolytes. If you begin to ask questions, you get reading assignments and directed to a higher authority. I personally went through this religion … until I finally go so I and so informed they had to say “you’re just not going to get it”.
For now, let’s start with a quick history lesson about bitcoin. Bitcoin was officially unveiled to the public in a white paper published October 31st, 2008. The white paper is actually extremely readable, very short (just 8 pages), and incredibly elegantly written. If you want to understand why bitcoin is so compelling straight from the horse’s mouth, you must read this paper. It will explain everything better than I or anyone else likely ever could.
MD: Or if it was so “elegant” he could tell us the concept with making us go there. Another religious reading assignment from one who claims to be teaching us. My electrical engineering instructors gave me reading assignments to how ohms law worked. They just wrote down on the chalk board.
I won’t delve too much into the technical details of how bitcoin works (which are better elucidated in the white paper), but will instead focus on a broader exploration of its history and implications.
MD: You always get this from those who”can’t” delve into the technical details. They come across as condescending when in reality, they don’t get the details themselves. History and implications? Isn’t that what I get with “all” religions? Believe it or you’re going to hell?
Subpart: The Background Context of Bitcoin
Bitcoin was invented in the aftermath of the 2008 financial crisis, and the crisis was a clear motivating factor for its creation.
Numerous banks and other financial institutions failed across the world, and had to be bailed out by governments at the expense of their taxpayers. This underscored the fragility of the modern financial system, where the health of our monetary system is reliant on banks and other financial institutions that we are forced to trust to make wise and prudent decisions with the money we give them. Too often for comfort, they fail to carry out this fiduciary responsibility to an adequate degree.
Of particular note is fractional reserve banking. When you give a bank $1,000, the bank doesn’t actually keep all that money for you. It goes out and is legally allowed to spend up to $900 of your money, and keep just $100 in the off chance that you ask for your money back.
MD: They don’t keep “any” of that money. Banks have an elite privileges of 10x leverage on their fictional capital. A capitalist is defined as “two years”. Give an elite person the privilege to invest say $10M and lend then lend out $100M at a 4% spread. That gives them a 40% return on their $10 in less than two years. They can then take their $10M off the table and let the rest ride. Over the span of a 30 year career, that is a return of over 12,000x … at zero risk. Do you really think there is any kind of capitalism besides “crony” capitalism?
In the most simplistic case, if you are the only depositor at this bank, and you ask for more than $100 back at once, the bank won’t be able to give you your money, because it doesn’t have it any more.
Shockingly, this is actually how banks work in reality. In the United States, the reserve requirement, or the percentage of net deposits banks are actually required to keep in liquid financial instruments on hand, is generally 10% for most banks. This means that if a bank has net deposits of a billion dollars, it needs to only keep 100 million on hand at any given time.
MD: With a “proper” MOE process there is no reserve requirement at all. There are no banks. It recognizes it is traders who have been the creators of money all along.
This is fine most of the time, as generally the customers of that bank won’t all try to cash out at the same time, and the bank is able to stay liquid. However, the moment customers start to question the bank‘s financial stability, things can go south very quickly. If just a small number of customers begin asking for all their deposits back, a bank can rapidly become depleted of all its liquid funds.
This leads to what’s known as a bank run, where the bank fails because it is unable to fulfill all the withdrawals customers demand. This can escalate quickly into a systemic bank panic, where multiple banks begin to suffer the same fate. Each successive failure compounds the collective panic, and quite quickly, the whole system can begin to collapse like a house of cards.
MD: With a “proper” MOE process, there is no such thing as a “bank run”. First, there are no banks. Money is guaranteed to exhibit zero inflation so there is no return a bank can give someone on their money. They’re just as well putting it under a secure rock … it never devalues … like bank money does with it’s designed in 4% leak.
I’m now going to scan ahead to where he tells me how a block chain works. You can read this nonsense if you want to. Otherwise, scan ahead with me.
This is what led in large part to the Great Depression, for instance. The whole system is fundamentally predicated on trust in the system, and the second that vanishes, everything can go south incredibly quickly.
The financial crisis of 2008 highlighted yet another risk of the modern banking system. When a bank goes out and spends the 90% of net deposits it holds in investments, it can often make very bad bets, and lose all that money. In the case of the 2008 crisis, banks in particular bet on high risk subprime mortgages. These were mortgages taken out by borrowers very likely to become delinquent, to purchase houses that were sharply inflated in value by the rampant ease of acquiring a mortgage.
When those mortgages were defaulted on, the artificially inflated values of the homes began to collapse, and banks were left holding assets worth far less than the amount they had lent out. As a consequence, they now had nowhere near the amount of money that customers had given them, and began experiencing liquidity crises that led to their ultimate bankruptcy and demise.
After the Great Depression occurred, the government attempted to address this issue by creating the Federal Deposit Insurance Corporation (FDIC), which technically guarantees all customer deposits in participating banks up to $250,000 per account.
Unfortunately, the FDIC is just as dramatically underfunded as banks are. As the FDIC itself acknowledges, it holds enough money to cover just over 1% of all the deposits it insures. In other words, if banks reneged on any more than 1% of all their deposits, the FDIC itself would also fail, and everyone would yet again be left in the dust without recourse.
In fact, this has already happened. The FDIC used to have a sister corporation that insured savings and loan institutions, as it itself at the time only insured bank deposits, and not savings and loan institution deposits. This was known as the Federal Savings and Loan Insurance Corporation, or FSLIC.
In the savings and loan crisis of the 1980s, over 1,000 of the 3,200 savings and loan institutions in the United States failed in rapid succession. The FSLIC almost immediately became insolvent itself, and had to be recapitalized several times with over $25 billion dollars of taxpayer money. Even this didn’t even come close to being sufficient to solve the crisis, and the FSLIC managed to only resolve the failure of less than 300 of the 1000 bankrupt institutions, even with all the handouts from taxpayers, before it just flat out gave up and dissolved itself.
For the most part, things generally work fine on a day to day basis. This belies, however, the true fragility of the system. It’s hard to anticipate these things before they happen, because it’s so easy to fall into the trap of assuming that things will always be as they mostly always have been. If things have been fine yesterday, and the day before, and the few years before that, or even the few decades before that, we just naturally assume that they will continue to be fine for the indefinite future.
History has proven this to be an often fatal assumptive error. The second things start to stop working, they tend to stop working in an extremely rapid, catastrophic fashion. There’s very little, if anything, stopping us from seeing another Great Depression sometime in the future, be it the near or longer term future. When that does happen — and it almost certainly will, sooner or later, if history is any good teacher — those who haven’t adequately prepared for it and taken appropriate prophylactic measures may very well find themselves in a bad spot.
Subpart: Fiat Currencies Compound the Dilemma
Mistrust in fiat currencies, or currencies created and backed solely by faith in a government, both because of the modern banking system and because of the inherent nature of fiat currency, has in large part been why gold has been used as such a reliable store of value over millennia.
Fiat currencies are the world’s predominant form of currency today. The US dollar or the British pound, for instance, are fiat currencies. These are currencies that are entirely controlled in their supply and creation by a national government, and are backed by nothing but faith in that government.
This has proved a mistake countless times throughout history. Zimbabwe is a classic example, where the Zimbabwean dollar, thanks to an incompetent government among other factors, experienced enormous levels of hyperinflation. At one point, inflation was estimated at almost 80 billion percent in just a single month.The following image gives an idea of just how rapidly and absurdly a fiat currency can spiral out of control, once it reaches the point of no return.
Lest we think this an isolated instance, Venezuela is experiencing incredibly similar hyperinflation in the present-day, right this moment. The Venezuelan Bolívar inflated over 800% in 2016, and shows no signs of stopping in 2017.
The US hasn’t been immune to these crises, either. The US began its foray into fiat currency with the issuance of Continental Currency in 1775. Just three years later, Continental Currency was worth less than 20% of its original value. 13 years later, hyperinflation entirely collapsed the currency, and the US had to pass a law guaranteeing that all future currencies would be backed by gold and silver, and that no unbacked currencies could be issued by any state.
In comparison, the early history of the US dollar makes the relative volatility of bitcoin in these first 9 years look like peanuts.
Once adopted out of necessity, the gold standard became part and parcel of US currency, just as it was with most other currencies from around the world. The gold standard removed some of the need to have pure faith in US dollars in of themselves, as it guaranteed that all paper money the US issued would be exchangeable at a fixed rate for gold upon demand.
Naturally, you still had to believe that the government would actually keep enough gold to fulfill all these demands (déjà vu and foreshadowing, anyone? Any flashbacks to fractional reserve banking yet?), but it was certainly better than nothing.
Gold, unlike fiat currencies, requires no trust and faith in a government to responsibly manage its money supply and other financial dealings in order to believe that it will retain its value well over time. This is because gold has no central authority that controls it and effectively dictates its supply and creation arbitrarily. Gold is fundamentally scarce, and only a small amount of it can be mined every year and added to the whole net supply. To date, the estimated total of all the gold ever mined in the history of humankind is only 165,000 metric tons. To put that in perspective, all that gold wouldn’t even fill up 3.5 Olympic sized swimming pools.
No government, no matter how much they wanted to or needed to, could simply conjure up more gold on demand. Fiat currencies, on the other hand, can and often have been printed on demand by governments whenever they happened to be short on cash and needed a quick infusion.
This printing of more money generally leads to inflation, as the total value of all the money in existence rationally should stay the same, no matter how many dollars are printed. Hence, if more dollars are printed, each dollar is worth fractionally less of the total money supply.
In fact, governments design their currencies and monetary policies to inflate intentionally. This is why $100 US dollars in 1913 (when the government officially started tracking inflation rates) is equivalent to $2,470 dollars today, just over 100 years later.
Gold, on the other hand, doesn’t inflate like fiat currencies do. That’s because there’s an intrinsically limited supply, and consequently, things tend to cost the same in gold over long periods of time. In fact, 2,000 years ago, Roman centurions were paid about 38.58 ounces of gold. In US dollars today, this comes out to about $48,350. The base salary of a captain in the US army today comes out to just about the same at $48,500.
This makes gold, in many ways, a better store of value based on fundamental principles than fiat currencies over time. You don’t have to trust anyone to trust that your gold will retain its value relatively well across the sands of time.
Unfortunately, the gold standard collapsed multiple times during the 20th century and was ultimately abandoned altogether by almost every nation in the world, because governments effectively played fractional reserve banking with their gold reserves. Who could blame them? It must be irresistibly tempting, knowing that in all likelihood, the vast majority of the time, only a fraction of people will ever want to trade in their dollars for gold. Why hold all that gold when you could hold just a fraction of it and get to spend the rest with no consequences in the short term?
Inevitably, this caught up with each and every government over time. For the United States, the gold standard was suspended in the aftermath of the Great Depression. The Bretton Woods international agreement instituted in the aftermath of World War II restored the gold standard to the US dollar, but this was short lived.
Under the Bretton Woods system, numerous foreign governments held US dollars as an indirect and more convenient method of holding gold, as US dollars were supposedly directly exchangeable at a fixed rate for gold. However, by 1966, gold reserves actually held by the US were already pitifully low, with only $13.2 billion worth of gold being held by the government.
By 1971, other governments had caught on to this, and began demanding the exchange of all their US dollars for gold, as was promised to them. Naturally, the US had nowhere near enough gold to fulfill their promises, and this became a government version of the bank run, essentially.
The US chose instead to fully renege on their promised exchange rate, and announced in what was known as the Nixon shock that the US dollar would no longer be redeemable for gold, and would henceforth be backed solely by faith in the US government (very faith-inspiring, no?).
Almost every nation quickly followed suit, and since then, fiat currencies have been allowed free reign to grow as they please with no accountability whatsoever in how much a government chooses to expand their money supply.
This, thus, requires anyone holding fiat currencies to have extreme trust that their government will manage their money supply responsibly, and not make poor financial decisions that will severely devalue the currency they hold. This compounds with the trust one must hold in the banks in which one deposits their fiat currency, to create an ultimate monetary system that has multiple points of very real possible failure, as history has shown time and again.
