Lightning network: will it save Bitcoin? Or break it?

Lightning network has been heralded as the way to scale Bitcoin into the future, but as it is starting to become apparent that two very separate camps with differing opinions on how to scale Bitcoin are starting to draw lines in the sand, it’s worth taking a pragmatic look at this technology, seeing as it seems to be shaping up that once adopted, it will be very difficult to back out¹

First off, I want to say that Lightning as a concept is pretty interesting.  I think that it will have many uses in the world of Bitcoin.  Yes, I have read the white paper (both long and short version) and I believe I have pretty good understanding of how it works.  A disclaimer, as most of the development is happening behind closed doors via BifFury, it’s hard to comment on any of the new yet unreleased progress, such as developments on the routing algorithm.

Let’s examine the pros and cons of the Lightning overlay network.

  1. Unlimited txn/s
  2. Secure from double spends
  3. Requires Bitcoin to use

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Bitcoin’s need for Anarchy


Nobody votes to adopt anarchy, it just happens.  It is emergent, it is organic, and that is exactly the way it should be.

If you asked anyone what was the most innovative thing about Bitcoin, you would likely get an answer such as “censorship resistance” or “financial disintermediation” or “deflationary money”.  But the truth is that the biggest innovation of Bitcoin is the fact that it is headless.  In fact most of what makes Bitcoin capable of delivering on the aforementioned promises is the fact that there is no company owning Bitcoin, no CEO to sue, or entity to hold accountable.  Bitcoin is simply a protocol.  Unlike previous protocols like TCP/IP however, this is a protocol that can represent money directly, and as such is likely to have a lot of politics embroiled with its implementation.  In the project’s nascency it was just Satoshi who maintained the software, and after his disappearance that torch was placed on Gavin Andresen, and subsequently Wladimir van der Laan.  As the project grew in popularity and media coverage, more developers came forth taking on more active roles in its development and maintenance.  This is a good thing.  The progression went from solo designer, to committee stewardship during the first 5 years of it’s life.  Like any committee tasked with such a heavy burden of safeguarding over 6 billion dollars in value, bureaucracy does what bureaucracies are arguably designed to do, slow down innovation in the name of conservatism.  For example, the current standing feature change policy enacted by Wladimir, is intended to only allow non-contentious features to be brought into the code base.  While this protects the status quo, it also effectively means that the system will cater to the lowest common denominator and prioritize preservation over dynamism and progress.

“Bitcoin will either grow to a million dollars per BTC, or go to zero…”

This is a fine opinion that any person or group is entitled to have, but certainly to impose that ideology onto the network would be in itself an act of oppression, yet we find ourselves presently with a dearth of viable alternatives should we choose to disagree with the conservatism of the Bitcoin Core team (a few of which work for Blockstream).

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Dr. Bitlove* (or how I learned to stop worrying and love XT)

So with such a contentious title which is sure to be an attention grabber aside, let me explain:

I don’t *love* XT, I love what it represents. Not specifically small blocks vs large blocks, but a counter voice in a collective democracy which is the Bitcoin community. I believe that we as a community need to have contrary views and healthy debates which voice all sides of an issue, so that we can remain impartial and objective, and resist becoming an echo chamber of unified thought, which is just another form of centralization.

In my previous writings I warned against moving into a dictatorship like model, where we blindly follow leaders.  What we must also be wary of is the propensity to naturally devolve into such a situation when all counter viewpoints are forced from the public discourse.

That unfortunately seems to be the case with Mike Hearn leaving XT, along with a lot of anti-XT vibes I felt at Scaling Bitcoin.  I think that I feel as many do, that the consensus was that a small bump in block size is not contentious, and such a hard fork should be pursued in parallel with other non-block size scaling initiatives (such as SegWit), if for nothing else but to collect data on how a non-contentious hard fork would propagate through the network, and to prove that the network has the resiliency to execute such a change if and when it is needed.

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Why only Bitcoin Matters — (and why everything else matters less)

The industry is abuzz with the new poster child of ‘disruptive’ innovation, Permissioned Ledgers.  I spent quite a bit of time earlier in the year consulting for big name firms on bitcoin blockchain and permissioned ledgers.  At the time I didn’t really view one preferably over the other, I considered each on its merits and useful applications.  Of course when you are paid to technically consult for a company, they don’t want your biases, they want your technical expertise.   Without fail, those of them who were interested in B2B models were interested more in a permissioned ledger, and those who were doing B2C models were interested in using Bitcoin to monetize their online business models.  Most that were interested in B2B solutions had very bank-like businesses dealing with near-money like value systems.  Decentralized ledgers are great as payment systems.  Bitcoin is digital money,  that runs on a decentralized ledger.  Notice the difference? The ledger part is just a small part of Bitcoin’s innovation which is the money aspect.  Because it is a money it is natural that banks or bank-like entities would want to steer clear of Bitcoin.  There are very strict laws surrounding the control of who gets to print money, what is legal tender, currency control laws, and Bitcoin turns all of that on it’s head.

When I used to compare the two for my clients I would tell them that Bitcoin was harder to create a business model on top of due to the yet unclear legal issues while with permissioned ledgers I saw a clear potential for profit in developing cost saving systems. I was quite impartial to this difference until only 6 months ago, seeing both as equally beneficial as a technology.  However, something happened in the interim that changed my views — Greece.  With the Greek crisis, the world witnessed how the will of the common people matters little against the will of the privileged few.   Many would like to blame the Germans but that would be unfair.  The german economy suffers with continued bailouts as well; “throwing in good money after the bad” those of us in the industry call it.  The central banking system is to blame, as whether deliberately or by greed or by chance, the world economy is starting to collectively crumble under the weight of our bad habits of spending, lending and investing with debt.  And we witnessed first hand that when the chips are down, it will be everyman for themselves. Bail-in clauses have been put in place in all major countries of the world, so that the banks have a right to take your money to save themselves before you.  They justify this as necessary to save the system as a whole.  But is it really?

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Is Money the Same as Currency? — The True Nature of Money

It’s a simple question.

But it is one that 95% of people will answer wrong. Don’t feel bad. I would have as well if you were to have asked me 10 years ago.

Ans: They are not the same thing.

Those in power would like you to think of them as the same thing. In fact, we have been taught since we were children that they were the same. That is, if you were lucky enough that they taught you anything at all about money in school (more than just recognizing coins and dead presidents faces that is).

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Articles of Bitcoin Constitution – A Genesis Block of Governance

One of the ongoing issues with Bitcoin, besides the scalability issues, is the fact that it lacks a clear governance model.  The fact that we don’t have one is likely an artifact of Satoshi not really knowing how far Bitcoin would go.  Actually it’s not so much of a governance model problem than the fundamental issue that we don’t know who we are.  What is the Bitcoin project and what are its goals?  Indeed, it was designed to be an (almost) foolproof solution to the problem of consensus without governance.  But, like Gödel’s Incompleteness Theorem (which proves that no formal system of proof — such as mathematics, can prove its own validity using only its own set of inference rules) Bitcoin’s consensus solution itself has an Achilles Heel — the hard fork.  A hard fork basically means that competing versions of the same network are simultaneously running a different set of consensus rules.  In the real world, we call these competing rule systems, ‘jurisdictions’ or ‘countries’, and we call the methods by which we come to agreement, ‘politics’.

Bitcoin developers have debated this problem at length in the past, and the problem is not an unfamiliar concept to them, but they have failed to come up with any workable solutions to date.  The Bitcoin Foundation was founded originally with the mandate of governance, but it fell apart due to infighting, alleged corruption and scandals.  Several of the ex-board members are presently in jail, and others have reputations which have been mired in dubious dealings.

