A critical look at appcoins

There has recently been a resurgence of interest in the phenomena known as “tokens”, digital assets that are issued and traded using a blockchain. What makes tokens interesting is the fact that they can be issued and traded digitally and globally without permission from a third party.

Tokens can represent many things: currency, property titles, collectibles, coupons, even corporate equity. There’s one type of token in particular that I will focus on in this post, and that is the “appcoin”.

An appcoin is a type of token that is required to use a specific app. Appcoins are like arcade tokens that are traded on the open market and fluctuate in price based on supply and demand for the token. You buy the token to play the game, and with appcoins, each game needs its own unique token.

A real-world example of an appcoin is GEMS, a token that was issued on the blockchain and was used to pay for advertising slots in the Gems social networking app. Another example is SJCX, an appcoin that is used to pay for hard drive space in the StorJ network. With both of these apps, you need to buy the appcoin to use the app.

Appcoins came about as a way for developers to fund the development of their applications without having to go the traditional finance routes of raising money by selling corporate equity or asking users for donations.

The idea is that once the app is completed, it will gain a critical mass of users who will have to buy the appcoin if they want to get value from the app. This drives demand for the appcoin, supporting its price and potentially delivering a financial return to the people who bought the appcoin early on during the app’s development phase.

As an investor, there are several problems that I see with this model:

1. The model is very developer-centric, solving a problem for app developers (raising money) but not for the app end-users. In fact, appcoins create new problems for end-users, since they now have to go out of their way to buy an appcoin to use an app instead of paying with the money they already have (or not paying any money at all).

2. Appcoins are a redundant form of digital money. Apps that require the use of appcoins can always be cloned and modified to remove the appcoin. Since appcoins add friction to what should be a frictionless interaction, users will prefer the apps that accept the money they already have in their wallets (or no money at all, the way free software has been used for decades).

3. Appcoins centralize development of an application. When one person or company issues the appcoin, this puts them in a privileged position over everyone else who could contribute to app development. This central issuer gets to decide who is granted shares of the initial stock of appcoins, and also who gets paid out from the proceeds of any sale of the appcoins to fund development and marketing efforts. This could lead to cronyism and inefficiencies typical of centralized resource allocation efforts.

In short, I believe that appcoins do not solve any problems for end-users, are easily replaced with more widely accepted forms of digital money, and present incentive problems that threaten the health of the app development ecosystem. Appcoins therefore do not offer investors a stable or sustainable long-term store of value – great for sellers, bad for buyers.

The only argument in favor of appcoins that I see as having any merit is the argument that applications that would otherwise be un- or under-funded now have a new way to raise funds for development. If users like the apps they use, they will buy the appcoin to support development.

My counterargument is that yes, so far appcoins have been a great way for some developers to fund their software projects. However this argument does not address the fact that, more often than not, appcoins are not a technical requirement for an application to work and could therefore be replaced by apps that do not require the use of an appcoin. If app users want to support developers, they can just pay developers with the money they already have.

My prediction is that this is exactly what we will see happen: as soon as an appcoin reaches any significant level of early traction, some enterprising developers will copy the app, remove the appcoin, and monetize the app by other means. This will flatten the market for the appcoin, leaving investors and users holding the bags.

I love the financial innovation that’s been enabled by the invention of cryptocurrency and the blockchain. I think that many financial assets will be tokenized, and valuable new assets we haven’t even thought of yet will be created and traded on these platforms. I just don’t believe that appcoins will be one of them (for long).

“Should I create a new token?”

This is a decision tree that I came up with for developers who are considering the idea of creating a new token for their app:

Untitled drawing (8).png

If you can’t articulate a compelling reason for why your app needs a token and why that token can’t be bitcoin, then you shouldn’t create a new token (and people definitely shouldn’t buy it if you decide to create one anyways).

Relevant links

What are Appcoins? [link]

Appcoins are Snake Oil [link]

Thoughts on Tokens [link]


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The problem Bitcoin solves

The problem that Bitcoin solves is the reversibility of electronic payments. In the seminal Bitcoin whitepaper, Satoshi Nakamoto wrote,

Commerce on the Internet has come to rely almost exclusively on financial institutions serving as trusted third parties to process electronic payments…

Completely non-reversible transactions are not really possible, since financial institutions cannot avoid mediating disputes…

With the possibility of reversal, the need for trust spreads… 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.

The solution that Nakamoto devised to solve the problem of reversible payments was,

… 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.

The result was Bitcoin, which has continued to deliver as a solution to the reversibility problem since it went live over eight years ago. The means by which Nakamoto solved the reversibility problem was by eliminating the need for a trusted third party that could willingly or unwillingly reverse transactions. In place of a trusted third party, Nakamoto used a chain of cryptographically-signed transactions secured by proof-of-work to order and validate payments. And thus, the blockchain was born.

pow

Today, the blockchain is used to securely order and validate more than just payments. People have figured out how to use the blockchain as a way to prove that a digital file existed at a certain point in time, creating a so-called “proof-of-existence“. People are also exploring how to use the blockchain to track ownership of all kinds of digital assets including domain names, game tokens, stocks and other financial instruments, and even real property titles.

