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National Cryptocurrencies: Boon and Bane

cryptocurrency bitcoin ethereum ripple images together

Nation states such as China India US and Senegal have embarked on an agenda to either propose or start creating cryptocurrency infrastructure to replace existing “note” based infrastructure. Singapore, a trailblazing technical powerhouse is at the leading edge of implementing such technology through their well publicized Project Udin experiment. Such an initiative has several advantages:

  1. The robustness of a permissioned or permission less blockchain ecosystem is extremely well known and well understood. It is secure and extremely robust to all kinds of attacks on its cryptographic protocol.
  2. Dynamic monetary policies will enable governments and national financial institutions to accurately create, tweak and develop new forms of monetary policies that did not exist earlier.
  3. The cost of printing, regulating and preventing fake -or duplicate physical fiat currencies is reduced to 0 – since digital cryptocurrencies can never be duplicated and/or faked. The ledger validates with 100% surety.
  4. Problems such as double spending, money laundering, etc. are easily stoppable and recognizable.
  5. Governments, now need not necessarily introduce different fiat nominations and digital nominations and over a period of time, can wield significant control over the country’s money supply, flow and accounts which today – due to the percolation of physical fiat currency notes  is very difficult to ascertain.
  6. Nevertheless, e-commerce and regular commerce will significantly become easy.

There are some disadvantages too for the national cryptocurrency system.

  1. the volume of cryptocurrencies needed will significantly be large – and as a result will need decades of developing a robust infrastructure to support both high cost and high speed of transactions.
  2. If national monetary systems become completely digitized over time then existing business models including those of currency notes, banking infrastructure i.e., money transfer systems, ATM networks, connection infrastructure among banks,  that has existed over the past 100-150 years will have to be replaced in its entirety. Imagine if one just needs an internet connection and a digital wallet to access one’s account – what would be the need for a bank?
  3. Such national cryptocurrency systems will need to interoperate among different nation states since each nation state will want to build its own infrastructure.
  4. Lastly, monetary freedom of a nations citizens and people can completely disappear when central control of digital currencies happen.

Libra – and the monetization of network effects

Facebook Libra coin

Over the past few days, there has been a lot of buzz about Libra – Facebook’s version of a (stable)cryptocurrency and potentially a smart programming platform. While Libra is a brand new innovation and yet another blockchain with an extremely well-defined governance model, adoption and governance are not as straightforward as it seems. Below I highlight some of the features, use cases, and challenges that will be faced by an ecosystem like that of libra’s – including regulatory ones.

What is Libra?

Libra is a cryptocurrency proposed by Facebook going to launch in 2020. It is a stable coin with governance from corporate partners like Visa,eBay, Uber, Paypal, and Mastercard. The libra association is a governing body that open sources the libra blockchain and developer platform along with developing its own programming language called MOVE.

What will be the Use of Libra?

Libra is supposedly going to be the form of value transfer on Facebook’s network which includes the Facebook platform, facebook messenger, Instagram, and WhatsApp’s crypto-wallet Calibra. Libra’s use cases vary – firstly, from providing a user friendly way to transfer money between people using WhatsApp, to trade with other affiliate companies (or use as a currency on eBay, uber, PayPal, etc).. In addition, Facebook expects that its 2.38 billion people will somehow get to use Libra, while its value is stable – This onboarding of 2.38 billion people onto the ecosystem will suddenly bring the whole connected world- in direct touch with cryptocurrency through one of Facebook’s many services. This reach is truly the largest a cryptocurrency can expect in the world and will significantly increase volumes significantly on exchange markets because once people realize how easy it is to adopt or use libra then they will trade/participate on exchanges that support other cryptocurrencies too, cross chain innovation (e.g., multiple blockchains being able to interact among themselves), applications in other constrained environments too.

Bitcoin, Ethereum VS Libra.

Libra is a centralized permissioned blockchain network backed by real currency value in the form of currency and/or debt bonds from the stakeholders or partners. Bitcoin and Ethreum have their own value but Libra will depend on the currency value. Bitcoin is highly volatile but Libra will be a Low volatility stable coin – according to Facebook.
. Every large firm in the world will now be motivated to launch its own crypto e.g., United Lever, AT&T, Verizon, Sprint, etc… or join the Facebook Libra or one other crypto platform. In foreign countries like India – ridesharing firms such as Ola and e-commerce platforms such as Flipkart have their own rewards mechanism.

Challenges

1) Government regulation on monetary equivalents or money will significantly challenge libra’s global adoption – since governments control all aspects of money within their boundaries. While Facebook has the monetary power to push through or lobby for regulation in all geographies, it will take time to really make it a globally adopted monetary equivalent. Secondly, Facebook’s push into cryptocurrency markets will overall be good for the entire crypto-ecosystem since regulation will now ease adoption of other cryptocurrencies as well. We have seen this with organized efforts from the

2) While Facebook has promised to back up libra with monetary equivalents – it has yet to be seen how this will be audited in each geography.

3) The low volatility coin hopefully does not lead to secondary markets where libra is traded and demand far outstrips supply.