A brief history in politics

Some political systems had their share of faults

Some political systems have their share of unfortunate downsides

Up to this point, changes to the Bitcoin protocol have been loosely controlled by a small set of people, rightly called the ‘core devs’.  They extend from the dynasty of Satoshi, through appointed successors, through to Gavin, and now to Wladimir van der Laan.  Like a mirror of human society, which has seen a progression through the phases of political development from a dynastic empire, to monarchy, to the current oligarchy,  how a move to a true democracy can be accomplished, is truly a difficult problem.  It is hard because it skirts on difficult socio-political issues that human society has always struggled with: corruption, collusion, nepotism, uninformed or disinterested masses etc.  Many attempts in human history have been made in an attempt to solve these problems, such as the monastic system of organized religions, (Gregorian monks, Shaolin monks, the Sisterhood of Nuns) which requires one to devote one’s life to monastic pursuits and restricts interaction with society at large.  Our current system, that of a republic, was borrowed from ancient Greece, and focuses on the mutual distrust and competition of senators in order to achieve consensus.  Other more drastic solutions practiced in dynastic China, such as the forced castration of all political advisors to the court, ensured that one would have no other loyalties than that to the state.  I should hope we, in this age of information, need not have to resort to such barbaric methods of stemming the corruption of human virtue and integrity in our leaders.

So what can we do?

Must have been chaos back then.

I think we have managed to solve problems like this in the past.

We can try to follow in the footsteps of the American Founding Fathers.  Indeed, what we are experiencing presently, is something akin to what I would imagine the debates and infighting that must have occurred when the initial Continental Congress was being formed.  Putting yourself in the shoes of say, John Adams, with the full might of British Empire oppressing them, they had to come up with a way to galvanize the support of the colonists, to fight the crown rule, and to defend their freedom.  On July 2, 1776, the congress gave a unanimous vote for independence, and 2 days later, the Declaration of Independence, was signed.  The United States of America, was born.

We, citizens of the global nation of the internet, need something equivalent, to guard the founding principles of Bitcoin.  We need to define principles, articles of constitution, if you will, and we need the current leaders of Bitcoin, to vote unanimously to support them.

The current model – BIP

Everyone technical in Bitcoin is familiar with what a ‘BIP’ is.  It stands for Bitcoin Improvement Proposal.  Developers wishing to change the Bitcoin protocols create a BIP.  It is vetted by the core devs and if it is valid, then it is given a number, like BIP101 (which is Gavin’s auto-block-limit increase change).  Being valid doesn’t make it accepted however, it needs to be further discussed, debated and only if a unanimous agreement on the BIP can be reached by all core devs, will it be accepted into the code base which is released to the public.  This is the current system of governance.  It has flaws in that it makes it very easy for 1 member to veto changes.  This is one of the criticisms that have been raised by Gavin Andresen in the past; which is that it takes just 1 dev with ulterior motives to sink an improvement proposal.  Given that some of the devs are involved with other companies, it soon becomes clear that this system is inefficient in coming to consensus, assuming everyone may have personal agendas.

Hard forks need to be resolved by humans.  So humans need to agree on a set of principles to follow.  Open principles. Clear principles.  These core principles should be held by all who wish to propose changes to Bitcoin as BIPs, as well as all who evaluate these change proposals to ensure that they adhere to these principles.  I touched upon these in my previous article, but here I shall elaborate on them more fully.

Words and ideas. It's what binds us together, as a people.

Words and ideas. It’s what binds us together, as a people.

Articles of Constitution of Bitcoin (draft)

BGIP 0.1 – The use of BGIP as the governance model

A Meta-BIP.  A BGIP, or Bitcoin Governance Improvement Protocol.  Which would govern and guide core devs (present and future) on how BIPs are accepted or rejected.  Of course, having a way to modify a governance model implies we need a governance model to begin with, a sort of ‘genesis block’ of governance if you will.  Bitcoin needs a Constitution.  A BGIP itself is subject to change, via amendments, but these amendments must receive 95% approval of the miners (not the devs), and cannot amend the Core Prime Principles. (that is amendments can be added, so long as they do not subtract from the efficacy of the pre-existing Core Prime Principles.  Any such violation of the Core Prime Principles, amounts to a rejection of this process entirely, and shall not be deemed ‘legitimate’ by those who honour these Articles of Constitution of Bitcoin.  So long as every core dev, can justify their approval or rejection of any future BIP based on these rules, then we should regard them as acting on behalf of the legitimate blockchain of Bitcoin.

Core Prime Principles

In order of importance:

First Principle (axiom)

Consensus, above all must be prioritized. Consensus by means of adhering to a core set of principles, which we are defining henceforth.

(anything which is deemed to break from these principles, shall be rejected)

Second Principle:

Decentralization must be preserved, any change should not detract from decentralization, or indirectly result in more centralization of the network.

(anything which can be shown to cull the diversity of miners etc, shall be rejected)

Third Principle:

Open Access.  Bitcoin network should be open for anyone to use, free from censorship or prejudice, regardless of political affiliation, geographical location, religion, race, or creed.  Bitcoin core code shall always be open sourced for all to examine

(anything that stands to restrict access, mark coins, block users shall be rejected)

Forth Principle:

Store of Value, the value of the token (bitcoin) should be preserved, that is, disregarding free market effects, the value of the bitcoin token on the network should not be endangered with existential risk.

(any attempt to change the money supply, money base, or fixed inflation schedule, shall be rejected)

Fifth Principle:

Efficiency as a Payment System, should be improved so as to increase the reliability, availability, utility, and security for all users.

(anything which will adversely affect the efficiency of the network, shall be rejected)

The Pyramid of priorities

Pyramid of prime first principles

Pyramid of Prime First Principles

The above is just a draft.  It is my proposal.  I am not a lawyer, so I make no presumptions about the above proposal being air tight, or all-inclusive.  If you have helpful suggestions to add to it as an official amendment, I give permission for any core dev (or anyone better at legalese) to amend it if you wish.  All I ask is that if you do, you name it appropriately, so that people can identify different versions.  For example, the first alternative can be called BGIP 0.2,  If it is adopted and ratified by the core devs, then any future amendments should only be allowed as additions to the Constitution, and proposals to add them shall be called BGIP 1, BGIP 2… and so forth.   I would encourage miners who support this to put the message into their block headers; “BGIP 0.1” which would mean showing support for this constitution and governance process.

When enough miners have shown their support for the core devs to take notice, I would like a unanimous vote by the core devs to adopt and adhere to this process, and use it henceforth to govern judgments on BIPs.  How they chose to technically do so, I leave it open for discussion, (and perhaps an official amendment), but I envision that BIPs shall be ‘innocent until proven guilty’, which is to say, if a BIP can be shown to not violate any of the principles, then it should be adopted.

I’d like to think that if we can all agree on this constitution, then any competing fork in the future can be clearly identified as ‘not-bitcoin’, and should be encouraged to create their own blockchain, avoiding dangerous Hard Forks.  This is not meant to stifle competition. It is not meant to restrict innovation. It is meant as a unanimous statement of identity, of who we are and the values that we hold. It is the hope that once that is clear, then at least a certain group can always claim to be upholding these values.

This is the ‘genesis block’, for Bitcoin governance.  With it, I hope we all can build a future together cooperatively, and collaboratively.

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Governance begins with consensus

Bitcoin XT vs Core, Blocksize limit, the schism that divides us all.

Forking Bitcoin, the first existential milestone

Forking Bitcoin, the first existential milestone

The news recently is all abuzz about the Gavin Andresen and Mike Hearn’s fork of Bitcoin called Bitcoin XT.  For the first time in the history of Bitcoin, its very existence has been put into peril by way of what is termed a ‘Hard Fork’ of the protocol.  I have watched the situation develop, and I feel that I must comment on this topic as the amount of FUD coming from both sides of the camps is reaching alarming levels, and frankly I think this is hurting Bitcoin. (the price as well as the community).  This is a long post, apologies.  Normally I would have split it out into several, but I wanted the message to be complete, and atomic.  If you want the executive brief, jump to the summary at the end. Go on, I won’t mind. (but don’t come back to me with questions later!)

Priorities of Bitcoin

Bitcoin, as a vision conceived by Satoshi Nakamoto is a decentralized cash payment system.  For such a system to work, you need a decentralized solution to the Byzantine General’s problem, which is something that I have detailed in the past and is succinctly defined here.  The reason Bitcoin is such a brilliant invention, was that it solved the consensus problem in a decentralized way.  The solution isn’t a perfect one, in fact, it cannot be formally shown to hold in all cases, (which is a source of consternation for many folks like Vitalik Buterin and likely drove him to develop Ethereum in response to the desire to have a formally provably secure solution), but it is shown in practice to work, in most real world situations so far.  For this solution to work, Bitcoin holds the following priorities in descending order of importance:  Consensus, decentralization, store of value, and payment system.  It would seem that the goals of the Bitcoin project have since diverged, under the leadership of Gavin, to focus more on the payment system use case for Bitcoin, at the expense of consensus and decentralization.  I would argue that sacrificing consensus, threatens all the other aspects of Bitcoin, not the least of which is its use as a stable store of value.  In fact, I believe such a consensus breach is an existential risk to Bitcoin itself.