The reason that people are using Bitcoin for these transactions instead of any other system for recording ownership information is precisely because of Bitcoin’s security. At the time of this writing, Bitcoin block makers, or “miners”, collectively calculate over 30 billion SHA-256 hashes per second at a cost of approximately $15,000 per block using hundreds of millions of dollars worth of bitcoin “mining” computers. It would thus be extremely expensive to reverse a transaction with even one confirmation, ensuring strong security for transactions that are included in a block added to the most difficult valid blockchain.

For users to benefit from all this security, they must run their own full node and verify that their transactions are included in the most difficult valid blockchain. Then they can decide based on their risk preferences when to consider their payments “settled” based on how many confirmations they have. The more confirmations a given transaction has, the less likely it is to be reversed.

If you need strong assurances that when you receive a payment, that it can’t be easily reversed, then Bitcoin can solve your problem. If you need to be certain that when you create a record of ownership or proof-of-existence, that it will still be there when you go back to find it in ten years, then Bitcoin can solve your problem.  But if your problem doesn’t need sealed-in-stone-forever security, and you can get away with using a plain old database to record your transactions, then Bitcoin – and the blockchain – isn’t for you.

Addendum: what about bitcoin (the currency)?

When Satoshi created Bitcoin, he really created two distinctly valuable products that by necessity are joined at the hip: the first blockchain, and the first cryptocurrency. If the blockchain was created to solve the reversibility problem, then bitcoin was created to solve the blockchain’s incentive problem.

The proofs-of-work that are used to secure the blockchain require energy to create, and energy costs money. Since Bitcoin could not rely on any third parties to operate, no third party payment mechanism could be used to pay miners for the energy they spent generating proofs-of-work. A new payment mechanism had to be created – bitcoin.

By paying miners using a currency that is issued and transferred exclusively by the blockchain, Nakamoto provided an incentive to miners to protect the integrity of the chain. If any miners attempt to subvert the integrity of the blockchain by colluding to reverse transactions, then they would also subvert the value of the block reward, throwing away money on the table and threatening their investment in specialized mining computers.

The bitcoin currency therefore ensures that incentives are aligned between miners and users so that the implicit promise of irreversibility is upheld. Even after all the bitcoin is mined, miners will continue to prefer to be paid in bitcoin for transaction fees because it is a highly liquid digital asset free of counterparty risk.

Although bitcoin solves interesting problems on its own – such as providing a new “safe-haven” asset class to investors – its value is derived entirely from the security of the blockchain and the ability for users to easily verify that security. Without these properties, bitcoin as a currency would be no more interesting than WoW Gold or Linden Dollars. It’s important to remember that bitcoin is a means to an end, and not the end itself: an irreversible electronic payment system.


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Ten Ways Governments Threaten Bitcoin

Governments are strange beasts. Not quite market, not quite commons, governments occupy a unique space in the economy where societies permit (or tacitly tolerate) territorially-bound corporations that have fiat monopolies on important social functions and institutions. Governments use these exceptional permissions to create and enforce laws and regulations that inhibit the free flow of goods, services, and ideas within their jurisdictions, simultaneously creating and limiting opportunities for entrepreneurs, investors, and workers in the economy. All the while, governments engage in covert campaigns to undermine and neutralize foreign and domestic targets that are seen as threats to “national security” (read: government power and/or the profits of incumbent corporations), creating blowback and bad precedents that have come back to haunt governments and their citizens years later.

The Bitcoin network is a relatively young but growing part of the economy, spawning hundreds of businesses and nonprofit groups that support the fledgling technology, fueled by over $1 billion in venture capital and angel funding that has been invested since Bitcoin’s invention. While the Bitcoin network itself is decentralized, transcending government borders and legal jurisdictions, there is an uneven patchwork of government regulations bound by geography and international treaties that are creating centralizing forces and vulnerabilities in various parts of the Bitcoin economy. This is a cause for concern among members of the community that value resiliency and decentralization of power in the network. Unless there is a focused movement to eliminate the government interventions that threaten Bitcoin companies and distort the market to create these centralizing forces, we can expect this drama to continue to play out for years to come.

Note: This is not an exhaustive list of government threats to Bitcoin.

1. Bitlicenses and banking regulations

A “Bitlicense” is a specific license required to operate a business that serves as an exchange or brokerage firm for bitcoin and other “virtual currencies.” This kind of license prevents competition by limiting the number of companies that can legally do business within a jurisdiction, and puts customers at risk by requiring businesses to collect and store sensitive personal identity information.

First implemented by New York, some version of a Bitlicense has been proposed or implemented in states and countries around the world, including tech hubs such as California and growing financial hubs like the Isle of Man. In jurisdictions that have not adopted a Bitlicense, previously existing banking, money transmission, and money services business regulations have been used instead, producing the same cartelizing effects as a Bitlicense.

[1] [2] [3] [4]

2. Bitcoin bans

The alternative to licensing of Bitcoin exchanges has been the consideration or actual implementation of bans on Bitcoin exchanges, which further centralizes power in the remaining exchanges throughout the world and pushes people into underground market exchanges. While not an existential threat to Bitcoin, this concentration of power in regulated exchanges puts pressure on customers to comply with onerous KYC/AML requirements that put them at risk for identity theft and financial surveillance. This added friction slows down the adoption process, excludes people who are undocumented or security-conscious from the exchange market, and pushes people into slow, expensive, and risky gray or black market exchanges.

