Blockchain

Open Source Development and behaviors – It pays to be nice!

Behavioral game theorists have long studied, how behaviors of open source developers, lead to either the success or failure of software projects, that are open source.  While amicable, courteous and teamwork have their benefits, these could also lead to groupthink and cause the team to overlook major flaws in design such as security flaws. Another school of thought has led to the belief that – a strong emergent leader from within the open source development community e.g. Linus Torvalds, or, Alan C Cox has helped shape the thinking and bring divergent views to a concur. Such concurrence – an equilibrium state of the system, has propelled many long-term projects to significantly leapfrog the competition and accrue immense value to society.

The birth of Bitcoin and its handing over to a group of diverse developers, by Satoshi Nakamoto,  has recently shown how decentralized decision making can potentially fail. For most of 2017 – what has played out on all major developer forums for Bitcoin, was an intense battle of minds. Groups of developers pushing their own versions of development systems to solve the scaling problem. Some of these agendas even led to a fork in the main network – creating a new coin altogether. Observers can argue that this fight has led to a sudden increase in value to the system.

The ecosystem and its core development team – despite having put in significant thought into each performance upgrade, has not been able to push forth its scaling agenda in the form of Segwit2X (or something similar). This despite the overarching commitment from the Consensus New York Agreement to roll out the performance upgrade.

I wish that 2018 will bring about a new structure to the development of open source crypto ecosystems, and,  some working mechanism by which sparring developers will not try to dominate each other. Eventually, being nice to each other and reaching an agreement will potentially propel software forward. There is an example in Linux, that has survived large challenges from many quarters and has survived for over 30 years now to become the world leading server operating system. Similarly, there is Apache and the group of developers led by the Apache foundation who have written and maintained world-beating software – year after year.

2017:The year of the HODL investor

Behavioral models

For many years, behavioral economists and scientists studying behavioral finance have tried to understand “Why and When do people buy and sell in financial markets? ” This shift in thinking from trying to directly predict prices of stocks to the behaviors of traders arose is more recent years. Many theories abound in this space – that of a rational investor, that of a greedy investor, that of an arbitrageur, the opportunistic investor, the value investor, etc… Off all these theories, some such as Ray Dalio’s investment theory based on “Principles” and deep analytics have been seen as a successful mechanism to model a large (investment) firm’s behavior and also to base one’s investment philosophy.

These models, however, attempt to mathematically depict investor intentions to buy and sell equities in markets that are a) heavily regulated  and monitored by organizations such as SEC, IRS (and their equivalents) b) operate at predetermined times c) have a fixed point of sale and uniform prices (e.g. the share is priced only at the market where it is sold) and d) is usually geographically constrained because buyers and sellers are limited to institutions or individuals who are allowed to trade legally within a geographic boundary. There is a sense of fairness (or imposed fairness) in trade here. As traders, rules of trade, and institutions surrounding markets have evolved over decades, these markets have matured sufficiently so as to reflect capitalistic progress. Buoyed by very little volatility in the indices, robust growth and supported by strong institutions that have been time tested by many black swan events such as the mortgage crises, the 2000 dot-com bubble, these markets indicate progress made by society in encouraging capital markets.

Behaviors in Crypto markets

The nascent Crypto markets, however, are entirely different. Institutions, governments, and regulators are just waking up to the rise of crypto coins that today are worth about 1/2 a trillion dollars in market capitalization. These markets operate on a 24X7-365 day basis and each exchange where such trade occurs can have overlapping users. Assets traded do not have a fixed point of the sale price (meaning a single bitcoin can fetch the seller different prices, depending on which exchange was chosen to sell the bitcoin). Usually, buyers and sellers are not geographically constrained though exchanges operating using fiat currencies sometimes attempt at regulating traders by geography. This lack of regulation, oversight, and global distribution has brought tremendous volatility to these markets. The monthly volatility in these markets is comparable to large black swan event (such as the dot-com crash or the 2008 market correction on account of the housing mortgage crisis). For example in the 2008 crash, the DJIA dropped about 52% and the SnP500 dropped 20% in a single day wiping out wealth to the tunes of billions of dollars.  Such crashes and corrections are treated with great alarm in regulated markets, and, all institutions rush to ascertain that there is no market manipulation. The fallout of such an event has a wider economic impact leading to job losses, temporary suspension of economic activity and so on…..