Holding gold privately removes the need to trust either of these points of failure in the modern banking system, but comes with its own host of problems. Namely, while gold has proven to be an excellent store of value over time, it is incredibly poor for actual day to day use in the modern economy. To transact with gold is excessively cumbersome and inconvenient. No one would consider walking around with an ounce of gold on them, measuring and shaving off exact portions of gold to pay for a cup of coffee, groceries, or a bus ride. Worse, it’s even more difficult and time consuming to send gold to anyone who isn’t physically in the same exact location as you.
For these reasons among others, fiat currencies have traditionally been preferred for everyday use, despite their many shortcomings and associated inherent risks.
No solution to this tradeoff conundrum has heretofore been discovered, or even necessarily possible. Bitcoin, however, with the aid of recent technological advances (computers and the internet), solves all of these issues. It takes the best of both worlds, and puts it into one beautiful, elegant solution.
MD: Ah … finally, we’re about to hit the mother lode!
Subpart: Bitcoin to the Rescue
Holy long-windedness, batman! 2,700 words later, and we finally get to talking about bitcoin. I’m as relieved as you are. Remind me never to write again.
Bitcoin was designed, essentially, as a better ‘digital gold’. It incorporates all of the best elements of gold — its inherent scarcity and decentralized nature — and then solves all the shortcomings of gold, in allowing it to be globally transactable in precise denominations extremely quickly.
How does it do this? In short, by emulating gold’s production digitally.
MD: He comes right out there and says it. It emulates an attribute of gold which is proven “not” to be an attribute of real money … but observe, still nothing on the block chain.
Gold is physically mined out of the ground. Bitcoin is also ‘mined’, but digitally. The production of bitcoin is controlled by code that dictates you must find a specific answer to a given problem in order to unlock new bitcoins.
In technical terms, bitcoin utilizes the same proof-of-work system that Hashcash devised in 1997. This system dictates that one must find an input that when hashed, creates an output with a specific number of preceding zeros, among a few other specific requirements.
MD: Another reading assignment. But “proof of work” has nothing to do with making a promise. The work come in “delivering on the promise”. It is a promise over time and space. What’s the point in reaching back for some other trader’s work? See how they’re off the tracks before even blowing the whistle to leave the station?
This is where the ‘crypto’, incidentally, in cryptocurrency comes from. Cryptographic hash functions are fundamentally necessary for the functioning of bitcoin and other cryptocurrencies, as they are one-way functions. One-way functions work such that it is easy to calculate an output given an input, but near impossible to calculate the original input given the output. Hence, cryptographic one-way hash functions enable bitcoin’s proof of work system, as it ensures that it is nigh-impossible for someone to just see the output required to unlock new bitcoins, and calculate in reverse the input that created that output.
MD: Ok. He has described the long well known RSA technique … which was an improvement over the “exclusive or” … which by the way … works just as well or better with a “one time pad”. So they’re mining for these big “one-way” factors. Aren’t all the other cryptocurrencies doing the same thing? Aren’t they “all” coming up with the same numbers? Even if they’re not, the block-chain is worthless for real money if it costs anything but “zero” to create a new block.
Bitcoin is further ingeniously devised to guarantee that on average, new bitcoins are only found every 10 minutes or so. It guarantees this by ensuring that the code that dictates the new creation of bitcoin automatically increases the difficulty of the proof-of-work system in proportion to the number of computers trying to solve the problem at hand.
MD: But it has no idea how many computers are trying to solve the problem … so it can’t know it will take 10 minutes … can it!
For instance, in the very beginning of time, it was only the creator of bitcoin who was mining for bitcoins. He used one computer to do so. For simplicity’s sake, let’s assume this one computer could try 1000 different values to hash a second. In a minute, it would hash 60,000 values, and in 10 minutes, 600,000 values.
The algorithm that dictates the mining of bitcoins, therefore, would ensure that on average, it would take 600,000 random tries of hashing values to find one that would fulfill the requirements of the specified output required to unlock the next block of bitcoins.
It can do this by making the problem more or less difficult, by requiring more or less zeros at the beginning of the output that solves the problem. The more zeros that are required at the beginning of the output, the more exponentially difficult the problem becomes to solve. To understand this why this is, click here for a reasonably good explanation.
MD: Another reading assignment. I presume it will explain how this ingenious scheme took into account deployment of FPGA’s, ASICs, and massively parallel computer meshes … and still takes 10 minutes per block. Do I really have to do the reading assignment?
In this case, it would require just the right amount of leading zeros and other characters to ensure that a solution is found on average every 600,000 or so tries.
However, imagine now that a new computer joins the network, and this one too can compute 1000 hashes a second. This effectively doubles the rate at which the problem can be solved, because now on average 600,000 hashes are tried every 5 minutes, not 10.
Bitcoin’s code elegantly solves this problem by ensuring that every 2,016 times new bitcoin is mined (roughly every 14 days at 10 minutes per block), the difficulty adjusts to become proportional to how much more or less hashing power is mining for bitcoin, such that on average new bitcoin continues to be found roughly every ten minutes or so.
MD: So how does it even know how much “hashing and mining” is going on? I’m not buying this argument … but even if its true, the scheme is a non-starter for money where the cost of creating a new block in the chain “must be zero”.
You can see the present difficulty of mining bitcoin here. It should be evident from a half-second glance that the amount of computing power working to mine bitcoin right now is immense, and the difficulty is proportionally similarly immense. As of the time of this writing right now, there are close to 5 billion billion hashes per second being run to try to find the next block of bitcoin.
This system holds a lot of advantages even over gold’s natural system of being mined out of the ground. Gold’s mining is effectively random and not dictated by any perfect computer algorithm, and is consequently much more unpredictable in its output at any given moment. If a huge supply of gold is serendipitously found somewhere, it could theoretically dramatically inflate the rate at which gold enters the existing supply, and consequently cause an unanticipated decrease in the unit price of gold.
MD: But the gold attribute of rarity is the opposite of what we want for money. We want money to be in “free” supply. So this whole concept of wasting to create money is counterproductive.
This isn’t just theoretical — it’s the reality of gold production. This graph illustrates vividly the fact that gold production has been dramatically increasing over time, and is today over four times higher than just a hundred years ago.
In fact, more than half of all the gold that has ever been mined in the history of humankind has been mined in just the past 50 years. The difficulty of mining gold doesn’t proportionally increase with the number of people mining it, or with technological innovations that make it significantly easier to locate and mine gold over time.
In fact, it’s already known for certain that there will only ever be a total of 21 million bitcoins in the world.
MD: If the total is 21 million, won’t mining stop when that is reached? We already know it’s an issue. They just “forked” the whole process … after a big disagreement among those who control this “non-controlled” money.
This is because the amount of bitcoin that is mined every time a hash problem is solved and a new block is created halves every 210,000 blocks, or roughly every 4 years.
The initial reward per block used to be 50 bitcoins back in 2009. After about four years, this dropped to 25 bitcoins in late 2012. The last halving occurred in July 2016, and dropped the reward per block mined to 12.5. In 2020, this should go down to 6.25, in 2024, 3.125, and so forth, all the way until the reward drops to essentially zero.
MD: If these drops happen at epochs, that’s another reason to find this whole scheme disgusting.
When all is said and done, there will hence be 21 million bitcoins. Exactly that, no more, no less. Elegant, no? This eliminates yet another risk with extant currencies, gold included: there are absolutely no surprises when it comes to knowing the present and future supply of bitcoin. A million bitcoin will never be found randomly in California one day and incite a digital gold rush.
On top of this, bitcoin is trivially divisible to any arbitrary degree. Presently, the smallest unit of bitcoin is known as a satoshi, and is one hundred millionth of a single bitcoin (0.00000001 bitcoins = 1 satoshi).
MD: And this is the same argument that traps the gold-bugs. You can’t just change the value of an ounce of gold. It gives an advantage to all current holders of gold … and to current gold miners. The same has to be true for bitcoins as well. You don’t solve a scarcity problem by cutting into smaller and smaller pieces. A proper MOE process creates exactly as much money as is needed at any point in time. It is the nature of every trade.
This means that unlike gold, bitcoin is perfectly suited to not only being an inflation-proof store of value, but also a day-to-day transactable currency as well, as it is easily divisible to any arbitrary amount. You can buy a cup of coffee with it just as easily as you can buy a car.
MD: Oh, it’s inflation proof alright. In fact, it is so “deflationary” that traders will never spend one. They will never use one in trade. Why make a trade in one today when you can make the same trade tomorrow for twice as much stuff … and twice as much again the day after that?
Moreover, bitcoin can be sent incredibly quickly and remotely over the internet to anyone anywhere in the world. This is because when bitcoin is mined, the miners are actually providing a service in powering the bitcoin network.
MD: So can any other kind of information. And bitcoin mining has nothing to do with this. No “mining” is necessary to maintain the ledgers of domain names by the DNS servers.
What happens when a miner mines bitcoin is actually that they add a ‘block’ to what is known as the ‘blockchain’. The blockchain is a ledger that contains a record of every transaction ever made with bitcoins since its inception. When someone decides to mine bitcoin, they must download the entire blockchain as it presently stands.
MD: Download it from where? Don’t they already have it as part of the process?
Then, when they successfully find a solution to the next hash problem and mine a block of bitcoins, something magical happens. They get to add the block they just mined to the end of the existing blockchain — and with it, they include every transaction that was initiated on the bitcoin network since the last block was mined. They then propagate this block they just created to the rest of the network of bitcoin miners, who all then update their own blockchains with this new block, and begin working on solving the next hash problem.
MD: So where do they find “every transaction that was initiated on the bitcoin network since the last block was mined? What keeps those transactions from being forged in the mean time?
As a reward for providing this valuable service, miners are allowed to add a single transaction to the beginning of the block they mined, called the ‘coinbase transaction’. This transaction contains the brand new bitcoin that was created when they mined the block, and allows the miner to claim this bitcoin for themselves.
MD: Whoopee! Where else is he going to record it? The last block is, by definition, full?
At this point, a particularly shrewd reader might become concerned with the fact that the reward for mining a new block of bitcoin gradually shrinks to zero. Won’t this cause miners to stop mining bitcoin, and consequently to stop providing the invaluable service that allows the bitcoin network to function and for transactions to be sent?
MD: Seems to me, the reward goes to infinity … not zero. The cost may go to infinity too.
The answer is no, because miners are not solely rewarded by the new bitcoin that is generated each time they mine a block. Users may also send a transaction fee along with their transactions, which is paid out to any miner who decides to include their transaction in a block they mine. Over time, as the bitcoin network becomes used for more and more transactions, it is expected that transaction fees will be more than sufficient for incentivizing enough miners to continue mining blocks to keep the bitcoin network safe, secure, and robust.
MD: Is that transaction arbitrary? Is is competitive? Typically, when they have a solution to an improperly understood problem, and keep getting trapped by its failures, the institute more and more complicated practices to mitigate it.
It’s important that enough miners keep trying to mine blocks because this is another valuable service miners provide the network. Bitcoin, like gold, is powerful as a store of value because it is decentralized and trustless. There is no one central authority who holds all the power over bitcoin, just like no central authority holds power over gold.
MD: Trust is a fact of life. You don’t go into any day without trust. As Reagan said … trust … but verify. Transparency is all that is needed. Society will do the rest. A “proper” MOE process has no central authority either. For all intents and purposes it is an “open source” solution to trade over time and space. Meet the criteria and you are a player. Fail to meet the criteria and nobody comes to your party.
No one person or government can decide to conjure up more bitcoin on demand, or to take it away. The only way the rules that govern bitcoin can be changed is if the software bitcoin miners run to mine bitcoin is changed.
MD: What do you mean? There are myriad versions out there now! It’s become a very noisy space … like initial radio transmission by sparks.
Technically, any bitcoin miner could decide to change the software they run to mine bitcoin at any time. However, this still doesn’t have any impact on changing bitcoin itself. What it would do is cause a ‘hard fork’, or a divergence in the block chain.
MD: And a hard fork is just what they collectively took … at least some collectively took. And they can fork again … and again. And every time they fork what they have has less and less a chance of facilitating trade over time and space … i.e. being money.
This occurs because any block that the rogue miner who changed their software mines won’t be accepted by all the other miners who are still running the original software. Consequently, all the other miners will begin mining different blocks, and adding those to their blockchain. This leads to a fork in the road, essentially, where two completely different blockchains are formed — one by the rogue miner, and one by all the other miners.
