Biggest selling point of bitcoin & cryptocurrencies is decentralization & open contributor network (mining) where any one can contribute to the network hash power to reap the benefits, it does opens up the opportunity to bad actors who can take over the network & bend it accordingly. Once they’ve the control of network, they can pretty much do anything they want. These kinds of attacks are not easy in bigger networks such as bitcoin but smaller networks are very much vulnerable to it.
Imagine a single financial institute having control of the entire world ledger where they can manipulate the information & enforce new rules. They can send fake deposits that appear real or deprive any one of their balance.
Yesterday, Ethereum Classic suffered a 51% attack where
approximately 1 Million worth of ETC tokens were fraudently transferred on the
network. This fraud in specific is “double-spent”, where a single transaction
is spent more than once. You can think of it as counterfeit currency that looks
100% as original. This devalues the existing token value since now you’ve more
supply that was produced illegitimacy & negatively impacting the tokenomics.
Bitcoin so far has been safe from such 51% attach though
there were many potential opportunities. It however has impacted coins with
much smaller market cap, because it’s easy to control it. Again, take an
example of taking over a small company vs large company. You can purchase a
small company stake for much cheaper over large company. Protections in case of
small networks are generally small as well.
Easier solution to avoid double spent is by having longer
confirmation threshold. While speed is an essence & experience, at times recipients
are okay with 1-2 confirmations, but in this case they’ve to rely on 6
confirmations in majority cases. If the network is busy, it may take hours or
even days for a transaction to clear. Imagine every bill verified at a toll
booth through counterfeit currency checker. There is a tradeoff between
experience & protection.
Decentralized networks operate on a trust level where every
contributor is expected to act in good faith & by design if 51% of the
contributor decide to change something, rest have to follow. This is a
limitation in any proof-of-work network. If you remove this clause, it pretty
much removes the basic promise of proof-of-work network.
Going a bit deep, I’ll try to explain how it actually happens.
Miners are the driving force in any proof-of-work (PoW) network. Their goal is
to support the network by validating & storing every transaction on the
shared network. This shared network is referred to as “blockchain”. If one of
the contributors have got the 51% power, means he has simple majority on the
network. He can now forge transaction history, add a new fake transaction or
reject any upcoming transaction. Consider it as equivalent to a ruling party
with simple majority in the parliament who can rewrite anything they want.
Actually, worse than that because here you don’t even know who the ruling party
is who can come, conquer & leave without any indication of their identity.
This forge or chain manipulation is also referred as “chain
reorganization”. Every chain reorganization has two attributes. depth &
length. Depth is number of existing blocks which were replaced & length is
number of new replaced blocks.
In all honesty, it’s very difficult to carry on similar
attack for long so generally they last anywhere between couple of minutes to
hours with rare exception of more than 24 hours. Once there is any suspicious
activity detected, major merchants or recipients stop accepting transactions on
that network till things have figured out. Once the attack is over, blockchain
is resynced excluding all the fraudulent transactions.
Victim in this case is the recipient if he delivered the
product with the assurance that the funds are legit. Once the blockchain is
reverted back to original form, that transaction doesn’t exist anymore. This
also has a major impact on the confidence that users have on the network &
can be used to manipulate the prices. Imagine you’ve a massive short position
that’s not in your favor & you’ve to cover short. You may be better off by
attacking the network rather than covering your short due to margin call.
With smaller networks, it’s very cheap to conduct such
activity & interestingly in many cases it’s less than 0.1% of the network
value that can bring it to knees.
This also may define a new model for valuations where networks would be valued at multiples of cost of 51% attack. I’ll cover cost of such attacks in next post along with the market cap they’ve. Subscribe to my mailing list to be informed.
Concept of Bitcoin was introduced by a pseudo entity Satoshi Nakamoto through a white paper on 31st October 2008. This genesis block was mined on the principles laid out in that white paper
On 3rd Jan’09, The London Times ran a cover story entitled “Chancellor on Brink of Second Bailout for Banks”. This title was quoted and embedded into the very first transaction ever to be included in the new Bitcoin blockchain, by Satoshi Nakamoto. The block containing this transaction is called “The Genesis Block”
This note has been interpreted as both a timestamp and a comment on the instability caused by fractional reserve banking.
First recipient of the bitcoin transaction was Hal Finney, a cyberpunk who created the first reusable proof of work system ( RPOW) in 2004. He was probably the first person to download the software upon release & was transferred the first set of 10 bitcoins from Satoshi on 12th Jan’09. This was the first ever transfer that took place on bitcoin network.