[5]

3. Energy subsidies

The largely unregulated nature of Bitcoin mining makes it a nearly free market with nearly perfect competition. Miner profitability relies on many factors, including connectivity with the rest of the network, the cost of operating expenses, and hardware quality. The miners that survive these competitive conditions are the ones that are able to reduce their costs while increasing their hashrate and block propagation speeds as much as possible. Electricity is by far the largest operating expense of Bitcoin miners today, and so the miners that are most profitable today are the ones with the cheapest electricity costs – and the lowest cost is “free.”

Energy is highly controlled by governments in most parts of the developed world, either directly through government-run energy companies or indirectly through government-sanctioned energy cartels/ monopolies/ duopolies/ oligopolies. When energy companies have a surplus of electricity, governments will sometimes decide to give this electricity away for free. Governments also subsidize the production of energy by providing preferential tax treatment or direct cash subsidies to energy companies, artificially reducing the costs of certain kinds of energy.

Energy subsidies by governments create an uneven playing field in the energy markets, leading bitcoin mining to consolidate around areas with access to artificially cheap or free electricity. Given that there are only a relatively small number of places in the world with these kinds of subsidies, the hashpower responsible for Bitcoin network security is concentrating in just a handful of legal jurisdictions. This makes it easier for a government or coordinated group of governments to take control of the Bitcoin mining network through nationalization or de facto nationalization by regulation.

[6] [7] [8]

4. Labor and immigration laws

Much of the Bitcoin industry relies on highly specialized knowledge in the fields of ASIC manufacturing, cryptography, computer science, finance, and economics. Labor and immigration laws restrict the movement of workers with this specialized knowledge, preventing a free market for labor from arising. Labor is artificially cheaper in some areas, or more expensive in others, because of government intervention that distorts the supply and demand curves of these markets. This creates concentrations of power in areas where these specialized skills and distorted labor markets exist: China for ASIC manufacturing, Europe and North America for cryptography and software development, London and New York for finance and economics, Silicon Valley for startup capital, etc.

[9]

5. Research grants

Within the past couple of years, governments have become increasingly interested in Bitcoin. In 2015, the RAND Corporation published U.S. government-funded research about the ways that governments can disrupt “virtual currency networks” like Bitcoin. Governments have also become interested in blockchain data analytics, creating a cottage industry of companies devoted to tracing illicit flows of funds and other criminal uses of Bitcoin. In June 2016, the U.S. Department of Homeland Security announced that they had awarded research grants of approximately $100,000 each to Block Cypher and RAM Laboratories for “Blockchain Applications for Homeland Security Analytics.”

These kinds of government grants create incentives to do research that the market might not otherwise demand. They also create incentives for grant recipients to attempt to block certain changes to the core protocol that would impede such research e.g. automatic CoinJoin, Confidential Transactions, ZK-SNARKS, etc, in the case of analytics research. There is no evidence as of the time of this writing that the companies that have been awarded research grants for blockchain analytics are making any concerted efforts to block fungibility improvements in Bitcoin software. The general principle here is that core developers and full node operators will have to remain vigilant about spotting conflicts of interest by those that would seek to influence core protocol development.

[10] [11]

6. Legal tender laws

Legal tender laws are laws that give special privileges to bank-issued “fiat” currency above all other currencies. Fiat currencies issued in a legal tender regime (such as the U.S.) must be accepted for settlement of debts, public or private, such as a lawsuit settlement or payment of taxes. It’s like if McDonald’s was the only place you could legally eat in your area, and you had to pay for everything with a currency they issued called “McBucks.”

Since everyone who earns income is required to pay taxes, this means that everyone who earns income has an incentive to have at least enough fiat currency at the end of the year to pay their taxes. Since most businesses only accept their local fiat currency, consumers have an incentive to have much more than the minimum amount of fiat currency needed to cover their tax burden so that they can easily make purchases from local businesses without needing to exchange for fiat currency first.

The incentive structure created by legal tender laws privileges fiat currencies and hampers adoption of alternative currencies, even if the alternatives have more desirable characteristics. Such an uneven playing field is bad for bitcoin. The playing field must be leveled for bitcoin to truly compete with fiat currency on its own merits.

[12]

7. Key disclosure laws

Key disclosure laws are laws that require suspects to turn over their decryption keys to police if a court order or warrant demands access to encrypted materials. Failure to comply with the order could result in contempt of court charges and lengthy prison sentences. Bitcoin uses private keys to sign and authorize transactions to transfer bitcoin. Encryption is used to encrypt private keys and messages containing transaction data, protecting this sensitive information from hackers. Courts may one day use key disclosure laws to force suspects i.e. people who have not yet been convicted of a crime to turn over the keys needed to decrypt such sensitive data. Courts may also force the disclosure of Bitcoin private keys so that the court can appropriate the bitcoins on behalf of the government or a plaintiff in a lawsuit.

Key disclosure laws put bitcoin owners at risk by creating a legal avenue by which they may be forced to disclose the private keys that control ownership of their assets and protect their transaction data, even if they are not convicted of a crime. This could open bitcoin owners up to theft by corrupt government agents or hackers who gain access to the private keys that have been involuntarily disclosed to the government.