Compounding the problem, is that the XT camp (and to a lesser extent the Core camp) is increasingly using populist and alarmist strategies to scare the public onto their side, betting on ( and rightly so ) that most people do not know enough about the inner workings of Bitcoin and thus will be drawn to believe what they say based on their reputation alone.  From the perspective of an interested 3rd party, I can no longer watch the partisan media campaign war that is taking place, using carefully misleading language and omitting of facts to steer public to their causes.  I could cite actual examples of such disingenuous wording and statements, but I will chose to leave it up to the reader with a critical mind to identify such examples on their own. (See appendix) Morally, I refuse to join the ad hominem smearing, and instead choose to focus on discussing the pros and cons of the debate from a purely scientific standpoint ( in hopefully, language that will make sense to the non-technical )

The block limit debate in a Nutshell

So what is the big debate about anyway?  Block limit.  I won’t go into the nitty gritty details of how the blockchain is put together, but suffice it to say that the current limit of the size of each block on the blockchain is 1mb. (1000000 bytes actually, but who is counting?) And one block is mined about every 10min on average.  That works out to be a theoretical limit of a paltry 7 txn/s (tps). Not stellar, as payment systems go. That is precisely why Gavin and Mike Hearn have been pushing for increased block sizes, in principle.  For comparison, VISA can supports on average about 2000 tps, PayPal about 115 tps.  VISA’s theoretical limit is an astonishing 50k tps.  So why is Bitcoin artificially limiting itself to something so low?  Because Bitcoin being a decentralized system with no one central point of processing, it is susceptible to denial of serivice (DoS) attacks.   What that means is that bad actors on the network can collude to attack the network stability itself, if it becomes profitable for them to do so. Making it unprofitable for them to do so is the key innovation of the Nakamoto consensus solution.  Satoshi put in the 1mb limit himself, in anticipation of having some limiter to the size which would prevent bad actors from breaking the system before it was widely adopted enough to be resilient.  He did himself foresee a time when the limit could be relaxed, but wasn’t sure at what point that may be, due to the fact it depends on a lot of variables.  We still don’t know what the limit should be, but the general consensus is that 2mb is okay, 8mb unknown, 20mb definitely risky.  Why? Read on.

Mine mine all mine!

Mine mine all mine!

Selfish miners

Selfish mining, is one such attack which was clearly explained in Satoshi’s paper as a possible weakness of Bitcoin.  This entails a miner, who has a significant amount of hashing power, mining blocks but not publishing them, thereby creating a secret longer chain that the rest of the network does not know about, with the intent of broadcasting it later, and in doing so will reverse some transactions that may have already been confirmed on the public (but shorter) chain.  This is the infamous double spend attack.  Normally this can only be accomplished reliably when one possesses over 51% of the hashing power of the network.  What most people don’t know is that network propagation is also a factor here.  Satoshi admitted that his calculations on the percentage of hashing power in order to be able to pull off a 51% attack reliably assumes no significant network propagation delays.  Indeed the danger of allowing block size to increase to the point where the expected delays in block propagation through the network has been discussed ad infinitum in the past, and the reason why the block debate has been ongoing since at least 2011.

In this regard, I can understand why Gavin feels that he must do something drastic to force the issue.  The attack goes as follows: If blocks were allowed to be ‘too big’ (big enough to add plausible delays to propagate to all nodes) then a miner would be incentivized to stuff the block they are mining full of txns that pay himself (or a cohort), up to the allowable block limit.  They do not broadcast these transactions to the network unless they solve the block themselves, removing the possibility of paying miner fees to some other miner.  If they manage to solve the block, they immediately broadcast all their spam txns and block solution.  The other miners would have to drop what they are mining, and start downloading the new (very large) block (which may take some time) and verify it, which involves checking the validity of all contained transactions (which will take some more time).  All this results in a appreciable head start that the attacking miner can enjoy in mining the next block.  So what he has successfully done is increased his ‘effective’ hashing power giving him a slight edge over his competitors.  Of course this is a game-theoretic problem, so we can assume that once one miner starts doing this, then either all miners will start doing this, as well (and make orphan blocks and double spends a lot more common) or band together to share high bandwidth connections/nodes (and push the system more towards a centralized one) both situations are bad for Bitcoin.  So everyone can agree that too big of a block size would open up bitcoin to a certain type of fragility that has up until now, not been a problem.

So how big is too big?

So unlimited block limit is clearly bad, and 20Mb is generally agreed upon as pretty risky (up to 8sec propagation delays).  What’s wrong with just 8Mb?  Frankly, it’s probably ok.  Probably.  The problem is that nobody knows.  Because nobody has finished researching the issue to a satisfactory level yet.  This is why some core developers are calling for more time to analyze what the ‘safe’ limit would be given the current bandwidth limitations of the present internet.  Others have proposed counter solutions to increase block limits that take a much more conservative approach.  XT proposes to start with 8Mb limit and scale up automatically 2x every 2 years until it reaches 8Gb. Gigabytes.  That will certainly make bitcoin able to compete with VISA.  But, can we be certain that network bandwidth growth will continue trending up monotonically without fail? What happens if a global downturn occurs and we see a slowdown in technology development?  What happens to the people who bought Bitcoin as a hedge against a fiat money collapse?  But for me the scariest part is that once XT block limit increase schedule is triggered, there is no turning back! (see Appendix)

What we are really arguing about here

That brings me to the crux of matter.  What we have here is an ideological schism in Bitcoin.  Most people fail to realize that this is what the block debate is really about.  On one hand you have folks who believe Bitcoin should be the new VISA system.  They believe that Bitcoin should be able to handle all the transactions on planet earth, from everyone’s daily coffee purchase, to everyone’s house purchase, to how Google cars should be paid for their services.  On the other hand, you have those who believe Bitcoin’s core value is the fact that it is a hedge against fiat currencies, and by extension, governments (in the case they decide to infringe upon your liberties).  Bitcoin CANNOT be both. It’s just not possible.  For a system to be able to support the proposed 53k tps it will need to be massively centralized (like VISA).  If such a system existed (like VISA), it would no longer be immune to government coercion or control.  The opponents of XT will argue that it is inevitable, and nay, necessary that sub-domains riding on top of the Bitcoin network be setup to handle local payments between local parties, thus keeping the required number of txns on the main net of Bitcoin manageable.  A current project under development, Lightning Network, is exactly one such solution.

Risks of not raising the Limit

The biggest argument against doing nothing (or doing nothing urgently — because I believe mostly all the devs agree the limit should be raised eventually) is that if the limit is hit due to real transactions in the network, then confirmation times will be variable, and delayed.  This is a valid point.  What will happen is that due to transactions piling up, people will no longer be able to reliably assume that they will get a confirmation in around 10min.  The simple rebuttal to this is that for customers of payment processors like Coinbase and BitPay, it doesn’t matter, as they will give you a confirmation without waiting for a block anyway.  What it does mean is that there is a chance that your txn could be double spent (and the payment processor would have to cover it).  I personally don’t consider this a major concern to current users.  Most people who don’t use a payment processor aren’t really that sensitive to confirmation times.  If you were sensitive to confirmation times then you are likely already happy waiting an hour to confirm anyway.  Another valid concern is that txns piling up unprocessed will put memory pressure on nodes running on small memory capacity hardware.  But the biggest rebuttal to this is that transaction traffic (natural traffic, not a contrived ‘stress test’) will not happen suddenly.  If it seems like the limit is getting hit persistently, and confirmation times are becoming a problem, an emergency limit increase is something that the core devs can patch very simply and quickly.  They can execute such an emergency block size “QE” if you will, at a moments notice.  They have demonstratively done this kind of deployment before, during the one previous hard fork, and with the F2Pool bug.  So what is the rush?