MD: And a “proper” MOE process doesn’t have this problem. For all instances, INFLATION = DEFAULT – INTEREST = zero; and money is created transparently by traders and is thus in free supply. Bitcoin is worse than non-competitive. It is outright dimwitted!
Everything up to the point of the software change remains the same in both blockchains, but after that change, the blockchains diverge. Once diverged, they can never be reconciled and remerged.
MD: Oh really? Not that that is any concern of mine, but I guarantee, they is a way to merge blockchains. All it takes is a “forking” block and a “merging” block to hook up the hashes.
This isn’t a concern, however, because the bitcoin network runs on consensus, and accepts whichever blockchain is the longest. In practice, this means that whichever blockchain has the most computing power behind it is effectively guaranteed to win, as they’ll be able to calculate the solutions to the hash problems and find new blocks faster than their less powerful competitors.
MD: So what happens to all the transactions when it switches from one long chain to a longer chain?
This does mean that in theory, bitcoin is vulnerable to what’s known as a 51% attack — an attack in which if a single entity was able to gain control of at least 51% of the total hashing power being directed at bitcoin mining, it could outpace a legitimate blockchain and temporarily take control of the network.
MD: Should I know what is meant by “hashing power” by now? I don’t.
This is an extraordinarily difficult feat to accomplish, however, as the more people there are mining bitcoin, the harder it is to take over the network. At the current worldwide mining rate of almost 5 billion gigahashes a second, it would be extraordinarily difficult for even the most powerful organizations in the world (e.g., large-scale governments) to mount a successful 51% attack. It would be enormously costly, and quite possibly more financially detrimental to the attacker than to the network.
Indeed, the only thing a 51% attacker could really accomplish is destroying collective faith in bitcoin. They couldn’t somehow steal and gain all the value of bitcoins for itself. The attacker wouldn’t be able to generate new bitcoins on demand arbitrarily, and would still have to mine for them. They also would have no control over taking bitcoins created in the past that didn’t belong to them. The only thing they could do, really, is repeatedly spend bitcoin they already owned again and again, but even this is limited in its value, because ‘honest’ miner nodes would never accept these fraudulent payments.
MD: So, there is no such thing as a 51% attack. Oh … I see… they could “counterfeit”. And the process has no way of showing that that is being done. A “proper” MOE process has that kind of transparency built in … and it spells out specifically, for all to see, who is doing it. Does tarring and feathering come to mind?
Hence, no rationally self-interested bitcoin miner would ever try to mount a 51% attack, as in all likelihood, they would lose massive amounts of money doing so and gain almost nothing from the effort. The only reason someone would want to conduct a 51% attack is to attempt to destroy faith in bitcoin — large governments, for instance, who might one day feel that their fiat currencies that presently provide them great value to them are becoming threatened by bitcoin. However, the likelihood even of these enormous entities to successfully conduct a 51% attack is already becoming vanishingly small, as mining power increases.
MD: Ah … trot out the boogy man … big government. Heck, a “proper” MOE process puts big government in its place in much more constructive fashion. It just competes them away. They “have” to use force … and they’re using force against their own constituency. How is that going to play out?
Thus, bitcoin has perfectly utilized recent technological advances to create something heretofore impossible: an extremely safe, reliable, decentralized, and globally transactable digital and better version of gold, and possibly of all types of extant currency at large.
MD: But as is easily proven … gold is an awful role model. A proper MOE process would easily drive out bitcoin … just by competing it into oblivion.
The advantages don’t stop there, however. Bitcoin is also ‘pseudonymous’, meaning that while all transactions ever conducted on the network are public and known by all as everything is recorded in the blockchain, unless someone knows who owns the bitcoins that are being used in these transactions, there is no way to trace those bitcoins and transactions back to a given person or entity.
MD: Again. That’s an attribute you don’t want money to have in its “use”. You only want that attribute in its “creation”. Transactions in a “proper” MOE process are totally confidential. He cites an attribute that a proper MOE process doesn’t have either … it is a strawman argument.
This serves a dual purpose of both allowing extreme transparency when desired in making transactions, and also allowing a lot of anonymity when desired. If one wants to ensure that they have perfect undeniable proof of their transactions, all they have to do is prove they own certain bitcoins, and then any and all transactions conducted with those bitcoins are undeniably theirs and most certainly occurred.
MD: I don’t think proof of ownership of a certain instance of exchange media is necessary or desirable. What is essential is knowing it is not counterfeit. The same encryption techniques bitcoin uses could be employed to assure this … without saying anything about ownership or origination.
If one wants, rather, to keep the movement of their money less overt, one simply needs to ensure that the bitcoins they own are never tied to their identities, and that their transactions on the network are obfuscated. This can be accomplished with a variety of methods, such as using a tumbler, which allows one to send bitcoins to an intermediary service that will mix these bitcoins with bitcoins from numerous other sources, and then send bitcoins forward to the intended destination from sources entirely unrelated to the sender’s original bitcoins.
MD: But with a “proper” MOE process, the exchange media is “never” tied to any identity. The only identity is “who created money, when, under what promises, and have they delivered as promised”. That’s at the creation and tracking point which is “not” anonymous … but rather totally transparent. It is “not” at the point of use. In fact, there is “no” way to do it at point of use.
To clarify this a bit more, bitcoins are stored at what are known as ‘addresses’. Think of this as an email address or a mailing address. These addresses allow for the storage, sending, and receiving of bitcoin. The blockchain ledger contains a complete record of the movement of bitcoins from one address to another.
MD: This seems like a stupid way to assure that the coin is not counterfeit.
A tumbler allows someone who say, wants to move bitcoins from address 10 to address 100, to instead move their bitcoins from address 10 to a totally random address, say 57. In some other transaction, the tumbler has accepted bitcoins from someone entirely unrelated at say, address 20, who wanted to send the coins ultimately to 200 and sent these instead to another completely random address 42. It then sends the coins stored at address 42 from sender 2 to the address sender 1 originally desired, 100, and sends the coins stored at address 57 from sender 1 to the address sender 2 desired, 200.
MD: None of these issues have existed between traders who do business on account. Why are they an issue now? You keep your set of books … I keep mine. We reconcile regularly. If we don’t agree, we investigate … and find and correct the point of disagreement.
This is highly simplified, but effectively how a tumbler works, albeit at much larger scale, and with many more senders and receivers of all sorts of varying amounts.
MD: Notice how enormously … and unnecessarily … complicated this has all become? This is characteristic of minds that go off the track, can keep unbelievable strings of detail in memory … but can’t see they have gone off the track. They just keep running into problems and solving them. If they had taken a different turn, they wouldn’t have run into any of these problems in the first place. But by now, they are the only ones who understand the mess they have created. It’s much easier to know something by being involved in every stupid step, than it is to try to figure it out from documentation that is worse than randomly dropped crumbs.
This ability to transact more anonymously in a digital, global fashion than ever before has indeed opened the gateway to some of bitcoin’s more infamous use cases. Much illicit activity has been enabled by this pseudonymity of bitcoin, including the sale of drugs and other illegal goods online. A more recent development has also been ransomware, whereby malware can now cut straight to the chase and lock up your computer and demand straight up money in the form of bitcoin in exchange for the release of your computer’s data.
MD: Actually this “illicit” activity is the only trading activity using bitcoin. Real traders are not going to use it. It’s appreciating too fast. People who are thieves are the only ones using it. You don’t steal in slow motion in broad daylight.
These developments have been enabled not only by bitcoin’s pseudonymity, but also the irrevocability of transactions. Unlike current forms of digital payment, such as credit cards and bank transfers, bitcoin transactions are irreversible and do not involve any middleman who can mediate between disputes.
MD: That’s like an accounting system that requires you make reversing entries in a journal rather than fixing mistakes directly. It’s just an audit trail. It’s nothing novel.
This has its disadvantages, but also its advantages, and was indeed one of the primary benefits the creator of bitcoin (a pseudonymous as-of-yet unidentified figure himself, Satoshi Nakamoto) outlined in the bitcoin white paper. In his own words:
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.
MD: This is nonsense. There is all kinds of trading going on with no intermediate party. And more will come into the fore with a “proper” MOE process.
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 nonreversible services. With the possibility of reversal, the need for trust spreads.
MD: Again … nonsense. It would be a simple task to implement a micro billing system to say “read articles like this and pay the author”. You pay ten cents and you get an copy of the article. The ten cents is added to your account which you pay each month. Essentially zero transaction. Essentially zero payment cost.
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.
What is needed is an electronic payment system based on cryptographic proof instead of trust, allowing any two willing parties to transact directly with each other without the need for a trusted third party. Transactions that are computationally impractical to reverse would protect sellers from fraud, and routine escrow mechanisms could easily be implemented to protect buyers.
MD: Base it on transparency and you have close enough scrutiny to make “proof” unnecessary. You have evidence. You know exactly where your evidence, and your trading partner’s evidence deviates … and you know why. If something shows up on your bill, it should who up on records of being shipped to you … and shipped by them to you. That’s just one type of instance where the audit trail is the proof … and you don’t have to trust in the audit trail … you trust in the process, and know it to be worthy of your trust because it is constantly proving it to you.
As Satoshi notes, bitcoin’s irreversible, trustless nature removes the need for any middlemen to mediate and broker the process of payments from one person to another. Middlemen (e.g. banks and credit card networks) inherently introduce overhead costs and inefficiency into the system, which make transactions — and micropayments in particular — more costly than would otherwise be the case.
MD: He has slain the strawman. Big deal.
Fraud is also inherently eliminated, as any transaction propagated and confirmed by the bitcoin network by 6 or more blocks is generally accepted to be impossible to ever revoke.
MD: With a proper MOE process, there is no limit to the number of entities that would have a copy of all transactions a particular trader makes in the process of creating and returning money. Services like title companies would even sprout up to “insure” this.
Trustlessness in this sense is a huge component and advantage of bitcoin and cryptocurrency at large. Another ground-breaking innovation the blockchain introduces is the concept of a smart contract, or a contract that similarly requires no trust or middleman to mediate, but is rather contractually executed in a deterministic fashion through code run on the blockchain.
MD: Only in their imagination is it a “huge component and advantage”. They’re solving a non-problem. The real problem is our money’s 4% leak that sustains government and all tax dollars going to the money changers. The solution to that problem is a little less than trivial. A proper MOE process solves it immediately … and through competition … not by edict or force.
Traditionally, with a legal contract, two parties agree to certain terms with the understanding that if one party reneges, the other party can seek legal recourse with the governmental justice system. Lawsuits, however, can often be inordinately expensive, and in many cases the outcome is far from certain. A good or bad lawyer can make or break a case, and one is also at the mercy of a judge and/or jury and their subjective, possibly mercurial whims. Not the most efficient or foolproof system.
MD: Bad example to choose? How many of the legal contracts that are presented to you daily on the internet do you actually read? Answer: zero. You don’t have time to read them. And you didn’t read your FHA contract when you bought your house either … or you would not have signed it. You wouldn’t have agreed to their demand that you insure against a risk “they” don’t have.
A contract written with and enforced by code, however, removes the need to trust a third party arbitrator (such as a court system), in much the same way that transactions enforced by bitcoin’s code remove the need to trust a third party financial institution. The code is written in such a way that clearly specifies the conditions of the contract, and will automatically enforce these conditions.
MD: Open source doesn’t give such insurances. Why would we expect Bitcoin to. The more complicated you make it … especially when unnecessarily so … the more vulnerable you make it to attack and abuse. Keep it simple stupid!
For instance, if two parties decide to make a bet on Donald Trump winning the election, historically, this could only be done by either word of honor or by some ad hoc legal contract. For a say, small $100 bet, it would be absolutely a non-starter to pursue legal action in the case that one of the parties decided to renege on the deal in the aftermath of the election. Normally, the reneged-upon party would simply be left in the dust without recourse.
MD: Bookies have performed that service for eons. They don’t last long if they don’t perform that service robustly.
With the advent of smart contracts made possible by the blockchain, however, this is (soon-to-be) a thing of the past. One can create a simple smart contract at effectively almost no cost that specifies in code that each party will send it $100 in bitcoin, and that upon the completion of the election process, it will either send all $200 to the party that bet on Donald Trump winning the election, or send the $200 to the party that bet on him losing the election. No ifs, ands, or buts. The code is clear, objective, and deterministic. Either the contract is fulfilled in one direction, or it is fulfilled in the other. No need to trust the other party in the bet at all, much less a third party to mediate.