In the face of such uncertainty in the crypto-markets is a large user base of both individuals and institutions who are labeled as HODL – “Hold on to Dear Life” investors, who trust the technology significantly more than all rational thought. The HODL groups behavior is completely irrational and every time the price drops below a certain level, they form a strong support base who purchase more of these assets, bringing both the technology and the price within reasonable ranges.2017 was the year the HODL investors really participated in these markets – buying at times of huge dips and holding without selling when the prices rose. The HODLs are the ones responsible for limited supply of these coins in the markets for trade.

It will be interesting to see what 2018 could bring up to the HODLs and others.

 

Berlin allows Bitcoin as Legal Tender

One of the most important predictions if 2017 was that atleast one major economy in the developed world will give Bitcoin the status of the legal tender. Its close to being a legal tender.

Becoming Legal Tender vs. Legal Bitcoin

The following Wikipedia link shows the status of Bitcoin’s legality across the world. While holding Bitcoin as an asset and exchanging it for fiat currency is legal in many countries, this new  criterion of “legal tender”  removes the intermediary step of conversion to fiat currency for all practical purposes. This means, Bitcoin in itself will be accepted as an alternative to the Euro.

Tax implications

The challenges with this approach might be many folds. For example, how will the government tax the good or service that accepts bitcoin ( will that tax be levied using fiat exchange rate, or, will the taxed be in cryptocurrencies).

CryptoKitties, Price irrationality and scaling

Cryptokitties
Cryptokitties mother and board (owned by an early crypto-kitty enthusiast and collector)

 

CryptoKitties is the first game created on the Blockchain.  The game works when individuals purchase a digital cat by spending ethereum. Individual cat owners can combine one or more cats to produce a third cat that shares physical features of  it’s parent cats. Additionally, there is a marketplace where one cat owner could trade in digital cats. During the initial stages of the game, each digital cat, that released onto the network sold for 1$ worth of ethereum.

Irrationality in Prices of Cats.
Over a short period of time (past 2 weeks) the marketplace exploded with millions of dollars worth kitties trading hands. More recently, cats that were sold during the early stages of the game were being sold at prices more than 100000 USD. The processes of breeding, selling, and buying were all configured as smart contracts wherein trade was autimated when suitable buyers and sellers were matched. An exponential increase in trade of kitties was responsible for almost 15% of the most recent transactions (1500 blocks) on the ethereum network as per the ETH Gas station.

This backlog of transactions resulted in excessive delays on the Ethereum network, even holding up some ICO offers.

Price Irrationality

Off late,  crypto coins (bitcoin, litecoin, ethereum, etc..) and crypto assets (e.g. crypto kitties, ICOs, etc.) have seen extreme price irrationality combined with volatility. This has caused significant press and attention to these assets. In this case of crypto kitties, linking the ownership of a digital asset (crypto kittie) through a smart contract and allowing this contract to reside permanently on a globally distributed Blockchain is the main feature.  The same functionality can be accomplished for other types of assets, e.g. titles of cars, titles of houses, or titles of land, birth certificates of individuals, etc… and is much more potent at changing real-world product markets. With crypto kitties, price irrationalities are potentially related to the scarcity of supply, since, the rate of production of new kitties is significantly lower than the demand from blockchain enthusiasts.

Advantages

That being said, these technology demonstrator distributed apps and their problems have larger engineering and economic impacts.

  1. The large adoptions of the dapps surfaces infrastructure and engineering problems related to scalability that cannot be unearthed through any form of distributed software testing.  In the short term, the core engineering teams will have to increase their scalability efforts so as to support scale. Just a single successful app, can hold up transactions for hours from other applications on the network at the current rate. If the original goal of becoming a world computer that can theoretically execute any type of contract, has to be achieved, this scalability is imperative.
  2. This explosion of dapps, increases monetary gains for all segments of the crypto-ecosystem e.g. dapp writers, traders, and,  other owners of ether. Such a sudden increase in valuations for a tradeable digital asset has physical limitations, and is going to be corrected – hopefully by market conditions and not by regulation.