[13] [14] [15]

8. Intellectual property laws

Intellectual property (IP) laws turn ideas into private property. Such laws grant companies and individuals a government-granted monopoly over unique innovations, such as certain kinds of bitcoin wallets or mining chips. Once this monopoly is granted, the company that owns the IP via copyright, patent, or trademark can send government agents to attack anyone that copies the idea and compel the copier to either stop their IP infringement or pay rents for each copy.

This kind of monopoly on ideas slows down technological progress by making it a crime for people to copy or improve upon already existing ideas, blocking off certain avenues of innovation. While Bitcoin itself is free software, open for all to copy, remix, reuse, and redistribute, the same is not true for innovations built on top of Bitcoin. This has the potential to centralize control of important innovations in Bitcoin in the hands of a small group of people, who can then use this control to extract rents from the ecosystem or even take control of the network itself through e.g. mining centralization.

There is good work being done to counter-act the negative effects that intellectual property laws have on innovation in the technology industry. To fully protect creativity and innovation, intellectual property laws must be abolished so that people are once again free to copy, modify, and reuse ideas and information as has been done since the dawn of our species.

[16] [17] [18]

9. Internet controls

As a peer-to-peer digital currency, Bitcoin is almost wholly dependent on the internet for its existence. In theory, Bitcoin can be used without the internet, but the inconvenience of “sneakernet” transactions makes the technology impractical to use and eliminates the majority of benefits offered by Bitcoin. The internet has become essential in other parts of modern life as well, from academia and business to entertainment and social services.

In recognition of the internet’s importance and power in society, governments have begun enacting various laws that impose controls on the kinds of content that people within their jurisdictions may publish and consume. In China, these controls on the internet are so pervasive and totalitarian that they have been given a nickname: the “Great Firewall of China,” a reference to the famous wall that once separated China from its northern neighbors.

Internet controls have the potential to negatively affect Bitcoin in several ways, including:

  • Privileging or harming miners by manipulating internet speeds in and out of the country.
  • Filtering out Bitcoin transactions passing through unencrypted connections.
  • Limiting the information that locals can find about Bitcoin, distorting their view of the technology in ways that may be good for the government but bad for Bitcoin.
  • Limiting the dissemination of dissenting viewpoints that would question government policies about Bitcoin, alternative currencies, the internet controls themselves, and other relevant issues.

[19] [20] [21]

10. Corporate espionage

Allegations of corporate espionage by governments around the world are among the most troubling revelations to come out of the classified documents leaked by Edward Snowden. Governments have allegedly gone so far as to have their agents infiltrate private companies without the knowledge of those companies to spy on internal processes and interfere with the security of information technology products. In early 2015, it was revealed that spies working for the U.S. and U.K. governments allegedly hacked into the network of a German company called Gemalto, compromising private keys produced by the company for cellphone SIM cards and enabling the spies to decrypt the communications of potentially billions of cellphones without a warrant.

While the Bitcoin network is not yet large enough to warrant the kinds of expensive infiltration tactics seen in previous government operations, it’s possible that Bitcoin companies may become influential enough in the future to become serious targets for corporate espionage by governments around the world. Bitcoin hardware manufacturers, miners, wallet developers, exchanges, and other influential members of the Bitcoin industry could all be targeted, and will need to prepare accordingly.

[22] [23] [24]

Free Bitcoin

Like all government regulations, these interventions are creating distortions in the Bitcoin economy that prevent the market and technology from growing naturally and organically, instead crippling Bitcoin in some areas and subsidizing growth in others. As Bitcoin’s influence grows, it will become increasingly important that Bitcoiners recognize government interventions that affect Bitcoin’s growth and then work with others in their area to put an end to these interventions so that Bitcoin can grow to its fullest potential without unfair help or hindrance.


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The Key Decision-Makers in Bitcoin

Over the past year, there have been intense debates about the future of the Bitcoin network. These discussions have mostly revolved around the topic of scaling Bitcoin, and several proposals have been put forward to address the question of how the Bitcoin network will scale to be used by the billions of people and machines we have on this planet. These scaling proposals are not all mutually exclusive, but nearly all of them involve a fundamental change to the Bitcoin protocol that would require what is called a “hard fork.” A hard fork is a change that would cause there to be multiple competing Bitcoin networks, all but one of which would die off as a majority of users decide to use the strongest network.i

Because of the potential to split the network, such fundamental hard fork changes are not deployed often. Planned hard forks require an orchestrated software upgrade by multiple stakeholders in the Bitcoin network. Since Bitcoin is a decentralized system that is not controlled by any central authority, whether or not such an upgrade is deployed and adopted by the network is determined by several key decision-makers that must agree to the change: Bitcoin developers, economic Bitcoin nodes, bitcoin-holding users, and bitcoin miners.

Bitcoin Developers

Bitcoin developers are the first group that must be convinced that a hard fork change is necessary. If the maintainers of popular Bitcoin implementations do not accept a proposed change, the only remaining options are to fork an existing Bitcoin node software repository or start developing a new implementation from scratch. Convincing developers of an existing implementation can be politically challenging, and starting a new implementation from scratch is a herculean task. Forking an existing project is the easiest route, but still requires convincing a majority of the network to use the fork in order for the change to be adopted by all Bitcoin users.