Fee (free) markets

On the other side of the fence core devs want to let the limit be reached, in order to force wallet apps to implement the necessary protocols/interfaces for developing a fee market. What this means is that they see that Bitcoin can never be ‘free for everyone’, if it were, it would have to be centralized (see above).  So although I believe everyone wants Bitcoin to be cheap enough (cheaper than any present centralized alternative), the core folks want to encourage a free market mechanism where if the network transaction load is high, you will need to pay more fees to get your txn processed on time.  Currently that is technically possible, but due to most wallet software’s inability to estimate the likely charge that is required, or lacking the ability to pay more to raise the priority of your txn that is already broadcast, it is not implemented in practice.  Part of the reason they want the block limit to be hit (gently) is so wallets are forced to upgrade to be able to make this experience better for their users, and thus be ready when the real limit (the unknown one where bandwidth creates the significant DoS attack concern) is hit, because core will not be able to raise it any further beyond that without compromising the integrity of the network.

What is a Hard Fork, and why is it dangerous?

Okay, thank you for bearing with me.  If you soaked in all the above you have a pretty good grounding on what the debate is about.  Now onto the process by which XT is going about the fork, and why it is irresponsible.  A hard fork means that the blockchain will split, with each side having a common ancestry, but be irrevocably non-reconcilable with each other.

I will spare you most of the details of the XT forking rules as I am sure you can find info elsewhere (see the Appendix below for link to Gavin’s BIP 101), but generally after Jan 2016, if 75% of the last (consecutive) 1000 blocks are mined by XT miners, then XT miners will be able to accept up to an 8mb block as valid. Sometime after that, once this first big block is mined, –let’s call this the “Judas” block (see diagram), then it will be rejected by the remaining 25% of the network.  They will drop it and continue mining the block on top of block “Jesus”, and when mined let’s call it “John”.

Bitcoin XT hard fork worst case scenario

Bitcoin XT hard fork worst case scenario

The XT miners cannot accept “John” as it builds on top of an invalid parent block (they need it built on top of “Judas”) and so goes on to mine “Pontius”, meanwhile, the core loyalists will mine “Paul” block which builds on top of “John”.  Any subsequent block mined by either side will be dropped as invalid by the other.  Effectively we now have 2 Bitcoin networks, with respectively 25% and 75% of the pre-hashing power before the Judas block.  It is untrue that the 25% will be compelled to join the majority.  They may go on happily mining on the John chain in perpetuity.  Their block rewards (mining income) will not be diminished (in fact, they will make MORE mining rewards, due to a smaller mining pool).  What will end up happening is that the hash power distribution will have changed.  The previous owner of 10% hash power pre-Judas block now will find themselves with ~45% of the hash power of the new John chain, and similarly miners on the Judas chain will have increased effective (relative) hashing power.  In truth, both chains are now less secure than the combined chain, pre-Judas.  Most importantly fungibility of bitcoins are now broken.

Both chains will still get transactions from the whole network.  Indeed txns of coins that were mined before the Judas block are valid on both chains and thus will be attempted to be mined on both, than is, unless the txn include any coins minted from a block after Jesus (in either fork), in which case it cannot be spent on the opposing chain from whence it came.

So what?

Why is this situation really bad?  Because of the exact reason why Hard Forks are dangerous.  If they have a consensus, they are resolved quite quickly with one fork winning over the other. (and it doesn’t matter which is longer!) That’s how it was resolved in the past, by unanimous endorsement by core to choose one over the other (and upgrade or downgrade accordingly).  IF there is no clear winner, because each side wants to stick by their guns due to ideological reasons, then we have a problem.  Why?  Consider Alice, who uses wallet A, and Bob, who uses wallet software B.  Wallets need to communicate with nodes to get their block confirmations. If wallet A is connected to a Bitcoin (John) chain node, and Bob’s wallet B is connected to a node running the XT (Judas) chain then they are no longer going to see the same block confirmations, and they won’t know about it!  Alice will send bitcoins to Bob, she sees a confirm, but Bob will never see a confirm, if the coins are originally minted from a post-Judas block.  If it is from Jesus block or less, then her transaction with Bob will work and be seen by both of them, BUT then Alice can re-spend those same coins with a counterparty on the John chain!  (and this goes both ways).  This breaks the fungibility of bitcoins, and will likely cause a massive loss of confidence of Bitcoin as payments will no longer be able to be reliably confirmed.  Because both are operating on the same network (IP ports, QR codes, URI etc) there is no way to detect a-priory if your payment is being made to a receiver who can receive it, until after you try (or unless they are really tech savy and you both know which side of the fork you are on).  This bad situation can happen as early as 100 blocks after Judas block. (about 16 hours).  Much of the chatter in the social channels portraying the XT upgrade as perfectly safe seems to be deliberately ignoring this fact.  And for understandable reasons.  IF (and only IF) everyone does upgrade to XT, then we will have no problem.  But if they don’t and it turns out to be a game of chicken, then we all will suffer.

Help us Satoshi Nakamoto, you're our only hope!

Help me Satoshi Nakamoto, you’re our only hope!

Where is Satoshi?

So with all these scary uncertainties, you may ask why hasn’t Satoshi come out to speak on the behalf of one side or the other in order to settle the dispute?  Indeed it would be akin to him coming out to act as a 3rd party mediator, such as when a parent comes in to break up a fight among siblings.  There has in fact been a post by someone claiming to be Satoshi, from a valid known Satoshi email address, claiming pretty much that the XT fork is unnecessarily dangerous, see here: Satoshi? Despite the many allegations that if this was really Satoshi, he would have signed his message with a known PGP key or perhaps moved some of his coins to prove that it was him, he has not done so.  I for one do not believe that he would.  If you read the message, (ignoring for a second who it is from) he is saying that Bitcoin’s vision is not one where it is subject to the egos of charismatic leaders, including Satoshi Nakamoto.  People who harp on the fact that Satoshi has not made a provably authenticated statement is clearly missing the whole point of this message.  If he were to do so, rest assured the whole of the community will rally with him, but that is exactly what he doesn’t want to happen, a whole community blindly following authority!  Consistently so, the author points out that if it takes a benevolent dictator to pull us out of this mess “deux ex machina” then Bitcoin, as a project in decentralized money resistant to authority, has failed.  That tautological statement, is provably true if you can wrap your head around it.  Therefore, if Satoshi wants it to succeed, he won’t use his ‘God card’ and settle disputes.  If Bitcoin continually needs Satoshi to keep us from going astray, then Bitcoin isn’t worth saving.   Considering that Satoshi has likely the most coins at risk than anyone else, and him coming forward to break the impasse would likely save us (and the value of his own coins) it is truly commendable that he has not done so.  The fact that he hasn’t tells me that he (where ever he or she is) is truly acting in an altruistic manner.  He is more willing to let Bitcoin die, than to let it continue on as a system that does not value consensus as its first and foremost priority.


(yeah you can skip to this if the above is more than you can digest in one sitting)


There is no spoon [danger] in a Hard Fork, but only if we ALL *believe*

Gavin and Hearn are trying to force consensus in an “Inception” like manner, betting on the fact that if 75% agree with him (whether they are well informed actors or not) then the 25% remaining will be forced to fall in line otherwise risk breaking Bitcoin for everyone.  Why are they doing this?  One can only imagine they feel that Bitcoin needs to grow otherwise risk being overtaken by a competing cryptocurrency.  Although current transaction volumes are not hitting the limit yet, they believe that adding capacity will stimulate growth.  That sounds more like strategy that Ben Bernanke or Janet Yellen might believe.  What they may end up doing is that they will cause the end of Bitcoin themselves if the 25% minority believe it is better to continue running a reduced (hash power) version of Bitcoin that values consensus, over one that is run by a charismatic leader who is willing to force changes onto the network, or split it off into separate sects if he doesn’t get his way.  If we choose that to be the overriding model of Bitcoin, then Bitcoin as Satoshi envisioned it, as far as an experiment in “collective consensus building money, free from authority”, has failed.  So just ask yourself one question, given all the unknowns and potential existential risks to Bitcoin, — What is the rush?  Why the urgency?

On the other hand, the appeal of XT’s ideology is that block limits (in fact the consensus rules themselves), shouldn’t be something that is left for us humans to decide.  Once set, the code itself, in an Inception-like manner should be the only one that guides the future path of Bitcoin.