Important Computation problems in the ethereum blockchain

Important Computation Problems

Having the ability to process a large number of transactions has become the key focus area for many blockchain implementations.

In the following talk Vitalik talks about 4 categories problems that most blockchains have to handle.

  1. Privacy – a public ledger verifies data, but many nodes also access the data. This compromises the privacy of the user.  Many solutions such as a mixer, etc… are being worked on at this point in time.
  2. Consensus safety – the possibility of reducing the power consumed. (according to some estimates proof of work consumes more power than 1/2 the national power consumption of several small countries). Additionally achieving consensus has problems that arise from privacy violation, etc.
  3. Smart Contract bugs – loss of ethereum every year because of bugs in existing code bases of smart contracts. Therefore the proposal of Formal Verification (possibly automated) mechanism could reduce instances of these problems.

Scalability – the most interesting and complex problem to solve

Scalability – support for a large number of transactions. Many off-chain solutions similar to the lightning network, Raiden, plasma are possible- but their throughput is limited because of the main blockchain’s ability to handle attacks, etc… Therefore, the current proposed solution is to use “sharding” as a mechanism to scale the main chain solution. Sharding has its origins in large scale distributed databases and has been used to reduce query times from large databases, by partitioning data based on rules.

The following talk by Vitalik discusses the basics of the sharding approach for the Ethereum Blockchain. This approach suggested, is a hybrid approach wherein some part of the validation is done off-chain. The talk discusses the ability to target VISA scale validation for smart – contracts (not just pay and receive).

The Battle for Scaling Transactions

transaction support
A total number of transactions supported by ethereum has surpassed the combined transaction volume of all other cryptocurrencies in the past 24 hours.

Over the past few weeks, support for large transaction volumes has been at the heart of all design and other discussions in the cryptocurrency ecosystem. Scaling has two key aspects to it. Firstly, the ability to support large number of transactions (count). This means the underlying network should authorize the exchange of value, by Byzantine fault-tolerance and double spending prevention. Secondly, the time to validate each transaction on a network of nodes that are globally distributed should be within reasonable limits to allow for real-time trade. Though a sub-second (millisecond) transaction time is ideal, for most real-world systems such as a POS a confirmation on the blockchain is not possible and may not be required. Payment systems, point of sale systems, etc. will need to use completely different mechanisms to validate transactions  in real time, be it for either the bitcoin or for ethereum.

Currently, bitcoin’s block confirmation time is around 8 minutes as per this chart. If the Segwit2X performance enhancement was rolled out, this time would have reduced to under a minute.

In fact, in the real world it is much more delayed because at least 6 confirmations are needed for confirming a new transaction.

Comparing this with Ethereum’s block confirmation time, Ethereum has been able to, despite the surge in volumes, keep the block confirmation times to under 0.5 minutes (or less than 30 seconds). This is because of their most recent network upgrade that was not contentious as the Segwit2x and had wholesome support from the ethereum community.

Eventually, in my opinion, the cryptocurrency battle, will in the short term be based on scaling. The payoffs for the platform that scales the fastest in terms of two parameters i.e. transaction time, and, transaction count (volume) will be the highest.

Ripple Effect and Price irrationality of Bitcoin

Irrationality in prices

Behavioral economists have tried to correlate and predict price movements in markets with behaviors of traders. Since most such analyzed markets were in stable economies that were efficient and usually upheld the rule of law, irrationality was quickly absorbed by markets. Irrational exuberance, as in the times of the dot-com boom quickly devolved and disappeared. All this was good, as long as the markets were local (geographically) and as long as traders were local firms that were under the purview of the law of the land.

With Bitcoin, things have changed.