Economic Bitcoin Nodes

Economic Bitcoin nodes are full nodes that accept Bitcoin in exchange for other forms of value and include Bitcoin exchanges, wallets, payment processors, and businesses that accept Bitcoin in exchange for goods, services, and other currencies. If economic nodes do not upgrade their full node software when a hard fork change is introduced, then blocks that are produced by miners who do choose to upgrade will not be considered valid by nodes that have not upgraded and the blockchain will split. To everyone on the old chain, miners producing blocks with the new software will lose the block reward to a competitor producing valid “old chain” blocks. The economic majority will only choose to upgrade their software if they believe the change is a) beneficial for the long term value of Bitcoin and/or b) acceptable to most of their bitcoin-holding customers.

Bitcoin-Holding Users

Bitcoin-holding users that rely on the services of economic Bitcoin nodes have a choice of where to take their business. If an economic node such as an exchange, wallet, or merchant upgrades their Bitcoin node software to implement changes that their customers do not agree with, then those customers may choose to do business with another economic Bitcoin node instead. However, it is not always obvious what version of the Bitcoin software an economic Bitcoin node is running and so the best way for bitcoin-holding users to have influence over changes to the Bitcoin protocol is to run and rely on their own Bitcoin full node for block verification and transaction broadcasting. If a hard fork upgrade is proposed that a bitcoin-holding user does not want implemented, then they may voice their concern to the economic Bitcoin nodes they do business with in hopes of dissuading them from implementing the upgrade. Similarly, bitcoin-holding users can lobby the economic Bitcoin nodes they do business with to implement a hard fork change if that change is beneficial to them.

Bitcoin Miners

In the early days of Bitcoin, economic Bitcoin nodes were either nonexistent or not that important, and the roles of “full node” and “mining node” were largely bundled together. Bitcoin miners would use low-power laptop and desktop computers and did not have much of a reason to sell the bitcoin they mined to cover operational expenses. Since then, the price of bitcoin has risen dramatically and bitcoin mining has evolved to become a large-scale industrial operation. Bitcoin miners now rely on economic Bitcoin nodes to convert bitcoin into value that is then used to cover the costs of bitcoin mining. While a hard fork change will never be implemented if miners do not upgrade their software to support the change, miners will only upgrade their software if a majority of the economic Bitcoin nodes have also implemented the change.ii

It is a common misconception that Bitcoin miners are the final decision-makers about what version of the Bitcoin software is the “dominant” version that drives consensus in the Bitcoin network. The reality is that Bitcoin miners are just one of many stakeholders which must be convinced to upgrade their software, and for game theoretical reasons are actually most likely to be the last to upgrade their software in the event of a hard fork change being introduced. Most Bitcoin miners operate on thin margins and are therefore very conscientious of their revenue and costs. They will only run software that produces blocks that are accepted by a majority of the economic nodes in Bitcoin, who in turn will only upgrade their software if the change supports the long-term value of Bitcoin and/or is acceptable to most of their bitcoin-holding customers. Coordination is therefore required among all of these stakeholders to debate the merits of proposed hard fork changes and make hard but necessary decisions to ensure that the Bitcoin network continues to grow to support widespread usage.

Making Progress

If the Bitcoin protocol does not evolve to accommodate growing demand and new use-cases, then growth could stall and the unmet demand will be serviced by another competing network instead, potentially harming the long-term value of bitcoin and bitcoin mining equipment. It is therefore in the best interest of Bitcoin developers, bitcoin miners, bitcoin holders, and economic Bitcoin nodes to implement changes that support the growth of the Bitcoin network while maintaining Bitcoin’s key innovation as a decentralized solution to the double-spending problem.

iThe alternate networks may not die off if the hard fork change proposed is a change to the mining algorithm itself. In this case, there is a possibility that the miners on the old chain will continue mining and serving the users who prefer the status quo to the new mining algorithm.

 

ii A hard fork change could be implemented without miner support if the change is a change to the mining algorithm itself that renders the previous network of miners obsolete.


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What’s at stake in the Bitcoin block size debate

What Bitcoin Is and How It Works

First described by Satoshi Nakamoto in a whitepaper released in late 2008, Bitcoin is a “P2P electronic cash system” that enables two people on the Internet to transact with each other without having to go through a traditional payment processor such as a bank or credit card network. Bitcoin was invented by combining several previously existing technologies, including digital signatures, peer-to-peer networking, and cryptographic proof of work, into a single application.

In Bitcoin, digital signatures are used to transfer the bitcoin digital currency from one account to another, peer-to-peer networking is used to broadcast transactions to the network for verification, and proof of work is used to determine which transactions get confirmed by the network. This process of determining which transactions are confirmed has come to be known as “Nakamoto consensus,” and it enables computers on the Bitcoin network to come to agreement on the current record of all transactions that have been accepted by the Bitcoin network. This Nakamoto consensus process produced a key innovation that did not exist before Bitcoin: a decentralized solution to the double-spending problem.

The Nakamoto consensus process confirms new transactions on the network by batching them into “blocks” which are produced and verified by the network approximately every ten minutes. Anyone can participate in the Nakamoto consensus process and make blocks by adding their computational power to the network. This decentralized network of block makers competes to collect a block reward consisting of new bitcoins and any transaction fees by racing to solve a complex math puzzle. The number of new bitcoins that are produced with every block is programmed to get smaller over time until the block reward disappears completely. At that point, block makers will be competing to earn only the transaction fees from all of the transactions that are included in the blocks they produce.