One thing is for sure, if we make it out of this without blowing ourselves up we will see a big jump in BTC price.

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Post Scriptum:

So you decide*, was Satoshi’s vision to have consensus rely on a group of humans who need to always maintain internal consensus before a change? Or was his vision to leave consensus of the protocol, even at this meta-level, mostly in the hands of the code itself, once triggered?  That is the choice that we all need to make now.  *And if you really want to throw your mind into a self-referential loop, consider if Satoshi himself, would have wanted the public to have to be making this choice?

Appendix: (for you geeks)

I) Misleading media coverage (one example)

Incorrect misinterpretation by media:

The blocksize increase activates, at fixed dates,
 if a super-majority of 75% of miners have
 opted for the new block size by indicating 
their preference in their submitted blocks. 
Without 75% miner consensus no block 
size increase activates.

The misinterpretation is that once XT is activated, at times during the increase periods it can be stopped by another supermajority vote. That is, you get a chance to vote again every 2 years. That is incorrect, as the code specification clearly states (below link). Once started, we are on a linearly increasing block limit doubling schedule that cannot be stopped until 8Gb is reached. Furthermore, the increase is not a step function that occurs once every 2 years, the limit increases with each block linearly. (They each bump up 1/730 of a step)

II) Useful background references

BIP 102 The simplest solution – Jeff GarzikBIP 100 An increase schedule with voting – Jeff Garzik

Bitcoin XT BIP 101 specification – Gavin Andresen

Hard Forks vs Soft Forks and why Hard Forks are supposed to be Hard

III) Once XT is triggered there is no turning back! Why? Because forks are voted upon my miners choosing to run one version of bitcoin over the other. And while theoretically if we were all on XT and something like a global downturn did necessitate a pause or scale back on the continuously increasing block sizes (due to bandwidth tech not keeping up) we would be hard pressed to convince the miners to cap or scale back their big blocks as bigger blocks means more fees collected by mining and there would be economic incentives to favour them.

“Decentralized”? – What does that really mean?

You hear this term thrown around the crypto-sphere a lot, but I wager that 90% of the supposed experts that you ask don’t actually understand the meaning of it, and only serve to continue the cycle of misunderstanding.  I hope to clarify the situation and I hope that after you read this, the next time someone says that “[so-and-so] is not decentralized” you will be able to correct them, with the confidence of the Dos Equis man with a half lit cigar and a bourbon.

So what does it mean to be decentralized?

Let’s start with the good ol’ Webster-Merriam definition:

noun de·cen·tral·i·za·tion (ˌ)dē-ˌsen-trə-lə-ˈzā-shən
1:  the dispersion or distribution of functions and powers; specifically : 
the delegation of power from a central authority to regional and local authorities 
On the surface, it simply means there is no central authority or controlling power.  But we know that when we speak about technology, we must also consider the different dimensions of meaning to which they can apply.
According to the dictionary meaning, would you say that the internet is decentralized?  Certainly most would agree with you in terms of its ability to bring commerce to the marketplace without any central control or authorization.  Indeed, the internet was really the decentralization of information, for before its mass adoption, we relied on the media of newspapers and periodicals, along with that of television and radio for the dissemination of information.  But even as the internet decentralized information in the broader sense, is the internet itself a decentralized technologyInternet Corporation for Assigned Names and Numbers (ICANN) controls the issuing of domain names.  We rely on ISP companies to give us an on-ramp onto the information superhighway (how long has it been since that term was used? Sorted!) and they in turn rely on BGP (Border Gateway Protocol) routers which form the backbone of the internet to route your traffic.  Most of these routers are physically situated in USA, and most of them run on the hardware developed by one US company, CISCO.  Still think it’s decentralized?  Not so clear anymore huh?  Well that’s exactly the state of affairs in the cryptocurrency industry.  The word decentralization is being paraded and sold as a feature of various projects, and thus the word is overused and over-abused.  But as with many things in life, when you start peeling back the layers, you soon see many different versions of truths, and many times conflicting viewpoints are actually simultaneously true, depending on the context or point of view.  So lets enumerate all the different contexts in which people in the crypto field normally speak of in terms of decentralization.

Network topography

Before we examine the specific aspects of cryptocurrency systems in light of their degree of ‘decentralization’ let’s first begin by clearly defining what each type of topology looks like.
Centralized systems have one hub or server, and every other node is a slave or client. Centralized systems have many advantages, namely in speed and ability to relay information quickly without having to worry about data contention.  This is because as updates are only happening in one place,  sequencing them in a consistent way is as simple as putting them in the order that they arrived at the hub.  Additionally,  the ability to unilaterally control the rules of participation and membership are either necessary or an advantage in the domain in which they are operating.
Traditional systems which work best in a centralized way are rail/traffic control systems, telecom networks,  governments and the central banking systems.
If you look at the decentralized graph in the middle, there are no large control centres but instead there are many smaller clusters with a hierarchy of mini-hubs.  This network topology is much like what we have in the internet today, which is small centralized clusters of users connecting through small hubs (local ISPs) which in turn connect through large hubs (global ISP, BGP routers).  You will note that although there is certainly less centralization than in the first case, you will notice that there are certain nodes which are ‘better connected’ than their peers.  Natural systems tend to develop in decentralized ways, from human societal structure, friend association networks, to tree root systems and fractals.  It’s pretty safe to say that it is the most ‘natural’ state in which complex systems and living things in our universe arrange themselves.
The last diagram shows a distributed network, you will see that the difference is that each node connects to all of its local neighbours and on average each node has about the same number of connections as their peers.  Notably, this means that it would be impossible to clearly designate any group of nodes as ‘better connected’ than others, and thus we no longer have any notion of hub nodes.  Systems like this are found in highly independent systems, such as BitTorrent and other systems where every node is simultaneously a client and a server.

So with those images in mind lets go over all the different contexts by which we can judge a cryptocurrency in terms of its topology.

Source Code

Who controls the source code of the project?  If it is closed-source, then clearly it is centralized, and opaque.  But what if it was open-sourced?   Does that mean it is decentralized?  Certainly we can’t call a project which is open-sourced centralized in terms of control of its code, as it could be simply copied and forked by others.  Though if you look at Bitcoin as an example, although its code is open, the number of people who hold commit rights to the code base are a very select few.  Although this control is limited, I would still label an open-sourced project a decentralized one.  It may not be as decentralized as say, the internet, but it is certainly not as centralized as say, the code for MS Office.


How do participants join? Who gets to determine who is allowed to participate? How are bad actors handled? Are they expelled by the will of a superuser controller or voted out by a quorum of network peers or simply ignored?  As most cryptos are Dynamic Membership Multi-Signature (DMMS) systems, they are all decentralized by nature.  We can contrast this with traditional banking and brokerages, which whom you must open up an account with in order to participate.  Even the internet is more centralized in this regard, as we discussed earlier, you must register domain names with a registrar which operate under the oversight of ICANN. Although some fine folks are working on changing that. With crypto, you can join the network and create your own accounts without getting anyone’s permission, and indeed this is the basis upon which most ‘cold wallets’ work.

Value distribution (token distribution)

How is the distribution of its token handled?  Is it dolled out to groups or early investors from a central repository controlled by an entity? Is it earned or mined by participants themselves? Is it some combination of the two?  This is a particularly contentious topic and one that will most likely get at least 3 people in the room embroiled in a heated debate, that may or may not end with a broken nose. That is because the method of value token distribution is at the heart of why many claim crypto-currencies are scams or ponzi schemes.  Apparently making a token out of nothing and selling it to people for profit is something that only the government licensed banks are allowed to do.  If you make your token yourself and distribute or sell it to people, then you are running a centralized value token.  You may or may not be operating a ponzi-scheme.  Proof of work is the only way to achieve decentralized distribution of a token without picking favourites.

Validity and Security, immutability

How is security of the data ensured?  What prevents bad actors from selectively partitioning the network or promoting their transactions over others?  How do they prevent actors from filtering out or delaying certain transactions and isolating victims?  How is the data protected from being modified without anyone knowing?  Mostly all cryptos have decentralized verification and integrity roles, as they are normally part of the job of every node to validate transactions in the P2P network.  Contrast this to the traditional banking system where only the banks could validate and clear cheques, which is a classic centralized system.