Bitcoin has sparked a movement or a strong debate in existence of programmable money that leads to open & financial financial system.
It’s been a roller coaster ride. I got involved 7 years ago & thought late to the party. 10 years since first bitcoin transaction & I still think we’re early to the party
Industry has been growing daily defying any resistance internally & externally. This is probably the most undisputed financial technology innovation till date. It’s not just the tech, but combines economical, financial, political & philosophical movement.
Biggest strength of bitcoin is that it’s running now for 10 years in a row with 100% uptime, without a single fraudulent transaction that exists today & not deviating from its original monetary issuance schedule. Only 20% more bitcoins will be issued over next 10 years. In comparison, we’ve no clue how much of government issued fiat will exist even in next 12 months. I am really a fan of the transparency, where I can predict with a very high degree of certainty that every 10 mins, a bitcoin block will be created.
So unless the bitcoin network disappear which I find slightly hard to believe at-least over next 10 years or governments start putting a check on their money printing press, there will be a serious competition for storage of value. I suspect majority of the governments will give up on their currency & adopt another currency. It’s similar to languages where major languages have a network effect. With every passing day, confidence is bitcoin is growing & the pedigree that bitcoin has achieved over it’s competitors is unprecedented
Though we’re very far from where we should be, today’s the day to celebrate the bitcoin genesis block’s 10th birthday. Looking forward
5 years ago, we installed the first bitcoin ATM in Toronto at Decentral. These 5 years passed by quickly. I am humbled by the people I met, experiences I had & opportunities I got through that experiment.
That venture started as a fun weekend project that turned into a business. Today it’s a thriving company. I’ll cover that story later but today I’ll write about why I think Bitcoin ATM is a killer use case for cryptocurrencies.
It’s fairly easy to buy bitcoins in today’s age & date however it wasn’t the situation in 2013. We had disasters like MTGox in addition to some shaddy exchanges which wanted you to transfer funds to an offshore entity. At time it used to take months before you can see your money in bank account. Bank accounts were also getting shut down for just dealing with an exchange.
Idea behind Bitcoin ATM was very simple. It’s a simple machine that converts fiat into bitcoins & vice versa. It was considered one of the most unpopular startups due to it’s nature. Like here everyone is building next generational cryptographic solutions & here we were cranking steel boxes with cash recyclers. In the utopia world of crypto, it was hard to make an impression & was laughed upon.
5 years passed by & today there are over 4,000 BTMs serving performing millions of transactions every year. For majority of people, their first interaction with bitcoin was through Bitcoin ATM. I do often come across stories of how people use these machines. It’s one of the most important component of the entire cryptographic currency movement.
I still to date believe that one of the most weakest link in the decentralized financial world is traditional banking. Today if banks shut down any exchange bank account, they’re done. Building an exchange using a bank is like building an AirBnB in the lobby of Marriot
Here are some interesting use cases around how these Bitcon ATMs can do more than just
People can buy stable coins through it & store it in their wallet. Banks are generally only interested in banking the top 1% so there is a big number that can be served.
Infrastructure as a Service
These BTMs can be used to offer services to unbanked directly from these machines. Companies can built applications targeting this market segment & BTM can serve as an intermediary
Despite digitisation majority of the money remittance is done in cash. 80% of the expenses for a money transmission company are due to location & KYC. BTM can slash these expenses by 95%
If you look at any financial institute, they’ve to dependent on SWIFT or central bank network for transfer of fund. Through BTMs foundation of an independent financial system that be laid which can be built parallel to legacy. This system have it’s own rail tracks allowing more flexibility. There is a bigger opportunity to build a network of BTMs which can perform any function that any other financial institute can perform.
These BTMs can have cash recycler and in an ideal scenario there isn’t any need to replenish or fill up the cash. They can independently operate & replace any branch effectively improving profitability 5X.
Have you ever used a Bitcoin ATM or is there a Bitcoin ATM nearby yours ? Also what else do you think these BTMs can do ?
Bitcoins was a hope of beacon in the world of crazy inflation that’s impacting every one. Since bitcoin isn’t tied to any country monetary policy it’s only worth what believe it to be worth it. Though it has consistency outperformed every legacy asset on a longer time horizon, it’s still far from mass adoption and one the major reason is price fluctuation.