Each block is mathematically linked to all previous blocks, forming a “chain” that stretches back to the very first block produced by the network. This chain of blocks is referred to as “the blockchain,” and the network is designed to always refer to the longest blockchain when disputing the legitimacy of a transaction. As more blocks are built on top of a transaction that has been confirmed by the network, it becomes less likely that the transaction will be removed from the record, reducing the risk of a double-spend attack. An attacker trying to double-spend the network would have to be able to solve Bitcoin’s complex math puzzles faster than the rest of the network, which would require more than half of all the computing resources securing the network at the time of the attack. It is essential to the security of Bitcoin that no one party gains such a concentration of power in the network.

Preserving Bitcoin

The pursuit of a decentralized solution to the double-spending problem was the primary motivator that led Satoshi Nakamoto to invent Bitcoin. In the Bitcoin whitepaper, Nakamoto wrote:

A purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution… 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.

Trusted third parties, Nakamoto pointed out, introduce “inherent weaknesses of the trust based model” into payment systems, including “the possibility of reversal” by the trusted third party or an attacker who is able to compromise the trusted third party. It was this understanding that led Nakamoto to come up with the Nakamoto consensus process to solve the double-spending problem using a decentralized network of computers instead of a trusted third party.

Nakamoto designed Bitcoin so that the more computational power there is securing the Bitcoin network, and the more widely that computational power is distributed, the more difficult it would be for an attacker to launch a double-spending attack. With the number of people using the network growing larger every day, the requirement that the distribution of computational power remains decentralized has led to debates about how the Bitcoin software should evolve to accommodate higher transaction volumes. Both change and inaction could disrupt the equilibrium that allows the Bitcoin network to function today and deliver on its key innovation by providing a decentralized solution to the double-spending problem. Increase transaction capacity too much, and fewer computers will have the resources required to participate in the network, concentrating power in the computers that remain. Increase transaction capacity too little, and people may lose interest in Bitcoin as the cost of using it goes up, causing the system to collapse under the weight of its own success.

This is the challenge for Bitcoin developers: to engineer a way to scale bitcoin transaction volume while preserving Bitcoin’s key innovation, for to lose Bitcoin’s key innovation would be to lose Bitcoin itself. This will be no easy feat, and it may require taking risks that would be considered unacceptable or even impossible in other systems, but it is necessary for Bitcoin to scale if it is to continue to grow and become the world’s standard for “peer-to-peer electronic cash.”

When Bitcoin’s key innovation is used as the guiding principle for deciding which scalability proposal to implement, the decision chart looks like this:

Proposal 1 Proposal 2 Proposal 3 …etc
Preserves Bitcoin’s
key innovation
Doesn’t preserve Bitcoin’s key innovation

It is up to the community of Bitcoin developers, miners, and users to experiment with each proposal and fill in the blanks. The proposal that increases transaction capacity the most while preserving Bitcoin’s key innovation is the one that should be adopted.


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Silicon Valley’s Deep Debt Weighs Heavily On My Future

Recently, I’ve been thinking a lot about what I want to do next with my life. Visiting home for the holidays and thinking about a “new year, new me” can do that, the way a long shower can sometimes lead to an existential crisis. Almost two years ago, I moved to the San Francisco Bay Area with plans to start or join a company that serves the bitcoin economy, and have spent most my time since pursuing that dream. I started a consulting website so people could contact me to learn about bitcoin, and I started a blog and podcast to share my ideas about how bitcoin and all things p2p can change the world for the better.

The latter two endeavors have been more hobby than business, not netting me any notable financial gains. Instead, I consider them speculative philanthropy in pursuit of educating the public as to the best ways to acquire and use bitcoin and other p2p technologies. My more entrepreneurial endeavors have so far netted me no notable financial gains either, instead serving as learning opportunities that no accredited university could have ever offered me. I’ve learned a lot about cryptocurrency technology, startup entrepreneurship, and the Bay Area entrepreneurial ecosystem. I’ve also learned something which may forever change how I look at my role as an entrepreneur: Silicon Valley is in deep environmental and social debt.

My journey as an independent thinker started when I was a child, reading encyclopedias and history books in my free time, but reached a peak around the time that I graduated high school. I graduated early, leaving me with a lot of free time on my hands while my friends were still at school. This time was mostly spent playing video games, surfing Wikipedia, or watching documentaries online. It was these documentaries, and everything I learned from the Internet when I was following up on claims or references made in them, that led me to think deeply about my lifestyle and my own impact on the planet.

What I learned about the state of society and our planet’s environment made me more conscious about where the products I purchased came from. I chose to use a credit union instead of a bank, I began to buy organic products almost exclusively, I bought local produce more often to reduce greenhouse gas emissions and support the local economy, I bought an electric bike to reduce my dependency on oil companies, and I purchased clothing made from a hemp blend instead of cotton or polyester; in general, I started to “vote with my wallet” for a better world. This trend continued when I found bitcoin, which I saw as an alternative to a financial system that is rigged top-to-bottom to benefit the largest banks, corporations, and governments at the expense of everyone else.