Consensus mechanism

How is consensus achieved and ensured?  Through a vote, or through a proof of work? This is basically how the network manages to ‘stay in sync’.  Which is to say, how it manages to agree on the ordering of transactions which are all asynchronously floating around the P2P network.  What does it mean if a proof-of-stake system which depends entirely on the rules of the system to determine who gets to be the ‘forger’ of a new block, to be decentralized?  I would argue that in these cases of PoS, where the essential nature of consensus is based on a distribution algorithm, then the algorithm rules themselves being written by developers form a sort of centralized control system.  Unlike proof of work, where only the amount of work to be done is controlled and miners are free to maximize their ability to perform the work in order to increase their chances at forging a block, stake systems having no work requirement so anyone’s chances at becoming a forger depend solely on their stake in the system through some formula decided by the developers.  This is a form of centralized control.

Exchange mechanism

Some cryptos have a built in exchange protocol or match making engine along with the ability to store an open order book.  The orders are stored as part of their blockchain and matchmaking is done via the network transaction mechanism itself.  If they can run without the need of a central service hosted in one place, then they can be considered a decentralized exchange.    In contrast, there are many exchanges which are run off-chain as a business and these are centralized, as their order books are maintained by them on proprietary databases, and if you open a trading account with them, then you wear all the counterparty risk in the odd chance they were to fold and go under. Not that that happens very often.

Armed with these contexts, you can now start to talk about decentralization in a way which may be meaningful without the discussion degrading into the “You aren’t decentralized!” Yes we are!” mudslinging-fest that they sometimes tend to do.

In the next article, I will go over some of the more popular cryptos and rate their degree of decentralization based on these criteria.

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PoW and the evolution of commodity currency

The last couple of posts were devoted to the complications arising from Proof of Stake coins which I argued serve little purpose other than as a digital equity and move corporate and governmental powers to developers from the bankers and industrial magnates of the real world.  I have since been asked to give more details of Proof of Work and why it and it alone is different and can result in the creation of a commodity money.  Fair enough, so here it goes…

Commodity Money

Commodity money, as I have detailed in the past, is commodity that is naturally adopted by society to serve as a common medium of exchange, i.e. money.  The ability of a  commodity to serve as a money depends mostly on its intrinsic characteristics of divisibility, immutability, fungibility, and scarcity.  But, what makes a commodity, say, different from a credit note, or a bill?  Simply stated, a commodity is an asset or a thing (physical or virtual) that:

1) Required work to produce it

2) Had some initial intrinsic value

Let’s look at each of these in turn.  First, it must have taken some work or energy to produce or to prepare it for use.  That work or energy was consumed in a physical (or computational) process and the process cannot be reversed, or whose energy cannot be otherwise reclaimed.  We innately understand this, as every commodity we produce in the real world is a product of human labour and work, requires energy, and results in an asset produced.  Symbolically:

Work + time * efficiency ==> asset

Expend energy in producing useful work, put in some time, subtract waste losses, and out pops an asset, whether it be a gold bar, plutonium ore, or bitcoins.

The ‘birth by work’ concept is important because the producers of the commodity are 1 level removed from the politics of the commodity’s use as a money.  The producers (or miners) of a commodity are simply interested in improving their ability to extract or mine the commodity and sell it into the market for use as money.  In this way, the creation of the commodity money is pure as it first enters the economy through the free market, regulated and controlled only by the natural forces of supply and demand and price.  Contrast this to fiat money which is regulated and controlled by ‘experts’ in an ivory tower, who believe that they have the magic formulas to make decisions for the economy, because they are smarter than the collective opinions of everyone else.  (To those of you who believe this fallacy, I implore you to watch this: Why Socialism doesn’t work ).  Astute readers will be thinking right now, “hmm… this sounds a lot like all the criticisms you wrote about previously with PoS systems!” and you would be exactly right. Essentially a PoW produced coin is a free market money, whose supply is controlled by the market, while PoS ecosystems are just digital forms of socialism.  Centralized control of a rule-based system, no matter how noble in conception, will inevitably fail, as history has shown us.

The second important aspect of a commodity money is that it must have originally had some intrinsic value to it.  As Ludwig v Mises describes in The Theory of Money and Credit, the value of a commodity money (or the price) derives from its previous value the day before, and the value it had the day before, on the value on the day before that, etc. If one could trace back until the origin of the first exchange of the commodity asset for something else, you will discover the value of commodity money comprised of only the value of it as a asset (consumable) alone.  This initial intrinsic value as a commodity is what initializes the objective exchange value of a commodity money and as it slowly gains acceptance, it acquires value as a money.  The relationship can be seen as:

commodity money value = value as a money + value as a commodity(intrinsic value)

Where the intrinsic value of a commodity money is more or less stable, its value as a money is what fluctuates greatly and rises as it is demanded for in its use as a money instead of as a commodity.

With bitcoin, and other virtual assets, we for the first time find ourselves lacking the language to properly describe the phenomenon of how a digital commodity money can come into being.  The notions of work being the means to convert some atoms from one state to another (more useful) state don’t apply as nicely.  But if we ignore the physical reality of the creation of a digital asset for a moment, and assume that it is done via some magical mining process akin to the mining of a physical metal, what then, is the initial intrinsic value of a bitcoin?  This is the key sticking point that has prevented the acceptance of bitcoin by many of the hard money advocates and Austrian economists around the world.  This is where I will likely draw a line between them and I, although we hold many of the same beliefs:  I believe that the intrinsic value of bitcoin is in the utility of the blockchain.  The initial value which bootstrapped the digital commodity of bitcoin into the mystical category of money was that it provided a measurable, quantifiable, utility.  Which was this: the ability for the first time to have a shared database owned by everyone and no one, and have it maintained by trust-less parties acting all according to their own interests alone.  The value of an immutable, incorruptible transparent record, is what that initial intrinsic value of a bitcoin represented.  To own one was to take part in an incorruptible public record system, which is something that could certainly have been used many times in human history to solve many disputes, even wars (the corrupt Byzantine Empire may have fallen sooner, to be sure).  The fact that the value of the token derives from the network in which it exists is the reason many detractors may call Bitcoin a ponzi scheme.  Indeed this same feature is present in all crypto-currencies, where the reward in participating in the network is paid for by in-system tokens.  The difference between them though, is that work is expended in their creation, and thus Bitcoin and other PoW tokens are commodities, and not equities.  That being said, the digital commodity we call bitcoin is the only digital commodity to date to have reached a ‘money’ level of valuation and use.

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Centralization: how everyone is trying to ‘solve’ a very old, very hard problem

Several weeks ago, I mentioned that I would explain why Bitcoin is the only commodity currency that can exist.  I am not doing this topic enough justice, but I will touch briefly on this before moving on.  Succinctly, the reason is that commodity currency is always spontaneously created in a locality in order to facilitate indirect exchange in the immediate community that it serves.  This has been shown in the past, with gold, silver, and to a lesser extent, sea shells, jade, glass beads developing as the commodity used for exchanges.  The extent of the geographical usage of a certain type of commodity money, was based on how far its reach extended while still retaining its characteristics necessary to perform as money.  For instance, seashells didn’t have too large of a locality, because pretty soon as the economies that it served got larger and larger, people found out that seashells were actually not scarce enough and hyper-inflation destroyed the value of the commodity as money.  Another issue that physical commodity currencies faced was that due to their physical form, their circulation was very much limited to the extent that they could be passed from person to person. This meant that societies isolated from each other (economically) could individually develop their own preferred commodity to be used as money.  This is how it became the case that some societies settled on a silver standard while others settled on gold.  Both metals possessed all the necessary characteristics required of money, and the only reason that more than one standard evolved was due to the fact that the societies were isolated from each other, and thus had no need for inter-commercial connections.  This fact also illustrates how economies will inevitably settle on one standard, barring physical restrictions.  Bimetallism, where both gold and silver were simultaneously used as the official unit of money only developed, (without the help of any government) due to the limitations in the ease in which gold could be divided into smaller portions, and as such silver facilitated small scale commerce while gold handled the large value transactions.