With a 24X7 market and a globally available(distributable) asset, these behavioral inconsistencies can potentially last for a long long time. Off late, this irrationality and exuberance have meant arbitrage opportunities for other asset classes in nations where political and economic instability have taken place.

Such instability has had a tremendous spillover effect on the price of Bitcoin. Over the past 3 days, since the regime was toppled in Zimbabwe, citizens have – attempted to move their assets into Bitcoin. Exchanges for the local currency saw brisk trades giving it a rise of over 200%.

Ripple Effect

However, these prices are mostly local and do not spiral out to global markets, on account of low demand for such expensive assets. For example, the markets in Zimbabwe have had less than monthly transaction volume of USD 1 Million. Compare this with an average daily transaction volume of greater than 1.4 Billion USD for Bitcoin globally.

This clearly shows that though local markets can, at times, in the face of sudden economic uncertainty exhibit irrationality in prices; global markets will not be affected unless volumes are large.

You can consider this as similar to a ripple effect on a large pond of water. Unless and until the stone thrown into the pond is large enough the ripples will not reach the edge of the pond. In Physics and Economics, this is modeled as a Ripple Effect.

Question: How much of a volume is needed to move the price up irrationally for Bitcoin in a global market?

FAQ’s about digital tokens and blockchains – part 1

The layman’s FAQs about digital tokens and blockchains

What is cryptocurrency, digital token, crypto-token?

A digital token or a crypto-token is a unique set of bytes ( combinations of 1’s and 0’s) produced by running a computer program. It has certain properties.

1. The total number of digital tokens issued until the current time `t’ is publicly known.

2.The total amount of currency that will get produced until colossus (i.e. end of the universe) is going to be limited. This means that in all of time only `Nmax’ units of currency are ever produced and until some random time `t’ , `n’ units have been produced.

3.This ’N’ is fixed and is a large number. For example for Bitcoin N = 41 Million, for Ethereum N = 100 Million.

4.Users can own crypto-tokens and store them through a variety of physical and digital methods.

What is meant by owning digital tokens?

A) Anyone in the world who can connect to a computer can technically own digital tokens or cryptocurrency.

Individuals can either purchase it from other individuals who own it by using government-issued currencies (otherwise known as fiat currency) e.g the US dollar, the Yuan, or the Euro  or they can earn it through a process known as “mining” in which specialized (and often powerful, expensive) computers  specialized programs run to serve some purpose on the network. In the case of Bitcoin, miners create and validate new transactions through the block creation process. In some other forms of cryptocurrencies, existing holdings are staked to serve some purpose on the network (e.g. staking their currency to validate other transactions)

B) Any individual can send either full units or partial units to anyone else at anytime, anywhere provided the receiver shares his address to the sender.

What is the blockchain?

The blockchain is a public record  of information that:

1) stores all information pertaining to every transaction, about every unit of currency, that was ever produced by the  program till time `t’ ,   and,

2)  will perennially continue to record every transaction.

PS: In computing terms, the blockchain is a sequential state machine, that stores all transitions

What are the functions of the Blockchain i.e. why should we bother about this store of all transactions?

The blockchain is a very large book of account that efficiently and almost instantaneously records every transaction related to all produced (mined) tokens. i.e. every time sender A sends x$ worth of cryptocurrency to receiver B. Whenever a new transaction takes place the blockchain does the following:

a) validates and verifies whether the sender has enough balance in his account

b). Validates that A is sending x$ to only B and simultaneously not sending x$ to other individuals e.g. receiver C, receiver  D or receiver E.

This is known as the double spending problem.

Why is it called the Blockchain?

Consider Blockchain B as a datastore with records of all transactions until time t.   At t+ delta.t another block ‘C’ gets linked to the existing block `B’. This new block is a record of all transactions that happened in time delta.t.

This creates a chain of blocks with each block recording all transactions since the previous block’s creation and gets linked to the previous block through a series of cryptographic hash functions.

Blockchain Security

As people depend on storing personal data on interconnected networks, the ability to protect networks becomes very crucial. The increasing number of hacks on corporate networks unveils the vulnerabilities of the computer system. With hard copies being replaced by system databases, companies undesirably invite trouble through exploits.