MD: Again … a complicated solution to an age old task that has no problem in the first place. Bitcoin is a solution looking for a problem as this discourse demonstrates.
Ethereum, as will be noted later (hopefully in another article because my god I never want to write again), takes this concept to the next level and runs with it.
MD: So, is Ethereum Bitcoin? Is it a Bitcoin wrapper? Is it a Bitcoin franchise? Does the marketplace care? Does it need it? I really don’t want answers to these questions. You lost a sale to me long long ago.
One further benefit to bitcoin is that it is truly yours to own, and you can keep it yourself, without the need for a bank or any other intermediary, and use it just as easily as you might a credit card.
MD: And the same is true of a proper MOE coin or currency. They are an instance fo the media (in contrast to a ledger record) that is totally anonymous and personal. They go under your rock or mattress very nicely … and never lose their value.
This ensures that you won’t fall victim to a banking system collapse brought on by fractional reserve banking or irresponsible government and financial institution fiscal policies in general. It also ensures, however, that no one can take your money from you even on an individual basis, global financial apocalypse aside.
MD: With a “proper” MOE process you won’t fall victim to a banking system collapse either. It doesn’t employ one. And the process itself will not collapse. Its transparency and competitiveness will make it evergreen.
This, like systemic banking failures, is not something most people generally have to worry about 99% of the time. However, in the 1% of cases where this does become an issue, it becomes a very serious issue. Refugees and other victims of persecution and oppression are clear examples of this.
MD: Bitcoin is far more vulnerable than the current banking system. Lose the computer and you’ve lost everything. You will never get a hard copy of a bitcoin ledger. However, any trader can have a current hard copy of “all” his money creation and return activity … as can the certifier. And of course they would have electronic backup systems. I keep all my receipts … but I keep my records on Quicken and back them up regularly. And I have “no” bank account. It proved to be unsafe from IRS intrusion.
As a refugee, generally, if you hope to escape with your money, you have to carry it in physical form on you, either in gold or in paper currency. This is limiting for a few reasons: one, you can only take so much as you can carry or convert to physical form, and two, physical currencies are exceedingly simple to detect and confiscate.
MD: With universally adopted “proper” MOE processes, it would be easy to carry certifiable records of the money you hold in electronic form … just like you can get a letter of credit sent to where you’re going. The process would facilitate it as part of its natural transparency. Services could easily set themselves up as borderless wallets … just like title companies simplified the property title verification process … very very efficiently.
Again, while this all seems incredibly far-fetched today for most people (but not all, as the present day European migrant crisis has made abundantly clear), it happens much more often than one might expect. A little remembered fact is that the United States itself once outlawed the possession of gold, back in 1933 with Executive Order 6102, and forced all its citizens to relinquish all gold to the United States at a fixed price of $20.67 per troy ounce.
MD: Do you know about the Indian process Hawala. It’s based on trust … and has been in operation since the 8th century. This isn’t religion or myth. It exists today and has existed continuously without interruption. It evidently works.
Ok … he’s back to the history lesson so I’m back to scan mode.
Immediately thereafter, the US Treasury revalued all their gold at $35 per troy ounce for foreign transactions, and in the process reaped an enormous profit at the expense of all the citizens that were forced to give up their gold at fire sale prices.
It sounds incredible, but this is real life. The government threatened to fine anyone caught possessing gold in violation of this order $10,000 ($185,000 today) and throw them in jail for up to ten years. A famous case involved one Frederick Barber Campbell, who had on deposit at Chase Bank over 5,000 ounces of gold (worth over $6 million today), and attempted to withdraw the gold that he rightfully owned. Chase refused to allow him to do so, so he decided to sue Chase for depriving him of his assets.
In response to his lawsuit (this case demonstrates the value of basically everything about bitcoin, from the ability to store your own money to the ability to not rely on the legal system for recourse), Campbell was counterattacked and indicted by a federal prosecutor, and had to defend himself in court for not giving up his gold.
MD: It shows gold is vulnerable. And bitcoin is vulnerable. Everything is vulnerable to force. But force is impotent when it has to operate against itself. If a proper MOE process is instituted and gets a foothold, force can’t shut it down … because the force would not know what to shut down. It would be ubiquitous and totally non-centralized, as bitcoin claims to be. But it would be founded on proper principles … not religion and lore.
Ultimately, while Campbell didn’t end up going to jail, the government did decide to seize all his gold, and confiscated all $6 million worth of gold from him.
It took a full 40 years, or until 1974, before Gerald Ford signed a bill making it once again legal for private individuals and corporations to own gold within the United States.
This underscores the oft mercurial whims of governments, even well-regarded ones like that of the United States, that most citizens heretofore have been subject to without relief or alternative. Most of the time, things run well enough that we all get by without having to think about this fact too much. Sometimes, however, things do go really, really wrong.
MD: Earth to Ben … the USA is an occupied country with an occupied government … witness the mysterious collapse of WTC7.
Bitcoin fundamentally changes this equation. Unlike even gold, bitcoin is nigh impossible, when stored correctly, for anyone to confiscate without consent. The addresses at which bitcoin values are stored are protected by ‘private keys’, which can be thought of as a password or a key to a lockbox. Without this private key, it is generally impossible to steal the bitcoins held at the public address to which the private key corresponds. So long as you keep this private key secure, your bitcoins are secure.
MD: Tell that to the Silk Road guys.
With things like brain wallets possible, this means that even in the worst case scenario, you can literally store your bitcoins in your brain and nowhere else, and thereby easily prevent their confiscation. Just yet another fundamental innovation in the evolution of currency that bitcoin has made possible — its fully intangible nature is actually an asset.
MD: You can’t even store your current crop of passwords in your brain. You “have” to write them down.
The intangibility of bitcoin, however, does seem to hang some people up. It’s sometimes difficult to immediately conceive of how bitcoins could possibly hold value, as these people contend, when they are intrinsically worthless. They are nothing but a concept, backed up by some computer code. Gold is a physical, tangible object that you can hold in your hand. It has real uses in industry and as jewelry that lend it value. Even paper money can be used for kindling or toilet paper if the need necessitates.
MD: And it will remain inconceivable to them until they actually see a transaction in them. And there will never be a transaction in them (other than the illicit ones) because it’s stupid to trade away something that is appreciating so fast … even though it’s false appreciation like Ponzi’s was.
Bitcoin, on the other hand, is fully intangible. It is just a concept backed by code, no more, no less. It can’t be used for anything functional besides being transferred in concept to other people as a store of value. How could something like this possibly hold value like other existing currencies?
MD: The process is code … just like any MOE process can be committed to code. But part of a proper process is transparency of creation and bitcoin doesn’t have that. I can’t find a current list of who created how many bitcoins and when. With a proper MOE process I could see that information, any time I wanted to. And remember, that “doesn’t” mean I can know anything about the use of the money after it is created and before it is returned and destroyed. That is anonymous.
It’s a good question, and one that underscores just how interesting the concept of money really is, and how rarely we actually think critically about it.
MD: Ben, not only have you not thought critically about it … you don’t know what money is. Bitcoins do not represent an in-process trading promise. They are never returned (delivered) and destroyed.
Sure, let’s say that you can’t compare bitcoin to gold and say it’s better because gold has tangible, real-world utility and bitcoin doesn’t.
What is the value of that real-world utility? Only about 12% of gold purchased every year is actually used for industrial and medical purposes. If this is truly where gold’s value is derived from, gold would be worth dramatically less than it actually is.
MD: If 12% is taken for golds real and legitimate use, that makes the amount available to be money just 88% of an ounce per person.
To the other point, gold’s coveted status in jewelry is merely a derivative property of its perceived value, which leads to its designation as a status symbol. Without that underlying perceived value, it would command far less value in jewelry. Consequently, the question still remains about the gap between the industrial and medical value of gold and the actual value of gold as determined by the market. Where does the value in that gap come from?
MD: Does gold command more value than $2,000 per ounce when artfully put into jewelry form. I doubt it!
This is even more true of paper currency. Yes, you can utilize and reuse the paper for all the intrinsic value paper has. But what is that intrinsic value of paper? This is easy to answer, because we can just see how much the government pays to make paper money. $1 and $2 bills cost less than 5 cents to make on the low end of the spectrum, while $100 bills cost 12.3 cents on the high end.
MD: If you knew what money was, any mention of its intrinsic value would blow your cover. Money has “no” intrinsic value. A promise has “no” intrinsic value … and that is what all money obviously is.
I don’t think I can continue this further … maybe I’ll come back to it. But it’s really going nowhere. For now I’ll end it here.
Even the $1 bill, which seems to be the best deal if one is valuing the worth of one’s currency based on its intrinsic ‘tangible’ value, has only ~5 cents worth of actual paper value behind it, or <5% of its actual denominated value. Where does the rest of that 95 cents of value come from?
It turns out these gaps in value between the worth of the ‘tangible’ thing itself and the actual value of the currency as it stands on the market today is just as much conjured up out of thin air as a mere concept as bitcoin’s perceived value is.
This ‘intangible’ worth that we ascribe to currency, which accounts for the vast majority of the value of all currencies, not just bitcoin, is ultimately what makes money work. Yuval Noah Harari captures this fact very well in Sapiens, where he lays out the case that the value of a given form of money is essentially an indication of trust in that form of money. It is our shared collective trust and belief in a currency that gives it value, not its intrinsic tangible utility or anything else.
Gold holds its value well because we trust that we will all collectively continue to trust it as a store of value forever, predominantly due to its scarcity and lack of centralized control. Fiat currencies hold their value well when they do because people trust that everyone else trusts the currency as well, and that it is deserving of trust. The moment that collective trust collapses, so too does the currency, no matter what its intrinsic ‘tangible’ value.
This is why no fiat currency has ever stood the test of time over a long enough timescale, whereas gold has to date always stood the test of time and retained its value well. Collective trust for gold has never collapsed because of its inherent scarcity and immunity to the vicissitudes fiat currencies must endure at the hands of capricious centralized governing powers, whereas collective trust in every historical fiat currency has inevitably failed to date, and collective trust in many present-day fiat currencies continues to fail as we speak.
With this in mind, bitcoin can arguably be seen as the purest form of money, as its value is entirely predicated on trust in it, and nothing else. It can arguably also be seen as the most trustworthy of currencies, as it was bespoke made by intentional design to exhibit all the best elements of historically trustworthy currencies (e.g. gold), as well as to introduce for the first time a number of characteristics that make it even better than all previously extant currencies.
If people have trusted gold to date as a store of value because of its inherent scarcity and resistance to centralized control and price/supply manipulation, bitcoin does all that and more, and does it all better. Gold’s scarcity, as illustrated above, is anything but constant, and we’ve more than doubled our world’s supply of gold in just the last 50 years. Bitcoin, on the other hand, has a precisely and publicly known proliferation schedule, and will approach the limit of its supply in just a few more decades.
As a thought exercise, imagine a new fledgling nation called the United States came into formation and decided to create their own fiat currency today. At the same time, bitcoin is introduced as a currency.
Which would you trust? My personal bet would be absolutely, wholly, and unequivocally bitcoin. With the new US currency, I would be effectively required to trust that the US government would act without fail over the entire course of its indefinite existence to practice perfect fiscally responsible habits and not screw up its economy in any dramatic ways. I would also be aware that even under perfect circumstances, the currency would be fundamentally designed to inflate, and consequently my money would continue to lose value over time if I decided to hold and save it.
Furthermore, I would be forced to use an intermediary financial institution such as a bank to hold my money for me, and thereby expose myself to yet another layer of required trust and accompanying risk. I would also be aware that these institutions would almost certainly practice fractional reserve banking to the maximum extent they could get away with it, such that they would be extremely fragile to small perturbations and vulnerable to things like bank runs and runaway systemic banking collapses.
On the other hand, with bitcoin, I wouldn’t have to trust anyone at all. I would know for certain that my coins wouldn’t lose their value due to inflation as a consequence of their designed and indelible scarcity. I would also know that as I stored my coins myself, no one else, not even a bank, could actually go and spend 90% of my money, and fail to give it back to me in the event of a bank run. Furthermore, no one could forcibly confiscate my money under any circumstances, as I could always store it in such a way that it could never be retrieved except with my consent. No one would even necessarily be able to know how much money I held, unless I chose to make that information public.