4) The reach of libra is far greater than that of any other cryptocurrency – but, will libra now managed (and governed) by the libra organization, be able to replace all banking infrastructure globally.

Government regulation Vs Libra.

1. US, Maxine Waters, the chair of the House committee on financial services, said that Facebook should hold the Libra launch temporarily.
2. The current state of India cryptocurrency policy won’t allow Libra to launch in India.
3. China already banned crypto activities, Companies like Ali express and Tencent are not going to follow Facebook

Let’s wait and watch this private digital currency future.

Coinbase-Earn Strategy

Earn Strategy

Earn.com – a Coinbase company, has created an innovative way to accomplish a)crypto- education, b)getting users on its network and c) seeding cryptocurrency networks through their earn.com strategy.

Imagine, listening to a video tutorial and getting paid for it, in cryptocurrencies, that can possibly be immediately traded for USD or equivalent.

https://www.coinbase.com/earn/dai/lesson/1/

Such a strategy accomplishes multiple goals: Firstly, it promotes the cryptocurrency usage amongst new users, since many will login with the goal of earning the cryptotokens. Secondly, it familiarizes users with a new cryptocurrency platform. Finally, these tokens start seeing increasing volumes when users who hold them, start trading them. Potentially when the doles are large enough, the market value of the token would increase since this creates a demand for these tokens (even though artificially).

Some news reports claim that Coinbase is spending about 100 million USD in association with the token foundations.

Smart contract platforms – Part 1

Smart Contract

This past year i.e. 2017 saw the nobel prize in economics go to Hart and Holmstrom for their work on contract theory. An old pre-print version of their thesis on the Theory of contracts is found here.

Their theory argues that contracts improve efficiency in transactions by setting rules for transactions, and, mechanisms by which rules are enforced. This basic understanding spawned several debates including ones about the boundaries of firms, and, saw entire industries such as software outsourcing, etc. being created.

Smart contracts build upon this theory by  automating exchanges of value, by validating rules, between two intervening parties for any transaction. Ethereum & Solidity programming have been predominant mechanisms by which contracts are written on software applications.

A unique token mechanism that provides for a global validation of the contract on the Blockchain has created a very unique set of applications. For example Augur is a smart contract based token that rewards participation in prediction markets.

Similarly, GNT is a smart contract based token that rewards individuals who lend their spare computing cycles. There are many more such contracts for automated payment based businesses, media platforms such as TRON, Block-chain software based EOS, Exchange token BNB used for transferring standalone value, etc…

A recent study found that off the top 100 most valuable coins by marketcapitalization, about 90% of them are smart contract based tokens built atop Ethereum.

Ethereum itself supports many forms of contractized tokens:
1.ERC-20 the most popular value holding token.

2.ERC223- a standardized token that validates and corrects problems with ERC 20.

3. ERC721- Digital asset standards on ethereum.

4. ERC827- A modification of ERC20 that allows transfer of value in-conjunction with Data.

A comparison of these different contracting mechanisms can be found here.

In the next few parts of this post we will look at the Waves platform, the Tron Platform and the NEO paltform all of which advance the smart contracts business.

Consensus algorithms on the blockchain

blockchain image

Distributed consensus based algorithms on crypto-networks have been created to ensure byzantine fault-tolerance. Many such algorithms have their sources in the Proof-of-work. Proof of work itself has evolved to different mechanisms e.g. ethhash, SHA-256, scrypt, equihash, cryptonode, and others.

A few other important ones are listed below:

1. Proof of stake (PoS) – going to be adopted by most leading blockchains
2. Delegated Proof of Stake (DPoS)- Adopted by STEEM wherein witness nodes randomly selected validate transactions and create blocks. The witnesses are voted by other members of the community.
3. Proof of activity (PoA)- a mixture of Proof of Work and Proof of stake
4. Federated Byzantine Agreement – Proof by consensus amongst nodes – Ripple and Stellar cryptocurrencies use this mode.
5. Proof of Space – Here, nodes concur about the amount of space or storage that has been used.
6. Proof of Authority – wherein a particular set of nodes randomly become validators, with the rule that no two subsequent blocks are not mined by the same node
7. Directed Acyclic Graphs ( DAGs ) – Examples include Pay-it-forward consensus where each node on the network is responsible for validating networks before forwarding it. Typically a centralized node also validates each transaction. e.g. IOTA uses this.
8. SPECTRE – Serailized Proof of work through Recursive elections: This proposal uses a combination of PoW and DAGs to accomplish scalability on the Bitcoin blockchain.

 

Each of these consensus algorithms have suffered from one or more drawbacks e.g. PoW is computationally expensive, PoS leads to No Stakes problem, FBA proponents disagree about the decentralized nature of the protocol, PoS claims resource usage in terms of space, etc… Overall, what we see is practical manifestations of years of research in computer science in fields as diverse as graph theory and theory of computation taking shape and supporting a large economic and financial shift in the way business problems are solved.

The Tragedy of the Commons in the blockchain

Blockchain

What is Tragedy of the Commons?

