Does Bitcoin cause capital outflows from nations or does it add to the GDP?


The Question

There has been a debate raging in most countries where citizens invest in cryptocurrencies. Governments that enforce capital control, think of Bitcoin and other cryptocurrencies as a means, to siphon off money outside the borders of the nation.

Cryptocurrencies move money outside their monetary control – possibly from their entire economy.

  1. Can investment in a crypto-currencies lead to a credit crunch – because people stop holding money in zero balance accounts?

2. Can capital exit banking systems that lend for other economic activities?


Can cryptocurrencies add to a nation’s GDP( nominal/PPP)if they appreciate (e.g. gold or other assets)?

A few caveats to consider are as follows…

a) global money flows –  Crypto-currencies do not differentiate amongst nations – because all cryptocurrencies are transferrable amongst peers globally, without the need for any intermediary agency (like a bank or a wallet or any other service).

b) relative size of the monetary system  – currently the total market capitalization is about 0.5 Trillion dollars. Compare this to the size of the monetary system (i.e. cash in circulation, stock market capitalization and other forms of liquid assets). Economists (monetary) have classified this into M0-M4 systems. For nation-states like the US, the 0.5 Trillion dollars is small enough and not as yet significant to cause major swings in the M0-M4 system. However, for many other states, the M2, M3 and M4 systems could see significant reduction owing to the short-term attractiveness to attract higher appreciation.

c) relative size to the nation’s GDP-. For many smaller nation-states with smaller nominal (or PPP) GDP’s, the crypto-economy is large enough to cause (either a positive or negative) swing in the economy. As an example, holding crypto-assets that are valued internationally can increase the nation’s GDP.

d) Volatility – The extremely volatile nature of crypto-currencies, and sometimes totally unknown currencies such as BTCC, cause enormous risk. For example, the direction of monetary flow, demand and supply is completely not controlled by a single entity.


Should I buy Bitcoin now?

Question mark With bitcoin

In the last 3 months, an increasing number of people have asked me if its a right time to invest in Bitcoin. The first time when someone asked me was when the price was 1200$. Nowadays the questions are – what do I invest in” – with about 1200 + coins traded on a variety of platforms.

Since then my answers have been consistent to each one of them –
“Why is it that you want to invest in bitcoin? or any other crypto currencies?”
“What do you understand about cryptocurrencies to invest in them?”
” Do you understand that these markets are completely unregulated and global in nature?”
” Then, Why do you invest in them?”

I give them a picture of 2 Stock market crashes that I experienced in my life time, that of the dot com bust around 2000-2001 and in 2008 the housing crash. Both times, the average NasDaQ and NYSE fell by about 40% within a day. I explain to these folks that this 40% fall is almost a monthly occurence in the crypto markets. Last month Bitcoin hit its peak of about 19500$ and bottomed out at around 10,700 i.e. almost a 48% drop in valuation within 1 month. I tell them that this is what the crypto markets are about –

Bitcoin chart

What we are seeing is a phenomenon that is unprecedented. A globally fungible and tradeable asset, that has multiple uses and is purely digital. One can buy in South Korea and Sell in Singapore or in the USA or in Europe….but just a few clicks of buttons.. added to that, these markets operate 24X7 and 365 days a year.

What I am worried about is that young college kids put in tuition money into these highly volatile assets, and sometimes loose out too much. We are seeing global speculation and greed of unheard off size… Most times, I point to them saying – a stock that has a low Beta or very low volatility but of moderate growth will bring them much better returns at a definite rate…

Personally, I understand or try to put in a honest effort to understand the underlying technology, the value addition each blockchain technology can create to society, and further the need for a coin as an investment vehicle to back that technology. That is when I invest – It is not for the sake of greed or downright getting rich soon …. though that is a nice side effect.

Bitcoin and the Bandwagon effect


Does Bitcoin encourage the bandwagon effect for investors.

Bandwagon effect implies that people are doing some activity just because others are doing it, and not because of any value they see in the activity. history is replete with such examples, e.g. the california gold rush, the tulip mania, the dot com boom etc.. Is bitcoin similar?

Below I try to describe why the recent price rise may not be entirely because of the Bandwagon effect.

Firstly, Bitcoin is an asset that is not controlled by a central entity, and that is secure, international and fungible, liquid and is available in a limited supply for trade. The demand for such an asset has caught attention of hedgefunds(1), retail investors and futures markets alike. This sudden surge in demand, coupled by global economic uncertainties has created a surge in demand for an asset class that is not controlled by the government.   This demand, at near constant supply, has caused prices to go up disproportionately in a short period of time, attracting more investors. What we have in Bitcoin for the very first time is an asset, that is not controlled by the government, is very liquid, does not need institutional backing, and is fungible globally for a wide variety of fiat currencies.  The bandwagon effect is because of the large demand, owing to limited supply of a globally traded asset.

Secondly, the Price of Bitcoin has reflected the overall information in the marketplace. If one were to trace the rise and fall of bitcoin prices, they are all driven by events. In scientific terms, a classic event study would show a high correlation between bitcoin prices and global events. Some of the more recent events are: India’s decision to demonetize 80% of the circulated currency, China’s decision to ban Bitcoin exchanges on Mainland China and the approval of CME and CBOE to start a Bitcoin Futures instrument, Each of these main events, have reflected positively (in the case of the first and last event discussed above), and, negatively(in the case of China’s ban). Bitcoin prices markets, similar to securities markets are sensitive to all kinds of news and information.

Lastly, there is a scarcity in supply (partly decided by the algorithm, and partly because most investors are HODLers of Bitcoin). This scarcity in supply, for, a global asset that can easily be purchased with a few clicks of a mouse has caused prices to rise disproportionately.

While the number of new investors may not increase significantly, what is seemingly happening is that most buyers who buy BTC are holding onto it and not actively trading the asset class. shows that less than 5% of BTC is traded on an average per day, and the rest 95% are just being held. This 5% includes new BTC mined every 10 minutes,  etc…



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.

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 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.


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.