Remember: just 13 years after its inception, the US currency had already suffered fatal runaway inflation and collapsed. Bitcoin, on the other hand, is worth more than ever just 9 years after its inception, and currently boasts a market cap of over $40 billion. Which would you trust?
The other common argument against bitcoin is that it is useless for any real world functions right now besides ransomware and illegal activities, and is therefore worthless because it has no good use cases.
This is a fundamentally flawed argument that can be lobbied against absolutely any new technology or invention, and fails to take into account the natural process of growth and gradual adoption over time. The exact same argument was used against the internet in its early days, and I find this article from Newsweek, published in 1995, particularly illuminating in this regard.
After two decades online, I’m perplexed. It’s not that I haven’t had a gas of a good time on the Internet. I’ve met great people and even caught a hacker or two. But today, I’m uneasy about this most trendy and oversold community. Visionaries see a future of telecommuting workers, interactive libraries and multimedia classrooms. They speak of electronic town meetings and virtual communities. Commerce and business will shift from offices and malls to networks and modems. And the freedom of digital networks will make government more democratic.
Baloney. Do our computer pundits lack all common sense? The truth in no online database will replace your daily newspaper, no CD-ROM can take the place of a competent teacher and no computer network will change the way government works.
What’s striking in this is that while everything he said at the time was true, and certainly none of those things were particularly possible back in 1995, it all came to pass eventually. Today, remote workers are a huge part of the global workforce. Online education is booming. Amazon is taking over all of commerce and is larger than any retail store in the world. Print newspapers and magazines are dying left and right, replaced by a proliferation of online news.
The same growth trajectory is how I see bitcoin, cryptocurrency, and blockchain technology at large playing out. If all goes well — and there’s no guarantee it might, everything indeed might fail and all our hopes and dreams might gang aft agley — there’s no reason at all that bitcoin can’t one day surpass even our wildest imaginations today, just like the internet did before it, and fundamentally rewrite the script for how we interact with money and the world as a whole.
Yes, today, it is far from this goal, but even now, we make progress in pushing forward the utility of bitcoin in every day pragmatic life. Already, it has proved indispensable to myself and hundreds of thousands of people around the world. I pay many of my employees today in bitcoin, even, because several of them live in Eastern Europe where they’re subject to draconian capital controls.
Were I to send them a wire (as I used to), their banks demand a mountain of documentation detailing every last dollar and hold their money for upwards of half a month before ultimately releasing it to them. Naturally, this is a pain in the ass and highly inefficient, time consuming, and resource intensive for all of us. Bitcoin easily sidesteps all of these issues.
Bitcoin is also dramatically cheaper to use than almost any other form of international money transfer today. Already, for this use case alone, it proves its worth over current dominant international money transfer solutions, such as Western Union. I can transfer money to anyone in the world, in any amount, and have them receive it without moving a finger in just a few minutes. For this privilege, I have to pay just a few cents, no matter how much I’m sending, instead of a huge proportional percentage, with hefty minimum fees and surcharges.
It’s also extremely convenient and valuable for a merchant to use, and we had great success implementing it for a trial run at my company Sprayable back in the day. In the past, we’ve suffered from rampant fraud after our site was targeted on a carding forum (a place where people buy and sell and use stolen credit cards). When we were paid in bitcoin, however, these concerns were completely eliminated, as fraud is an impossibility on the bitcoin network with enough confirmations.
This is only the beginning. You don’t expect a horse to become a world champion racer straight from the womb. It takes time, training, and a fair bit of luck. The same is true of bitcoin and blockchain technology. But just because a horse may not be a world champion just quite yet, it doesn’t mean you shouldn’t bet on that horse in the long run. If you see potential in that horse, and are willing to wait it out for the long run, go ahead, bet on that horse. One day, it might just take over the world, and if it does, you might just win big.
Part II: Investment Philosophy
Okay — now that you hopefully have a good grasp of what cryptocurrency is and why it’s interesting, we can move on to dipping your fingers in getting some.
We can all be honest — the reason the vast majority of you are reading this is probably because you’ve heard a lot about just how much money people have made investing in cryptocurrency. Many, if not all of you, are wondering how you, too, can get on the gravy train and start making millions.
This isn’t necessarily wrong, or inaccurate. This is the reason I first started paying attention to bitcoin. Countless people *have* made shocking amounts of money investing in cryptocurrency. I’ve personally made over $400,000 in less than two years. In fact, bitcoin has already proven to be the best investment in all of recorded history by a shocking margin for those who got in at its most early stages.
Here’s a story about a completely random Norwegian student who bought 5000 bitcoins for $27 back in 2009. Today, with a single bitcoin pushing past $2700, those 5000 bitcoins are worth over $13.5 million. That’s a gain of over 500,000X. No other investment in recorded history that I’ve been able to discover has ever come close to touching these sorts of gains.
Even the Dutch tulip bubble, which is classically regarded as one of the first instances of massive speculative market mania, saw increases only on the magnitude of 10–100X — not even remotely close to 100,000X+. And even the most successful of extremely risky angel investments in companies, such as Peter Thiel’s initial $500,000 seed investment in Facebook, see returns on the scale of 10,000X or so or less — Thiel’s $500,000 investment, had he held it all the way to the present day, would be worth $6.8 billion, or approximately a ~13,500X gain. More incredible than just about anything else, certainly, but still nowhere even near Bitcoin’s meteoric rise in price.
What’s also striking is that traditionally, these sorts of ‘angel or seed’ investments in new technologies have been closed off to all but an incredibly well connected inner circle of elite high net-worth individuals and institutions. Peter Thiel, for instance, was only approached to become Facebook’s first outside investor because he was already incredibly well known within Silicon Valley for having founded and sold PayPal for over a billion dollars. In contrast, with bitcoin, a random student in Norway was able to invest just $27 and make millions.
That said, just as with everything, there’s survivorship bias here. What you don’t hear about are the profusion of people who lost their entire fortunes investing in cryptocurrency. While there are a few ways you can beat all the odds and come out vastly ahead in cryptocurrency, there are infinitelymoreways you can lose everything you put into it and end up in a much worse place than where you started.
Here, I’ll try to cover the most common ‘mistakes’ people have made. Do keep in mind that this is all entirely my own opinion. Please come to your own conclusions here.
The most common mistake people seem to make is investing solely based on the price alone and its short term historical trajectory, and nothing else. The second mistake is investing in assets that they don’t actually understand or believe in long term, are not planning to hold for at least 5 years, and will be tempted to sell if the price begins to fall in the short term. The third mistake is believing that they’ve already missed the boat on the most established and successful cryptocurrencies, like bitcoin and ethereum, and that consequently they should invest in much less established, much more speculative ‘altcoins’ to achieve truly outsized gains, for no truly good reason besides the fact that the price/market cap for the altcoin is a lot lower than bitcoin’s, and seems like it has more room to grow. The fourth mistake is day trading, and trying to capitalize on short term market movements. I’ll address each of these in turn, and why I believe them to be mistakes.
On the first mistake — I made this mistake myself when I first got into cryptocurrency. I first heard about bitcoin from a friend who was raving that we should all get into it just around the time the price of a single bitcoin reached $100. He had gotten in at $30, and was extremely pleased with his gains.
At the time, it was relatively big news that bitcoin had reached $100. I remember thinking to myself that it was clearly too late to get in, and promptly forgot all about bitcoin.
The next time I heard about bitcoin was in the fall of 2013, when it began its last truly meteoric price rise from $100 all the way up to $1200. This time around, I distinctly remembered thinking I’d missed the boat back when the price was just $100, and kicked myself for being totally wrong. I resolved to not make the same mistake again, and tried to get in before I missed out again.
I ended up wiring several thousand dollars to an incredibly sketchy Russian exchange, BTC-E.com, to purchase my first few bitcoins at around $1000 apiece. Before I knew it, I was addicted to constantly checking the price, and spent a full 48 hours doing nothing at the height of the November 2013 bubble doing nothing but refreshing BTC-E.com and seeing how my investments were doing.
I ended up making another big mistake here too, and figured that bitcoin had already gone up way too much, and that my best bet was to invest in some smaller altcoins as well. I made this decision after seeing litecoin (LTC) skyrocket from $4 to $40 in just a few days. The buzz at the time was that litecoin would be to silver what bitcoin was to gold. The price seemed incredibly low compared to bitcoin, and this made a superficial sort of sense (meaning, no sense at all), so I decided to jump in. For good measure, I also decided to jump into a few of the other most popular altcoins of the time — peercoin (PPC) and namecoin (NMC).
The 2013 cryptocurrency bubble burst just a few days later, brought on by the collapse of Mt Gox, the largest bitcoin trading exchange at the time. It was revealed that Mt Gox had either been hacked or embezzled from, and no longer had any funds left to honor customer withdrawals. As a result, anyone who had decided to keep their bitcoins in Mt Gox at the time instead of withdrawing them to their own wallets ended up losing all their money. How much the price of bitcoin rises doesn’t mean anything if you lose all your bitcoins, unfortunately.
The price of bitcoin cratered about 80%, falling all the way to about $200, before stabilizing at that price for much of 2014 and 2015. Litecoin, on the other hand, fell from over $45 to about $1, and consequently lost over 97.5% of its value. PPC and NMC suffered so badly that I didn’t even bother to calculate how much I had lost, because it was basically everything.
This is when I first saw the light, and realized that investing in altcoins that I didn’t really believe in, and that didn’t really have any truly compelling reasons they would ever overtake bitcoin or deserve any level of market share, was an incredibly foolish move. It was certainly true that these altcoins did often gain on bitcoin and appreciated far more rapidly in many cases while the bubble held strong, but the moment it began to collapse, the altcoins were the first to go, and often fell all the way to zero.
As a general rule, what goes up can come down, and what goes up particularly quickly is privy to come down just as quickly. This is not to say that things will come down if they go up, but merely that they can, and certainly have before. This is particularly noteworthy today, with ethereum having seen some truly wild gains this year, all the way up from $7 back in December of last year to over $350 presently — a gain of 50X in just about half a year. Again, this isn’t to say ethereum will fall, but merely that it very well might, for any host of reasons, and it’s very important to keep this fact in mind and not overextend yourself with investments you perceive to be less volatile than they truly are. I’ll get back to this more later.
What I ended up learning was something the smartest people in the investment world had learned a long time ago. Benjamin Graham, the mentor of Warren Buffett, who became the richest man in the world by practicing the principle of value investing, has a pretty wonderful analogy that I think is worth repeating here. You should buy your stocks (or any investment, generally) like you buy your groceries — not like you buy your perfume.
What he means by that is that for some reason, people tend to buy stocks when they’re going up in price, and sell them when they’re going down. At face value, this makes no sense. We wouldn’t buy a watermelon when it was $10, and sell it when it was $2. With groceries, it makes intrinsic sense to us to buy watermelons at $2, not $10, but seemingly not so with our investments.
The short term price movements of a stock shouldn’t concern a long term value investor in the slightest, as a value investor doesn’t care about what the market has valued the price of a stock at, but rather only about the intrinsic value of the business behind the stock, and its future potential value. Only after coming to a conclusion about the actual value of a company and its future potential value, should an investor then look to what price the market has assigned a stock, in ascertaining whether or not a stock is a good purchase.
In the case of a watermelon, what we intuitively grasp is that there is some fundamental, intrinsic value to the watermelon, and a ‘fair’ price for it. We have a general understanding of what this price should be, and are more than happy to buy watermelons when they are on discount relative to their fair price, and are reticent to do so when they are being sold at a premium to their fair price.
If we decide that a watermelon’s fair intrinsic value is $6, then we’d be happy to buy watermelons all day long at $2, and reticent to do so at $10.
With investments, it’s the same deal. If we decide that Company X is presently worth $100,000 dollars, and that it has strong growth potential in the future, and the market is presently valuing Company X at $50,000, that would probably be a good buy.
On the other hand, if we decide Company X is worth $100,000, and has ambiguous future potential, and the market is presently valuing it at $200,000, it might not be such a good buy.
In a third case, if we decide Company X is worth $100,000 today, and has extremely strong growth potential, and the market is valuing it at $100,000 today, it might still be a good buy to hold and capitalize on that future potential.