Here are some of the bitcoin price crashes
2017 was the craziest year for cryptocurrencies where we saw crazy gains of 10,000X but 2018 wiped off everything. This led to party moment for few but a nightmare for many. Fingers on the argument that bitcoin as a storage of value were raised & classic example of tulip mania was back in the market. It’s hard to argue with the pessimists because bitcoins doesn’t have any underlying fundamentals behind it. More & more negative media however has attached a taboo towards this revolutionary technology through which money can be programmed.While I personally have seen crashes multiple times over last 7 years, it’s tough to see market take a toll like this. Overall I am bullish on the cryptocurrencies however sanity has to prevail. It’s hard to deny the advantages cryptocurrencies provide but price volatility is keeping them off field for many serious players. While it’s exciting to see the upside swings, not everyone has an investor mindset. Since majority of the countries regulations are hostile towards cryptocurrencies, volatility keeps the institutional investors further away. There has been one thing certain about bitcoins & that’s volatility. There are many funny memes & jokes around but the following one is my favourite
A boy asked his bitcoin-investing dad for 1 bitcoin for his birthday.
Dad: What? $15,554??? $14,354 is a lot of money! What do you need $16,782 for anyway?
There is an interesting case of token velocity which is super high when someone is using it as the currency and doesn’t want to hold. In case of cryptocurrencies, if you’re holding for long you’ll get a HODLER ( Hold On for Dear Life). HODLERS are generally regarded as highly respectable in the industry because they’re considered to be in for the long vision rather than flipping. Everyone loves to HODL, however the scary swings aren’t for the faint hearts.
Welcome Stable Coin which does take care of the volatility problem by being pegged to a fixed value such as fiat or commodity. This is the answer to every day users who don’t want to be exposed to price movements. It does fulfil the basic functionalities of money which are
Means of exchange
Unit of Account
Storage of value
Transaction in cryptocurrencies have been complicated due to fluctuations & stable coins are supposed to put a stop to that. It’s almost impossible to transact in exact amount. Stable coin prime job is to protect the immutability of the transaction value. This also makes a strong case for cryptocurrencies and graduates it into a mature storage of value. 2018 has been a good year for stable coins which mushroom growth of stable coin provider. Everyone have their own way of approaching the solution but majorly they can be divided into two which are further subdivided into two. The two solutions are first divided by the way they’re designed and then by the virtue of their functionality. Overall they serve the same purpose, provide stability in the price of the user-desired assets.
There are two major types of stable coins philosophies
#1 – Centralized
#2 – Decentralized
Centralized coins are the one where there is a centralized entity keeping possession of the assets while in decentralized case, it’s generally a smart contract stabilizing the value.
Centralized coins are issued through a financial institute who has the custody of the asset backing them. There are two major types of assets which are considered colletral while issuing stable coin
This is the most common type of coin where the stable coin is issued against fiat currency by a centralized financial institute. Here are the features of fiat-backed stable
It’s value is pegged to a fiat currency such as USD in a fixed ratio such as 1 stablecoin would be equal to 1 USD. USD is the most common pair but other pairs are also available.
Financial institutes at any time is in the possession of the fiat currency backing the coin.
Transaction may run off-chain or it’s own private or dedicated public chain
Total collateral should be equivalent to circulating supply at any given time.
Technical wise, this is the most simplest way to issue a stable coins since the financial institutes just issues coins based on the amount they’ve. They are tradeable on exchanges and redeemable by issuing financial institutes. Trust in the entity backing is super important. Financial institutes does have an incentive in increasing the fiat backing because they can earn interest on the money without any risk. Even at 2% interest for 1 billion deposit, they’re earning 20M/year risk free. Cash handling cost is much lower than this making it a cash cow the financial institute. Cost involved are generally occured by the financial institutes anyways. We’ll see more and more financial institutes issuing similar kind of stable coins.Due to centralized nature, if the financial institute backing the coin has any problem, it’ll have directly impact on the the stable coin issued by them.
Similar to fiat, there are stable coins which value is pegged to commodities they’re backed by. Most popular form of commodity is gold followed by silver, but we’ll be able to see other precious metals & petroleum based coins as well.
It’s value is pegged to an asset such as gold in a fixed ratio such as 1 stablecoin is equal to .01 ounce of gold. Gold is the most popular but silver and other exotic commodities are also being issued.
Financial institutes at any time is in the possession of the commodities backing the coin.
Transaction may run off-chain or it’s own private or dedicated public chain
Total collateral should be equivalent to circulating supply at any given time.