Bitcoin was like a strong magnet, on the one side attracting me, and on the other, repelling. I have written before about how its total transparency was both reassuring and frightening to me, and about how unsustainable its mining process seems from an environmental standpoint. Addressing the sustainability concern is of deep interest to me, and is why I’ve been supportive of efforts such as Ripple and Ethereum, both projects that are trying to address some of the challenges that Bitcoin faces today. The reason Bitcoin’s sustainability is of such interest to me is that, as my personal story here describes, I am conscious of the impact that my existence has on the world and try to do my best to make my impact net positive. If I am going to put my money into something, and go so far as to encourage other people to also put money into something, I want it to be something that is holistically sustainable – something that is a win-win-win all around to the greatest degree possible.

Right now, bitcoin is kind of disappointing from a sustainability perspective. Bitcoin mining equipment itself has issues stemming from “dirty” component sources to questionable labor practices in certain manufacturing centers. Mining machines also require a lot of electricity to run, and while some of that electricity is thankfully coming from solar, hydroelectric, or geothermal power, I’d reckon a lot more of it comes from coal, oil, nuclear fission, or natural gas (it’s hard to say for sure since the mining network is decentralized and lacks meaningful statistics aside from its current and historical hashrate). I consider coal, oil, nuclear fission, and natural gas unsustainable due to the fact that they are non-renewable and environmentally destructive to produce and consume. Even solar, hydroelectric, and geothermal have their issues; the components used to create solar panels can be toxic, hydroelectric projects have been known to disrupt local ecosystems, and geothermal has only been deployed at a meaningful scale in areas near tectonic plate boundaries. On the whole, bitcoin mining is dirty business which will only get worse as the bitcoin price goes up and the network hashrate increases.

Thinking about bitcoin mining in this light has brought me to think about the broader environmental and social impact of electronics in general. Such technology has brought about rapid advances in productivity and connectedness, and yet average working wages in the US are stagnant and increased connectivity has brought with it mass surveillance and a new generation of narcissists. At the same time, landfills are overflowing with toxic e-waste, and recycling simply can’t keep up with the demand for new electronics, fueling a destructive mining industry and increasing demand for toxic chemicals and cheap labor (which only remains cheap because governments prevent competition in the labor market to protect incumbent businesses).

It is in this context that I find myself as a budding entrepreneur who is conscious of the impact my existence has on the world, and who seeks to always leave things better than I found them. I can’t even consider buying a laptop without feeling a twinge of guilt as I think of the workers exploited and air, land, and water polluted to create the device and deliver it to my doorstep; instead, I have chosen to use the same laptop since 2011 and I am not yet looking forward to the day that I must replace it. I have heard people justify such purchases as being a means to an end. I used to hear this argument in response to criticisms of environmentalists who fly on planes for work or play, and never found it very satisfying.

As I wrote in the first post on this blog, I have been thinking of shifting my focus from cryptocurrency to identity, and accompanying this shift is a desire to build and sell servers for personal use so that people can gain control of their digital identity and personal data. My concern is that, if I am to do this the way I perceive to be the right way, I face a lot of difficulty in doing so. I will have to source all of the components from both environmentally and socially ethical and sustainable sources, and manufacture the devices in facilities that offer people healthy working conditions and not just a living wage, but a thriving wage. Doing all that would be very expensive, even prohibitively expensive given that I am not a rich founder who can bootstrap a venture to success. Such a venture is something I’ve been discussing at length with my colleagues at the okTurtles Foundation as a means of making our work financially sustainable, and they share my concerns.

There is some precedent for success in ethical electronics: Fairphone is a really fantastic initiative to “open up supply chains, solve problems and use transparency to start debate about what’s truly fair.” That social enterprise has been alive since 2010, and has been independently funded without donations or VC investments. Ind.ie successfully completed a crowdfunding campaign and raised over $100,000 to finance the development of a distributed social network, which will culminate in the development of an “indiephone” and personal cloud platform which gives people control of their data. Combining these projects with networks like Maidsafe and Ethereum could create the ultimate p2p platform and fulfill my dreams of sustainable, ethical technology without the need for a new venture to catalyze change.

And where does that leave me?

I don’t know, but I do know that Silicon Valley and the electronics industry in general has a deep environmental and social debt to pay, and I wish to add no more debt to that burden.


Email is probably the most popular decentralized messaging protocol. Add yourself to my email contacts if you would like to stay in touch!

The First Post Is Always The Hardest

It is September 28, 2014. A year and a half after purchasing the domain name “lightco.in,” a website has found it’s home here. Welcome! A special thank you to INRegistry and NIXI for letting me be here. One day I’ll get an uncensorable domain name a la Namecoin, but that day is not today. Namecoin is a really interesting concept, but I think it is likely to be overtaken in adoption by superior technology. The problems that prevent me from using Namecoin right now are problems I would like to work on and am actively interested in. In terms of technology, I’m mainly interested in two distinct yet related areas: Identity and value transfer. Identity is a tool used to socially interact with others, and value transfer tools are used to economically interact with others. Conceptually these are both deeply powerful and inherent to human nature, yet in practice the tools used for Identity and value transfer end up being deeply disempowering.