In all of these cases, however, a value investor first and foremost must decide, with rigorous analysis and thorough examination, what they believe the fair value of an investment to be, and what degree of future potential it has. Only from there do they then examine what value the market has assigned the investment, in order to ascertain whether or not the investment is a wise one likely to yield good returns. Under no circumstances should one ever buy into a stock without knowing much, or anything at all about the stock, save for the general market sentiment or hype surrounding it, and its short term price movements. Buying a stock merely because it has seen great gains in the past, without any understanding of why it saw those gains and what gains it might expect to see in the future based on fundamental analysis of the stock, is an inordinately risky and foundationally bereft strategy.
If you’re interested in learning more about value investing at large, I’d highly recommend The Intelligent Investor, by Benjamin Graham, who again was Warren Buffett’s personal mentor and a professor of economics at Columbia University. He pioneered a lot of the foundational concepts around value investing, and can give you much better and more nuanced advice than I ever could.
All of this said, while these principles can and should be kept in mind at large for just about any investment, cryptocurrencies are dramatically different from stocks, bonds, or any other sort of traditional investment vehicle. They’re also so early stage and so volatile that it’s a near-certainty that a value investor like Benjamin Graham wouldn’t even dream of labeling such opportunities as investments, rather than speculations (at best, they would be labeled growth investments, but I’m working with the Buffett philosophy that there is no difference between ‘value’ and ‘growth’ investing, and that good value investing appropriately takes into account growth).
Investments, under this distinction, would be clarified as things that could generally be safely assured not to suffer from dramatic, catastrophic losses in the absence of dramatic, catastrophic situations. Coca-Cola and Walmart might be considered investments. They’ve been around for well over a century and a half century respectively, are massive, mature companies with a healthy track record of stable, non-volatile growth, and show no general signs of turmoil that might portend a sudden collapse in value.
Speculations, on the other hand, are like the Wild West of opportunities. They’re extremely high risk, extremely volatile, and could on one hand multiply one’s principal manyfold, and on the other, dissipate it all into thin air. A seed ‘investment’ in Facebook, for instance, could be considered a speculation. In the vast majority of cases, such an investment is likely to fail outright and lose all of the money invested. In a few instances, however, that investment just might succeed, and return tens, hundreds, or even thousands of times the principal invested.
It’s important to note that the mere fact that something is speculative does not necessarily mean it can’t be a good investment, or that it is merely akin to blind gambling, dependent solely on the luck of the draw. Poker might be a suitable analogy. Poker can be played well or poorly, and skill and calculation lends an incredible degree of advantage to a player’s odds of success. However, the game still fundamentally deals with an immense degree of unavoidable variation and unknowns, and even the best poker player is guaranteed to lose many of their games, even if they play each one ‘perfectly’. The goal, simply, is to win more than you lose, and with the right amount of skill, knowledge, and preparation, this is a possible feat in poker.
The same might be said of speculative investments such as those in cryptocurrency. You can and absolutely should do your part to learn as much as possible about this field, and come to your own personal conclusions on its current and future potential value. However, no matter how much research you do and how many calculations you make, there will always be a fundamental and inextricable degree of pure luck involved in determining the ultimate outcome of your speculation. Any number of future events could tip the scales for or against cryptocurrency, or more specifically, any one cryptocurrency, and a number of these will be ‘black swan’ events that are fundamentally unpredictable in their nature and timing, but in aggregate whole, almost certain to occur.
Just because there is this element of luck, however, does not mean that you necessarily shouldn’t play the odds, if you so believe with very good reason that those odds are in your favor. What you do have to make sure of, however, is that you have such good reason to believe that those odds are in your favor, and that you don’t put up more than you can afford to lose, given the odds. The key takeaway and lesson to be learned, again, is to invest, both in speculations and in ‘safer’ investments, based on firm knowledge of the underlying asset and intrinsic analysis, to the extent possible, and never merely based on price movements.
In the case of bitcoin, my personal belief is that there is enough to justify the possibility of long term gain based on fundamentals and first mover advantage. If everything goes right, I do see a future in which it’s possible that bitcoin achieves a market cap similar to that of gold’s, given that so far as I can see, it provides all the benefits gold does, and a host of incredibly valuable advantages on top of those existing benefits. I even see a future where it just might be possible that bitcoin goes even further, and becomes a dominant leading global currency. It’s also possible that bitcoin’s blockchain is used to power many future technological innovations, such as smart contracts and even DAOs, and thereby creates and imbues itself with even more value.
At the same time, I also see a million and one ways where bitcoin fails to reach the promised land. Bitcoin has already experienced numerous growing pains, and at the present moment, is suffering most acutely from a huge backlog of transactions that can’t be fit on the blockchain. This is because blocks are presently limited to 1 MB in size, and can consequently fit only a small fraction of all the transactions that are trying to be propagated over the network. This forces those who want to have their transactions go through to pay inordinately high transaction fees in order to prioritize their transaction over other transactions.
There are already a number of proposed solutions to this issue, such as the implementation of the Lightning Network, but in order to implement these solutions, the majority of bitcoin miners must agree to update their bitcoin software. Many bitcoin miners are reluctant to do so, in large part because high transaction fees are good for miners, at least on a short term basis, as it means they earn far more per each block mined. The implementation of the Lightning Network and other solutions threatens to take away this extra revenue stream. Hence, users of bitcoin and miners of bitcoin find themselves at odds with a very understandable conflict of interest. It’s unclear as of yet how this will be resolved, though it seems the community is pushing forward towards a resolution, and I’m of the personal belief that they’ll get there eventually.
Similar problems like this are virtually guaranteed to occur in the future as well, and it’s simply impossible to predict right now how the bitcoin community might respond to and handle those problems, and if they’ll be successful in doing so.
At the same time, it’s entirely unclear how governments will respond to bitcoin as it continues to grow, and if they’ll attempt to crack down in a very strong way and prohibit the use of bitcoin, or the creation of bitcoin related service companies, such as exchanges. If exchanges were banned from operating, for instance, it could very well make it very difficult for most people to transact between fiat currencies and bitcoin, and render the latter far less useful than it otherwise might be.
On the flip side, if the world suffers a global financial meltdown on the scale of the Great Depression or something similar again, and fiat currencies start to crater, it very well may be such that governments are forced to resort to accepting bitcoin and other cryptocurrencies, if enough people simply flat out refuse to put their stock in fiat. This was exactly what the US government was forced to do just 13 years into their original experiment with Continental currency, when they agreed to promise to back all the currency they issued with hard gold and silver.
These are just a few of countless twists and turns and vicissitudes our much vaunted (and much derided) bitcoin will have to endure before its long journey comes to an end, either six feet under or as an indelible fixture in our global economy. There’s no telling which way it will go, and one must come to one’s own conclusion on how much faith and conviction one chooses to place in bitcoin.
That’s the case as I see it for bitcoin. In the case of most altcoins, however, I don’t see remotely enough to even begin to justify the possibility of long term gain in the first place. Even with speculations, or perhaps especially with speculations, it’s incredibly important to thoroughly analyze a given investment opportunity for at least the potential for long term gain and success, and assess the magnitude of that possible gain, and then to weigh that potential versus the likelihood of outright failure of the speculation. With most altcoins, their value over bitcoin or ethereum is far from clear, and generally superficial or minor at best.
Dogecoin is the most pure example of this. Dogecoin offers just about no fundamental innovations over bitcoin, and is in fact a self-deprecating cryptocurrency premised (initially, at least) entirely on poking fun at itself. The name itself is a reference to the doge meme, and offers little to no further justification for its existence.
Despite this fact, Dogecoin’s market cap is presently valued at over $300 million. Come to your own conclusions here.
Less immediately obvious examples include things like Litecoin. Litecoin, too, offers fundamentally no truly great innovations over bitcoin — in short, nothing that bitcoin itself couldn’t adopt over time. It uses a different hashing algorithm and just adopted Segregated Witness, the same update that bitcoin is debating adopting that would allow the implementation of layer two protocols such as the lightning network, but beyond this, doesn’t have much in the way of unique differentiation going for it. This said, Charlie Lee, the creator of Litecoin and previously the Director of Engineering at Coinbase, one of the most well respected and successful bitcoin exchanges, just announced his departure from Coinbase to focus solely on improving Litecoin. It remains to be seen what will come from this endeavor, as Charlie certainly is without question one of the most accomplished and formidable players in the cryptocurrency sphere, but largely litecoin appears to be a small hedge in the slight off chance that bitcoin doesn’t actually manage to resolve its scaling issues, and begins to catastrophically lose market adoption and faith and crumble into the ground. In a case like that, the notion is that litecoin would be able to quickly take over the ground lost by bitcoin, and become the dominant cryptocurrency.
There are a number of issues with this, however, and a lot of things would have to go right before this occurred. There are several cryptocurrencies, for instance, with ethereum being the most notable, that are already far larger than litecoin, and it would have to be demonstrated that there’s some reason something like ethereum couldn’t simply take the place of bitcoin, and that litecoin would have a better shot at doing so than the larger players that already exist in this space.
Litecoin would then have to deal with exactly the same issues bitcoin has faced at scale, and it’s not clear at all that litecoin would fare any better at resolving such conflicts if ever reaches the same scale as bitcoin presently has.
All of this said, it does seem extremely likely to me that there will inevitably be some true innovation in this space, and that some cryptocurrencies will be able to carve out niches of varying degrees of value. One might even prove to ultimately demonstrate so many more advantages as to overtake bitcoin one day — ethereum, for instance, is teetering remarkably close to doing just that, at least in terms of market cap, if not quite yet other markers such as developer activity and transaction volume. The true feat here will be discerning those few new technologies with true fundamental potential and innovative advantage (and an incredible execution strategy) behind them, from the vast swaths of similar looking yet ultimately worthless contenders almost certainly doomed to eventual failure.
Expected value is a useful concept frequently employed in poker that also serves to provide utility here. In short, expected value is a way to decide when an outcome is not certain, but a set of outcomes are probabilistically determinable, if a given action is going to be net positive or net negative, and to what degree.
The simplest example is flipping a coin. This will yield heads 50% of the time, and tails 50% of the time. Expected value of betting on the coin yielding heads, hence, is 0. This is because in any one given flip, the coin has exactly a 50% chance of coming up heads. Hence, if you bet $100 on the coin coming up heads an infinite number of times, your expected gain, or value, from such an action, is to be $0.
Conversely, if you bet at even odds that a six sided dice roll would come up 3 or higher, your expected value would be positive, as you would be correct 2/3 times. Hence, if you repeated this bet an infinite number of times, you would be guaranteed to be earning more money than you lost.
Similarly, if you were able to bet at 1:2 odds (meaning if you bet $100 and win, you get $200) that a coin would yield heads, this would also be very +EV (positive expected value). The coin would still yield heads half the time, but that half of the time, you would earn $200, and the other half of the time, you would only lose $100. Hence, repeating this bet an infinite number of times would allow you to dramatically earn more money than you lost yet again.
There are far too many variables and unknowns to take into consideration with most speculative bets, and cryptocurrency in particular, to be able to hope for anything so nice and clean as an exact mathematical probability of how + or -EV a given bet on a given cryptocurrency might turn out, just as there are far too many unknowns to calculate the precise fundamental present and future potential value of a cryptocurrency for the purpose of value investing analysis, but regardless, holding both principles at large as a general guiding strategy in determining one’s actions here and elsewhere is a good bet.
Personally, for myself, a quick back of the napkin calculation that I can do to estimate the possible future value of bitcoin is to see what the market has valued all of the gold in the world at, and use this as a rough guiding principle for seeing how much appetite the world currently has for something that can hedge against other currencies and holds similar characteristics to gold as a store of value. I can see that the total value of all the gold in the world is over 8 trillion dollars, and consequently, if bitcoin were to reach that same total valuation, each bitcoin, assuming 21 million eventual bitcoins, would be worth approximately $400,000. Dividing this by bitcoin’s current value, I can see that there’s still room for approximately 150X gains. This means that if I truly believe this is a possible outcome for bitcoin, then as long as I believe this outcome has more than a 0.66 percent chance of happening, or 1/150 chances of success, it would be an +EV bet to make.