Technical wise, it isn’t difficult either but the fluctuating price of underlying asset does require financial management and generally the storage cost is higher as compared to fiat. Commodities which are generally supported by stablecoins has to be fluid and tradeable on exchanges. They are tradeable on exchanges and redeemable by issuing financial institutes. Trust in the entity backing is super important. Having higher deposit strengthen the balance sheet which empowers the financial institute be leverage. Similar to fiat-backed stable coins, we’ll see more of commodity based coins as well.
Decentralized coins are not controlled by a single entity but more by code that stabilizes the value. There are multiple 3rd parties who have to participate in order for the value to be stable.
Most common form of decentralized stable coin are backed by cryptocurrency. There isn’t major difference between cryptocurrency and fiat backed stable coins in terms of logic but due to nature of the transaction everything is done through smart contract & is on-chain. User put up their funds as collateral which is generally significantly higher than the stablecoin issued to cover up in case there is a flash crash. Despite higher loan to value, there are still liquidation events which even has more impact on the price and has lead to black swan events.
Here are some of characteristics of stablecoins
Value is pegged to fiat but it’s pegged by a cryptocurrency
No centralized body is in control of collateral but it’s locked through smart contract & is executed on-chain
There are additional supplementary instruments and concept of oracle which keeps the price stable. These oracles have act more like a bounty hunter which is looking for liquidations and make a small profits whenever it is able to execute properly
Though it’s very similar to any centralized stablecoins in terms of mechanics, risks are far higher. Biggest risk is code exploitation which can lead to collapse of entire system. Though there are constant audits, but still history is full of breaches and hacks. Here the stakes are much much higher. Smart contract doesn’t execute by itself but requires a third party execution so the system has to rely on them. If they fail to act in time, liquidations might not happen in time destroying the peg value. Easiest option is to have a very high value of collateral with respect to loan however it may make tit unattractive since investors are looking to leverage up not the other way around.
They’re similar to a Decentralized Autonomous Organization ( DAO) which controls issuance and pricing, which are referred to as seigniorage-style (or algorithmic) stablecoins. They’re completely digitalized and non-dependent on any collateral whatsoever. Supply, demand & target price is controlled by the code which makes it truly decentralized and no regulatory oversight. Both of these features increases its ability to scale as compared to counter part solutions since there are not any additional collateral requirement with supply increase
Here are the major features
Cheaper to maintain the price immutability due to lack of collateral requirement
It operates on the basic principle of supply and demand where coins are issued if there is enough demand & destroyed if the demand drops. This issuance and destruction keeps the price stable. Generally if the price goes down. Bonds are issued and if the price goes up seigniorage shares are issued. This is most exciting form of stablecoins but haven’t been in production yet.
There are also creative proposals on how to achieve stability while keeping the decentralization property and it’s a work in progress.
Stable coins aren’t stable
There hasn’t been a single example of stable coin that have been successful at keeping the exact peg for extended period of time. Multiple times they’re traded few percent above or below their actual value. Theoretically they’re great but they’re prone to market fluctuations as well. In one case, value of a stable coin has dropped by 70%.
Do they bring stability ?
Bitcoin does have a connection with alternative coins when it comes to price movement so generally the overall market doesn’t move much with respect to each other. Bear and bull markets are correlated. Stable coins adds a different dimension to market pricing where people can bring in fiat and take a short/long position making the market extremely unstable. So with stable coins, the term shouldn’t confused with the fact that it’ll bring stability to the market. It just keeps the value stable for the holder of that specific coin
It is a new concept and haven’t been tested over long period. There are chances that one of them will break causing a spiral downward market crash. It has happened in the past but they were not as popular at that time having minimal impact. Even decentralized coins are prone to hacks Stable coins generally require us to trust a central third party. In case of centralized coins, there are always risk of custodial going illiquid.
Pursuit to perfection
Cryptocurrencies basic moto is decentralization but there isn’t a fool proof system to get a perfect solution. We’re far from perfection but we have came a long way. Stable coins are on the rise with over 2 dozens companies working on the solutions. Every has a unique approach and hopefully we’ll have a perfect solution soon. Stable coins are the holy grail of crypto and is a necessity piece in the puzzle. With extreme volatility in cryptocurrencies, it would encourage people to get in and out of the market whenever they want. None of the solutions are reliable so they’ should be only treated as an ad hoc solution. Right now it’s limited to startups, but bigger financial institutes will move into the game and I won’t be surprised if countries start issuing their own digital currencies on the principle of cryptography. Rome wasn’t built in a day & future won’t be either. It’s an evolution towards better & better