Identity in the modern world consists of two primary experiences: one in which our Identity is chosen for us, is attached to us foreveri, and we have to tell our secrets to everyoneii, and another in which we choose what Identities we want to assume but we’re told we have to remember different secrets for every context and these secrets must be hard (for a computer) to guess but easy (for a human) to remember. I am referring here to Legal Identity and Self Identity. Legal Identity can be the Identity people are given by their parents, and registered with the State, often in exchange for a unique number for purposes of identifying oneself as a unique Person in the State system; it can also be the Identity given to people by an organization they opt-in to later in life, like a school, business, NGO, etc, which is often linked to the State Identity. The Self Identity is an Identity people choose for themselves, often in online communities where a reputation can be built around a self-chosen name. Both Identity experiences are useful in theory, but in practice can often seem like more work than they’re worth. This is a serious, critical pain point in complex technological societies, and there is an urgent sense that there must be a better way.

Value transfer technology has been historically flawed as well, ranging from pieces of metal and paper whose value are easy to dilute, to slow and expensive electronic systems run by centralized, monolithic institutions. Then in 2009, the Bitcoin software was released and everything changed. Suddenly value of any amount could be transferred anywhere there was an internet connection as fast as email and for less than the cost of a postage stamp. The underlying technology which made this possible, the block chain, is a public ledger that is synchronized worldwide by a network of computers that run high-energy computations to secure and store each entry in the ledger. These computers compete to add new transactions to the block chain and are rewarded with tokens called “bitcoins” that are needed to make additional entries to the block chain. Only a limited amount of these tokens exist: 25 are awarded approximately every ten minutes (this amount halves approximately every 4 years), with a hard cap of approximately 21 million total bitcoins that will ever exist. Once that total is reached, the only incentive for the computers to participate in the security of the Bitcoin block chain will be transaction fees, which a computer earns each time it adds new transactions to the block chain. The invention of this system made the secure transfer of value across an open network possible for the first time, and has spawned a wave of innovation and a new class of technology that is broadly referred to as “cryptocurrency” (though the ledger is as much a star of the show as the token or “currency”).

The problem with Identity today is that it is centrally controlled and too easy to copy, like the currency of old. Now, cryptocurrency technology has decentralized control over currency and made it much more difficult to copy, and this technology can do the same for Identity. Combining these two concepts, cryptocurrency and Identity, could give us a system where Identity is controlled by the individual and easily verifiable using a public ledger system without revealing private information. The problem I see holding back that vision is the insecurity of hardware and software that most people are using right now. While cryptocurrency is really hard to compromise in theory, in practice it can be relatively trivial due to the insecurity of everything. Any attempts to make the technology more secure will inevitably make it less convenient to use. However, I believe that technologists are making the gap between security and convenience smaller all the time, and there will come a time when the security of hardware, firmware, and software are improved to the point that physical security will be the only concern. When this is achieved, then it will be possible to trust our devices with our Identity.

Efforts are being made to secure cryptocurrency at the hardware level. Trezor was the first commercially produced, dedicated hardware device for the purposes of storing Bitcoin private keys and signing messages with them. Just as Bitcoin private keys authorize the transfer of value from one person to another, so too could private keys authorize access to remote and local systems the way Identity does today. Identity can give you access to a driver’s license, financial services, vices, firearms, entertainment venues, online accounts, and more. It’s a challenge/response system: is this person eligible for access to this good or service? Identity answers that question. Usually the challenge is very specific: what is the person’s birth date? What is the person’s username and password? What is the person’s name and social security number? Instead, the questions could be much less invasive, reducible to: can the person produce a valid signature for this public key? To trust the answer to that question, people must be able to trust the source of the answer: the hardware, firmware, and software. This gets us back to trust in the security of technology.

For us to make the leap from analogue to digital, from centralized to decentralized, we must trust the security of our technology. Trezor is an excellent first step for technology designed for protecting cryptocurrency private keys, and I think similar devices will be produced for digital Identity. In fact, since both kinds of devices would simply be used for storing private keys and signing messages, one device could serve both purposes. With such a device, the number of accounts one could create would be limited only by computer memory. One account could be for a State Identity, another a Professional Identity, another a Hobby Identity, and on and on. These accounts could be stored on separate devices for better security (since risk is decentralized). With such a device, Identity and value transfer can be managed easily by everyone, with full control in the hands of the individual.

Right now my main focus is increasing awareness and adoption of cryptocurrency and other p2p technology, but my next focus will definitely be in the production and distribution of hardware designed to protect private keys and enable convenient cryptographic message signing. Such devices would have a multitude of uses, but value transfer and Identity are easy market entry points. Probably Identity first, since many people are already comfortable with digital Identity in one form or another, then cryptocurrency once that technology gains broader adoption. Perhaps such devices will be the catalyst for widespread cryptocurrency adoption, since it will make the technology more secure and user-friendly. Either way, if you’re interested in working on the problems discussed in this post, do get in touch.

State of Mind is a blog series about various topics that are on my mind. Current events, discoveries, questions, stories, and insights will be shared here.

iThere are often processes for getting a new government-issued Identity, but they are not exactly convenient.

 

iiConsider how many times you’ve been asked for your name, address, and social security number, and then consider that every time you complied, you gave the other person (and anyone else who could access that information) everything they would need to steal your Legal Identity.


Email is probably the most popular decentralized messaging protocol. Add yourself to my email contacts if you would like to stay in touch!