That said, it’s extremely important to keep in mind that one doesn’t get infinite opportunities to keep playing this bet out over and over again. There is only one bitcoin in the world, and we only have one opportunity to play out this exact bet. Given this fact, it’s important to realize that if this were somehow to actually be a perfectly EV neutral bet, with a possibility of a 150X upside and a 0.66% chance of realizing that upside, it would still mean that we have a 99.33% chance of losing all our money that we place on this bet. It would be extremely foolish, therefore, to invest all our money into such a wildly speculative investment, even if it is technically EV neutral or even slightly EV positive. What might make sense, is to set aside a responsibly proportionate amount of money specifically earmarked for such wildly speculative investments as a part of a holistic investment portfolio, that one is fully willing and able to lose without significant impact to one’s well-being or quality of life, and to invest that amount of money in a +EV bet like this.
Returning to the question of calculating potential investment upside here, there are countless other ways to make projections on the future potential value of bitcoin, and I encourage you to try to make some depending on your personal beliefs regarding the level of success bitcoin might have, and the ultimate utility it might provide to the world. For instance, if you see bitcoin primarily as a way to simplify making international transactions and cut out inefficiencies there, you might look to see what the overall market size is for a solution that might solve that problem and capture that market. Western Union, as one example, is a company with a market cap of $9 billion. Consequently, it might be reasonable to expect that bitcoin’s true ultimate value would be something roughly in that order of magnitude, if this were to be bitcoin’s one true long term use case.
If you see bitcoin as most useful for its blockchain, you might calculate hence the value you think can be created through applications, contracts, and other technological innovations run on the blockchain, and use that to guide your estimation of bitcoin’s value.
If you think bitcoin will be used to primarily enable black market transactions, same deal. And so on.
I hope that this elucidation provides some insight into why I personally see it as suspect to invest in something based on price alone, and why I urge extreme caution particularly if one is exploring whether or not to invest in an altcoin, especially if one is at least partially motivated to do so because of the feeling that the ship has already sailed for bitcoin, and that there might be better potential for outsized gains with a smaller altcoin. Again, this certainly may be true, and often is true even for altcoins destined for eventual failure in the short term while a bubble/bull market continues, but risks are amplified just as much as the opportunity itself when it comes to altcoins, and oftentimes moreso in a bubble than otherwise.
It’s easy to be swept away in the fervor of a frenetic market, and the fear of missing out can be overwhelming especially when you see altcoins rising by wild amounts overnight, but my personal guiding philosophy is to always try to keep in mind fundamentals to the maximum extent possible, to never invest in anything I don’t actually understand or see long term value in, and to only invest in things I intend to hold very long term (for at least 5 years), especially in such a volatile market.
Speaking to that last point now (the ’second’ mistake I mentioned at the beginning of this part) I’m of the personal opinion that it is incredibly important to not only invest solely in things that I truly believe have the real potential to succeed in a big way long term, but to actually commit and hold to that investment, once I make it, no matter what happens with the price short term. If some fundamental fact underlying my investment changes, I can certainly re-evaluate it, but if the price drops 90% or even 95% in the short term for no particular reason except a collapse of a local maximum in price speculation (e.g., a bubble popping), I must never be tempted to sell and try to ‘time’ the market in any way. Instead, I have to hold that investment with firm conviction in what I believe the eventual price based on fundamentals is worth, regardless of how the market values it in the present moment.
This is critically important precisely for incredibly volatile speculative investments such as cryptocurrency, and plays into the fourth mistake I mentioned above, day trading, as well. More than possibly any other market I’ve seen, short term price movements for cryptocurrencies are oftentimes absolutely mystifying and nothing short of mind boggling. Highly anticipated events, such as halvings in bitcoin’s reward per block mined, come and go without any real perturbation in price. Other times, things rise when reason seems to suggest they should fall, and fall when they seem to have every reason to rise. For instance, bitcoin’s price collapsed to $200 after the bubble popped in 2013, and stayed stagnant at those levels, despite massive development in bitcoin infrastructure and significant growth in the adoption and usage of bitcoin over that same period of time.
More recently, the approval or rejection of a bitcoin ETF was widely touted as being the contributing factor to a bitcoin bull run from under $1000 to over $1200. It was speculated that if the ETF were to be rejected, that naturally the price would fall to where it was before the bull run began. Indeed, the moment the ETF was announced as rejected, the price did momentarily fall to almost $1000. However, it just as quickly recovered, and began an inexorable climb all the way up to over $2700, where it stands to this day.
Consequently, with the short term price movements of bitcoin and other cryptocurrencies being incredibly volatile and oftentimes nothing short of inexplicable, I highly caution anyone against making decisions such as selling their bitcoins on the way down in anticipation of a market crash, so as to either avoid the crash or to buy their coins back at a cheaper price at the bottom of the crash.
This goes hand in hand with mistake number four I mentioned above: day trading. This is absolutely number one the reason I see people who have gotten into bitcoin and cryptocurrency lose their money. If you at almost any point in the history of bitcoin (earlier than say, this month of June), merely bought bitcoin and held it to the present day, you would have made money. However, countless people have actually lost money in bitcoin, and this is because they ended up trading their bitcoin somewhere along the way.
I would venture to say that most people have far more confidence in their ability to predict short term market movements than is actually the case. I’ve seen plenty of instances of people who have thought that they could capitalize on short term volatility on the way up, and essentially ‘buy the dips and sell the tips’, and in every single instance I can recall, this strategy eventually fails, and often in a big way. At face value, this seems to make sense. If you think you can time when the dips will occur and when they will end, and similarly when the peaks will occur and when those will end, you can definitely make more profit along the way by selling high and buying low.
However, as I’ve mentioned before, this is far more difficult, if not impossible, to do with cryptocurrency, more than even normal investment vehicles like stocks. I’ve seen people who think that bitcoin has hit a peak and must necessarily stop going up sell, intending to wait until bitcoin falls again to buy in again and make maybe a 20% extra profit, miss out entirely because bitcoin kept going up and never came back down. There are numerous stories of those who bought into bitcoin at $1 or less, but sold well before it ever reached even $10, much less $2500.
With something as speculative as cryptocurrency in the first place, it makes no sense to invest in this space to begin with if your only goal is to make 20% profit. It almost certainly isn’t worth the risk at that level of gain. Hence, risking losing out on the long term upside of 10X+ that you’ve calculated and come to the conclusion does exist for a gain of less than 1X or .5X in most cases makes little to no sense at all. It only makes sense if it’s essentially a guaranteed gain with no risk, and that, again, is almost certainly not the case.
Indeed, some market movements are fundamentally unpredictable in their short term timing. Two very vivid examples of this were the collapse of Mt Gox for bitcoin, and the hacking of the DAO for ethereum. Both of these events absolutely cratered the price of bitcoin and ethereum respectively, and both of them were fundamentally unpredictable in their exact timing. These are examples of the black swan events I mentioned that are certain to continue playing a large role in short term price developments for bitcoin and all other cryptocurrencies at large, that make it doubly dangerous for those who day trade.
I’ve also seen plenty of people who intend to hold long term, but lose faith when they see their investment crater 30%, 50%, or even 70%. At this point, they lose faith, and decide to sell their investment to at least recoup some of their initial capital, and not lose everything outright. Thus, they end up buying high and selling low, and then having double regret when bitcoin eventually ended up rebounding even higher than the ‘high’ they bought at.
This illustrates even more vividly why it’s incredibly dangerous to invest in anything you don’t actually believe in, and aren’t willing to hold, long term. If you aren’t going to hold something long term, then generally you must believe that while the price will rise in the short term, it will not continue to rise in the long term. If you hold this belief, it generally means that there’s some reason that you believe what you are investing in won’t hold true value long term, but that there is enough speculative mania in the short term to make the price go up anyway. The thinking goes that if this is going to be true, you might as well profit from this speculative mania and buy in now, wait for a little bit for the price to rise, and then sell it for short term profit.
The problem with this is that just about everyone else investing in these things is thinking the same thing, and everyone involved is effectively playing the greater fool theory, expecting that they will be smarter than everyone else and be able to time the market better than everyone else, and get out before everyone else does, and before the price eventually collapses. By mere inviolable fact, most people who engage in this form of speculation are guaranteed to lose in a big way. Over enough iterations, the eventual likelihood of loss generally grows to become one, in my opinion, as one must continue to time a market correctly time and time again for this to work. While it may seem like the market will continue being bullish for you to get in and get out before things go south, this is true of every moment in time right up until things go south all at once. Inevitably, at some point, the gravy train will have to derail and explode in a rolling ball of fire.
I know for a fact that I’m certainly not remotely smart or knowledgeable enough to pull off this kind of short term investment that aims to profit from market sentiment alone, especially not in the turbulent, mercurial waters of cryptocurrency, and that’s all I can say about this here. On top of this, the existence of black swan events that can crater an entire market unpredictably short term introduces a variable that inherently is just about impossible to predict, and makes short term bets like this even more dangerous.
The most dangerous game of all, then, in my opinion, is day trading in altcoins that one doesn’t believe in long term. This is basically combining every ‘mistake’ I mention above: trading in something because of short term price movements, not holding it long term, day trading, and speculating in highly risky small cap altcoins. If you manage to survive doing this over any long period of time (5 years+, let’s say) and end up net profitable (particularly if you end up more profitable than just buying and holding over that same period of time), please do let me know, as I’d be extremely curious to hear just how you pulled it off.
Going back to my personal story, ultimately the crash from $1200 to $200 for bitcoin was the best thing that could have ever possibly happened to me. At the time, of course, it certainly didn’t feel that way. It felt like I had made an absolutely stupid, foolish decision, and had lost all my money. In fact, I did make a stupid, foolish decision, but not for the reason I thought at the time. I didn’t make a stupid, foolish decision because the price had cratered to $200. I made a stupid, foolish decision in deciding to invest in bitcoin and altcoins without actually having done my research and without really knowing anything about them.
Had I actually done my research and believed that it was a fair bet to make that one day bitcoins would be worth far more than even the height of the local maximum bubble at the time, it absolutely could have been the right decision to buy in then, even if it crashed later temporarily to $200. What wasn’t right was buying in simply because the price was going up and I had a fear of missing out.
The crash proved to be the best thing that could have happened, however, because it gave me time to actually do my research and learn about bitcoin, and have real reasons for believing in it long term, at a point in time where the price was unusually deflated. As a consequence, I was able to buy more bitcoin at the very bottom of the market, around $230 or so, when I became truly convinced of bitcoin’s long term potential. I was also lucky enough to decide not to sell the bitcoins I had originally purchased for $1000 or so, and ultimately saw even those return 250%+ in profit.
It was at this time, incidentally, that Coinbase, became worried about stagnant growth of their user base, and decided to offer a truly astounding proposition. They offered to pay anyone who referred a new customer to Coinbase $75 if the new customer purchased just $100 in bitcoin. Coinbase took a 1% transaction fee at the time, meaning that for every $100 in bitcoin a person purchased, Coinbase charged $1. In short, Coinbase would pay out $75 for every $1 a new customer paid them.
It didn’t take a genius to see a clear arbitrage opportunity here, and I wrote up a quick blog post detailing this opportunity and fired out a single Facebook post telling my friends about it. From that post and just a few hours of work, I ended up earning almost 17 bitcoins entirely for free — worth over $45,000 today. I had plans to scale this strategy en masse, but singlehandedly ended up killing the program almost as soon as it started, when Coinbase finally came to its senses and realized just how much money it was hemorrhaging here with no hope for eventual recoupment (at the time, the lifetime value of the average customer was only something like $25 to Coinbase — a far cry from the $75 they were offering).
Digression aside, that sums up most of the thoughts I have about the primary things to be cautious about when it comes to bitcoin investment. There are a few more practical matters to be extremely cautious about (namely, how you store your cryptocurrency), but I’ll address those in the next part, which will be an actual how-to guide showing actually actionable steps for those interested in getting into bitcoin investment.
The final point to make, then, are a few thoughts on how to correctly invest in bitcoin and other cryptocurrencies. I have no truly great pieces of wisdom to offer here, but do have a few ideas that primarily aid in being psychologically being resilient to the short term vicissitudes of cryptocurrency investment.
Once you’ve decided that you truly believe in a cryptocurrency long term, and are willing to commit to it for the long term and hold it no matter what the short term price movements might be, the next step is to decide how much to invest, and when to invest. One might be hesitant, with not bad reason, to invest at an all time high, even if one believes that that all time high will one day be exceeded.