The recent Equifax (one of the nation’s 3 major credit reporting agencies) hack, and, the attack on Anthem (one of the nation’s largest health insurers) a couple of years ago has brought to the fore, the risks of storing sensitive data of individuals. The biggest harm of storing personal information is that once this information is gained, others can use  this identity to access credit. A hacker who has an individual’s name, Social Security number (a popular target for hackers), birth date, address, email, employment information (including income data) can now become that person.This information can be used for all legal purposes, such as accessing credit, providing information to legal agencies, etc.  On the gray/black market, combinations of Social Security numbers, birth dates and names sell for more than even credit card numbers.

With complex thefts, complex solutions to protect data are being  invented using the blockchainblockchain security

Blockchain-based security platforms such as Guardtime, REMME and Obsidian are restructuring cybersecurity.

Blockchain eliminates security flaws by taking away the weakest link, the human factor. The impact remains big with demand of more control of identities. Blochain based credit validation can potentially replace existing database based verification.  One such company working on Blockchain based credit validation is Bloom.

Bloom is an end-to-end protocol on the blockchain for identity attestation, risk assessment and credit scoring, thus making access to credit services more secure.  In addition, Bloom allows both traditional and digital currency lenders to serve people who cannot obtain a bank account or credit score. Bloom aims to address the “High Risk of Identity Theft” where borrowers are bound to expose all their personal info when applying for a loan. The attacker uses this same info to open new lines of credit.

The Bloom Protocol provides solutions allowing any lender authorized by a borrower to safely and securely issue credit to that borrower. The protocol work by validating prior stored information about credit access requests, on a secure network of nodes. Once this is authenticated the system proceeds to validate credit. This approach of validating a creditor’s prior history on the Blockchain after authentication will potentially do away with the need to independently use credit monitoring agencies to do such checks.

Forks – Bitcoin vs. Ethereum

Bitcoin’s forking problem

Today’s fork created Bitcoin Gold. A couple of month’s back there was a fork that led to the creation of Bitcoin Cash. Again in November, there is going to be another fork to Segwit2x. Many more forks can happen down the road -each claiming to have a new variation of the Bitcoin blockchain. Afterall, bitcoin’s source code is open source, and so is the blockchain accessible to all participants. If a group of people decides to host nodes with a particular version of the BTC code software with a particular change in the code (or logic) and start mining their own blocks a new chain is created.

The largest challenge for participants(traders, nodes, exchanges, miners) in the crypto-ecosystem is to identify that one of the forks is the original Bitcoin. Recently a couple of early adopters (Bitcoin millionaires) started claiming that Bitcoin Cash was the original Bitcoin and that they would fight for the rebranding.

Needless to say, this looks like the wild west in finance, where many versions of the same chain can exist independently, without anyone to control or coordinate these changes. (Time series Price correlations between Bitcoin Cash and Bitcoin has been < 0.6 since the birth of Bitcoin Cash).

Every exchange that supports Bitcoin will at the time of the fork have to decide at the  time of the fork to either support or to not support the fork. This is tedious work, to ensure that wallets of all users now access the corresponding keys on different blockchains to reflect the right balances. For exchanges will millions of users like CoinBase, Kraken, etc. this is a huge software update challenge.

Ethereum’s Fork (No! Problem)

Compared to Bitcoin’s forking problem, Ethereum’s hard fork to the Byzantium release did not create either a new chain or a new token variant of Ethereum. The Ethereum ecosystem, though, closely resembling Bitcoin’s ecosystem rallies around Vitalik and the Ethereum Foundation’s proposed changes. This is a wonderful model for large scalable open source systems, and, is slowly but surely leading to a self-regulated environment wherein a core team decides the roadmap for scaling (or other features) to be rolled out. The entire community of nodes, miners, and developers rally behind the fork and adopt the fork almost instantaneously.

Scaling the network, for all participants i.e. nodes, exchanges, transaction endpoints such as payment nodes, etc. become significantly simpler with Ethereum’s fork.