Bitcoin Series 35: How I Stopped Worrying & Learned To Love Hashing Rates

Bitcoin Hashing Rate over time (source: Blockchain.info)

Every few weeks, someone involved in Bitcoin writes the following somewhat breathless blog post:

1. Block rewards account for almost all mining rewards 
2. Block rewards are going to drop (next drop in 2016/2017) and drop by 50% every four years forever
3. There won't be enough rewards for miners leading to insufficient hashing power
4. Therefore either (a) Bitcoin is in trouble (anti-Bitcoin camp) or (b) block rewards / inflation will have to be increased to keep miners incented (pro-Bitcoin camp)

Points 1 and 2 are true.  Points 3 and 4 are an exercise in ignoring all data that you can't model, like the old cliche of the drunk looking for his keys under the lamppost because that is the only place he can see...

First, let's recall how rewards in $ terms to miners are calculated because that is what matters for hashing rate since silicon and electricity are priced in $, not BTC.

[# of bitcoins in the block rewards] x [price/bitcoin] + [# of transactions] x [fees per transaction]

Things to ask the author when you read the inevitable Concerned-About-Hashing-Rate-In-The-Future-But-Sanguine-About-Hashing-Rate-In-The-Present Blog Post.

1. What is your assumption for BTC price at the time of the block reward drop?  Also, in the long-future (2020s before it drops again!), what are your assumptions about transaction volume and fees?
   
   As a general rule, nobody has any defensible assumptions because if you can predict the BTC price in 2017 and 2021 (note, you can't), you would have more lucrative pastimes than predicting hash rates!
   
   I will declare upfront that I have no idea what BTC price will be 1/5/9/13 years from now (same goes for transaction volume) and I have never read any credible analysis suggesting anyone else has a clue either.
    
2. Isn't it a bit odd to be predicting that BTC price certainly won't double at least once every 4 years (particularly since reduced block rewards mean fewer BTC to market)? If that not-particularly-dramatic-move-by-BTC-standards happens, rewards in $ terms stay stable or rise, even if transaction-related fees don't rise.
    
3. How does your model account for the last 2 years?  The block reward in $ terms swung 10x over the last couple of years during the price run up/down.  During that period, hashing rate has gone consistently up (see chart above)   Why would a crisis emerge with a 2x swing in block rewards when it did not with a 10x shift in block rewards?
    
4. Do we have [not enough][too much][just the right amount] of hashing power today? How about six months ago when we had less? Was it a crisis?  Or 18 months ago when there was much less?
   
   This is a very tough, very technical question but not nearly as tough as predicting if tomorrow's hashing power will be sufficient (since today all the variables like BTC price, transaction volume, etc) are known.
   
   So, without a credible model for "Is hashing sufficient now?" how can one have any opinion on "Will hashing be sufficient in the future?"

This is not to say that I have the answers to the questions above and/or I know it will all be OK.  I don't! 

My position is that:

1. I don't know what will happen but neither does anyone else.   In these cases, worrying is premature since small shifts in other variables will render the block halving irrelevant.  In fact, if you want to worry about blockchain security, worry about colored coins, not native units (that is a different post though)
2. The implied models of the pessimists don't account for the history of the hashing rate to-date very well at all if they were to be back-tested...
3. It is hard to imagine too many cases where Bitcoin is a big success and either BTC price doesn't go up or transaction volume doesn't go up.  In which case, in the cases when you want the network to work, it will reward miners and in the cases where it won't need a lot of hash rate, it (correctly) won't have it.

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Bitcoin Series 34: Oracles, Oracles, Oracles and Oracles again

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Eugène Delacroix - Lycurgus Consulting the Pythia. Wikimedia Commons

One topic that I believe is under-studied, under-invested and generally under-played in the world of Bitcoin is that of oracles.   Bitcoin is a spectacularly smart global decentralized open programmable value network that can natively trade any asset without counterparties so long as that asset is bitcoins, a currency that is a unit of account in exactly zero economies.

On the other hand, once you want to trade in instruments related to the existing financial system (currencies, stocks, bonds, etc), you are back in the world of issuers, counterparties and slow moving centralized organizations.

Oracles (today, mostly at the concept level) propose an incredibly useful solution to this topic. Imagine an arbitrary number of sources (each with different level of user-determined/rated trustworthiness) broadcasting, for lack of a better world, financial, political, weather and state-of-the-world information in a format that could be incorporated into Bitcoin contracts.   Once that exists (and it will), you will have an explosion of decentralized financial instruments executing over the Bitcoin network.    

Here are some sample contracts you could design to work natively on the Bitcoin blockchain in a world of oracles:

(1) Call options on IBM shares where price is determined by the end-of-day values provided by the following 5 oracles: Google,  Bloomberg, Financial Times, Thomson Reuters and Wall Street Journal. If less than 4 of the 5 agree, cancel the contract.

(2) Weather derivatives that pay out based on the average rainfall in Maine as measured by the average of [the National Weather Service oracle] and [at least 100 Weather Underground Stations oracles]

(3) Election contracts based on majority [5,000 out of 7,000] oracles on who the President of the USA is in 2020

(4) Futures contracts on electricity prices from distributed solar generators in San Francisco for your self-flying Jetsons car 

And so on.  I summarize this concept in this chart below.