The mere fact that the future potential is still huge doesn’t necessarily preclude the fact that cryptocurrency may be in a short term bubble, and that prices might crater any day by 30%, 50%, 80%, or even more.
Generally, the strategy suggested to average out such short term volatility for something that one is investing in long term is to practice dollar cost averaging. This preaches that one should set an exact time at regular time intervals to buy an exact amount in fiat currency of the investment one is looking to purchase — e.g., $1,000 worth of bitcoin on the 1st of every week, or every month. This means that over time, you’ll be able to take advantage of bitcoin’s general trajectory upwards, but balance out the relative short term volatile price movements both high and low, such that you experience a more linear growth trajectory over time of your principal.
I think that this is a great strategy, and personally practice it with a few modifications. While I’ll never sell at any price essentially (unlike other investments, bitcoin and cryptocurrencies are unique in that they are currencies, and consequently if they succeed, you won’t have to sell them to gain value from them. You can just use them directly, just as you might US dollars or any other form of currency. In the manner that I use the word sell here however, I mean that I likely won’t sell at any price under $100,000, as that’s where I personally see the moonshot value of bitcoin going towards, in the slight chance that it does succeed), no matter how high the price rises in the short term, if and when the price becomes particularly low as a result of a cratering market, I will look to buy more than I normally would, to double down on my investment here — all the while keeping in mind never to invest more than I’m perfectly willing to lose entirely.
Psychologically, if it’s helpful, I think it may be fine to sell off some small portion of your upside if you do realize upside over time, in order to recoup your initially invested principal. I don’t think that this is necessarily the most optimal actual move to make, but do think it likely makes a huge difference psychologically, such that it makes it far easier for you to hold your remaining investment with sangfroid in the case that it ends up cratering sometime in the future.
As for investing an initial lump sum to begin getting exposure in this space, my personal strategy would be to do a semi-timed dollar cost average, if one is particularly concerned that they might be investing just before a local minimum market crash, but also particularly concerned that the price may keep rapidly appreciating ad infinitum, and would like to get in before that happens. That is, I’d decide the total lump sum I’d be willing to set aside to invest here, say, $10,000, and invest 33% or 50% of it immediately. Then, if the market did crash, I’d be psychologically very happy, and be super excited to invest another 33% or 50%. On the flip side, if the market continued to rise indefinitely and never fell again, I’d also be happy that at least I was able to get exposure to the market and didn’t miss out entirely. A 33–33–33 split would allow me to invest 3 times when I felt the market was at a particularly good time for investment, and a 50–50 split twice. Just random arbitrary examples of divisions I might do here, depending on how exactly wary I feel about the market at the present moment in time.
That about sums up my thoughts on cryptocurrency investment at large. There are some nuances, but I figure 8000+ words worth of a brain dump is a good enough place to start. If you’re still here, please feel free to read on to Part III if your constitution allows for further word consumption.
Part III: How to Buy and Store Your Cryptocurrency
The shortest section by far. If you made it this far, you deserve to just be able to buy your crypto and be done with it all. I’ll try to make that as easy as possible. There are still quite a few bases to cover, however.
Note: The following bit about exchanges to use holds true for those in the United States. For those based elsewhere, you’ll need to do your own research on the best exchanges to use in your country. The rest of this post should hold the same for everyone in the world, however.
The easiest way to invest is to sign up at Coinbase.com. If you sign up with a referral code, you get $10 when you purchase $100 in bitcoin or ether. I’ve linked my mom’s referral code here if anyone is interested. Straight to her retirement fund! (In the interest of having zero monetary gain from my fiduciary advice, however, just email me if you use this link and buy over $100 of bitcoin, and I’ll send you the whole $10 my mom receives on her end as a referrer — so you get $20 for investing $100. Not bad!)
However, this is not the cheapest way to invest. That’s GDAX.com (no referral bonus with this, though). Thankfully, GDAX.com is the same company as Coinbase, and utilizes the same login. Once you make your Coinbase account, you can just login with it to GDAX.com.
At GDAX.com, which is Coinbase’s exchange, you’re able to get trades in for either 0% as a market maker (meaning you limit buy or sell and set your own price and ‘make’ the market), or 0.25% as a market taker (meaning you just buy or sell at whatever price the market is currently at with a market buy).
You can trade immediately as much as you want by sending a wire (only applicable for US customers) to your account following their deposit instructions. There’s a $10 fee for this that GDAX charges, on top of whatever your bank charges to send wire transactions. This is the fastest method to deposit any amount of money you want and trade immediately with no limits, but not the cheapest.
You can alternatively conduct ACH withdrawals from your bank as well by going to the Coinbase accounts page, clicking on your “USD Wallet”, and clicking the Deposit button in the top right hand corner. These are completely free, but take anywhere from four business days to a week to complete.
You can even use a credit card to buy straight from Coinbase.com, but fees here are very hefty. Use as a last resort.
Keep in mind that while you can put however much money you want into GDAX at any point in time, you are generally limited to withdrawing $10,000 per 24 hour period. Thus, if you are buying a large amount of say, Ethereum to send to a token sale address, keep in mind that if you want to send over $10,000, you’ll need to purchase that amount and withdraw it well in advance of the token sale.
For instance, if you wanted to send $100,000 of ethereum somewhere, you’d need to buy all that ethereum and withdraw over the course of 10 days (assuming you withdrew perfectly each day every 24 hours — realistically more like 11–14 days) back to Coinbase or your personal ethereum wallet before you could then send that ethereum on to somewhere else all at one time, like you would need to do in a token sale.
On GDAX, you can buy bitcoin, ethereum, or litecoin.
From there, if you’d like to buy any alternative currencies, you can use your bitcoin or ethereum on Shapeshift.io without any account to instantly transfer your bitcoin or ethereum to any other cryptocurrency under the sun, essentially.
To buy/sell on Coinbase or GDAX, you need no wallet, as Coinbase/GDAX will keep your coins for you. You’ll want to enable Google Authenticator for two factor authentication and keep your passwords and your phone incredibly secure, however, as if someone hacks your account, all your money is gone for good with no recourse. This happens a lot. Use a super strong password that you have not used elsewhere and that no one knows and that you won’t forget.
Ideally, you’ll keep the coins yourself on your own hardware device, which is ultra secure. I recommend Trezor.io (as of this writing, they’ve just run out of stock, but are only backordered a few days if you’re willing to pay a premium) for this purpose. Ledger Nano S is also good and cheaper to boot, but I personally haven’t used it and it’s very backordered in sales. I can recommend Trezor 100% wholeheartedly, however.
Trezor will keep your coins safe because the device itself is immune to hacking by design, and never exposes your private keys (the passwords to your accounts, essentially), even if your computer is infected by malware and is logging all your typing/passwords, or is specifically scanning for private keys, or is engaging in any other form of sneaky bad behavior.
It does this by signing all transactions on the device itself using your private key, and only transmitting the signature to your computer, and never your private key. As a general rule, this is very good, because a good rule of thumb is to never expose your private keys to the internet, under the assumption that the internet is inherently insecure, and if you ever have your private keys interact in any direct way with a computer that has been connected to the internet, you should consider the addresses those private keys correspond to to be compromised and vulnerable to being hacked.
A Trezor also allows you to set multiple passwords that open secret vaults to different wallets on your device, such that even if in some crazy scenario someone just kidnaps you and threatens to beat you with a wrench until you give them your coins (not too crazy actually — I’ve been abducted before and had to ransom myself for thousands of dollars in Africa), you can just give them a second password to another wallet that holds say $500 in cryptocurrency instead of $10 million, and there’s no way for them to know that that’s not all the money you had on your Trezor.
If someone steals your Trezor, they won’t be able to find your coins either, as they’re protected by a PIN that only you know (plus a password if you want to use that feature I mentioned above). You can also recover the coins yourself with the recovery seed the Trezor will give you the first time you use it, which you should store in a super safe location like a safe deposit box somewhere. If you don’t use utilize the password feature, however, keep in mind that anyone who discovers this recovery seed instantly has access to all your coins, and all your other forms of security are for naught. If you enable the password feature, however, they will need your password as well as the recovery seed in able to access your cryptocurrency, which makes it significantly more secure.
A Trezor will give you your own personal wallets for eitcoin, ethereum, dash, zcash, and litecoin, as well as any ERC20 token built on top of ethereum.
Another benefit of holding coins yourself, in a hardware wallet or elsewhere, is that you know that you 100% own all of your money. Exchanges are just like banks, in the sense that you trust them to hold your money for you. If they end up losing that money to hackers or stealing it themselves, you’re out of luck. This isn’t just a scary bedtime story — countlesscryptocurrencyexchanges have been embezzled or hacked (an enormous percentage, actually), and hundreds of millions of dollars have been lost.
Moreover, in the event of a hard fork, whereby two blockchains are created, and consequently, two sets of coins that you technically should own, only some exchanges will actually give you access to both sets of coins. Most notably, Coinbase has explicitly stated that they will only give you access to the dominant blockchain that emerges from a hard fork, no matter how much value the market assigns the non-dominant chain. They may or may not give you access to the other coins in the future, but there is no guarantee either way. In any event, with any exchange you are fundamentally agreeing to trust them to give you access to both sets of your coins, even if they say they will. If you own your coins yourself in your own wallet, however, you need to trust no one. You will automatically own both sets of coins by default in the event of any fork.
This, too, is not merely a theoretical matter. Ethereum did indeed hard fork after the DAO hack, and split off into ETH (the current dominant blockchain for ethereum) and ETC (the ‘classic’, or original blockchain for ethereum). As of this time, ETC is worth over $20 a coin — more, in fact, than all of ethereum was worth before the hack. Had I kept my ethereum on Coinbase or another exchange like it at the time of the hard fork, I personally would have lost 5 figures in ETC (at present values) merely because the exchanges wouldn’t give me access to these coins that I rightfully owned.
Finally, my personal preference is to avoid keeping all my eggs in one basket. Despite the fact that a hardware wallet like Trezor is technically one of the most secure options for keeping your coins safe with a fair amount of redundancy in recovery options, the fact remains that one day I might somehow lose access to my coins held within Trezor. I might suffer a concussion, for instance, that causes me to forget the password or the PIN required to access the Trezor, or perhaps I lose my Trezor and am unable to locate or decipher my recovery seed.
Because of this, I actually personally keep my cryptocurrency distributed in several reasonably safe baskets. For instance, despite Coinbase being an exchange that fundamentally requires some trust, they are more trustworthy than almost any other exchange on a technical level (their customer service, however, leaves something to be desired), and it is virtually impossible for their coins to be hacked to any significant degree, and all those at risk of being hacked are fully insured. As a consequence, I leave some of my coins with them, merely because in many ways, I trust their technical security measures more than I trust my own. Before GBTC started trading at such an absurd premium, I also kept some of my funds with them, both in part to diversify across multiple platforms to reduce the risk of losing all my coins with one bad black swan event, and also because it was the only immediately easy way to put some of my retirement funds into bitcoin, short of creating a self directed IRA.
Okay — so that’s about it for investing in the dominant cryptocurrencies available today. If you want to invest in other more speculative altcoins, you’ll have to create your own wallets for them, and investigate the best and most secure solution for doing so yourself. This should generally be a good exercise in any case to determine if you meet the bare minimum requirements for responsible investment in a given altcoin.
Congratulations, you’ve made it to the end. That’s it. Good luck!
Beautifully and clearly conceived and written. This is the best discussion of cryptocurrency I have read yet. Please don’t stop writing! Your presentation of inception of the concept, the analogy to gold standard and discussion of investment considerations are outstanding. Thank you.
Great read, thanks so much. It was worth the 4 hour read! I can see the future in Bitcoin and I do not regret not starting when it first came out, as we were all mindless idiots, but it is never too late.
By far the best article on Cryptocurrency till now. Took me 3 days (on and off) to finish the article but enjoyed every bit of it. Thanks for writing such an elaborate explanation to such an elusive topic.
Great article, you’ve single-handedly ignited my interest in cryptocurrency. I’ve been on a binge for the last two days trying to make sense of the subject, and am now slowly beginning to formulate a plan along the lines of the advice you gave about picking a lump sum and investing in increments.
Great article! Very thoughtful explanation of the mindset one should have when investing/speculating on Bitcoin. I’ve been wanting to put together something similar, but you’ve already done it better and in more detail!