The tragedy of the commons is a well known economic problem governing any resource constrained system. In any socio-economic system, how would one prevent users of the system who behave in their own self- interests, so as to be detrimental to the common good of all users of the system? For example, consider a common grazing ground in a village where any cattle owner can graze. How would one prevent a few cattle owners from over-grazing, so that the grass can be proportionally shared amongst all cattle owners?

The Tragedy of the Commons in Blockchain

Economists such as Garret Hardin has suggested a) State ownership of the common good and b) dividing the common good into parcels that can be individually owned as solutions. However, with the blockchain when we have millions of nodes coordinating to attain a function e.g in the case of Bitcoin that of transaction validation, and, in case of Ethereum, validating the Turing completeness of the smart contract logic., both these approaches fall short. Of course, state ownership will completely defeat the purpose of the blockchain since the nodes and resources on which the system runs is global. Similarly, proportional assignment of things such as memory, processing power, etc. to all kinds of contracts running on the system would be very hard to ascertain and control, especially when we have smart contract application growing in double or triple digits.

More recently Elinor Olstrom, another economist proposed an approach of community controlled natural resources wherein the local communities assigned to protect and use certain natural resources also controlled the dissemination of the resource. This approach is again not suitable.

Mechanism to Prevent Tragedy of Commons

The solution being discussed in the Ethereum community is one where usage would be charged “proportional rents” as a mechanism to prevent the “tragedy of the commons”. In this approach smart contracts or ethereum-progams that issue tokens are charged a rent (fee) based on their usage of the network’s resources e.g. memory (data footprint) and/or processing power.   There are many pros and cons of this approach.  While renting can reduce fraudulent contracts (ICOs), they also introduce an entry barrier for large applications. Similarly, renting can lend itself to monopolization. Imagine a big application such as Facebook or twitter that dominates the marketplace, then they could rent out all the memory and space available, thereby making it impossible or proportionally harder for other smaller businesses to host their applications or smart contracts on the blockchain.

We have to wait and watch, what approach is adopted by the developers of the crypto-ecosystem. However, this problem needs to be solved. There is no disincentive for people to stop writing data onto the Bitcoin or ethereum blockchain. Today Bitcoin’s blockchain bloat is caused by individual users writing and storing all kinds of data into the transaction record; some just for fun….. This leads to a huge size bloat for the Blockchain, and, definitely a wastage in processing power for validating transactions.

The role of crypto-tokens

btc

Crypto-tokens

Crypto-tokens are very important for the crypto-ecosystem. In addition to embodying an equity-like function, crypto-tokens also embody the following for the underlying business:
1) governance model – the model which dictates how many tokens are issued, and who decides the rules for business other than the founding team.
2) security model – the issuance of securities (or shares) of the underlying business based on rules for holding/selling/divesting/etc.
3) the revenue model  – the underlying mechanism by which the firm issuing the token earns revenues.
4) reward model – wherein participants on the network rewarded commensurate to their participation on the network

However, crypto-tokens are treated by many technologists and regulators as pure securities or financial instruments, that are akin to shares or bonds. Recently Facebook and Google decided to ban advertising for any new crypto-tokens that were issued, on account of too many tokens promising only “security” related functionality, without any functional revenue or governance model.

The fundamental difference between crypto-tokens and securities is that, though shares/bonds and other financial instruments can be encoded (or embodied) in a crypto-token, through smart contracts written atop ethereum (or other platforms), crypto-tokens can also embody a lot more. For example, they can indicate the true worth of the network as measured by storage available from all users ( e.g. as in FileCoin).

Initial Coin Offers

Whenever a new token is created, firms that create these tokens have to start seeding the network so as to generate a critical mass for the adoption of the token. Once the critical mass of adopters is reached, any token will automatically see increased subscriptions from regular retail users or other stake holders. All of this adoption process has been modeled according to the Bass model of diffusion of technology. What is new here is the process of creating the early adopters on token-based networks.

Airdropping is the new smart contract mechanism wherein networks of users are acquired by any new business. Fundamentally, users who subscribe to airdropping disclose their wallet addresses (bitcoin or ethereum) on a cloud-based exchange to the firm. In exchange for this wallet address, firms gift (airdrop) the new token into the user’s corresponding cloud exchange wallet address. Air-dropping has many functionalities:
1) Firstly, ensuring that the subscriber is aware of the coin technology and risks associated with it, and are genuine users and not bots.

2) Ensuring that subscribers are on particular cloud exchanges – This brings increased adoption to that particular cloud exchange.

3) Seeding the network for usage so as to kickstart the initial governance model for the underlying platform.

Blockchain and Artificial Intelligence

Robote

OpenMined Platform

OpenMined is a platform that integrates the Blockchain and Artificial Intelligence

Their mission is to enable users to earn rewards by improving learning models. These users contribute to improving deep-learning (or other learning) models without access to the actual data (that is hidden through homo-morphic encryption).

Their mission statement is  obvious:

“With OpenMined, AI can be trained on data that it never has access to.”

Podcast

This interesting shift in problem-solving would never have been possible without the blockchain.  A more detailed podcast from Andrew Trask on the Epicenter channel is given below:

Anyone who is interested in the intersection of these two domains should listen to this podcast.

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.