Side-note 1: Yes, you probably need some long exposure to bitcoin for this to work today and/or well developed ways to also hedge BTC-[your currency] risk during the contract period but either seems plausible by the time this exists 

Side-note 2: Yes, this is not totally decentralized but could be quite decentralized for things like "who won the Super Bowl" and reasonably decentralized for "what is the price of IBM stock EOD today?".  On the whole, probably at least as decentralized as mining is, if not much more so.

Side-note 3: Could be a nice monetization model for some sensor networks

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Bitcoin Series 32: I rented a NYC apartment with Bitcoin and I liked it

A few months ago, a family member needed to rent an apartment in New York.  I offered to help out and decided to use Bapple Real Estate as our broker since they were the first brokers in New York to accept Bitcoin. 

For those who have not had the pleasure of renting an apartment in Manhattan in 2015, it is something like applying to an elite university, but more expensive.   In this case, after an extensive application, we had to produce 6 (six!) certified checks (!!) to, among others, our broker, the landlord, the condo board and so on.  Bapple was willing to receive their payment via Bitcoin so this was the interesting part.

This is what the process looked like.

The Payments Made By Bitcoin

• Bapple sent me their address
• I sent them some bitcoins from my computer

Total Time: 5 minutes for me; 2 minutes for Bapple

The Payments Made By Certified Check

• Bapple sent me the list of check recipients
• I went to the bank branch during business hours
• I waited in line for 35 minutes for certified checks
• I realized the checks given to me mixed up the notes and the recipients
• I stood in line again for 30 minutes 
• I had the checks re-issued
• I called the broker
• She came to Midtown to meet me at the bank branch
• She wrote out a receipt on paper for the certified check

Total Time: 90 minutes for me; 90 minutes for Bapple

Now, what is interesting is that both processes have one flaw.  Most of the payments were refundable in case the condo board rejected the tenant.  But in both cases, I was relying on Bapple and the other parties to behave correctly.

Bitcoin has the ability to do better than that.   The money could have been sent to a multi-signature (2/3) address with an independent arbitrator.  If both the landlord and the tenant agreed that all conditions were met, they could release the money by themselves.  If there was a dispute, the arbitrator could be brought in to break the tie.  This is how things should work in 2015...

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Bitcoin Series 27: Bitcoin - a 6-sided Market and Network Effect

A good bazaar will have at least a 2-sided market and network effect.   Old Delhi, October 2011.

This is a brief post about network effects.  They exist in various forms and at various depths in different fields and today we will look at Bitcoin through this prism.   I must, at this point, thank Chris Dixon for introducing the '4-sided market' to my vocabulary.   Today, I will posit that Bitcoin is actually a 6 sided market.

(1) The basic example of a powerful 1-sided network effect is a social network.   The more people on it, the more valuable it is for others to be on it.   It can, however, be broken by a competitor that provides a more valuable service to one group, the users, who might then migrate en-masse (see Facebook v. MySpace).

(2) Successful 2-sided markets like eBay or Craigslist are significantly more difficult to disrupt.   Customers want to be there because vendors are there; vendors want to be there because customers are there.   To break them apart, you have to simultaneously have a better value proposition for both parties, otherwise nobody moves.   That is why Craigslist, with limited innovation, is still a dominant website, leveraging its early 2-sided lead.

My hypothesis is that the leading cryptocurrency (which, as of today, is clearly Bitcoin, but in theory any other cryptocurrency that gains a big lead) has actually a six sided market working in its favor, with six-sided network effects that will be very difficult to disrupt:

Side 1: Merchants will adopt Bitcoin because more customers hold Bitcoins

Side 2: Customers will adopt Bitcoin because more merchants accept Bitcoins

Side 3: Developers will adopt Bitcoin because more customers and merchants use Bitcoins.   Note that in a complex regulated financial product like Bitcoin, this does not only relate to the applications existing, but reaching scale, going through trial-by-fire, proving their trustworthiness, gaining regulatory approval and so on.  This is similar to the dynamics of an OS platform.

Side 4:  All the parties in 1-3 adopting Bitcoin creates demand for the currency, causing its price to rise, making mining rewards more valuable, drawing miners and their computational power to the currency and therefore making the blockchain more secure against a fatal 51% attack.   This makes it more appealing to developers and investors at a minimum.

Side 5: Adoption by the ecosystem plus the security of a strong blockchain, draws pure financial investors to the currency, who push the price up, drawing more miners.

Side 6:  More adoption plus better financial institutions ("Side 3") means more liquidity running through the exchanges that exchange Bitcoins back and forth to sovereign currency, which reduces the spreads to exchange into/out of the currency and making it more cost-effective for customers, merchants, developers and investors to use it.   (Spreads to sovereign currencies are the main transaction costs in any cryptocurrency, far outweighing the currencies internal transaction fees).  

And the cycle repeats.

Summary
Each one of the six sides reinforces at least one or more of the other sides.    In aggregate, it is a superb setup of market incentives for the first currency to hit escape velocity.  It is as if, by buying stock in eBay the company, you magically gave eBay a direct cost and security advantage in executing transactions that other auction sites could not match, that drew more customers to it, that raised its stock price and so on.

I can't guarantee of course that Bitcoin will maintain its lead and there might be a technical flaw that has been uncovered to date.   I will state with some confidence however that Bitcoin's 'lead' over other alt-coins will not be easily disrupted by other non-state backed coins and certainly not by small feature tweaks.   

The network effects are very strong in this one.

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