Fast forward to the age of digital currencies.  The locality of Bitcoin is the internet.  There is no hidden stash of bitcoins to be suddenly unearthed somewhere, so we can rule out a sudden unexpected jump in the supply of the commodity.  This means that, for the first time, we have a commodity which has a very stable well-defined supply curve.  From this it follows, that Bitcoin should at the least have the potential value stability as gold had in the past. Additionally, since the locality we are concerned with is the internet, whose reach is global, Bitcoin will suffer the issue of having competition from isolated societies that can compete for its usage, the way gold had to contend with respect to silver for a long time.  Thus, as Bitcoin already has a very solid economy and usage on the internet, along with the fact that the divisibility of Bitcoin is not an issue given its digital nature (if we ever needed sub-Satoshi value transfers, side-chains would be able to facilitate this), this is why I believe that Bitcoin is the only commodity money that the internet will ever need.


A hot topic in crypto currencies circles currently is the topic of centralization.  This topic is hotly debated in both Bitcoin camps and other non-Proof of Work projects.  Collectively I will categorize them as ‘PoS’ systems standing for ‘Proof of Stake’.  The reason this topic is so hotly debated is that any discussion that involves it will inevitably gravitate towards politics, democracy, and the preservation of individual rights and freedoms, and we all remember from our childhood family dinners that when politics are brought up at the table an argument was sure to follow.

Essentially what blockchain technology is, is the ability of a decentralized network system to be able to store a database of information (a ledger) in a synchronized way without any inconsistencies arising from the peer-to-peer nature of the network. Both PoS and PoW systems address the issue of consensus in a P2P network, which is to say, they govern how to ensure the integrity of the data, with peers freely joining and leaving the network.

I will try to address the criticisms for and against PoS and PoW, but first, some detailed explanations of each are in order.

Proof of Stake

Decentralized consensus systems rely on incentive systems to ensure honest actors prevail over bad actors.  Proof-of-stake essentially attempts to solve the incentive problem by requiring actors to ‘stake’ or lock up some of their in-system funds in order to participate in a lottery in which the winner is selected to ‘win’ all the fees from the transactions that were confirmed in the last block or update.  Some variations on this include systems that distribute the winnings in proportion to the amounts that were staked to all participants in the lottery, which essentially amounts to a deposit banking system, where as unneeded cash reserves are locked for a time, which serve to produce an ‘interest’ rate paid to the depositor.  These deposits are not on-demand (they are locked for a time duration) and thus constitute a full-reserve banking system model.  Without the requirement of work, PoS systems promise to be able to confirm blocks at a much lower external cost and faster than PoW systems as there would be no electricity required over the normal amount needed for just running the validating node itself.

Proof of Work

This is the system which Bitcoin uses, and as I described in a previous post, the work involved in creating the coins allows it to mimic a commodity money economy precisely.  In fact, if gold or oil reserves were completely known a-priori, (no sudden discoveries of new reserves somewhere, all reserves on the planet identified) then the evolution of gold from shiny metal to being the world reserve money would have followed the same path as Bitcoin, albeit on a slower time scale given that technologies to mine gold more efficiently took a lot longer to develop and required a lot more capital resources to develop.  This work expended in order to maintain and secure the network consensus, is an external cost to the system (in kW/h in this case) and the reward is paid for in internal network coins (bitcoins).  Unlike PoS, the amount of weight or influence you posses as a securer of the consensus system is not a function of the wealth that you have in the system (represented by your stake) but instead by the amount of external work that you can put into it at any given time (in kW/h and hashes/s). This cost to maintain the network being external, you will see, is the key to why PoW systems are in the long run more likely to succeed in creating a stable money system.  But for now, let’s address the individual pros and cons of each system.

The Problems with PoS

PoS coins are equity, not money.

I have found that a very accurate analogy for PoS systems is that of shareholders equity of a company.  The bigger share you have, the more voting rights or power you have to determine the companies future.  Your voting rights are proportional to your share ownership and dividends are paid out to shareholders.  One important fact that you will note is that while equities definitively have value, that value is tied to the health of the company, and certainly a share has little or no exchange-value/money value, because it isn’t used as a common means of facilitating commerce.  Indeed even if we could trade equity as freely as we can trade bitcoins or cash, I do not believe that it would be usable as a money-substitute, for reasons similar to the one against widespread credit money, simply the lack of people willing to accept it due to counter-party risk, would prevent it from getting widespread adoption.  Now there are some key takeaways here in the comparison of PoS systems to equity in a corporation.  Firstly, corporations are highly centralized entities;  how many of you who have worked at a large corporation and can say that internal politics were not an issue at work?  Fact is, when people are incentivized to expand their own shares in the system then there is a lot of infighting and manipulation of the rules of the system to one’s advantage.  The game inevitably (in a poorly run company) becomes one where the upper management is tasked with keeping the lower ranks of employees complacent and happy while they continue to use the system to enlarge and ingratiate themselves and their friends. If you think this sounds familiar, then you are right my friends, this is exactly how politics of government work. (yes, even in democracies!)  PoS systems mimic this exact system, because the rewards given to those who maintain the system are proportional to the wealth and power the parties hold in the system itself.  It’s the rich getting richer problem that those socialists always rant on about.  Pretty soon, given lack of competition, one ruling party will become incumbent and provide most of the security in the system, and you would have a mirror of our centralized political system in the real world.  This can be the only logical conclusion to any PoS based consensus system.

Advocates of PoS systems argue that unlike government, who’s rules are hard to change, with crypto currencies, they can reserve the right to tweak the system parameters as to avoid the centralization problems we see in the real political world.  I am not convinced that such a solution has ever been found.  Think about it, we as humans have been iterating over many different political systems in the last 6000 years of recorded history.  We have moved from centralized systems of monarchy, to federated systems of feudalism, to socialism, to capitalism, and to date we still have not found a completely ‘fair’ solution which is incorruptible.  Do you believe that a couple of computer science and math academics will suddenly be able to solve this problem which has plagued humanity since the emergence of civilization?  Perhaps, but I’m not going to bet the farm on it.

Staking incentives are economically biased

Being a proponent of free market economies, another issue that I see with PoS systems is that the staking process is inevitably linked to the fiscal health of the system.  What this means is that how much people will stake to help secure the network is akin to the decision of how much value would you save in the bank vs invest vs spend.  As we have seen, staking is essentially locking up an amount of value for a certain period of time, such that you can earn a return or interest on that amount.  This boils down to a lenders vs savers game.  As staking can be seen as a risk-free rate of return that the network gives you, as the demand for cash in the micro-economy rises (interest rates and investment returns rise), then you will see less people staking and the security of the network is adversely affected.  Also, as there is a greater incentive to stake with the more stake you own, you will see a gradual gravitation of large holders of the coin to simply stake and ‘collect rent’ from the network.  In the real world, as money becomes cheap, interest rates fall (it becomes increasingly easy to obtain capital from investors) and as such the deposit rates at savings institutions fall in step, thus reducing the incentive to park your money in a bank.  This creates a balancing effect between the supply and demand for money because as more people demand money, the supply of it becomes more available.  On the contrary, in a PoS system, where the ‘interest’ on deposits are paid for by fees of transactions, the more transactions that are processed, the more interest would be paid to stakers.  Thus, quite backwardly, the more money which is used up in fees and thus increasing the demand for money, then the less likely it would be made available by the people who control large sums of it, because they can increasingly make more money by just locking in with the richer risk-free rate of return obtained by staking.  This creates an economic bias to hoarding over spending.  The rich will in general hoard more while the rest will be forced to spend more (in an attempt to become rich).  As a student of free market Austrian economics, I do not believe putting any bias on the side of spending or hoarding is a good thing.

The incumbent whale problem

Another problem that PoS suffers heavily from is what I call the incumbent whale problem.  What this means is that a sleeping whale, with a lot of stake in the system (be it that they were an original founder, or an initial adopter who made a lot of gains in the system) can then immediately become an influential player in the stability of the system.  Imagine if a founder of a PoS coin (whether it be an individual or some foundation) with a significant amount of coins comes into the system and becomes a large part of the validating power due to the large stake that they are willing to devote to the staking process.  This means that at anytime, a large player can jump into the staking game, and adversely reduce the profit of all the little players who were in the stake pool.  This makes the process of staking your coins a very volatile and risky one, and this would likely discourage many would-be stakers from putting in too much of their value into the staking process, which reduces the security of the consensus process.  Compare this to a PoW system like Bitcoin, where even if the largest stake holder (presumably Satoshi Nakamoto) were to come into the system now, there would be nothing that he could do to affect the system stability directly.  The only thing which is in his power to do would be to sell off his large hoard of coins, into the market and depress the price of the coin.  This is a perfectly legal and valid activity from the free market perspective, and the size of his stake had no direct bearing in his ability to harm or profit directly from the system itself.  This is exactly the same reason why hard money advocates sing the praises of the benefits of gold over fiat currencies.  A large holder in gold has very little influence over the gold mining industry.  There is one argument that examines the risk of a large holder in gold paying off the gold miners not to mine, and we will address this particular criticism later on.

A secondary issue with the whale problem is that when an actor who has a large stake in the system, if caught attempting to defraud the system, will lose only their staked amount.  This means that an actor with a very large pool of coins can statistically always win over those with less stake.  This is similar to a game of Texas Hold’em poker where going ‘all-in’ is not permitted.  Basically the whale on the table only needs to out-bet his competitors by the minimal amount in order to ensure that he continues to maintain (and increase) his lead over the others.  Of course in this case you don’t win the stakes themselves but only the fees of the processed transactions in the block, though the premise is the same.  Additionally, if you were to blatantly commit fraud somehow either by filtering transactions that do not pay you or your conspirators, or by deliberately not relaying some transactions and you are caught, you only lose your stake, and are free to continue to try again next time with a new stake.  Compare this to a PoW mining pool which is caught in act of outright fraud; they would lose all their members immediately and would be forced out of business.  This is the situation I mentioned above where a rich gold holder pays a mining company not to mine, which of course we have not seen successfully employed in the real world.

Defenders of PoS will claim that they will and can enact rules into the system that would punish those who break the rules so as to provide enough of a deterrent to these would-be bad actors from doing so.  Even if that were true, (which once again, would be a remarkable breakthrough in legal and political systems that have yet to be solved in real life) that inevitably mixes the monetary system with the legislative, judicial and enforcement systems.  If we have a hard time agreeing on making small changes in just the economic rules of a cryptocurrency, then I don’t have much faith in the ability of a couple of math nerds to come up with the right rules of criminal justice.  And even if they did manage to come up with a perfect set of rules, we have already devolved our system into one that relies on a central body (the developers) to make the rules.  To say that a PoS system can come up with a set of rules to make sure people act fairly is to give up on the notion of a decentralized currency completely.  

There is a very clear delineation between the things that the developers of Bitcoin need to deliberate on (what size of the block to use, what confirm cycle time to use) and those of what a PoS system must decide on (how to detect, determine guilt and punish those who stake and defraud the network) An analogy would be that one is tasked with deciding on how wide to make the roads and railway tracks for practical reasons, while the other is tasked on deciding what is illegal and what rights of the participants in the system must be protected, and how so.  To mix these into the same bucket is to ignore the fundamental socio-political issues surrounding PoS staking.

The criticisms of PoW

Now that I have thoroughly elaborated on the criticisms of PoS, I shall turn to the common criticisms of PoW systems, which have been so emphasized by many media outlets, that they should come to no surprise to the reader to see them represented yet again.

PoW mining pools breeds centralization

Many people will say that due to the centralization of mining pools, this creates a centralized PoW system.  (We will assume for the moment that all proof of work algorithms will inevitably centralize for the sake of debate).  The truth is yes, while PoW does not guarantee the system to be free of centralization, much like the gold mining cartels of yore, if a magnate gold tycoon were to buy up all the mining companies they would indeed enjoy a monopoly over the production of gold, and thus the money.  But if that were indeed true in theory, then why did it not happen in our history?  Surely we had enough time since the onset of modern civilization to observe this happening if it indeed was possible.  Perhaps it was actually attempted several times in the past, but it failed and thus we never heard of it.  A clue to why it doesn’t happen can be seen in the diamond industry.  DeBeers owns a monopoly on the mining and sale of diamonds and that has severely limited it’s use as a money. Nobody wants to hold too much ‘storage value’ in a medium which has one controlling party at the reigns.  Correction, that’s exactly what we have with the Federal Reserve Note.  The difference is that with fiat we have the government’s legal tender laws forcing our acceptance of it.  So we can see that centralization of control of a commodity money will destroy its value and thus its use as a money.  PoS defenders however will rightly say that although it has never happened, it cannot be mathematically proven that it cannot happen in the future.  This is a constant source of debate between the mathematicians and the economists.  Take for example, the historical fact that we don’t need to prove that hyperinflation can happen to know that it will happen given the right conditions.  The systems in economics depend on the subjective behaviour of billions of individual actors, and to assume that we would be able to accurately model them with any degree of accuracy is a fool’s bet (at least given current computational resources).  To say that it cannot happen because we cannot prove that it will is an mistake.

PoW doesn’t solve the problem of centralizing powers, but it at least decouples the miners so that they are incentivized only to keep their business running.  If they sellout and defraud the network, then miners lose their users.  Significantly, mining pools are businesses.  These businesses exist to turn a profit (whether in Bitcoin or fiat).  If a business is found to be a bad actor, there is an extremely effective deterrent that has been employed over the centuries that has proven more effective than any government regulation ever could: the boycott.  Pool operators are businesses with clients.  Their clients are the actual miners.  If the pool operator ‘sells-out’ to a bad actor, for instance, by leasing out or lending their hashing power to a secret party for the purpose of a 51% attack, then they risk losing all of their clients when they are found out.  Indeed they would be incentivized to keep the value of the coin as high as possible in order to profit from the fees they are collecting.  The key here though, is that they are running a for-profit business.  In a PoS system, the large staker may be an individual, and has no business model or revenue stream to protect.  In addition, they can recover from a failed attempt to defraud the network and try again later on, losing only their staked portion for the failed attempt.  From the perspective of the miner/staker, the risk of defrauding the network is much greater for the miner of a PoW system, as it is represented by the capital investment in their mining farm hardware (paid for by external fiat money), and the future revenue stream in the fees.  For the PoS staker, it is just the amount of in-network coins that they have presently staked.  It doesn’t take a lot of analysis to conclude that a staker will have much less at risk than a large miner when trying to defraud the network.

PoW isn’t perfect solution, but at least it is one that has been shown to work historically in the past with gold.  We know that commodity money can become the world reserve currency on its own merit alone.  That is, at least until a government comes along and makes it illegal and forces us to use their paper fiat money instead.


In conclusion, the differences between PoS and PoW boils down to one of externalities.  In a PoS system the costs and rewards are internal, while in a PoW system the costs are external, while the rewards internal.  This complete disconnect with the outside world found in a PoS system lends to dishonest gaming due to ‘free simulation’ (it costs nothing or very little to attempt to game the staking process in your favour), and an incentive system that rewards those who have ample resources in the system more than those who have scant resources.  PoS hardliners and I agree on one thing, which is that PoS systems tightly couples the stakers with the health and welfare of the system, while in PoW the miners are somewhat isolated from the politics of the system and are driven only by for-profit motivations.  Where we disagree is that I believe that this separation is what keeps the number of bad actors in PoW miners to a minimum.  They will not do anything that would serve to undermine their future revenue stream of their mining business.  In comparison, the tight coupling of the PoS staker to the network and his individual influence within it incentivizes him to manipulate the system to increase their own stake and thus power within the network.  Thus PoS runs up against the exact sociological problems that we experience in present day political/corporate systems.  Though they argue that they will be able to contrive rules and punishments in the system to deter any such bad behaviour, (indeed the exact behaviour which a PoS system implicitly encourages if a rational economic actor were to try to maximize their profits and stake) we have seen that no satisfactory system of governance has ever been developed to control corruption in the real world, and the simple fact that we have to create governance rules in the system itself implies that the developers have central control of the system and can be bribed or corrupted themselves by the bad actors.  (Or a worse, and more likely scenario is that the large stakeholders in the system are the developers themselves).  This is essentially why I do not see any possible future where a PoS system can become a global money system.  PoS systems may enjoy some usefulness (and thus their coins some inherent use value) as an application coin, but by no means I see a PoS or a stake based coin ever becoming accepted as a universal currency.  The reasons for which are not technical, nor mathematical, and need not be proven.  They are economical in nature and in such things, as in those relating to human nature, history is the best predictor.

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